PFIAB MEETING WEDNESDAY, 11 MARCH 1987 - 1030-1200

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP89B00224R000903110003-0
• Release Decision: RIPPUB
• Original Classification: T
• Document Page Count: 35
• Document Creation Date: December 23, 2016
• Document Release Date: July 22, 2011
• Sequence Number: 3
• Publication Date: March 9, 1987
• Content Type: MISC

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-5E-ettET--
9 March 1987
PFIAB Meeting
Wednesday, 11 March 1987 - 1030-1200
TAB A Background on the Meeting
TAB B Iran-Contra Investigations
- IG Analysis of the Tower Report
-- Chronology of your Involvement
-- Your Letter to Senator Boren
-- Response to Bradley
TAB C Gorbachev's Initiative
-- Talking Points
-- Blackwell's Paper "Why Now"
TAB D Brazil Debt Moratorium
-- Talking Points
-- DI Typescript - "Brazilian Debt Moratorium = Potential
International Financial Repercussions" - 26 February 1987
DCl/DDCI Executive Staff
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MEMORANDUM FOR: D/DCI Executive Staff
FROM:
SUBJECT:
EA/EXDIR
PFIAB Meeting, 11 March 1987
4 March 1987
/ 1. At the Board meeting next Wednesday, Gary Schmitt indicates that the
4?PFIAB would like to hear Bob's views on the Tower Commission and SSCI
reports on Irangate and give him a chance to set the record straight with
the Board on whatever points he thinks would be appropriate. Scowcroft will
be meeting with the Board the following day. In addition, Gary suggests
having Bob give a rundown on the Brazil debt moratorium and on Gorbachev's
new INF initiative--especially, why now? (In this connection, ACTS, at
Gary's request, will be sending something down for the PFIAB members to
peruse ahead of time; I'll have ACTS send you a copy of whatever they send
to PFIAB.) Bob will be on from 10:30 to 12:00 noon.
2. I understand that the reception for Bob planned for 5:00 o'clock
Wednesday afternoon is still on.
3. I also understand (and I think Bob is aware) that PFIAB has decided
not to brief NFIC on the results of its SDI study at the NFIC meeting on
that subject next Thursday, March 12.
4. Attached is a summary of Agency support for the PFIAB since the last
meeting.
cc: SA/DCI
SA/DDCI
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CIA Support to PFIAB
15 January - 11 March 1987
D/NESA, NIO/NESA and a NESA branch chief met several times with Albert
Wohlstetter on the Iran-Iraq war, the internal situation in both countries,
and the major lines of analysis reflected in interagency and Agency
publications since the Iranian revolution. Prof. Wohlstetter appeared more
interested in the analysis concerning battlefield developments than the
internal situation. He also focused on Soviet activities and the Soviet
threat to Iran and seemed somewhat surprised that this subject had not
received more treatment in the interagency arena. Prof. Wohlstetter was
planning to use this background and historical information on intelligence
analysis of Iran in connection with a speculative paper which he was doing
for Carlucci on "whither Iran."
Nb/CT met with Richard Brody (of the PFIAB staff) on perspectives on
Iranian support of terrorism.
Documents Provided
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The Tower Commission and the CIA:
An Evaluation
We have read carefully the Tower Commission Report's
discussion of CIA's role in the Iran-Contra affair, and
conclude that the Commission's findings and conclusions about
the Agency are generally well-founded. Some of the same
shortcomings were cited in the initial IG Fact Finding Report;
some were mentioned by the A/DCI in his address to employees in
the Auditorium; and others were identified in the "Lessons
Learned" outline the IG gave the A/DCI last month. We cannot
argue with the Commission's principal conclusion: that this was
an operation undertaken outside CIA's normal covert operation
process and that Agency managers deferred to
others--"amateurs"--who ran the show.
Essentially, the Commission found the Agency guilty of sins
of omission rather than commission.
o The operation was not vetted internally, including
obtaining the views of the Directorate of Intelligence,
as is usually the case with important covert actions.
o Several tradecraft and command-and-control shortcomings
were identified, including the question of why
Gorbanifar was permitted to play such a central role
despite his unsavory reputation, the fact that the DDO
did not monitor closely the extent of George Cave's work
for LTC North, and the implicit criticism of senior
officials who did not bring their own professionalism
into play in questioning an operation about which they
had major misgivings.
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o DCI Casey is criticized for not pressing the President
to have the CIA assume operational control of the Iran
operation. Without endorsing the Commission's specific
criticism (while still supporting the general thesis
that the Agency, not the NSC, should run covert
operations), we would argue that a more relevant
criticism concerns the DCI's failure to have been more
forceful from the beginning in pointing out the
potential flaws in the ill-starred scheme.
o The DCI apparently did not promptly inform the
President directly when he was first alerted to the
possibility that funds had been diverted to the Contras
in early October 1986.
o CIA officials shunned knowledge of the fact that the
Contras were receiving out-of-channel funds, despite its
being a legitimate foreign intelligence issue, because
they did not want to know the source of such funds.
One possible sin of commission concerns the actions of the
Agency at the time of the 20 May 1985 SNIE on Iran. The
Commission report alleges that the NSC staff was "actively
involved" in the preparation of that SNIE and goes on to note
that "it is a matter of concern if this involvement and the
strong views of NSC staff members were allowed to influence the
intelligence judgments...." However the estimative process
worked for that particular SNIE--and it is not an issue the IG
addressed in its own report--it seems clear that Commission
members perceived or feared that the integrity of the analytic
process had come close to being threatened. As the Agency
seeks to draw the appropriate lessons from the entire affair so
that any mistakes will not be repeated in the future, we would
be wise to keep in mind the endorsement for the integrity of
the CIA's analytic process that is implicit in the Commission's
statement.
It is difficult to compare the Inspector General's report
on CIA involvement in the affair with information surfaced by
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the Commission for two primary reasons: (1) the IG was not
able to question DCI Casey before his illness, and thus was
unable to assess accurately either the extent of the DCI's own
involvement or his knowledge in general of the NSC initiative;
and (2) we have no way of knowing at this point how valid the
many references to CIA are in LTC North's White House Computer
messages, which are quoted extensively in the Tower report.
With these caveats in mind, we note that it would appear that
the roles of some Agency officers--Clarridge, Allen, George,
Fiers--were larger than they indicated during the IG's
interviews with them. They apparently were consulted more by
Ltc North than they told us, even though it is clear that they
were only bit players in a much larger drama.
Meanwhile, the IG is investigating further the roles of the
above-mentioned officers in an effort to clarify their actual
activity. The IG has already learned, for example, that Allen
was not totally forthcoming about his role in the operation
during our initial interviews with him, and that he failed to
provide us with much of his documentary holdings until after
the IG report was published. Moreover, the IG investigation
into the diversion of funds to the Contras is ongoing and we
are not yet in a position to comment on the extent of Agency
knowledge or involvement.
We did find some minor factual inaccuracies in the
Commission report. For example, on p. B-39, the Commission
quotes former DDCI McMahon as saying that General Secord
"visited the Agency" to try to obtain assistance in securing an
airplane to aid in the November 1985 shipment of Hawk missiles
to Iran. To our knowledge, it was LTC North, not Secord (who
was in Lisbon) who made the request. Similarly, on p. 111-9,
the Commission asserts that Clarridge "put Secord in contact
with a carrier that was a CIA proprietary." As we understand
it, Clarridge dealt directly with North who, in turn, passed
the information to Secord. But these are minor points of
detail that do not detract from the Commission's main message.
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In one instance, the Commission report accurately ascribes to
John McMahon the decision tb have the initial Finding cover the
use of the CIA's air proprietary retroactively. Then-General
Counsel Sporkin had told the IG that the retroactive provision
was his idea and we so noted in the report. However, we
neglected to note that this conflicted with McMahon's
statement, in an interview with the IG, that it was his idea.
In sum, we believe the Agency received fair treatment by
the Tower Commission and that its criticisms of Agency
officials at the time were largely justified. The Commission's
principal overall conclusion, that the Iran-Contra affair "was
a failure of people, not process" applies to CIA as well as to
the NSC.
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My Involvement with the NSC Iran Initiative: A Chronology
17 May 1985
5 December 1985
24 January 1986
29 January 1986
Early February
18 February 1986
19 February 1986
Receive copy of NIO paper recommending that the US
consider allowing European arms sales to Tehran,
simultaneously with others inside and outside CIA.
Did not know of, review, or approve paper prior to
distribution. Was not aware at this time of NSC staff
discussions and operational planning that ultimately
led to arms sales. Neither did Nb, who authored the
paper.
In capacity as DDI, attend meeting in DDCI's office
involving other officers from Intelligence and
Operations Directorates. McMahon mentions recent
flight to Iran, plans for future flights and
Presidential Finding. First awareness of some form of
covert action related to Iran.
Attend meeting in DDCI office involving McMahon,
North, Charlie Allen and C/NE.
Meet with Charlie Allen and receive an MFR from him
regarding a 13 January meeting he had had with
Ghorbanifar. That meeting covered the US hostages and
some background on the November 1985 shipment of
Israeli Hawk missiles.
See scenario paper prepared by North laying out
proposed schedule for exchange of arms and hostages
leading to mission to Tehran and strategic dialogue.
Briefed by Allen on another meeting with Ghorbanifar
regarding international terrorism.
20 February 1986 Recall MFR from Allen related to other discussions
with Ghorbanifar.
20 March 1986
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16 April 1986
3 May 1986
8 May 1986
3 July 1986
1 October 1986
2 October 1986
Tower Commission Report refers to communication from
North to Poindexter say "C/NE and Gates have urged"
North meet with Iranians in Frankfurt. Still DDI, I
would not have had such a role. Did receive phone
call from C/NE on 16 April and may have been updated
on negotiations status at the time.
Receive a memorandum, also addressed to the DCI, in
which Allen reports information concerning Ghorbanifar
and release of the hostages.
Meet with Allen and am briefed on the status of
hostage negotiations as well as preparation for the
McFarlane mission.
Meet with Allen. Probably briefed on developments
leading to release of
Allen meets with me to express concern over
operational security of NSC initiative and also offer
speculation that some proceeds may have gone to
support Contras. I tell him to brief DCI.
DCI and I hold regular weekly meeting with
Poindexter. Iran initiative discussed but I did not
share Allen's concerns since DCI not yet briefed.
7 October 1986 NIO briefs DCI in my presence. DCI tells him to
outline concerns in memorandum. DCI later receives
call from Furmark, who provided specifics of unhappy
investors. No mention of diversion.
9 October 1986
14 October 1986
DCI and I met with North for update on new channel to
Iranians -- DCI expressed concerns about operational
security. I told DCI we should have copy of 17
January Finding and North agreed to provide.
Conversation turned to capture of Hasenfus two days
earlier and his public assertion that same day that he
was involved with CIA officers. I asked North--as
cross-check, if he was aware of any CIA involvement in
private funding/support effort. He said no. I made
record. During this half of discussion North made
cryptic remark re Swiss accounts and Contras.
NIO memorandum received. In 7 pages only one
reference to possibility that unhappy intermediary
might allege profits from arms by diverting to "other
projects of US and Israel". Even more tenuous than
NIO's earlier concern.
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15 October 1986 Call in General Counsel. Relate NIO concern including
possible diversion. Asked him to look into CIA's
involvement in NSC initiative. He later advised that
he found no sign of impropriety. DCI and I meet with
Poindexter and have him read NIO memorandum in our
presence. We stress concern that project out of
control and should be made public. DCI suggests he
consult White House Counsel.
17-30 Oct 1986 Out of country. DCI receives additional information
from Furmark on 17 and 22 October. On 22 October
Furmark for first time mention Ghorbanifar's
allegations of diversion to Contras.
6 November 1986 DCI and I meet with Poindexter. DCI again urges that
White House Counsel review whole project, also urge
that public accounting be made.
17 November 1986 1700 I call DCI overseas to urge him to cut short trip
and return to give SSCI testimony on 21 November.
I hold meeting (George, Cries) to lay on draft
Testimony providing factual accounting of CIA role.
1845 I call North--presumably to tell him that DCI
returning for hearing.
19 November 1986 Serious dispute with North and CIA officer attempting
to pull together facts of CIA involvment. North
claims neither he or CIA involved in November 1985
flight. Other differences regarding dates.
1100-1300 I have three telephone conversations with
North.
1415 meet with those involved in preparing testimony
(Cries, George, Doherty, to
get update on testimony preparation. Again urge that
all facts regarding CIA role be laid out.
1600 George, Cave and I meet with
Poindexter in his office to brief him on results of
George's 18 November briefing of SSCI and HPSCI staffs.
Doherty suggests that I seek postponement of hearing
until all facts can be accumulated and discrepancies
cleared up. I consider but conclude just not
feasible. Insist that testimony make clear that not
all facts yet in.
DCI returns late evening.
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20 November 1986 DCI and I meet with Poindexter to deal with unresolved
dispute re November 1985 flight. We join ongoing
meeting with Attorney General. I tell North that
three of our officers prepared to testify under oath
to his involvement. Issue resolved on our terms. I
pick up copy of North's chronology.
1645-1830 I attend meeting with DCI and about 12
others for final scrub of testimony. Considerable
confusion since DCI was simultaneously editing and
revising text and quizzing officers as to their
recollection. Considerable discussion of events
related to November 1985 flight.
1900 DCI and I depart for day. I have no further
involvement in testimony preparation.
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Central Indigence Agncy
WashneortlIC 2050S
2 March 1987
The Honorable David L. Boren
Chairman
Select Committee on Intelligence
United States Senate
Washington, D.C. 20510
Dear Mr. Chairman:
I want to set the record straight on several false allegations:
1. Allegation: That I encouraged, approved and disseminated a paper by
the NIO for the Middle East in May 1985 recommending that the US consider
allowing European arms sales to Iran.
Fact: The memorandum was prepared by the NIO at his own initiative.
I did not know that the paper was being drafted, and I neither saw nor
approved it prior to distribution. I received my copy simultaneously
with others inside and outside CIA. The NIO's actions were consistent
with my policy that intelligence analysts feel free to challenge
conventional wisdom and provoke debate.
2. Allegation: That CIA colluded with NSC officials in preparation of
the May 1985 Estimate on Iran to reach specific conclusions.
Fact: Officials at State, DoD and NSC often request preparation of
estimates and list questions they would like to have addressed. In this
case, as with other estimates, while the NSC requested the paper, it was
not involved in drafting nor was it alloyed to participate in the
interagency intelligence coordination of the draft. There were no
dissents to the Estimate from any agency. The independence and integrity
of the intelligence process were preserved throughout. This can be
independently corroborated, and has been in the NIO's memorandum to me of
27 February, which I am providing to the Committee. Finally, I might
note that a 1986 SSCI report on intelligence estimates recommended that,
once the production of intelligence reporting has begun, the National
Intelligence Officer or other appropriate official should consult
regularly with the principal consumer to ensure that the concept paper,
terms of reference, or other guidance address the appropriate question.
This is particularly important with respect to unscheduled product." The
report also stated that the product should explore the effects of
alternative policy options."
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3. Allegation: That I encouraged an invasion of Libya in the summer of
1985.
Fact: CIA analysis prepared at my direction was the basis for
re ection of this policy option. My memo to the Director, which the SSCI
has, was downbeat on the chances of success and raised alternative policy
options for examination. Officials in DoD and State can independently
affirm CIA's role in this.
4. Allegation: That the Attorney General on 21 November launched an
intensive investigation of the Iran affair, and especially the
possibility of a diversion of funds, based on less information than CIA
had.
Fact: The Attorney General has told me that when he observed at the
White House on 20 November that there was disagreement between CIA and
NSC on basic facts surrounding the November 1985 flight, be became
concerned over the need for those who were to testify to have accurate
information about the whole Iranian initiative. On the 21st, the
Attorney General told the President it was important to get an accurate
picture of what had happened and the President asked Mr. Meese to
assemble such an accounting. There was no investigation and no
indication of possible wrongdoing at that time. It was only in the
process of assembling the accounting, including interviews with key
players, that the Attorney General found on 22 November the North
memorandum indicating a diversion of funds. It was that which changed
the Attorney General's effort to assemble facts into an investigation.
No evidence remotely resembling the North memo ever came to my attention
or, to the best of my knowledge, to the attention of any other CIA
officer.
5. Allegation: That CIA participated in a cover-up in preparing the
DCI's 21 November testimony to the SSCI.
Pact: This is particularly outrageous. All available evidence
substantiates my testimony that I urged getting all the facts before the
Committee, and insisted on accuracy and advising the Committee that we
did not yet have all the facts on 21 November and would provide them as
they were assembled. A note I prepared for the DCI to send to Poindexter
on 12 November (provided to the SSCI) in response to a request from HPSCI
for a briefing, urged that CIA not appear unless we could brief on the
finding and CIA's full operational role. I did not know during the
period up to 21 November many of the facts of CIA's role and, while
coordinating the effort, did not participate in drafting the testimony.
The Director changed a good deal himself in the last 24 hours. The
Committee can easily corroborate my effort to have the DCI present all
the known facts by interviewing those who did draft the testimony.
6. Allegation: That I acquiesced in the Iran policy, including
non-notification of Congress, and turned a blind eye to evidence of
diversions of funds to the Contras.
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Fact: As Deputy Director for Intelligence, I was not informed of the
full scope of the Iran initiative until late January/early February 1986;
I had no role in the November 1985 shipment of arms; I played no part in
preparing any of the Findings; I had little knowledge of CIA's
operational role. When I became DDCI, the policy initiative had been
underway for many months and the Finding in place for three months. I
received updates on the initiative every few weeks. During the summer, I
expressed my concerns to the DCI about the effect of non-notification of
Congress and about the policy. As deputy, I had no alternative to this
other than resignation. I -- along with others more senior in the
Administration -- did not believe the policy warranted resignation.
In October, I did not turn a blind eye to the speculation about
possible diversion I received from our National Intelligence Officer. He
acknowledges that I urged him to brief the Director as soon as possible
and that he waited a week. I pressed North on whether CIA was involved
in private support to the Contras and was assured we were clean. I told
our General Counsel all I knew about the Iranian initiative, including
the operations security concerns as well as the speculation regarding the
funding. I asked him to ensure that CIA's activities were proper and
sought his advice. And, I took his advice to get the information we bad
to Poindexter and recommend review by White House Counsel. Had be
recommended we go to the Attorney General, I likely would have done so.
In October/November, I was not given pertinent information by our own
people and was misled by the NSC. In my role as deputy, and with little
information, I acted to assure CIA's adherence to the lay, followed the
advice of our lawyers, and brought what little information I had to the
attention of those who could properly evaluate it and act -- our General
Counsel, the DCI and Admiral Poindexter.
There is nothing in four independent investigations (the CIA
Inspector General's report, the Senate and House Intelligence Committees'
investigations and the Tower report) plus my 13 hours of testimony to the
SSCI that is in substantial disagreement with this description of my
role. I should have argued harder for notification and I should have
been more aggressive in October, but I advised my boss of my concerns and
took action to bring information to the attention of the highest ranking
officials to whom I, as deputy, had access -- the DCI and the National
Security Advisor. I continue to believe that the steps I took were
reasonable, that the advice I received was sound, and that CIA's actions
were proper.
7. Allegation: That I lack independence.
Fact: The far-reaching organizational, procedural and methodological
changes I made in CIA's analytical directorate challenged
long-established practice and attitudes. The results in terms of
improved intelligence have been widely and publicly recognized. I am,
and always have been, a challenger of the status quo. Moreover, the
integrity and independence of intelligence assessments has been preserved
and protected. It is not unusual for our assessments to challenge or be
at odds with the positions of policy agencies, including The White
House. A list of examples has been made available to the Committee; more
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are available. We call them as we see them. And, in the last six years,
the Senate Intelligence Committee has not brought to our attention a
single instance of what they believed was slanted or politicised
intelligence -- and they get it all. We are sometimes wrong, but we are
proud of our independence.
I have worked with this Committee on a regular basis for more than
five years. During that time I believe the Committee has found me
forthright, candid and responsive. Similarly, it is my impression that
my actions as Acting Director over more than three months, particularly
with respect to trying to establish a new and more satisfactory
relationship with the Committee, have met with approval.
I appreciate this opportunity to correct the most egregious
allegations against we. I intend to make this letter available to the
press to correct the public record.
Sincerely,
_
' Robert M. G tes
Acting Director of Cen al Intelligence
cc: The Honorable William S. Cohen
Vice Chairman
Select Committee on Intelligence
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ANIO/USSR
2 March 1987
INF: WHY NOW?
The timing of the Soviet decision to move away from its package approach
to arms control comes as something of a surprise. While movement on INF has
been one option for ending the Iceland stalemate from the beginning, the
Soviets provided little advance warning that they intended to move in this
direction (save for Vorontsov's briefing the proposal to Kampelman a few hours
before the announcement). Why did Gorbachev decide to move now during the
nadir of the administration? What are Soviet calculations?
Beyond a desire to preempt our scheduled tablin of a draft treaty on
Tuesday, a number of cons
knows that his a roach at Iceland prospect t
frttV packaoe concept. Continu ng to hold to it makes it appear hat-the'
USSR is the primary o5'stacle to Gorbachev's strategy up until now
has rerretirg? any such impression.
cond, Gorbachev is impatient. He has a bias for action and a distinct
distaste achieving his objectives. In this case he
wants to keep the pressure on the US to deal on arms control. He probably
thinks t a reac ng agreemen on -- a perip era ssue -- will generate
political pressure within the US to work the main issues (SDI and strategic
arms). He does nt t w oin ,
especially g yen the uncertainties of what will follow and the inevitable need
for a new administration to take some additional time to get its views set on
this issue.
ons were e y invo rs ev
has ru its course. There is little or no
f the-agirbOtd%
reement on arms
ve
or
ac
I ?
. I ?
?
?
Third, he milts to further isolate the US from its allies in Europe and
indeed ?uilT ?ressure
p essurt t e I o ?o this e as s ng ed out t e one ssue where ag ement
inirinciple-ETready exists and signaled that European concerns about Soviet
short range systems will be addressed. This will make it very difficult for
the basing countries to oppose an agreement although privately they are
umbrella.
a
goo deal on its own men i s removing a US threat with little rea egra a ion
5 SovTet capablluy. enha.riclnt Soviet po1it1ii-ilifTaffei-In Europtt_antIt
_ ,
the same time encouraging anti-nuclear sentjjjit in Europe
Fourth he ws the a i all vulner le at home and ?
badl n need of s. ictory to restore credibility to its managemen
ore e sovirm have publicly been divided on the implications of
Iran/Contra for the President's ability to negotiate but on the whole it is
highly likely that Gorbachev's advisers ( Dobrynin and Yakovlev) see the
Pr real opportunity for the Sovie la its
-..cards. The position on short range sys e s es gne o make it difficu t
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for the administration's arms control skeptics to use poison pills to knock it
down. They may calculate that disagreements within the administration on
verification and allied opposition to highly intrusive verification regimes
will also make this issue less of a factor than it otherwise would be.
There may be some inclination in town to see this initiative as a
reflection of Soviet internal politics. The political temperature in Moscow
has heated up considerably and indications of resistence and even opposition
to his agenda abound. But, if it is, it clearly suggests a Gorbachev that
still has the bit between his teeth and room to run. The proposal if anything
is more forthcoming than any the Soviets have put forward on this issue and
contrary to the implications of the recent Rogov report almost certainly would
have required Gorbachev's active support. As in Iceland, however, he reduced
his political exposure by associating the Politburo with it; he even invoked
the authority of the Defense Council which he heads by making the first public
reference to his chairmanship of that body.
Finally. Gorbachev has made a tactical judgment that an INF a reement is
all that e likel can re sam sra o ? .ec .e. a ? is
.e time to ma e s na ef ort to cu a ?ea . He pro.a. y believes
h
t ere is already enough agreement on 1NIT?t5lliKke it possible to finalize a
treaty within the year and sign it at a summit in Washington. This would
provide him a grand stage to promote his broader agenda on the eve of the 1988
Presidential primary season.
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Central Intelligence Agency
Washington, D.C. 20505
DCl/DDCI Executive Staff
10 March 1987
NOTE TO ADCI
In addition to Bob Blackwell's paper
on "Why No*", and Larry Gershwin
have produced separate but coordinated
papers on various aspects of INF. Attached
is a memo from Larry on his concerns about
the current momentum. Behind that are
two papers from one on INF key issues
and one on the verification package, and
finally a paper from Larry on monitoring
the draft INF treaty. You have so much
material here that I have pulled out some
of the other background Larry provided to
which he refers in his "concerns" memo.
I am holding it if you should need it.
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National Intelligence Council
The Director of Central Intelligence
Wuhington, D.C. 20505
NIC-01054/87
10 March 1987
MEMORANDUM FOR: Acting Director of Central Intelligence
FROM: Lawrence K. Gershwin
National Intelligence Officer for Strategic Programs
SUBJECT: Monitoring an INF Agreement
1. I am concerned that with the current momentum towards trying to
conclude a separate INF agreement with the Soviets, monitoring issues will
take a back seat, despite the Intelligence Community's longstanding and
current emphasis on this issue. This may sound paradoxical, since several
senior US officials have said publicly that breakthroughs have been made
on verification, specifically with respect to on-site inspection. An
impression is being created, at least with the public and possibly within
the US Government, that on-site inspection is a panacea. As US
Intelligence has pointed out before, the monitoring situation is
considerably more complex.
3. If you'd like to discuss this further, please call. I have shown
this package to and we are in agreement on the potential for
problems down the road and the need for continued efforts by all of us.
Attachments:
As Stated
Lawrence K. Gershwin
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9 March 1987
TALKING POINTS FOR ADCI
Brazil's Debt Situation and Potential Repercussions
Backdrop. Brazil's current economic crisis is rooted in the growth-
oriented economic policies Jose Sarney embarked on to bolster his popular and
political standing after he unexpectedly ascended to the Brazilian presidency
in April 1985.
-- Freespending policies spurred 8 percent growth--fastest in the world
in 1985--but drove up inflation to double-digit monthly rates which
Sarney viewed as a threat to his democratic government.
To halt the inflationary spiral, he announced the Cruzado Plan in
February 1986--sweeping price-wage controls, currency reform, and an end to
the indexation system.
Inflation was stopped in its tracks, the balance of payments remained
strong, growth boomed, and Sarney's public approval rating soared to
90 percent overnight.
The program's immense popularity caused Brasilia to hesitate from
implementing necessary economic adjustments for fear of losing
support in the November 1986 elections.
Consequently, shortages surfaced, inflationary pressures resurged,
and the strong trade surplus dwindled.
Sarney's coalition party campaigned on a pledge to preserve the Cruzado
plan, but six days after scoring a resounding electoral victory Brasilia
announced economic correctives.
The abrupt announcement caused a firestorm of political protest and a
sharp decline in Sarney's popularity.
The loss of confidence in the government led to a rapid economic
slide. Inflation skyrocketed from 2 percent in November to 20
percent in February. The trade surplus plunged from $800 million in
October to $100 million since November, making debt repayment
increasingly difficult.
To regain political support and protect nearly depleted international
reserves, Sarney announced an indefinite suspension of interest
payments on longer-term foreign debt on 20 February.
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Current Situation. Sarney's unilateral debt action has scored political
points at home and the government is now searching for options to resolve the
country's economic difficulties.
Sarney has recovered political ground temporarily; polls indicate the
decision was supported by voters and endorsed by the coalition.
Nevertheless, he is not capitalizing on his political rebound to
implement needed economic adjustment policies.
At the government-to-government level, Brasilia is now pressing for a
political solution to its debt problem.
-- No negotiations have been set with commercial banks, probably because
Brasilia has not developed an economic program or a consensus about
what it will seek from creditors.
International Repercussions. Bankers report concern that other Third
World debtors will follow Brazil, but a "bandwagon" effect is not developing.
-- Initial reactions have been low key, especially as creditors have
mobilized to settle outstanding issues with other debtors in an
effort to isolate Brazil.
Directorate of Intelligence Coverage. We continue to devote substantial
analytical resources to monitoring the evolving Third World debt situation.
For example, our Brazil branch alerted officials to problems with the
Cruzado Plan in the International Economic and Energy Weekly last
August and followed by publishing regularly on that country's
economic and political difficulties for the National Intelligence
Daily. In early February they issued an Intelligence Assessment
entitled, "Brazil: The Demise of the Cruzado Plan."
-- A Directorate task force was convened in advance of 20 February to
analyze the potential repercussions of a Brazilian moratorium, and
this study was issued as part of a special edition of the Financial
Situation Report on 27 February.
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-- The Directorate is drafting a Special National Intelligence Estimate
entitled, "Brazil: Outlook for Debt."
-- We are bolstering our economic and financial coverage of the key
Third World debtors in the International Economic and Energy Weekly
and will convene our country analysts and international financial
experts at least monthly to discuss evolving trends.
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Central Intelligence Agency
t
DIRECTORATEIVYNIELLIGENCE
26 February 1987
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Brazilian Debt Moratorium: Potential International Financial
Repercussions.
Summary
Brazil's decision to suspend interest payments
indefinitely on its medium and long-term debt is fraught
with risks. Given its potential repercussions, we have
analyzed the likely impact of this move on Brazil, on the
other key debtors, and on their creditors. Our analysis has
been developed by using the experience of our country
analysts, international financial experts, and the
Directorate's most-seasoned economists. We are projecting
the consequences of the Brazilian move during a six month
time horizon. We have also identified the key factors that
could condition the outcome.
This typescript was prepared by
the Offices of African and Latin
American Analysis, East Asian Analysis, Global Issues, and Near
Eastern and South Asian Analysis. Comments and queries are
welcome and may be directed to the Chief, South America Division,
ALA,
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Following Brazil's unilateral moratorium on interest
payments, we believe:
Brazil's economy will continue to grow for several months
despite higher inflation and more difficulties in
conducting trade;
This action will shock financial markets--it immediately
drove down bank stock prices--but probably not lead to
destabilizing financial panic.
Other key Third World debtors will not initially follow
the Brazilian move, despite rhetoric to the contrary, nor
band together to answer a call for multilateral debtor
action.
Rather, the debtors will carefully monitor creditor
response--particularly ones showing retaliation against
Brazil and willingness to negotiate--for signals that
they should reevaluate their debt management strategies.
International cooperation in resolving debt problems
could be derailed by a series of swing factors--sudden
shifts in economic teams, volatile domestic political
events, imitative behavior, sudden economic
deterioration, and a hostile creditor response.
Successive debt payments suspensions by other key Third
World debtors could occur if debt rescheduling and new
money negotiations break down.
The Motives
On 20 February, President Sarney announced that the country
would suspend interest payments on Brazil's $65 billion medium-
and-long term debt to commercial bankers for an unspecified
period. He indicated that the suspension was necessary to
preserve Brazil's foreign exchange reserves, which have plunged
since September and are currently reported to be from $1.5 to
$3.9 billion, levels Brasilia reportedly considers to be an
absolute floor. Moreover,
assessment that an overvalued cruzado and shortages of key
components for exports will mean the trade surplus will not
likely recover from its recent monthly level of $100 million
before April. In addition, we know of no significant capital
inflows programmed for Brazil through March. In addition, we
believe Sarney was unable or unwilling to fend off intense
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inflows programmed for Brazil through March. In addition, we
believe Sarney was unable or unwilling to fend off intense
political pressure from several groups within Brazil--including
the left, labor, and some influential members of the ruling
coalition--to suspend payments.
Impact on Brazil
According to initial US Embassy reports, the unilateral
action against creditors has met with general public approval,
although it has drawn some critical response from the
conservative press in Brazil. According to the Central Bank,
interest payments will be held in a blocked account in Brazil
while the suspension remains in effect. Initially, we believe,
Brasilia will accumulate these payments as a war chest of
additional reserves. Consequently, the suspension of payments
would add some $800 million per month to the Central Bank's
coffers.
We also believe that Brasilia will soon be tempted to use
this cash windfall to support growth-oriented policies--the major
economic priority of the populist Sarney government. With the
funds saved by suspending payments, Brasilia will probably seek
to increase imports in an attempt to alleviate domestic shortages
of key foreign intermediate and producer goods and sustain
growth. Within a month or two, we anticipate Brazil will
encounter increased difficulty in conducting trade, except on a
cash-and-carry basis. Because trade will become more expensive,
inflation will begin accelerating in the subsequent six-month
period.
Immediate Financial Impacts-The System Holds
The unilateral Brazilian moratorium on interest payments
hits world financial markets at a time when several other Latin
American debtors are in the process of negotiating new financial
packages. A review of all source intelligence indicates that:
-- Mexico has yet to complete its $7.7 billion new money
package from commercial banks.
Argentina has begun negotiations for $2 billion in new
bank loans.
Venezuela is in the midst of negotiations for lower
interest rate spreads, a reduction in scheduled principal
payments and $400-600 million in new financing.
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-- Ecuador is bargaining for an immediate loan to cover its
cash-flow difficulties.
In cases where negotiations are nearing agreement on
rescheduling and new money, we anticipate talks will proceed.
For example, Chile agreed with bankers on 23 February to
reschedule $12 billion of extensive debt and retime its interest
payments to save $535 million. Given stronger institutional
arrangements than were in place in 1982, creditors are unlikely
to "cut-and-run" or retract short-term credit facilities.
Nevertheless, with $25 billion in US loans at risk, Wall Street
was shaken by the Brazilian announcement, with bank stocks
declining on 23 February. Prior to Sarney's announcement, press
reports indicated that bank stocks dropped slightly in West
Germany and Japan.
Banker Reaction
The scanty public reaction so far from international banks
indicates they are hopeful that new negotiations can lead to an
agreement to lift the moratorium on interest payments. According
to a press report, Brazil's Bank Advisory Committee will request
that Brasilia obtain an IMF program in return for financial
assistance. Other press commentary indicates that Brasilia is
preparing to table proposals for major financial concessions, but
we cannot confirm or deny these reports. Brazil's bank advisory
committee (BAC) has already set a date in early March for
financial negotiations. Some banks, especially smaller US and
foreign banks, are likely to try to cut trade and interbank
lines, but Brasilia has contingency plans in place to freeze
these facilities to prevent a major runoff. Full scale banker
retaliation, however, would occur only if Brazil completely stops
servicing its debt for an extended period.
Spillover Effects
Mexico stated it will continue to service its debt and not
follow Brazil in declaring a debt moratorium. We believe
President de la Madrid will continue to adhere to the rules of
the game in order to get promised credits needed to expand the
economy as the 1988 elections approach.
Argentina indicated it would suspend interest payments on
its debt if western banks refuse to provide new loans, but we
believe it will not initially follow suit. We judge that
President Alfonsin would not jeopardize recent progress on
inflation, structural reform and World Bank and IMF loans.
Nevertheless, we interpret the Argentine statement as exerting
maximum pressure on commercial banks for $2 billion in new money,
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a risky gambit. We believe
Alfonsin will continue to
rhetorically support Brazil, but will stand firm in the face of
political pressur for radical action on
its debt for the
immediate future.
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Although Brasilia claims that Caracas
has cabled its private
support, Venezuela's President
Lusinchi will be slow to react
publicly, seeking consensus
before making any moves and assessing
creditor response to Brazil's
action.
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In the Philippines, Finance
Minister Ongpin is likely to
advocate continued negotiations
with creditors to avoid
jeopardizra financial packages now in place and nascent economic
recovery.
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Egypt is unlikely to experience
any
near term adverse
impact. The Mubarak government
recently moved closer to reaching
an agreement with the IMF over the terms of a standby agreement.
Moreover, with most of Egypt's external debt in the form of
public and publicly guaranteed obligations, the major portion of
the debt rescheduling exercise will take
place within the
relatively congenial confines of the Paris
Club.
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Creditors' Unfolding Response
Because Brazil's move is unlikely to create an immediate
bandwagon effect with other debtors, creditors will most likely
focus their energies on Brazil. Last year, for example, Mexico's
financial predicament caused creditors to postpone other
negotiations. If discussions became protracted, negotiations
with other debtors could be pushed aside for many months.
Given generally reliable reports that bankers insist that
Brasilia must tackle its basic economic problems before new funds
will be forthcoming, we anticipate most major banks will
initially take a hard line.
The BAC will continue to demand an IMF-supported program
to obtain new bank credits and a restructuring agreement
even if Brasilia initially refuses to cooperate with the
Fund.
The BAC will closely scrutinize
economic and financial data.
The BAC will resist agreeing to
those Mexico received.
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and contest Brazil's
concessions similar to
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The BAC will insist that raising new medium-term credit
will be extremely difficult, in part because smaller
banks will refuse to participate.
European and Japanese creditors will be unwilling to put
up substantial new funds for Brazil; they can resist
Brazil's demands because of reserves against troubled
loans.
Swing Factors-The Signs to Watch
Events could unfold in a very different manner if the debtor
governments' and private creditors' assumptions were different
from those we postulated. In the event pivotal swing factors
came into play, the world financial system could be rocked by
successive debt payment suspensions.
Shifts in Economic Teams. We have identified at least one
instance where a ministerial shift could result in a policy
change adverse to US interest. According to our Philippine
analysts, if current negotiations with the banks break down and
confidence in the economy falls, Ongpin may lose President
Aquino's confidence and a harder line might prevail. In that
event, Manila will be more likely to look to the other debtors
for support in forging a new financial deal. If an agreement
with the commercial banks does not appear likely and Brazil calls
on debtors to join together and press the banks for a better deal
as a group, then Manila might join.
Internal Political Pressure. Several analysts spotlighted
internal politics as a crucial and volatile swing factor. For
example, our Ecuadorean analysts observe that Febres-Cordero has
swung from one of the most financially responsible nations in
South America in honoring its foreign debt obligations into
technical default. He has been on the defensive since his
temporary abduction by Air Force paratroopers last month and he
does not want to be span slashing reserves to satisfy foreign
economic interests, he has
been angered by bank demands for assurances tnar Lcuaaor will not
seek recourse to new money to meet February debt service
repayments. He feels Ecuador deserves special consideration,
given his administration's responsible debt payment record.
In another assessment, the analyst for Venezuela speculates
that strong public opinion against debt repayment could cause
Lusinchi to change Venezuela's course. Lusinchi's political
opponents have already capitalized on the administration's
relations with creditors, claiming the president is bowing to
foreign interests in the current negotiations.
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Imitative Behavior. The situation could be made worse if
other debtors imitated Brazil. According to our experts,
elements within both the Egyptian government and the political
opposition who are opposed to what they see as intervention by
the IMF, may be emboldened by a Brazilian debt moratorium. They
could attempt to block final approval of the standby program,
which could force a de facto payments suspension.
Creditor Response. We judge this is potentially the most
important factor. Bankers are growing weary over the many
protracted negotiations and are divided over how to handle
debtors. If bankers continue their hardline with Brazil and it
spills over to other debtors, these factors could lead to long
delays in reaching agreements for new money and rescheduling. If
other key debtors then experienced financial crises, these
governments would reconsider their strategies. For example,
according to our country expert, Mexico's stance over the longer
term likely would be affected by the way creditors responded to
Brazil. The strategy of de la Madrid or his successor almost
certainly would change if creditors failed to retaliate against a
Brazilian moratorium of if Brasilia appeared to gain by its
actions.
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