"Bail out the countries first and then the banks," said Treasury Secretary Donald T. Regan recently, a statement that better describes the order of events than the order of priorities. Saving bankers from the logical consequences of their own imprudence is once again a top federal priority.
Coercive vulnerability is the ploy bankers use so successfully in extracting federal aid. After making so many imprudent loans that the survival of their banks is at risk, bankers then demand federal aid on the grounds that terrible things will happen to the economy if their imprudent loans are allowed to turn into outright losses.
The Federal Reserve is generally the first to accommodate bankers' demands for rescue. Like a driver who swerves to avoid a blind or drunk pedestrian, the Fed swerves from its tight money policy as soon as it sees vulnerable bankers stumbling across the road. The fight against inflation is forgotten as the Fed switches to an easy money policy to help the banks. When foreign loan problems began to mount last summer, the Fed predictably moved toward an easier monetary policy.
Easy money lowers the interest burden on distressed borrowers and stimulates the economy. A rising economic tide refloats all but the most leaky of borrowers' boats, but occasionally there are some in so much trouble that federal loan guarantees are required to save banks from losing money. Loan guarantees to Lockheed Corp. and Chrysler Corp. were justified on the grounds of saving jobs, but the effect was to save the bankers' loans as well.
The two traditional means of federal aid to imprudent bankers -- easy money and loan guarantees -- are inadequate to deal with today's problem loans to foreign nations. Declining interest rates have eased the interest burden on distressed lesser developed countries, but the crisis persists, and the solution bankers prefer now is direct loans from their own government or from international agencies such as the International Monetary Fund and the Bank of International Settlements.
When Poland slipped into the facto default, European central bankers proposed a 50 percent increase in the IMF's resources as a way to bail out their own banks, which hold most of the $25 billion in dubious Polish loans. While it was largely European bankers whose ox was being gored, the Reagan administration stoutly opposed any large increase in the IMF's resources.
Once the locus of the problem shifted to Latin America, where U.S. banks have a large exposure to $300 billion in loans, the Reagan administration executed one of the more remarkable U-turns in financial history. No increase in the IMF's resources was too small to bail out European banks, but now no increase is too large to bail out their U.S. counterparts. Not only has the U.S. agreed to a 50 percent increase in IMF resources, but also it has gone the Europeans one better by proposing an additional "crisis fund" to avert defaults by large borrowers. Not even content to wait for the IMF to receive and disburse its funds, the administration has rushed federal loans to both Mexico and Brazil.
No matter that the rush to rescue imprudent bankers is at odds with the administration's cherished belief in free-market capitalism. Capitalism is not a system of profits for all, but a system of profits for competent business officials and losses for incompetent ones. The effect of the administration's rescue policy is to leave the past profits in private hands while shifting the present and future losses to the taxpayers.
From an imprudent banker's perspective, a better game scarcely can be imagined. Bankers are free to make marginal loans in good times and to keep the profits, but they can be confident that the federal government will prevent those marginal loans from becoming outright losses when recession strikes. If Las Vegas casinos offered a similar game where winners kept their profits and losers were rescued by the house, then much of the U.S. population would reside in Nevada.
Providing fresh public loans to paper over dubious private ones is only half of what is necessary to save imprudent bankers. The other half is that foreign borrowers be willing to accept those new loans even though it may not be in their own self-interest to do so.
New loans do not come cheap. The nominal and real rates of interest attached to both old and new loans are onerous by any historical standards except those of the last two years. Loans from the IMF come with unpleasant, deflationary strings attached. The burden of debt service amounts to more than 50 percent of export earnings for many LDCs, creating a powerful incentive to default and free all their export earnings to provide imports for their impoverished populations.A foreign borrower in default would be cut off from bank credit, but Argentina is reported to have considered the option of going to a cash-only basis for its trade and found that option none too painful.
From a foreign borrower's perspective, Western banks have victimized them. Bankers encouraged them to borrow heavily in the 1970s, when nominal interest rates were low and real interest rates were often negative. At the end of the decade, when foreign debts had piled up, bankers raised their interest rates to the 20 percent range, a rate once the exclusive preserve of loan sharks. To compound the problem, deepening recession and rising protectionism in developed countries are destroying the ability of foreign borrowers to repay their debts with exports.
Much to their credit (as a banker would use that term), foreign borrowers are behaving honorably toward their debts. Faced with a choice of inflicting the pain of default on their U.S. bankers or the pain of deflation on their own voters, foreign borrowers are choosing the second course of action. Not only is Brazil's current recession largely an attempt to appease its bankers, but also its planners have made their estimate of available borrowings the principal condition of managing Brazil's economy.
Like penguins jostling each other on an antarctic ice shelf, no foreign borrower wants to be the first to plunge into default. If one does take the plunge, then others may be quick to follow. The prospect that such a wave of defaults on foreign loans will destroy the international financial system so terrifies Western governments that they are rushing to save even the most imprudent of their own vulnerable bankers.
A happy ending for the imprudent bankers of the world requires that their own governments be willing to rescue them and that foreign borrowers consent to pay the price of being rescued. The U.S. government has provided ample evidence of its enthusiasm to rush to the rescue; now the ball is in the court of the borrowers.
What causes everyone to lose a little sleep is the knowledge that the power to prevent or precipitate a world financial crisis now lies in the hands of men who run countries that are poor, weak and more than little desperate.