Time to Regulate the Banks

The world banking system is in crisis. Mexico's announcement on August 13 that it could no longer come up with even the interest on its $80 billion debt to foreign hanks sent the alarm bells clanging - alarms that should have gone off some time ago.

The big private commercial banks - Bank of America, Citicorp, Chase Manhattan and the rest - simply are way over their heads in loans to Third World countries. In Mexico alone, Citibank is reported to have lent over 50% of its capital base.

How did this all happen? Flush with deposits from OPEC countries after the rise of oil prices in 1973, the big hank,, lent out aggressively and carelessly to Third World countries. Now, as these countries suffer under the world recession, they are unable to pay off their loans.

The risks here are great.

A default by a major Third World debtor could push the world financial system over the brink:- the overexposed U.S. banks would take a huge loss, engendering a panic and a run on the banks. If some banks go under, they will take corporations along with them into the gulch, for companies depend on banks for credit.

Rather than facing up to the crisis, leading U.S. bankers and Reagan Administration officials prefer to whistle in the dark. In an op-ed in the New York Times on September 14, Walter Wriston, chairman of Citibank, expressed "great hope" that developing countries - and the banks behind them - would make it through the current "illiquidity" period, downplaying the risk of default. (Wriston's cheerfulness was described as "just plain cotton randy" by former Under Secretary of the Treasury Robert Roosa a day later in the Times).

U.S. Treasury Secretary Donald Regan shares Wriston's outlook. At the World Bank-IMF annual meeting in Toronto - Regan claimed the system is "sound", praising it for its "basic strength and resilience."

It is in the interests of banks to minimize default risk, since they need the confidence of their depositors to stay in business. What is more, the major banks -- such as Chase, Bank of America, and Citibank --- may be betting that if the default risk materializes, the U.S. government will bail them out. This tacit insurance policy may in fact breed the kind of irresponsible lending policies that got banks - and the world - into the current financial mess.

The interest the U.S. government has in winking at the grave financial situation of the world is less clear. Perhaps the Reagan Administration is convinced that its economic policies are working so well that the world's economy will quickly pick up and the problems vanish. Or, perhaps the Reagan economic philosophy prohibits the Administration from taking any but the most short-term and ad-hoc measures to put out fires as they flare u{-- .

The recent $2 billion U.S. bail-out of Mexico appears to be an example of the kind of response the Reagan Administration will take. But the bail-out of Mexico was in fact a U.S. taxpayer bail-out of major U.S. banks. According to Business Week, the three biggest U.S. banks were heavily exposed in Mexico: Bank of' America with $2.75 billion in loans outstanding, Citicorp with $2.5 billion, and Chase with $1.75 billion.

What did the U.S. taxpayer get in return? What price did the banks have to pay for getting, themselves into the stew? Nothing. Thus the U.S. government reinforces the banks' assumption that whenever they get in trouble, Uncle Sam will come to their rescue.

The U.S. taxpayer should not have to pay for the profligacy of the major U.S. banks without gaining some say over banking policies.

Banks need to be reined in. They demonstrated beyond a doubt they cannot manage their risks. To curtail reckless lending, and to prevent a world catastrophe, it is high time the government imposed meaningful restrictions and surveillance on overseas lending practices of U.S. banks.