The Timeless Money Center/Government Dance

by: Alan Geik

“Hey, Let’s Have The Government ‘Hold The Paper!’”

Perhaps what is needed is a government funded RTC-like (Resolution Trust Corporation) organization that can buy back the mortgage-backed securities and then resell them when the market is better.

This is one of suggestions we are likely to hear in the coming months. It will surely gain the support of election year politicos. It can save us, they will tell us, from the dreaded “R” word. Of course the only ones to be saved, and to be made whole, would be the same characters who brought us the past two financial crises. Banks were bailed out both times by an orchestrated use of the “f” word (fear) in order to pass the burden to the Unwilling Greater Fool, the US taxpayer.

The “our banking system and the economy are in danger of collapsing if we don’t act soon” gambit didn’t just begin with the current Mortgage Meltdown.

Sec. Paulson, and former Sec. Rubin, were players in both past crises so they know how easy it is to gain support for a fear-based bailout…especially in an election year. Jim Cramer will probably be among the early supporters, declaring it the “only hope.” His performance will be dramatic…… “It is moider out dere. We need help NOW. The people I’ve been talking to…..”

The current Mortgage Meltdown is easily evidenced by the For Sale sign on Mr. Jones’s front lawn, and the effects of the S&L Fraud of the 80s could, at that time, be verified by the shuttered banks on Main Street. The Third World Debt Crisis however played out in exotic, foreign lands far from sight and oversight. So perhaps a short walk down memory lane is in order…….

The Foreign Debt Crisis of the 1980s….

In the early 1970s rising oil prices resulted in a windfall of US dollars for the Middle Eastern producers. Lacking attractive domestic investment possibilities they deposited the funds in Western banking centers. Concurrently the prevailing low interest rates and slowing US economy dampened the banks’ interest in US investments so they looked abroad.

They quickly found eager borrowers amongst Third World governments strapped by both higher oil costs, and diminishing exports to the US. The low US interest rates were also an inducement to the prospective borrowers.

Within a decade a trillion dollars had been loaned to these countries. It didn’t matter that almost all of them were military dictatorships (Chile, Argentina, Brazil, et al), and others just blatantly corrupt (Mexico, Peru). It was an easy score with a lot of fees and commissions for Wall Street, and of course, that is what was important.

Besides earmarking a part of the capital inflow for arms purchases to maintain tighter domestic control in the debtor nations, the rest was destined for personal Swiss bank accounts.

(Even if the politics of the governments were irrelevant as investment criteria, surely the influx of money from these countries should have been a tip-off that the funds were not being used for “development,” hence the ability to repay the loans would be seriously diminished.)

According to Koichi Yamada, Yale University, 23 debtor countries from 1978-83 added $381.5 billion to their national debt, and of that, $103 billion flowed back as capital “flight.” Argentina alone, the most notorious of the military dictatorships, incurred $35.7 billion in debt during this period, while $21 billion left the country.

Every US money center bank surely knew that the Mexican government staged a unique run on the Banco de Mexico. Early in 1982, the Banco de Mexico's vaults were opened to politicians and their entourages. This was acknowledged in a 1990 report by the Office of the Press Secretary to the Presidency of Mexico in an October 1990 report. The report estimated that at the beginning of 1982 $9 billion was transferred to overseas bank accounts.

The Third World borrowing orgy ended abruptly in 1982. After several years of global recession, higher US interest rates, and a sharp decrease in commodity exports, the debtor nations’ ability to pay even the interest on their loans became problematic.

In August 1982 Mexico announced that it was no longer servicing its debt. Soon after Brazil, Chile, and Argentina made similar declarations of default. The prospect of massive defaults was earthshaking on Wall Street.

US government banking regulators determined that the money center banks had insufficient reserves to cover these loan losses. They also realized that there was no international mechanism to pick through the bankruptcy of so many nations.

Further loans to these nations were abruptly halted. As the previous loans had been short term, a crisis ensued when refinancing was refused. The $$billions of loans that would have been refinanced were now due immediately.

The banking system publicity machine quickly began an intense campaign for US government financial support in order to “save the system from failure.”

In August 1985, I was in Havana, Cuba when Fidel Castro convened his Third World Debt Repudiation conference. During a four hour press conference with reporters from Latin America (many of them from right wing military-controlled newspapers, and not particularly sympathetic to his revolution) Castro was asked:

“What would you do if you were a Wall Street banker? “ (laughter)

Response: “First I would take an aspirin.” (laughter).

He then said he would write off the loans in the same way he would “write off a $100 loan to a brother-in-law who never had a job.”

He noted that, while someone loaning money to their brother-in-law absorbed the loss, the bankers always have the US government to make them whole again.

Lest this brief, sordid history be tarnished because of the sourcing of Fidel Castro, allow me to note that at the same time as the Havana Conference, a National Review article stated that

Two years ago there was a nine-month publicity campaign directing our attention to the international debt crisis. In the end it achieved its purpose. The Reagan Administration reversed itself and supported an $8.4 billion expansion of the International Monetary Fund's lending authority. (Tom Bethell August 23, 1985)

For the ensuing six years there was a grisly succession of bumbling government plans focused on IMF and World Bank intervention. They were, at their core, simply money-center attempts to have these agencies function as their debt collectors.

The result was the imposition of severe controls over the debtor nations. They were characterized as “reforms” ….. … cut-backs in government programs, reduced pension funding, currency devaluations, and higher domestic interest rates were demanded by the IMF and World Bank; all with the intended goal of squeezing repayment out of debtor nations.

A cynical view at the time, one I shared, was that, after a decade of engorging themselves with the borrowed funds, the military juntas were amenable to turning over the governments, and the keys to the now empty coffers, to the newly elected democracies, and getting out of town. The new governments were to be burdened with debt for many years, as well as the “reforms” that were never considered necessary for the military dictatorships.

The Baker Plan (James Baker, then Secretary of The Treasury) of the mid 1980s encouraged a “work-through on an individual basis” of the debt problems of each country. This was but one feature of a plan acceptable to none of the intended participants. The Plan was a dismal failure. Nonetheless the current Secretary, Henry Paulson, suggested the same “work-throughs” of potential foreclosures as a solution to this debt fiasco. His initiative, several months ago, despite a temporary positive reaction on Wall Street, has also been a failure, a predictable failure.

One of the last vestiges of the Baker Plan was the write-down in $$billions of Third World loans by Citigroup (NYSE:C). As they are expected to write down an additional $24 billion this week as fallout from their bad loans in the current crisis, one must wonder if there has ever been a risk manager “in the house?” What corporate culture is so resistant to learning from previous losses? Surely the lore of past huge loan losses would still resound around the latte machines at Citigroup?

Without a recounting of the Brady plan (a later attempt to deal with the debt crisis by the next Sec. of Treasury, Nicholas Brady), the result was, as reported in The National Review in 1990:

It's now possible to judge the Brady Plan on its results. Guess what? (Nowhere) is there a clear net reduction in debt. Instead, commercial debt has been replaced--almost dollar for dollar--by debt backed by Western governments, and therefore by Western taxpayers.

…….That the Brady Plan has been taken seriously by policy-makers and leading banks suggests that the game of debt charades has been played so successfully for so long that the orchestrators of the charade have become reckless. (March 19,1990 by Robert Stowe England)

In 1990 alone the US government funding for the IMF and World Bank was increased by $131 billion!

The Third World Debt Crisis similarities to the overlapping S&L bailout, and of course with the current Mortgage Meltdown, are rather obvious; originating loans that had little possibility of repayment, and intensive lobbying of congress and public opinion for government financial support.

It is a tired money center/government dance, but one that reinvigorates itself as new partners are taken out onto the dance floor whenever the band strikes up.