PANAMA SANCTIONS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP90G01353R001500190001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 28
• Document Creation Date: December 27, 2016
• Document Release Date: August 17, 2012
• Sequence Number: 1
• Publication Date: November 17, 1988
• Content Type: MEMO

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LUNCH WITH SECRETARY OF TREASURY NICHOLAS BRADY
Friday, 18 November 1988, 12:15 p.m.
Treasury Building
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The Director of Central Intelligence
wawintoloc.20505
National Intelligence Council
MEMORANDUM FOR: Director of Central Intelligence
FROM:
NIC 03323-88
17 November 1988
Assistant National Intelligence Officer for Economics
SUBJECT: Panama Sanctions
1. Action: None; this is background information on the status and the
impact of economic sanctions against Panama.
2. Economic sanctions continue to strain the regime's finances -- we
estimate they will cost the government some $250 million by year end.
Noriega is managing the situation skillfully.
-- The government is spending little more than what it takes to meet
payrolls. It has limited this amount by shortening work hours,
forcing employees to take unpaid vacations, and cutting salaries.
Noriega continues to cover military salaries in full.
-- Payments to foreign creditors remain suspended, as do many to
domestic suppliers.
-- The regime refuses to cash some of the government checks it issues in
varying denominations to pay for goods and services. The checks
continue to circulate as a quasi-currency.
3. Noriega also has relied on foreign assistance to cope with the
sanctions. Libya disbursed a $20 million loan, and Cuba and Nicaragua have
provided medicine and fertilizer. More recently, Libya reportedly provided
$14 million in investment funds and says the Soviets last
week told a senior Panamanian Communist Oficial in Moscow that they are
willing to provide $160 million worth of aid in Soviet goods.
4. The continuing gradual economic decline will erode popular support
for the regime, but we do not believe that economic factors alone will
prompt the General's departure in the next year. Beyond then, however, the
government's coping mechanisms incur asingly heavy costs and could
ultimately prove unsustainable.
Attachment:
The Extent of the Sanctions
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UNCLASSIFIED
THE EXTENT OF THE SANCTIONS
The International Emergency Economic Powers Act (IEEPA),
signed on 8 April 1988, blocked access to all assets and property
of the Government of Panama in the United States and generally
prohibited any payments to the Solis Palma/Noriega regime by the
US Government, US citizens or firms, or Panamanian entities owned
or controlled by US citizens and located in Panama. This action
superceded and expanded upon other restrictions that already were
depriving the regime of some $20 million per month in Canal
payments and pipeline fees and that froze government assets of
$50.5 million in US bank accounts.
Since the imposition of these sanctions, amendments have
been made to permit payment of social security taxes, import
taxes, travel-related expenses, postal and telecommunications
costs, payments for utilities and similar municipal services, and
indirect taxes including sales and excise taxes. IEEPA sanctions
still prohibit the payment of corporate and individual income
taxes, direct excise taxes to the Government of Panama, rental
fees, and Canal and pipeline payments. Nevertheless, we believe
some firms are paying the regime under the table in an effort to
avoid harassment.
UNCLASSIFIED
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LATIN AMERICAN DEBT
The economies of Latin American debtors have been plagued by
a number of similar problems:
High inflation and slow growth.
Large budget deficits, the result of excessive spending,
large state-owned enterprise sectors, and tax evasion.
Structural problems such as low investment levels,
restrictive trade policies, and excessive government
intervention and regulation of the economy.
Large net resource outflows, the result of capital flight
and high debt payments.
Although Argentina currently is the most troubled debtor,
Mexico causes the greatest concern because it appears ready to
take tough action on debt to achieve domestic economic goals.
Brazil, although facing serious domestic economic problems,
is of less concern because it has recently received new
loans and renegotiated its repayment terms.
Argentina, Brazil, and Venezuela become more troublesome
over the next year, however, as populist presidential
candidates are voted into office.
MEXICO
President-elect Salinas has made the fight against inflation
his priority. Under his behind-the-scenes guidance Mexico has
experienced a dramatic drop in inflation through a program which
froze wages, prices, and the exchange rate. This success has
been costly, however:
At home, living standards have fallen sharply--this year
real wages have fallen 30 percent.
Freezing the peso has caused it to become overvalued,
combined with political uncertainty, this ha S fueled
capital flight and depleted foreign exchange reserves at an
alarming rate.
Sharply higher imports--the result of an overvalued
currency and a lowering of import restrictions--have
combined with a large fall in oil revenues to produce a
current account swing of $6.5 billion--from a surplus of
nearly $4 billion last year to a deficit of $2.6 this year.
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e
To stem the loss in foreign exchange reserves and compensate
for falling oil prices while maintaining the anti-inflation
program, Mexico City in early October obtained $3.5 billion
bridge loan from the US Treasury.
At the time, reserves had fallen by $6 billion in five
months. We believe they have now begun to stabilize.
Overestimating oil prices in 1989 budgetary assumptions
will produce an unexpected shortfall of $2 to $2.5 billion.
These lost revenues add to a budget deficit whose size
already threatened to dash any permanent gains against
inflation once prices and wages are unfrozen.
In conjuction with US Treasury financing, Mexico City
announced that it would cut spending by $260 million,
accelerate privatization of state-owned enterprises, and
borrow more from banks.
The large budget and trade deficits we expect in Mexico next
year will keep the pressure on to devalue the peso.
Salinas could halt the run on the peso and boost nonoil
export revenues by devaluing, but such action risks a
return to high inflation.
A devaluation would prompt producers to raise their prices
to compensate for higher import costs, while workers will
demand higher wages to meet the price hikes.
These actions will combine with pent-up price pressures and
budgetary overruns to send inflation soaring once again.
k
Ct Although the Treasury bridge loan and World Bank money are
short-term palliatives, Mexico believes it needs substantial
fi\o- resources?either in the form of cuts in debt payments or new
loans--to keep inflation down and achieve moderate (3 percent)
growth.
If the economy doesn't grow sufficiently next year, which is
likely, Salinas will take a hard line to secure the financing he
believes Mexico needs. He will be pragmatic in his approach,
however, and deal through US Government channels. We do not
believe Salinas has settled on a firm debt strategy.
Preliminary position papers suggest a strategy to tie debt
payments directly to growth.
Reliable sources say his father is pressuring him to limit
debt payments to a fixed percentage of export earnings.
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-- We think Salinas will strive to avoid the complete
moratorium that some of his more radical advisors have
advocated.
Mexico City will continue to act based its conviction that
it enjoys a special relationship in Washington which gives it a
competitive edge in negotiations with US policymakers.
ARGENTINA
Argentina is the most troubled debtor, in terms of the new
money it is seeking, the money it already owes, and domestic
economic problems. In the last few days, Argentine officials
have promised they will take the macroeconomic steps that
creditors and the IMF deem necessary, but there is little
optimism that these measures will go far enough.
-- The country has managed to keep one step ahead of being
declared in default by making token interest payments.
-- It is now enjoying a financial respite as a result of
higher grain prices brought on by the drought, and bankers
want a piece of the windfall in the form of past due
interest payments.
-- Argentine wants $3.5 billion in new money for 1988 and
1989, as well as interest rate concessions.
Carlos Menem, the Peronist presidential candidate, has a
lock on the election in May. His widespread popularity has
allowed him to be vague on the issues, although most expect a
return to large social programs. Banks do not welcome his
election--Menem has advocated a five year "negotiated moratorium"
on debt payments.
The country has made very little progress in making the
structural economic reforms called for in the Baker Plan,
and with Menem coming to office, most think we have seen as
much reform as we are likely to see for some time.
Optimists hope that regardless of his philosophy, the depth
of Argentina's economic problems will force him to face up
to them. They are encouraged by the quality of his
economic advisors.
BRAZIL
With a new money package in hand and a record trade surplus
this year, Brazil's is unlikely to have debt problems for at
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least the next year. The government has turned its attention to
its worsening domestic economic problems, especially inflation
which is expected to rise to 900 percent this year.
The new loan packaged contains $5.2 billion and
rescheduling. $4 billion already has been disbursed, and
most has been used to clear interest payments that piled up
during the moratorium.
The remaining $1.2 billion in loans is tied to IMF economic
performance targets. The country will miss these targets
by a large margin, but everyone expects the Fund to issue
waivers.
President Sarney has his hands full with economic problems
while his hands are tied by the country's new Constitution.
-- Workers have responded to sharp losses in living standards
with violent strikes.
The recently announced "Social Pact", similar to Mexico's,
is not likely to work: business and labor will not sign
on, and the government has not even done its part by
cutting spending. Even if Sarney agrees to make
politically sensitive cuts, Congress may veto them.
Preliminary analysis of municipal elections in Brazil
suggest presidential candidate Brizola will widen his lead.
Brizola would likely take radical action on debt and has
advocated nationalizing the banking system, cutting foreign
investment, and restricting imports.
VENEZUELA
Venezuela has been the only major debtor to continue paying
both interest and principal. Low oil prices now has the country
in need of financial relief, however, and Venezuelan negotiators
will seek a grace period on principal payments (standard for most
other debtors) and some $2.5 billion in new money.
Similar to Argentina and Brazil, there is concern that
Venezuela's next president, Carlos Andres Perez (CAP), will
implement populist policies that will deepen the country's
economic problems and jeopardize future debt payments.
-- As President from 1974 to 1979, CAP implemented large
social programs which then were financable with oil
dollars.
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-- An ally of the Venezuelan worker, CAP has indicated he will
pursue similar policies, even though he will lack the oil
dollars to finance them.
Peru, Ecuador still not paying. Will they go to IMF?
Columbia wants $1.85 billion, banks willing to lend $1.5. Will
send signal because Columbia best credit risk. Chile doing ok,
buying back debt, but how will political situation affect things?
State wants the US Government to sit down with the Group of
7 to discuss debt. Treasury is concerned about this, about being
placed in a corner. They think the proper time will be later in
the year. Treasury concerned about who will go to Salinas's
inauguration, worried G-7 will raise debt issue.
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REAL INTEREST RATES PAID BY SELECTED MAJOR DEBTORS. 1982-85'
(percent per year)
1982
1983
1984
1985"
Average
Argentina
26.3
23.8 '
9.2
22.2
20.4
Brazil
22.2
19.6
8.9
17.1
16.9
Chile
33.8
8.9
15.8
13.9
18.1
Mexico
27.4
16.9
9.5
12.6
16.6
Nigeria
25.9
25.4
8.2
17.1
19.1
South Korea
14.0
12.5
5.3
12.1
10.9
Average
24.9
17.8
9.5
15.8'
17.0
SOURCE: World Bank and IMF Data Fund.
a. Real rates are nominal (money) rates adjusted by the country's export price index.
b. Estimate.
c. For all debtor countries, the World Bank estimates the 1985 real rates at 10 percent (oil-
importing countries) and 12.5 percent (oil exporters), respectively.
-
EXTERNAL FINANCIAL FLOWS IN LATIN AMERICA
(billion dollars)
Year
Net capital inflow
(1)
Net payment of
profits and interest
(2) -
Net financial transfer
(3) = (I) - (2)
1975
14.3
5.6
8.7
1976
17.9
6.8 ?
11.1
1977
17.2
8.2
9.0
1978
26.2
10.2
16.0
1979
29.1
13.6
15.5
1980
29.4
17.9
11.5
1981
37.5
27.1
10.4
1982
20.0
38.7
-18.7
1983
3.2
34.3
-31.2
1984
9.2?
36.2
-27.0
1985
2.4?
35.3
-32.9
1986'
8.6"
30.7
-22.1
SOURCE: UN Economic Commission for Latin America and the Caribbean, Preliminary Overview
of the Latin American Economy 1986, Santiago, 31 December 1986, table 14.
a. Preliminary estimates.
b. Includes both "voluntary" and "involuntary" lending.
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STAT
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ANALYTICAL SUPPORT
From the Desk of
the Director
14 November 1988
NOTE FOR: DCI
/-'Judge Webster,
This morning Colin Powell asked the briefer to
provide copies of the two attached memorandums which
you had given to him, to Secretaries Shultz and
Carlucci and the Vice President. The briefer will
take them down tomorrow morning.
General Powell was told that a copy of the
Transition Book would be delivered to him today.
Powell and the briefer discussed the article in
the Wazhington Time, which I have attached for you.
The briefer recalled that what the Vice President
was quoted as having said was taken from a Readee4
Digut item, and he told Powell that was the source
for the quotation.
No other comments or questions came up this
morning.
Attachments:
As stated
Directorate of Intelligence
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7 November 1988
MEMORANDUM FOR THE RECORD
SUBJECT: New Credit Lines to the Soviet Union
1. In recent months Western banks have offered the USSR credit
lines worth nearly $9 billion (see attached table). The bulk of the
lines are to be tied to Soviet purchases of machinery and equipment
for the production of consumer goods--not the direct import of
consumer goods. Terms for the credits are sketchy at best since
negotiations have not been completed--or even begun in earnest--for
many of the lines. To date, only the West German and Italian lines
have been signed. With the credits linked to projects, the payback
periods reportedly will be lengthy--up to 8 1/2 years for purchases of
plants. Interest rates will be determined at the time contracts are
finalized.
2. Responding to recent demarches from the USG, the governments
of those banks involved in negotiations offered assurances that there
would be no subsidization of the credits and that OECD consensus
guidelines would be followed. Government backing reportedly will be
provided for the British and Italian lines, and possibly for others as
the deals progress. This backing or "pure cover" is an agreement by
the governments to insure domestic suppliers against the political and
economic risks of exporting to the Soviet Union and does not involve
direct credits, refinancing, or interest subsidies.
3. Despite the flurry of activity, there is little evidence to
suggest that the USSR will make rapid use of these credit lines.
Moscow would have little trouble repaying loans of this magnitude
because of its healthy reserves of gold and liquid assets as well as
potential export earnings, but the Soviet leadership continues to
profess its aversion to a debt run-up to finance imports. Even a
modest drawdown of these new credits would have a beneficial impact on
the quantity and quality of Soviet consumer goods, albeit probably not
for at least several years because of the time needed to bring the
imported equipment on line. Moscow currently imports annually about
$280 million per year of Western equipment for its food processing and
light industries. A tripling of such purchases--consistent with the
size of the credit lines--would increase total machinery investment in
these industries by about 10 percent. The imports would afford the
Soviet capabilities that their domestic industry cannot effectively
provide--sophisticated leather tanning, textile finishing, and wool
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SUBJECT: New Credit Lines to the Soviet Union
processing equipment for production of clothing and shoes and
equipment for processing and packaging fresh and frozen foods.
4. The impact of the credits on other Soviet economic sectors is
harder to gauge. Increased imports of western machinery would reduce
at least slightly pressure for the Soviets to reallocate domestically
produced machinery toward expanding production capacity for food and
consumer goods. Soviet defense industry likely would be one of the
beneficiaries, inasmuch as it is now being pressured to use its own
resources to increase production of such machinery. The impact on
defense, nonetheless, likely would be small.
-- On the one hand, the credits are not large enough to enable
defense industry or any other sector to escape its obligations
to the consumer program. Between now and 1995 the Soviets
probably will invest the equivalent of about $80 billion in
consumer and light industries. The credits will help, but
most of the machinery will come from domestic resources and
imports from Eastern Europe.
On the other hand, in the absence of the credits it is
unlikely that defense would be tasked to make up the entire
difference. The Soviets might not modernize the light and
food industries on such a scale in the absence of the credits,
and non-defense sectors--singled out for wasting
investment--likely would share the increased burden. In the
extreme, defense industry might be forced to use its own
resources to increase annual investment in light and food
industries by the equivalent of about $500 million per year, a
very small share of total defense industrial output.
Finally, some of the domestic investment resources saved through using
the credits would have to be devoted to ensuring that the Soviets
would have the wherewithal to repay the credits. The Sovitare
likely to continue to have to rely on exports of fuels--par cularly
oil--for the bulk of their hard currency earnings. Just maintaining
current oil export capability will cost the Soviets the equivalent of
tens of billions of dollars between now and 1995. The costs of
increasing this capability to service new debt probably will continue
to make the Soviets take a cautious approach in drawing down the new
credit lines.
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UUNYIMNTIAll
USSR: MAJOR NEW WESTERN CREDIT LINE OFFERINGS, 1988
COUNTRY/BANKS
West Germany
(Consortium led by
Deutsche Bank)
Italy
(Consortium led by
state-ownded
Mediocredito Centrale)
United Kingdom
(Consortium of banks
including, Midlands,
Lloyds, and Barclays)
France
(Consortium led by
state-owned Credit
Lyonnais)
Japan
Canada
VALUE/TERMS
$1.7 Billion.
Maturity on credits
up to 8 1/2 years.
No fixed interest
rates. Signed.
$775 Million.
Maturity on credits
up to 8 1/2 years.
No fixed interest
rates. Signed.
$1.7 Billion.
Multi-currency
credit. Under
Negotiation.
$1.9 Billion.
Under Negotiation.
$2 Billion.
Under Negotiation.
$500 Million.
Under Negotiation.
CONFIDENTIAL
PURPOSE
Machinery and equipment
for food, leather,
textile, and clothing
industries.
Machinery for light and
food industries and
related services.
Machinery and equipment
for modernizing hotels,
airports, timber and
food processing
industries.
Machinery and equipment
consumer industries.
No details.
Projects in energy and
agricultural sectors.
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Central Intelligence Agency
Washington. D C.20505
DIRECTORATE OF INTELLIGENCE
NOVEMBER 1988
SOVIET DEPENDENCE ON IMPORTS FROM THE WEST:
WHY THE NUMBERS BELIE THE RHETORIC
Moscow's much publicized concern over the need to rapidly modernize
the economy and, more recently, to address consumer discontent has led many
Western observers to assume that Gorbachev will have to turn to the West in a
major way for economic and financial assistance. The recent spate of credit
lines linked to imports of consumer goods have served to reinforce this theory.
In reality, however, the Soviet Union has reduced its imports of Western capital
and consumer goods and reduced the growth of real borrowing since Gorbachev
came to power. Soviet preference for an indigenous solution to its problems and
longstanding concern over becoming vulnerable to Western economic and
financial sanctions, in fact, argues for a much more measured turn to the West.
This memorandum was prepared by the Economic Performance Division, Office
of Soviet Analysis. Comments and questions are welcome and can be directed to
Chief, Economic Performance Division
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Perceptions and Reality
There has been substantial discussion both inside and outside the Soviet
Union regarding Moscow's need for substantial imports of Western equipment,
technology, and consumer products. Debates initially focused on the role of
Western technology and equipment in Gorbachev's economic modernization
program. They have subsequently broadened to include those consumer goods
and services necessary to legitimatize Gorbachev's regime--and his program of
perestroyka--among rank-and-file Soviets.
In Western circles, such discussions are often a critical element in the
larger debate over the appropriateness of "helping" Gorbachev solve his domes-
tic economic problems. Although there may be wide disagreement over what
the West should or should not do in this regard, there seems to be a consensus
within political and media circles that (a) Moscow will rely heavily on the West
and that (b) the Alliance should take steps to ensure that it does not
inadvertently provide Moscow with substantial economic and military dividends
by competing for Soviet business.
Gorbachev and his economic brain trust have not discouraged Western
perceptions of a Soviet need for massive inflows of Western equipment, technol-
ogy, and consumer products. Economic imperatives aside, it serves Moscow's
broader national security objectives to have Western governments "vested" in a
positive outcome of the regime's economic and political reform efforts.
Discussions of major "joint-venture" arrangements with Western firms contain
elements of such vesting. This tactic seems most evident, however, in Moscow's
recent successes in landing the official blessings of West European governments
for the extension of large credit lines to underwrite Soviet purchases of equip-
ment in support of domestic efforts to improve consumer welfare.
Western expectations of increased Soviet economic dependence, however,
contrast sharply with actual Soviet behavior: trade and financial data demonstrate
that, if anything, Moscow has become more autarchic under Gorbachev:
-Once one discounts for exchange rate movements, net indebtedness has
risen by only 16 percent since 1985; net real borrowing actually fell by
$1.5 billion last year.
-Soviet imports of Western capital goods have fallen in real terms since
Gorbachev came to power; although attention has recently been given
to establishing credit lines to underwrite future imports, there are no
signs of a substantial upswing in actual orders. The 1989 Soviet
Economic Plan, for its part, calls for a slight fall in total trade turnover.
-The leadership cut back substantially on imports of consumer goods in
response to falling export earnings, and imports have yet to return to
pre-1985 levels despite the increased saliency of improved consumer
welfare to the success of perestroyka. Austrian companies, for example,
2
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complain that sales of shoes and clothes to the Soviet Union--more than
$100 million in 1984--have almost evaporated.
Understanding Soviet Behavior: Past Lessons...
Moscow's reluctance to turn to the West for help is better understood
when one considers the nature of economic problems facing the Soviet leader-
ship and the broader implications of economic integration for Soviet national
security objectives.
The leadership has undoubtedly drawn a number of sharp lessons from
Brezhnev's experience in the mid-to-late 1970s:
-The emphasis on Western technology and equipment as a means of
stimulating and leading economic modernization did not live up to its
advance billing. While certain sectors--petrochemicals, automobiles--
benefited from Western assistance, the overall record reveals a pattern
of equipment and technology purchases which were either inappropriate
to begin with, never properly installed or--even in the best of
circumstances--utilized effectively.
-Expanded trade with the West paid political dividends by engendering
potentially divisive competition within the Alliance for Soviet business,
both in terms of heavily subsidized credits and pressures to relax
COCOM guidelines. At the same time, the subsequent application of
economic sanctions to modify Soviet domestic and foreign policy
initiatives made the cost of economic dependency abundantly clear to
Brezhnev and his successors.
The leadership has paid close attention to the economic and political
problems faced by those East European countries that were unable to make good on
the gamble of using Western equipment and technology to jack up economic perfor-
mance to a higher plane:
-While some improvements occurred, the East European experience
demonstrated that the sought-after technological and economic gains
simply could not be achieved within an economic environment
characterized by central plans and administrative economic deci-
sionmaking.
-The price for this failure --economic austerity at home and a pronounced
dependency on the goodwill of Western lenders--is still being paid. In
some cases, i is at the heart of political dissatisfaction within Eastern
Europe.
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-Soviet concern with avoiding similar mistakes is captured in a recent
interview by the Soviet minister of Light Industry, who stated that
Moscow had decided "categorically" against instant gratification. "That
path has no future in it... and the Soviet Union will never be able to get out
of [such a] dependence on buying."
... and Current Realities
Gorbachev's economic advisers also recognize the potential gains from
increased use of Western technology and equipment, but they lack the confidence in
the ability of the economy--as currently configured--to effectively absorb and
ultimately diffuse imported technology on a large scale. They are specifically
sensitive to the incongruence between the present set of administrative rules and
incentives currently governing enterprise performance and the competitive
economic environment--price flexibility, decentralized decisionmaking,
competition for sales--needed if the USSR is to effectively draw on Western
technology and equipment:
-Firms currently lack the ability to bid for domestic resources or oth-
erwise elicit timely domestic machine builder response to their partic-
ular requirements. As a result, enterprises have a distinct bias toward
imported equipment --which can be tailored to individual specifications
and delivered on a timely basis--even when the same or similar equip-
ment is produced domestically.
-Firms currently are not held fully accountable for the effectiveness of
their import decisions. In the absence of an incentive structure to
reward proper choices and effective absorption or, conversely, to
penalize those who pay little attention to what is purchased and how and
when it is installed, there is little guarantee that scarce foreign exchange
will be well spent.
Steps have been taken to facilitate direct contacts between Soviet enter-
prises and Western equipment suppliers and to properly reward effective
decisionmaking. At present, however, Soviet enterprise managers are faced with the
worst of all worlds: the old rules governing the selection and purchase of imported
equipment have been remanded for many enterprises and ministries, but Moscow
has yet to fully develop the sets of procedures to take their place. This confusion,
combined with the uncertainties regarding the implications of imported
equipment for self-financing, product pricing, and the generation of hard cur-
rency export earnings, may well have resulted in an aggregate decline in enter-
prise demand for imported equipment. While some of this decline is entirely
appropriate for the reasons cited above, enterprise confusion has probably
resulted in a suboptimal level of equipment imports over the near term.
4
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CONFIDENTIAL
Import demand is also constrained by Soviet financial conservatism. This
leadership, like those before it, is sensitive to the national security implications
of becoming financially overextended. A number of leading Soviets have been
particularly explicit on the need to avoid any semblance of dependence on
Western financial markets to meet domestic economic imperatives. Any Soviets
who doubt the rationale behind this line of argument need only look at the
experience of Eastern Europe, the past imposition of economic sanctions, and
the persistence of those who seek to monitor and condition credit flows. This
conservatism--manifest in a low level of indebtedness, a substantial "strategic
reserve" of gold, and a high level of liquid asset holdings in Western banks--argues
against a rapid rise in borrowing unless the ability to repay this debt is fully guaran-
teed.
In this regard, the situation facing Moscow in 1988 is far different from
the USSR's position in the early-to-mid 1970s, when the Soviets allowed their
debt to the West to increase substantially:
-Brezhnev's economic advisers were confident of the Soviet ability to
repay a significantly higher level of debt with higher priced oil and other
natural resources. In 1988, in contrast, Moscow must contend with
stable or declining oil prices and uncertainties over the quantity of oil
which will be available for export. The leadership is painfully aware,
moreover, that substantial hard currency sales of manufactured goods
are not in the cards for the foreseeable future.
-Much of the debt runup in the 1970s was formally tied to Western
agreements to purchase Soviet raw materials, notably Siberian natural
gas, coal, and wood products. In all cases, the flow of hard currency
earnings far exceeded project-associated hard currency expenditures,
guaranteeing the Soviets an increase in hard currency import capacity.
Although similar deals cannotThe ruled out in the 1990s, there are few
indications that this option is being heavily pushed.
On the other side of the ledger, Western capital markets are far more devel-
oped and the Soviets more sophisticated in tapping them. Initiatives such as
bond issues allow Moscow to expand its borrowing before running up against
portfolio constraints and otherwise reducing access to additional funds and/or
raising the cost of future borrowing. Soviet pragmatists would contend, however,
that current conditions only serve to allow Moscow to get into bigger trouble
faster.
Gorbachev's Current Initiatives
Soviet emphasis on concluding joint ventures with Western firms reflects
these concerns and limitations. The deals, by forcing long-term Western involve-
ment in enterprise decisionmaking and productive efficiency:
5
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CONFIDENTIAL
-Improve the likelihood for effective Soviet absorption of Western
equipment and know-how.
-Increase the chances for increased manufactured goods exports to the
Developed West.
-Minimize the drain on scarce hard currency by virtue of Western capital
participation and agreements to repatriate profits in the form of
products.
The saliency of joint ventures to the leadership's economic agenda is seen in the
regime's willingness to bend or change the rules in order to attract Western
investors to priority projects. Alternatively, their inability to resolve issues perti-
nent to the joint venture's access to raw materials and intermediate products and
the ability to develop a pricing strategy, hire and fire employees, and repatriate
profits in dollars highlights the economic barriers to economywide
modernization using foreign investment.
Soviet interest in international organizations such as GATT and the IMF has
strong political overtones in signaling Soviet intentions to become a full member of
the international economic and financial community. From an economic
perspective, links with these organizations would improve foreign trade and
financing decisionmaldng and otherwise provide the framework for expanded
exports of manufactured goods over the long term:
-Moscow is probably most interested in becoming a party to GAIT rules
and negotiations. Moscow's cooperation agreement with the European
Community also reflects the desire to develop a better understanding of
potential export opportunities.
-Discussions with the IMF and the World Bank are far more exploratory
in nature. More than likely, the USSR is interested in developing a
detailed appreciation of the costs and benefits of membership before
making any formal approaches: there is no financial need to link up with
the IMF at this time.
Beyond joint ventures and a new interest in international trade and financial
organizations, however, Moscow's turn to the West is more show than go. By all
indications, there is no leadership consensus supporting a major turn to the West at
this time. Emphasis continues to be placed on domestic solutions in the belief that
substantial increases in the quality and quantity of civilian products--both producer
durables and consumer goods--will evolve from the implementation of ongoing
programs to:
-Draw on the expertise and productive base of the defense sector.
-Reduce the barriers to the effective development and application of
Soviet-designed production and process technologies.
6
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CONFIDENTIAL
-Decentralize enterprise decisionmaking and otherwise allow for
increased enterprise control over the quality and quantity of inputs it
receives.
-Alter the structure of incentives to better reward efficient enterprises
and productive employees.
-Increase the supply of consumer goods and services by allowing for
greater privatization of economic activity.
Its own reservations regarding the utility of relying more on imports notwithstanding,
Moscow has not belittled the belief among Western governments that Western
support for perestroyka can be a profitable business. In a move somewhat
reminiscent of the mid-1970s, Soviet negotiators are concluding a number of
major credit agreements with Western bank consortia, explicitly blessed by West
European governments, to underwrite future Soviet purchases of Western tech-
nology and equipment for the USSR consumer goods sector.
Credit Lines Extended to the USSR
Secured:
April 1974-March 1976
$Millions
Currently Signed
or Under
Negotiation
$Millions
Austria
$ 304
?
Canada
$ 487
$ 500
France
$ 3,095
$ 1,900
Italy
$ 1,917
$ 775
Japan
$ 1,648
$ 2,000
UK
$ 2,270
$ 1,700
FRG
$ 1,334
$ 1,700
While Moscow could well be lining up credit lines now to permit more
flexibility in resource allocation decisions pertinent to the next five-year plan, the
spate of activity, size of the lines, and their explicit and highly publicized link to
improving consumer welfare indicate the presence of a political agenda as well:
-There is no indication that Moscow is prepared to move quickly to place
equipment orders against these credit lines.
-Unlike the credit lines of the mid-1970s, when credit competition among
Western governments led to substantial interest rate subsidies, the
recently concluded lines do not offer preferential financing (outside of
7
CONFIDENTIAL
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25X1
25X1
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CONFIDENTIAL 25X1
the slight interest rate savings from the presence of government political
and economic risk guarantees) or otherwise materially broaden the
potential base for Soviet borrowing.
The Soviet initiative comes at a time of Congressional and Executive Branch
consideration of the propriety of restricting or monitoring credit flows to the
USSR. Within this context, Moscow--in lining up large credit lines backed by
Western political leaders--may have sought to steal a march on any attempt by
the US to develop an Alliance-wide consensus on the credit issue. More
broadly, Moscow undoubtedly sought to use the credit issue to promote official
Western support to Gorbachev's program of economic and social revitalization
to the betterment of its larger foreign policy and national security objectives.
And the Road Not Taken
Gorbachev may ultimately be forced to turn to the West for help in
transposing the Soviet economy and may buy time in the interim with substantial
inflows of consumer goods. Such a decision would quickly become evident to
Western analysts by virtue of the media attention to the signing of specific contracts
and the like. This option, however, holds dangers that Gorbachev's predecessors did
not have to face, making the choice much harder this time around. In many ways it
would be a clear sign of leadership desperation:
-Unlike the situation in 1970s, there is no guarantee that Moscow will be
able to repay a marked increase in hard currency indebtedness. Barring
export increases, the USSR would have to continually increase the level
of annual borrowings if it were to maintain a flow of imported goods
while servicing an ever-growing debt. It would be only a matter of years
before the Soviet leadership would find itself potentially vulnerable to
Western economic and political leverage.
-Western firms will want a significantly greater managerial involvement
and Western physical presence within the Soviet Union as part of any
agreements which meet Gorbachev's demands for Western technology
and managerial know-how.
-Unlike the 1970s--when the Soviet leadership viewed expanded trade as
a means of complementing a basically sound economic structure--
turning to the West this time around will be perceived as a sign that the
regime is incapable of fixing its economic problems on its own.
8
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SOVIET CONSERVATISM IS SEEN IN THE DECISIONS TO...
reduce imports, ...
Hard Currency Imports of Consumer
Goods, 1980-87
Billion US Dollars
80
81
82
83
84
85
--- Total
--- Non?Grain
86
87
Orders of Western Machinery and
Equipment 1985-88
911 02 03 04 101 02 93 04
85 86
...rather than increase debt.
Estimated Change in Gross Debt
illion US Dollars
1985
1986
1987
01 02 03 04 01 912
87 I 88 I
1-1 Change due to
exchange rates.
me Change due to
net new borrowing.
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in whir+ he will have to
anitized Copy Approved for Release 2012/08/17: CIA-RDP90G01353R001500190001-9 rties that
SPECIAL TO THS WASHINGTON TIMES
-
Photo by Stephen Crowley.The Washington Times
ack Jamie Morris during first half action in RFK Stadium
ense sent the Redskins down to defeat, 34-14. Story B1.
fie
port by, a task force
cience aofttd, whidti
)owers on both basic
ch and the technol-.
'toyed weapons sys-
spending an esti-
ion more than the
Ily on research and
e gaining qualitative
bptical devices, di-
chnology such as la-
3ar warheads, sur-
,les, tanks, anti-tank
guided missiles and naval cruise
missiles, the 85-page study said.
,The science board, the,Pentagon's
hiternal think tank on technological
issues, said that the U.S. lead is slip-
ping, in eight out of 15 basic-
technology areas where it enjoys an,
edge, including radar sensors, sub-
marine detection, high-tech materi-
als and biotechnology.
In deployed hardware, the board
fond only one of 31 major weapon
types ? strategic cruise missiles ?
where the trend is toward U.S. supe-
riority.
Among the weapons systems
where the United States is losing its
clear advantage to the Soviets are
submarine-launched missiles,
bombers, attack helicopters, jet
fighters, attack submarines, surveil-
see EDGE, page A9 ?
JERUSALEM ? Prime Minister
Yitzhak Shamir of the right-wing
Likud bloc last night won the chance
to form Israel's next government.
TWo ultra-Orthodox parties, Shas
and Agudat Israel, gave Mr. Shamir
their support after he promised? in
writing ? to gain passage of a law
that recognizes only Orthodox con-
versions to Judaism as the basis for
Israeli citizenship. The law now ac-
cepts conversions performed by Re-
form or Conservative rabbis outside
of Israel.
Shas and Agudat Israel told Pres-
ident Chaim Herzog yesterday that
Mr. Shamir was their choice to form
the ruling coalition. That gave Mr.
Shamir the support of at least 63
members of the newly elected Knes-
set, Israel's parliament, against only
55 who support Shimon Peres of the
Labor Party
Under Israeli law, the president is
obliged to empower the political
leader who has the most support to
try to form the government.
The decision by the ultra-
Reuters
Prime Minister Yitzhak Shamir will
begin to form Israeli government.
Orthodox parties means that Mr.
Shamir has first crack at forming
the next government. But difficult
coalition negotiations still remain ?
would make up his government.
Mr. Shamir will have 21 days to do
that, with an extension of 21 days if
he requests it.
If Mr. Shamir's coalition negoti-
ations with the Orthodox parties
should prove too difficult, he could
still opt for such a coalition with La-
bor ? a coalition that could lead to
new elections within a year, under a
new system.
The results of Israel's Nov. 1 elec-
tion gave the four Orthodox parties
18 seats and, through them, the
power to determine whether the
Likud or Labor would form the next
government.
All four demanded from the start
that the next Knesset amend the
Law of the Return, which grants
automatic Israeli citizenship to any
Jew who settles here.
That law now defines a Jew as one
who is "born of a Jewish mother or
who converts to Judaism."
A handful of immigrants to Israel
have been converts who went
see SHAMIR, page A10
Bush, unlike Powell, frets
over untied loans to Soviets
By David R. Sands
THE WASHINGTON TIMES
Vice President George Bush's re-
marks last week on Western lending
to the Soviet Union suggest the
president-elect may be leaning to-
ward a stricter policy than the cur-
rent administration.
Contradicto% statements by Mr.
Bush and Natiotial Security Adviser
Colin Powell last week also underline
the continuing internal debate on the
issue amongvolicy-makers in the
outgoing administration.
On the day that a French newspa-
per was publishing an interview
with Mr. Bush in which he said, "We
don't want to see untied credits be-
ing given to the Soviets at this point '
in time," National Security Adviser
Colin Powell told a group of investors
meeting in Washington that, to date,
such lending is not a security con-
cern for the U.S. government.
Mr. Bush, in using the term "un-
tied credits," was referring to loans
not linked to any specific deal or yen-
ture.
Commenting upon a proposal that
banks in the United States and other
Western countries restrict general-
purpose lending to the East bloc, Mr.
Powell said, "Absent a national emer-
gency, we believe such controls
would be counterproductive and less
likely to achieve intended results
than direct controls on goods."
The confusion appears genuine,
in that the Reagan administration is
see BUSH, page A9
n ipariprs
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I ey sa
;terday, appearing on?
wsmaker Sunglay" Dec la
r. Rollins said the incoming
sident's relationship with Con-
ss also will be determined by
tissues are at stake. In general,
Bush is likely to enjoy much
e leeway on foreign policy, in-
ing arms control talks with the
tOol
e?
U.S./Soviets Soviets
nor equal superior
XL,.
XD'
,?/?44-?,V
sultant who was
C.ncr. con
er
a variety of members twin a way tn nCt - _ _ _
ieuttIIIg act among /JURY and Cnngress can't find
ssified in Part - Sanitized Copy Approved for Release 2012/08/17: CIA-RDP90G01353R00150
7
uny is, that if the moderates
conservatives among the De
crats prevail, it will be good for B
in terms of his ability to lead the
nation in the short run but bad for
the Republican party in the long run.
"If the Sam Nunns and Chuck
Robbs win the power struggle and
Loein
o [the liberal congress-
__
and man and majority whip from Cali.
ma- fornia] isn't going to change his phi-
itch
losophy just because the Democrats
got beat five of the last six times for
the presidency" he said.
Another unknown element in the
relationship between Mr. Bush and
the new Congress is who will be.
BUSH
From page Al
internally divided over how to deal
with the question of trade and lend-
ing to the Soviet Union and its allies.
"The administration has clearly
been schizo on this one," said one
congressional aide who monitors the
issue.
In one corner are proponents of
Western lending and trade with the
East bloc, primarily in the State,
Commerce and Treasury depart-
ments. Opposing them are those who
fear the consequences of increased
commerce with the Soviet Union, in-
cluding many Defense Department
officials supported by a number of
members of Congress
Mr. Bush, in an interview pub-
lished Thesday in the French news-
paper Le Figaro, appeared to be tak-
ing a stand with those suspicious of
increased general-purpose Western
bank lending to the Soviet Union,
which the Bank for International
Settlements put at $8.4 billion (ad-
justed for exchange-rate fluctu-
ations) from 1985 through 1987.
c!f
position-whei7E:he--hag=tn:iiinke-hard
choices and_puil.back_froin deferye
sp'endineThat-4 sIiiii-Osed=to be one
of the hallmarks of perestroijp?
ff
welive him enough money, without
stipulating how he ii-t9Lpend
it, we
Make it possible fOt:hinl_to avoid
From page Al
sion that it was confirmed, but
could be prong. Is it.Oxford?Jsjt. the
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"There's no question revenues
must be a part of it," Mr. Johnston
sa'ci." a 's not a question of philos-
ophy. That's a question of mathemat-
ics."
Mr. Foley said Congress will not
initiate a tax increase without Mr.
Bush's full agreement.
"I'm absolutely certain that you
VVtLRN BANK
LENDING E
Syndicated loans to the Soviet Union, in miII,on of dollars
222.6 708.8 1,443.3 1,596.7 1,235.4
Mr. Bush was quoted as saying.
"So we don't want untied loans or
credits," he added.
Mr. Bush or his spokesman could
not be reached for comment, but op- t
ponents of current Western lending ?
practices with the East bloc have
moved quickly to pin the incoming t
administration down on the question t
of untied credits and loans.
Sen. Steve Symms, Idaho Republi- tti
can, immediately hailed the Bush re- m
marks printed in Le Figaro as "an In
important policy change from the
sition. .
previous Reagan administration po- vi
?
bl
"I am delighted to see him take the . m
leadership on this," the senator said.
Dennis Ross, a foreign-policy ad- vie
viser on the Bush
Chart by Greg Groesch / The Washington Times
Mt Foley said he believes
nu" 'ry to compromise on
0190001-9 ? ?
Mr. ?
the ;
and other key issues
because he is a "pragmatist, inter-;
ested in solving problems."
Sen. Richard Lugar, Indiana Re-
publican, agreed that Mr. Bush is not
Politics.
likely to engage in confrontationali!
"George Bush in my judgment
has always been a consensus figure,"
Mr. Lugar said on CNN. "I don't see : ?
a provocative bomb-thrower there."
cent from the end of 1981 to the end
of 1986. Growth is calculated using
constant exchange rates. Net debt?. .
gross debt minus deposits ? is
shown to have fallen by $1 billion, or
1.4 percent.
Lines of credit extended by Euro-
pean and Japanese banks to the So-
viet Union in the past few months
have totaled between $5 billion and
$6 billion, and 82 percent of the syn-
dicated loans made to the Soviet
Union in the first five months of 1988
were tied to specific projects and '
ventures, according to the report.
But the report also notes that the
ratio of untied to tied loans in 1988 is
very different from what it was the
evious five years. Over the period
983 to 1987, untied Western syndi-
ted loans made up an average of 80
ercent of all loans made.
Private critics of the interagency
port say that the sudden reversal
the figures results from the fact
at the U.S. government chooses to
heve its European and Japanese '
ding partners when they claim ?
t the new lines of credit are tied
specific projects.
'The fact is, established lending
hniques which could ensure that
se new loans are indeed tied to
cific trade transactions are not
ng fully employed," said Roger W
inson, a former National Secii-
Council senior director and
ident of a private international
economic consulting firm in Wash-
ington.
1
further indicated that policy may ? ca
shift. Mt Ross said Friday in the P
Wall Street Journal that untied cred-
its "subsidize" the Soviet military es- re
ablishment.
in
? Adding to last week's controversy th
was the release of an interagency be
ask force on Western lending prac- tra
ices drafted by the Treasury De- tha
artment and containing input from to
e departments of State, Corn-
erce and Defense and the Central tec
telligence Agency. the
While taking a generally benign spe
ew of Western lending to the Soviet bei
oc to date, the report supplies am- Rob
unition for both sides. rity
The report puts the growth of So- pres
t bloc gross debt to Western
nks and other lenders at 14 per-
transition team, ba
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inigii=1111111111111111.11.011MMIMMILIMMIMMIMMIIIM
THE THRIFT CRISIS
Going for Broke
How many more troubled S&L's can the Feds fix
before they need a big bailout of their own?
This could be the stuff of financial
panic. Every week or so, some-
where in the nation, another trou-
bled savings and loan association
is either liquidated or taken over
by a stronger institution. Remarkably,
American savers seem to be taking it all in
stride. When federal regulators closed
down American Diversified Savings Bank
and North America Savings and Loan As-
sociation in southern California last week,
depositors simply reclaimed $1.35 billion of
their money?the largest cash payoff in
U.S. banking history. Depositor Joan
Steen, a Huntington Beach marketing con-
sultant, got to her thrift 45 minutes before
its 9 a.m. opening; by 9:45 she was on her
way out with a check for $90,000 tucked in
her purse. "I chuckled to myself about it,"
she says. "They were not only validating
parking tickets, they were also serving cof-
fee and doughnuts."
Savers can afford to be calm, since ac-
counts of up to $100,000 are guaranteed by
the federal government. The nervous flut-
ters are felt at the thrifts themselves and at
the Federal Home Loan Bank Board, which
regulates them. About one in six of the
country's more than 3,100 thrifts is techni-
cally insolvent and about one in three is
losing money. The losses are huge: a total of
$13.4 billion in red ink was spilled in 1987,
more than double the $6.6 billion in earn-
ings reported by the profitable S&L's.
Many of the losers have little hope of ever
recovering their health?experts refer to
them as the "walking dead." That's espe-
cially true in Texas, where a number of
thrifts were run into the ground by inept or
even crooked operators who got rich on
questionable schemes (page 42). Nation-
wide, the plight of the S&L's will get still
worse if forecasts of rising interest rates
and then a recession in 1989 come true. The
only solution for most of these shaky thrifts
is a government takeover. But current bail-
out funds, provided by the Federal Savings
and Loan Insurance Corp., may be far from
adequate. And while they struggle to sur-
vive, the troubled thrifts continue to
lose money. "The problems in the S&L in-
dustry haven't been this widespread since
the 1930s," says Wall Street analyst
40 NEWSWEEK : JUNE 20,1988
Regulators are bailing out savings
institutions ata quickening pace.
Thrift Institutions
Insured by FSLIC
11187
Henry Pelts of Keefe, Bruyette & Woods.
In the case of the two California thrifts
that failed last week, FSLIC is paying $1.1
billion to American Diversified's deposi-
tors and an additional $209 million to
North America's. (Regulators hope to re-
duce their total losses to $931 million
through the sale of the thrifts' assets.) The
two institutions, which shared the same
sleek office building in Costa Mesa, Calif.,
typify much of what has gone wrong in the
savings business: inexperienced manage-
ment, freewheeling investment policies
and overblown interest rates.
American Diversified was run by Ranbir
Sahni, a former pilot in the Indian Air
Force. North America was owned by
Duayne Christensen, a dentist. Both thrifts
solicited deposits by telephone, offering in-
terest rates of more than 8.5 percent
as a lure. FSLIC took over American Diver-
sified in 1986, accusing Sahni of misman-
agement; he denied the charges and said
the government didn't understand his
strategy. Among Sahni's investments:
wind farms and ethanol plants. At one
point, the bank board declared 98 percent
of North America's loans were bad; when
regulators took over in 1987, Christensen
was killed in a car crash the same day.
FSLIC is now seeking a fraud judgment
against his estate and a former associate
(who denies the charges).
Tani scheme': Blame for the crisis may lie
partly with Congress. In 1982 it deregulat-
ed thrifts, letting them diversify beyond
the home-mortgage business. The move
seemed reasonable: the thrifts were in
trouble then because the interest they paid
to attract deposits exceeded what they
were earning on their mortgages. In the-
ory, income from other types of business
would put them back in the black. The
states deregulated, too, notably Texas and
California, where most of the failures are
concentrated. In Texas the situation was
? exacerbated by the plight of the oil indus-
try: when the price of oil plummeted, tak-
ing real estate with it, many Texas S&L's
were stuck hopelessly in the red.
?Last year Congress tried again, authoriz-
ing FSLIC to sell $10.8 billion in new bonds
to renew the rescue fund. It wasn't enough.
Without adequate cash to liquidate losers
or get them in shape for a sale or merger,
FSLIC had no choice but to take over thrifts
or leave them in the hands of the same
managers who led them astray. And
thanks to federal deposit insurance, even
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the worst losers usually managed to stay
afloat by offering higher interest rates
than solvent thrifts did. Crafty savers
knew the lofty rates reflected financial
weakness, but they also knew that each
account was guaranteed by the govern-
ment. Analyst Bert Ely says some S&L's
are running, in effect, "a government-sanc-
tioned Ponzi scheme," soliciting new depos-
its to pay interest on existing ones.
Joan Steen was one of these "rate chas-
ers." Her account at North America was
earning about 1 percentage point more
than average, but then she switched to
American Diversified last month to get a
still better rate. John Woolley, an Orange
County Superior Court judge, was playing
the same game on behalf of his 73-year-old
mother. "She lives off the interest, so you
try to get the most you can," he says. "Any-
body would."
The regulators are helpless to stop thrift
failures unless they can raise enough mon-
ey. Unfortunately, nobody really knows
how much is needed. FSLIC appears to
have sufficient funds to dispose of the 259
"hopelessly insolvent" thrifts on its books,
a job expected to cost $17.4 billion. But
whether it can handle the other 256 thrifts
likely to fall into its lap is another question.
FSLIC says the second tier of cases can be
settled for $5.3 billion (the thrifts in deep-
est trouble are being dealt with first, so the
second phase will cost less). FHLBB chair-
man M. Danny Wall says "There is no ques-
tion we have the resources" to deal with all
the problem thrifts by the end of 1991.
Huge shortfall: The General Accounting Of-
fice, however, claims the second phase
might cost as much as $19 billion. Among
other things, GAO says the insurance agen-
cy overestimated its revenues, which are
based in part on S&L deposits. FSLIC says
deposits will rise at their historic rate of 7
percent a year, even though growth has
missed that mark in each of the past three
years. GAO also says that FSLIC underesti-
mates the number of thrifts it will have to
liquidate. Eugene Sherman, chief econo-
mist for the Federal Home Loan Bank Board
of New York, says the shortfall could run
anywhere from $10 billion to $25 billion.
ILLUSTRATION BY GREG FtAGLAND
Alarmed by that crushing load, some an-
alysts suggest that FSLIC boost the rescue
kitty by merging with the Federal Deposit
Insurance Corp., which insures accounts
at commercial banks. That strikes most
experts as being basically unfair and un-
workable, however. Banks, too, are now
failing at a higher rate than at any time
since the Depression, thanks to iffy Third
World and commercial real-estate loans,
and the FDIC may not have much money
to spare. Who will pay for the S&L bail-
out? "It is ultimately going to have to
come from the taxpayer," says Sherman.
"There's no way around it." But Washing-
ton wants to cut federal spending, not
increase it. Key congressional figures now
admit more help is needed, but the prob-
lem is so sticky it probably will be passed
on to the next administration and Con-
gress. Meanwhile, the cost of saving the
S&L's keeps rising?just like compound
interest.
DAVID PAULY with MARK MILLER in Washington,
CAROLYN FRIDAY irtNeW York, HARRY HURT III
in-Los Angeles and bureau reports
NEWSWEEK : JUNE 20,1988 41
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ROBERT J. SAMUELSON
Bailing Out
the Thrifts
The taxpayers
may ultimately
have to pick
up the tab?
and it could
cost billions
tolerates ongoing losses that will inflate the final cost.
The problem isn't located exclusively in Texas, but with-
out Texas it would be more manageable. Consider some
numbers. At the end of 1987, the nation had 3,147 federally
insured thrifts with assets of $1,252 billion. Of these, about
510, with $145 billion in assets, are insolvent under general-
ly accepted accounting principles. Insolvent means that
their assets (mainly loans) are worth less than their liabil-
ities (mainly deposits). About 126 of these insolvent thrifts,
with $48 billion in assets, are in Texas.
What happened? Well, the Texas economy collapsed.
Many buildings planned on the basis of permanently high
oil prices and rapid growth are simply unneeded. But the
gluts of office towers, shopping centers and condominiums
reflect more than naive optimism. Generous tax"write-offs
for real estate passed by Congress in 1981 (and since re-
duced) fed the speculative frenzy. So did deregulation of
savings associations, which freed thrifts from investing
most of their funds in residential housing.
What shrewd operators found in thrifts was an ultimate
source of easy credit. Because federal insurance protected
depositors from losses, a thrift could attract all the money it
wanted by offering above-average interest rates on its ac-
counts. The money could then be re-lent for speculative
projects. If they went bust, the government would pick up
the tab. Developers (often allied with thrift owners) would
already have earned fees. Some stories are astonishing. At
one insolvent Texas thrift, 96 percent of the loans were
delinquent. Since 1982 the loans had grown by more than
1,000 percent, to $1.3 billion.
More problems? It's hard to estimate the thrift industry's
total losses for two reasons. First, no one knows the value of
the buildings underlying many soured loans. The gluts in
Texas are enormous. In Houston the office-vacancy rate is
32 percent. Are projects worth 70 cents on the dollar or 40
cents? Second, some thrifts?in Texas and elsewhere?that
are reported solvent by normal accounting practices may
not be. Loans haven't yet been written down to reflect their
true value. Ely thinks 300 more thrifts may be insolvent.
This is a story of greed, stupidity, bungled regulation and,
in some cases, criminality. (Yes, executives of some plun-
dered thrifts are being investigated. The allegations involve
kickbacks, phony land sales and false financial reporting.) It
would be funny if the potential price tag for taxpayers
weren't so steep. The tale would also be more satisfying if it
could be fitted with a happy ending. Unfortunately, there
isn't any quick solution. One suggestion is to bail out the
FSLIC by merging it with the healthier Federal Deposit
Insurance Corp., which insures commercial bank deposits.
At most, this would be a stopgap because the FDIC faces its
own mounting losses?many at Texas banks with their own
bad real-estate loans.
Put simply, this mess is likely to be around for awhile. The
trick is to clean it up at the lowest possible cost. The Bank
Board is moving more rapidly, but the pace is slow. A plan to
reorganize the Texas thrifts has yet to produce any results.
If Ely and Brumbaugh are correct, the delays will raise total
costs. It may be necessary to spend more now?on Bank
Board staff, on money to pay off depositors?to minimize
costs later. But Congress prefers to put off the problem in
hope that, somehow, it will go away.
The whole affair has an air of unreality. Suppose tomor-
row someone proposed spending $10 billion or $15 billion
more for schools or the war on drugs. Everyone might
applaud the goals, while saying that the price tag was
unrealistically high. By inaction, Congress may be making
an equivalent commitment to cover the thrift industry's
losses. This is not government by choice, but by abdication.
.
Some years ago I interviewed a Dallas businessman
named Ira Corn Jr. He was immense: he weighed
300 pounds, if he weighed an ounce. He smoked a
huge cigar and, in general, was the picture of a
tycoon. This was back when Texas was booming,
and I asked: what made the Texas economy grow? After
listing some obvious reasons?oil and gas, low taxes?Corn
got to the point. Credit, he said. People were more relaxed
than in the East. Banks loved to lend, businesses loved to
borrow. Easy credit was great. "You go where you can
borrow?where people [banks] lend on people not on as- ,
sets," he said.
The story comes to mind now (Corn died in 1982) because
the Texan passion for easy credit has reached its logical, if
destructive, conclusion. A sizable part of the federally
insured savings and loan industry is bankrupt, and the
greatest concentration is in Texas. The thrift insolvencies
could cost taxpayers billions of dollars. No depositor at an
insured thrift will lose a penny up to $100,000. But that's
the problem. Because deposits are insured, taxpayers may
end up absorbing some of the industry's huge losses.
How huge? No one really knows. Bert Ely, a financial
consultant, thinks they exceed $50 billion and are still
growing. R. Dan Brumbaugh Jr., a former top economist
of the Federal Home Loan Bank Board?which regulates
thrifts?guesses about $45 billion. The Bank Board esti-
mates its costs between $22 billion and $29 billion. The
upper limit roughly equals the projected reserves of the
Federal Savings and Loan Insurance Corp. (FSLIC)
through 1990. If the costs top that, the board would need
more money from Congress.
The scandal is that no one, aside from the experts and
officials directly involved, is paying much attention. Let
me make a small confession: back in 1985, Ely called me
and we had lunch. He forecast a FSLIC crisis. Thrift losses
were mounting, and FSLIC would exhaust its reserves. His
predictions sounded alarmist. The economy was improv-
ing. Why shouldn't the thrifts' health improve? I dismissed
his warnings. Boy, was that a mistake.
It's a mistake that others still make. The general attitude
in Congress is: hear no evil, see no evil, do no evil. Congress
has replenished FSLIC's reserves with "off budget" funds so
that the official budget deficits won't grow. But action has
been slow, and the amounts?compared with the problem?
have been insufficient. Brumbaugh, Ely and other analysts
think FSLIC now doesn't have enough manpower or mon-
ey to close down all the bankrupt thrifts it should. So it
52 NEWSWEEK : MAY 2,1988
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Economy & Business
On a Wing
And a Payoff
Northrop faces an F-20 probe
I n 1984 Northrop, the Los Angeles?
based defense contractor, turned over
$6.25 million to a company that was not a
usual supplier. The money, which was os-
tensibly to finance the construc-
tion of a hotel in S?lent into the
Hong Kong bank account of
trolled by Park Chong Kyu, a former--
South Korean general and owner of a
Seoul night spot called the Safari Club.
But the hotel was never built,
and Congress and the Korean gov-
ernment are investigating another
possibility: that the funds amount-
ed to a payoff to Park, who had ?
portant political connectio in
Seoul. Northrop alleges paid
Park. who died of liv cancer in
1985. to arrange f the Korean
government to b the company's
proposed F-2 ter plane. Had
Park suc ded, the Wall Street
Journal reported last week, he
stood to receive $55 million from
Northrop. Congress is looking into
whether there was a violation of the U.S.
Foreign Corrupt Practices Act, which
bars payoffs to foreign officials.
If promises were made to Park, they
did no good. Northrop canceled its $1.2
billion F-20 program two years ago with-
out having sold a single plane. The fight-
ers, developed with Northrop's own ca.,s1r"
instead of the usual Pentagon baciang,
lost their appeal after the combat:Proven
F-16s built by General Dv:ignites became
popular with the Israeii4ir force and Eu-
ropean governmirts. Then two F-20s
crashed in 19 and 1985, and the U.S.
?Air Force..decided not to buy any of the
Plantioming the fighter's future.
Ofthrop admits paying $6.25 million
,
to Park, who was knowrias,"Pistol" Park
because of his fondness-for handguns. But
the company contends the payment was a
legal part of so-called offset program,
which ma y U.S. firms use to invest in
coujrtes that buy their goods. Northrop,
.clliming it was defrauded, is suing a
group of Koreans allegedly involved with
Park in the scandal. "We made the invest-
ment in good faith," a spokesman says.
Investigators for the House Energy
and Commerce Committee are not so
sure. In most offset programs, the compa-
ny making the investment does so in in-
stallments, as funds are needed, rather
than in the kind of lump sum that Nor-
throp sent. In addition, the committee
wonders why Northrop sent the
money to a Hong Kong account in-
stead of directly to Seoul.
0 The latest F-20 revelations
come at a bad time for Northrop.
The company, long a target of Gov-
ernment probes into bribery
ges is under pressure from the
Pen
n to improve the workman-
ship on its, $46 billion Stealth-
bomber projec?fand to speed up the
delivery of guidance'devices for its
MX missile. Now Northrop must
answer a round of new questions
about one of its old mistakes. ?
The fighter was canceled before a single plane was sold
Too Far Gone
To Bring Back
Liquidating two big S and Ls
Even in an era of perilously go-go
thrifts, the two California savings and
loan associations seemed to be looking for
trouble. One of them loaned money for
energy schemes ranging from windmill
farms to cow-manure incineration, while
the other served as a whimsical and alleg-
edly fraudulent investment machine for
its owner, a former dentist. Last week fed-
eral regulators said they would liquidate
the two ailing S and Ls, a drastic step for
institutions so large. The Federal Savings
and Loan Insurance Corp., which guaran-
tees thrift deposits, will spend a record
$1.35 billion in cash to pay off insured de-
positors (up to $100,000 for each account)
of Costa Mesa's North America Savings
and Loan Association and the American
Diversified Savings Bank. The payout,
which temporarily slashes the federal in-
surance fund's cash balance by 40%, to
$1.9 billion, is likely to heighten the de-
bate over the adequacy of the FSLIC's r0-
sources to deal with the troubled thrift
industry.
The Federal Home Loan Bank Board,
which regulates savings and loans, trim to
avoid cash bailouts, preferring to merge
insolvent institutions with healthier ones.
But the two California thrifts were poor
prospects for such a rescue because they
lacked loyal, small depositors. Instead,
the two institutions attracted funds from
money managers who demand higher-
than-average interest rates.
Under the ownership of Ranhir Sahni,
a former airline pilot, American Diversi-
fied squandered the assets of the
Sand L on ventures ranging from synthet-
ic-fuel schemes to a national paging sys-
tem. North America Savings was founded
*in 1983 by a dentist, Duayne Christensen,
who made real-estate investments on be-
half of relatives and his girlfriend. Chris-
tensen was killed in January 1987 when
the car he was driving slammed into a
bridge abutment a few hours before the
regulators seized his Sand L.
The assets that the thrift operators
gambled away on risky loans are mostly
long gone, leaving the FSLIC to pick up the
tab. The Government is suing the manag-
ers of both thrifts for more than $100 mil-
lion, charging them with fraud and negli-
gence. But most of the $1.35 billion payout
will come from the FSLIC's reserve fund,
which is largely composed of premiums
collected from Sand Ls.
Federal regulators said last week that
liquidations will remain a last resort in re-
solving the industry's widespread insol-
vencies. Of 3,100 federally insured thrifts,
some 200 are considered hopelessly insol-
vent. The FSLIC's liability for these S and
Ls now significantly exceeds its assets on
hand, so that the fund posted a deficit of
$13.7 billion at the end of 1987, contrasted
with $6.3 billion the previous year. But the
FSLIC aims to narrow that gap over the
next few years, relying on income from
premiums and other sources. The FSLIC
estimates that it will have $20 billion
available for bailing out thrifts over the
next three years, an amount it deems ade-
quate for the task provided there is no
economic downturn. Yet some experts,
including Bert Ely, a Virginia-based fi-
nancial consultant, believe the cost could
exceed $50 billion. They fear that the
FSLIC will need a inultibillion-dollar infu-
sion from taxpayers to restore the thrift
industry to health.
TIME, JUNE 20, 1988
?
49
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