WASHINGTON, SEPT. 9 -- Brazil and its lenders must achieve a breakthrough in their debt negotiations next month or the commercial banks may be forced to write off some of their loans as bad debts, Treasury Secretary James A. Baker III said today.
"It is important that Brazil solve its problems with its creditors before action has to be taken by the regulators that you can't undo," Baker said in an interview. "My point is that once an egg is scrambled, it is very difficult to unscramble it."
Baker was referring to a scheduled Oct. 26 meeting of government bank regulators to review the status of U.S. bank loans to Third World countries. The session is emerging as a key in the Brazilian debt negotiations.
Brazil and its creditors do not need to reach a final agreement by then that would end Brazil's self-imposed moratorium on making interest payments on its $70 billion in bank debt, Treasury officials said. But regulators are likely to rule that loans to Brazil need to be downgraded to "value-impaired" if no significant progress has been achieved in working out a new debt package.
"It is going to be awfully hard under present circumstances for them to make any other classification," a Treasury official said.
A downgrading of the loans would force the banks to absorb heavy losses and Brazil would be hard-pressed to obtain new credit crucial to its economic health.
"It would start a downward cycle that would be extremely difficult to reverse," said one banker at a major regional bank. "It has never occurred with any of the Big Four debtors," he said, referring to Mexico, Brazil, Argentina and Venezuela.
On Tuesday, Brazil's finance minister dropped his radical proposal to unilaterally force banks to swallow enormous losses on his nation's huge bank debt after Baker rejected it as a "non-starter."
Treasury officials believe the negotiations between Brazil and its creditors "should be addressed in a conventional way," which would mean that Brazil would resume interest payments on its debt in return for fresh infusions of cash from its lenders.
The quarterly determinations by the regulating group, the Interagency Country Exposure Review Committee, are secret. But the regulators, who include officials from the Treasury Department, the Federal Reserve Board and the Federal Deposit Insurance Corp., are known to have required banks to write off loans to Peru and Zambia.
If regulators found that Brazil's debt had to be downgraded, bankers said they expect to be ordered to write off 10 percent to 15 percent of the face value of their loans to the nation, the largest debtor in the Third World.
Up to now, major banks have only set aside reserves for potential Third World losses, a move started by New York's Citicorp in May that some bankers hope will open the way to more flexible approaches in resolving the myriad impasses in negotiations between lenders and debtor countries.
That step forced banks to report losses for the quarter in which they boosted reserves. But, if Brazil agrees to a new repayment package, some banks might be able to reduce their loan-loss reserves, dramatically increasing their profits.
Brazil's flirtation with repudiating its debt, Treasury officials said, demonstrates the dangers of encouraging Third World debtors to expect widespread debt relief, as advocated by several key members of Congress