The Debt Dilemma

An interview with Rep. Bruce Morrison Connecticut Congressman Bruce Morrison has introduced an innovative debt relief plan that provides a concrete framework for debtor countries and creditor banks to begin to come to terms with the mounting Third World debt. The second term Democrat recently spoke with the Multinational Monitor about his debt relief plan, H.R. 4123, a modified version of which is part of the trade legislation bill (H.R. 3) in the House.

Multinational Monitor: Why did you decide to seek legislation attempting to deal with the debt crisis rather than allowing the current players - the private banks, the IMF and finance ministers - to find a workable solution?
Rep. Bruce Morrison: The Third World debt problem is one of the world's major economic problems. It has a dramatic effect on the economic stability of the United States and the rest of the world. The debt creates instability in the banking system which is dangerous to our economy. The inability of debtor countries [to buy American goods] deprives America of markets and deprives American workers of jobs. Many debtor countries are of interest to us geopolitically - our foreign policy and national security interests are at stake. From the standpoint of long-term U.S. interests, solving the debt problem will probably be the shortest distance to giving us long-term, stable relations with friendly democratic regimes. Failure will make it much more likely that we will have problems [with] unfriendly regimes. It is a global problem and each of its aspects ties into the global and economic security of the United States.

Monitor: How does your proposal, which creates a debt restructuring facility, differ from other legislation before Congress attempting to ameliorate the debt crisis?
Morrison: This is about the only proposal around that is a mechanism. This is a mechanism through which most of the other, if not all of the other proposals for particular substantive changes could be implemented. This is a vehicle for debt relief, for capitalization of interest, for debt-equity swaps, for securitization of the debt and for creating mechanisms by which local currencies rather than hard currencies could be used to pay. All of those things can be done under the umbrella of this institution.

Why an institution? Because we cannot depend on people with differing interests from our national interests to carry this out. What we currently have is bankers negotiating with countries. That's bad for the bankers and bad for the country. The banks have no national interest. Their only interest is the interests of their stockholders. They don't care about the future democracy in Argentina except in a very attenuated way. That's not their problem. We can never really [count] on a bunch of private sector bankers to take the big picture here.

Monitor: Your plan allows banks to take 30 years to amortize losses. But since the losses are already there, is this really going to change the way the debt is perceived on the market?
Morrison: The stock values already reflect the expected losses, and they will continue to at every point. You can't make value out of nothing. Those values are already there, but they are locked in without liquidity. Even the value that continues to exist - the 65 cents on the dollar - is theoretically being valued at 100 percent. But the market has long since discounted [the value of the debt]. You can see that by the fact that Citibank's stock went up when they took the reserves. Now the reserves are another indication of the fact that these losses are there. Those reserves still count as capital. The critical step, which is to book the loss, creates only one new problem. The markets already know what's going on out there. The new problem it creates is capital adequacy. The bill doesn't say they shall be amortized over 30 years, but no longer than 30 years. Any time period is arbitrary.

The mechanism has a very simple purpose, which is to give the banks liquidity in exchange for their taking market driven discounts and giving them regulatory relief so that the process of restoring capital to offset the losses can be done over an extended period rather than creating a capital crisis.

Monitor: What is the long term goal of this plan? Is the aim to get back to voluntary lending or is voluntary lending no longer a valid concept?
Morrison: Voluntary lending will have to be restored. Voluntary lending does not now exist in any significant amount except to service existing debt. Voluntary lending is not helping the countries, it's making it worse. It is piling more debt on debt. In the short run it is more important for countries to have their export earnings available for reinvestment than it is to expect new infusions of investment in loan form. New infusions of direct investment, equity investment that doesn't have anything to do but pay whatever return the country can pay that's valuable. We want to go away from debt service to reinvestment of export earnings and to equity investment. Down the road bank credits will become important again.

Monitor: How are you going to convince the bankers to participate in this program and how do you convince voters that this is not a bailout of the banks?
Morrison: Anything you do in dealing with international economics and banks has the risk of being misconstrued or intentionally misstated by people as being a bank bailout or foreign aid. Those are real problems. But the banks are in trouble with these loans. These banks aren't going to get paid back 100 cents on the dollar - no way, no how, never. They're already troubled loans. There's already a secondary market evaluation of what they are. Sooner or later, and starting already, the banks are going to take losses including tax losses, and they're going to get that help. We're not helping the banks with federal dollars at all in this; we are preventing further losses of federal dollars by getting the loans out of the banks to places where the government isn't the guarantor, where the government isn't the insurer. The losses aren't going to be any greater under this than they were already. The losses are going to be what the market is already evaluating these loans at. In fact, if the system works, the losses will be less because the loans will be repackaged in a form that is easier for the debtor countries to pay and their value will rise, not go down. Now, people will say that you're helping the banks. Well, to the extent that helping the banks means keeping them from going broke, yes. Do taxpayers want the banks to go broke? I don't think so, because when they go broke taxpayers pay. In that sense, creating a mechanism so the banks can get out from under [their debts] not for nothing, but for a fair discount which is what the market says the stuff is worth, that's just letting the market work.

Monitor: With the value of loans in the secondary market often falling well below 50 cents on the dollar, how do you think the secondary market will work?
Morrison: First of all, it's a very thin secondary market and almost everybody in the secondary market is buying only when they want to do a debt equity swap. It's not a real secondary market. There are two things wrong with it. All you can buy is the loans in their present form. It is not a securitized secondary market, therefore it's not providing the kind of breadth of investors that exist out in the world to keep the market values up. Nor does it allow for the restructuring of the debt. Everything that improves the long-term viability of the payment of the debt, the viability of the country, will improve the value of these assets. [If] values would rise, the banks would be happy to hold at least part of what they currently have. It's going to be a bank's choice. This is not an enforced sale, it's not a fire sale.

Now, I predict that it will make economic sense for them to get liquidity. That's a market judgment. The current market is not a viable market. What is needed is a restructuring and securitization. The benefit of having it done by a multilateral public sector entity rather than by somebody on Wall Street is that there is no profit needed by this entity. This entity does not need to give a return on its capital. All it needs to do is get back from the secondary market whatever it has to give to the banks.

Monitor: Should all of these loans be repaid? What is your position on loans that were made to dictators or which were wasted by their governments?
Morrison: From a moral standpoint there are lots of debts out there that were incurred by dictators who looted the money and there's very little moral obligation to pay. I think that's a domestic political dispute within the countries involved and they sort of have to make their case against a particular loan made by a particular bank which has the earmarks of being part of defrauding the country because the banks were giving it to a government that everyone knew or should have known was looting the money.

That really isn't the central focus. The central focus is to recognize market realities as you would if these countries were companies and this were Chapter 11, in which case you would be saying we want this company to survive because it's got a viable future. People take losses, banks take losses. Eventually banks also loan money to those newly restructured companies and things go on.

Monitor: Under this plan, where is new money going to come from?
Morrison: In the long run it's going to come from banks and other sources of capital. In the short run it's going to come from trade earnings. There's a huge amount of trade earnings that are going to service the debt. Those dollars can be invested in the country to the extent that they don't have to be used for current debt service. That's a significant source of new money. Beyond that, restructuring can lead to investment funds. One thing is local currency funds, local currency that has to be reinvested in the country. I imagine countries would be willing to pay a premium, that is give more, redeem more, take less of a discount. They'd even do 100 cents on the dollar for local investment because that would create funds that had to be reinvested in the country and securities dealers could resell that around the world. In fact, that's already going on to some extent. So the point is that there's still the availability of equity investment based on the long-term viability of the particular enterprise or the country as a whole. That viability is enhanced, not diminished, by the reduction of the short-term debt load and so it's going to be a more attractive place to put your money when we go through this restructuring. Now down the road the banks are going to come back in. Maybe this time they'll come in with a little more prudence. That's one of the reasons why they're in such deep trouble. They allowed countries to make very bad investments by not saying "what factory are you building with this [and] is it going to produce earnings that are going to allow you to repay it?" They didn't ask those questions.
 

Growing Out of Debt

An interview with Isaac Cohen Isaac Cohen is director of the Washington office of the United Nations Economic Commission on Latin America and the Caribbean.

Multinational Monitor: What do you see as the major trends in Latin American development in recent years? What has happened to the major economic indicators and the peoples' standards of living?
Isaac Cohen: The basic threshold in Latin America would be the 1973 and 1979 oil shocks. In 1973 traditional exports from Latin America did relatively well in international markets, and the countries were able to pay for the oil bill without constraining imports. At the same time, the oil price increases initiated the recycling of funds from the oil producing countries into what are now the debtor countries. In 1973 a period of considerable international lending started as well as a boom in export prices not only for oil but for all the other raw materials and basic exports of Latin America. Consequently the 1970s were a decade of positive evolution of economic indices.

Monitor: Including income distribution?
Cohen: Well, that's the problem in Latin America. The macroeconomic indicators do not necessarily translate into the betterment of the majority of people. In countries that have better income distribution like Argentina, Costa Rica or Uruguay, progress in macroeconomic indicators will immediately be better distributed than in those countries that have a relatively skewed income distribution as is the case with Mexico, Brazil, or Guatemala. The way progress is absorbed and channelled and distributed depends on the prevailing structures.

Monitor: By some indices countries like Guatemala seem to have gotten worse during that period since there was greater concentration of land holdings.
Cohen: Definitely. The basic flaw in Central American development under the 30 years of sustained economic growth since the Second World War--which was impressive because the growth was around 5 percent a year--was that it was very badly distributed. But at least the economies were growing. And then comes the second oil shock of 1979, which finds the Latin American countries in debt and with the prices of their exports going down. From then on, the whole situation changes dramatically. We move into a decade which I guess can be called a lost decade for Latin American growth and development. The region falls into the debt trap. It faces the impossibility of servicing and paying the debt. The whole external situation is aggravated because the prices of raw materials and non-fuel commodities fall to the lowest level that they had experienced since the crisis of 1929. Simply, growth stops. And whatever growth there is is destined to pay debt. So we move from a situation in the 1970s when we were growing, though probably not distributing very well, to a situation in the 1980s when we are not growing and not even distributing at all.

Monitor: Have the past few years begun another phase, the phase of adjustment to the debt problem where the countries have to respond to the International Monetary Fund (IMF) and the banks and not merely worry about paying off the debt but also about having to comply with the plans which the creditors impose?
Cohen: The problem of the debt in Latin America is not the difficulty of paying, it is the impossibility of paying because there is an economic crisis. The debt is an issue because there is no growth. There is no capacity to pay, there is no capacity to import. Trying to service that debt in the middle of this very negative circumstance aggravates the situation because adjustment has to take place with no growth.

Let me give you an example. Adjustment is required from the most indebted Latin American countries. By what means? By generating an external surplus. But you cannot generate that surplus by exporting more because your products are not getting good prices in the international markets. The only way you can generate a surplus exporting less is by reducing your imports. If you reduce imports in open economies, as the Latin American economies are, consequently you decrease your productivity and consequently you do not grow. On top of that, you use the surplus you generate to finance and service your debt. That's what makes the situation very bad.

We have always said the solution to the debt problem is to grow out of it. But in order to grow in Latin America you have to give these countries the resources to grow. That's why the issue is not so much what is already owed, but how much new money you need in order to grow and consequently pay your debt.

From a region which in the 1970s was importing capital, Latin America has become an exporter of capital. So here you have paupers exporting capital, which is absolutely terrible. There is no way you can have any progress at all if these countries are exporting capital instead of exporting raw materials or manufactured goods.

Monitor: Is there any possibility for a realistic growth strategy?
Cohen: It depends on how the economies of the industrialized countries evolve and it depends on the way the debt issue is confronted. That has moved in different stages also. The first stage was the period of adjustment for the Latin American countries to their initial burden. They adjusted severely in the 1980s. Imports were constrained severely and they ended up paying considerably. The second stage was one in which the Baker Plan was announced and the opinion there was, OK, it is necessary to grow in order to pay it. The third stage is the stage in which we are now where you see the banks incurring some losses because the real value of the debt - if you view it from the perspective of the secondary market that has emerged - is almost half of what it is worth.

This has been resisted up until now, but more and more what you are seeing is a recognition that the debt is not worth its nominal value, its face value. The market has, in that sense, made a decision on the value of the debt.

Monitor: Is that likely to decrease pressure on the debtor countries?
Cohen: Yes, if and when the debt could be traded in the market as any other kind of asset, that would decrease the amount of principal. Countries could buy back part of the debt at reasonable prices. Instead of paying, the best thing to do would be to buy back these loans if they become tradable as securities. The present negotiations by the Brazilians are focused on the possibility of transforming some of their debt into marketable securities at their market value. That is going to be important because it means that, first of all, some kind of securities will have to be created that will have to be taken by the banks in exchange for the debt. They would be thrown onto the market and bought by whoever is willing to assume the risk. This is the way that the third stage is beginning to appear.

Monitor: How can the Latin American economies address the problems of poverty and malnutrition? Won't any infusion of capital be insufficient if the economies are not structured for self-sustaining growth?
Cohen: The key is employment. If these economies are not able to generate sufficient employment, there is no way you are going to solve those problems. International lending on favorable terms can help with some problems like hospitals or very basic, urgent needs, but you must find an alternative that generates sufficient employment because the only way to break the cycle of poverty is to employ people. People are willing to work, but there is no employment.

Monitor: But since there are so many jobless people, is it really possible for the manufacturing sectors in Latin America to undergo the massive expansion that would absorb them all? Would there be more prospect of generating domestic jobs if in addition to the exporting you had to do to get the hard currency you need to buy supplies, you also put an emphasis on producing for the internal market?
Cohen: Both are important. You need to expand your internal market. That you can do by generating employment, which gives people income and boosts domestic demand. But in some cases the internal markets of these countries are too small to sustain manufacturing levels which are of a scale required to be efficient. You could expand the market through economic integration and arrangements of free trade among the Latin American countries and at the same time, the emergence of a structure that competes efficiently in the international market. That would be the ideal solution, together with addressing the basic needs of the population through economic assistance from multilateral institutions under soft terms. That would be important. Take the case of Central America. It illustrates how important external assistance is for the survival of any kind of regime you find there. More and more countries are receiving considerable amounts of foreign assistance. Nicaragua gets around $600 million a year in economic aid. Costa Rica gets about $500 million, Honduras, $300 million to $400 million, and El Salvador, $700 million. So all of these countries are receiving some kind of external support because the fact is that for such small economies, it is very hard to become self sustaining. You need the expansion of the internal market, you need the expansion of the regional markets through economic integration, and you need the international market. But in order to be able to export, to compete, you need to be efficient. And the markets of the developed countries have to remain open. I am supposing that protectionism in the industrialized countries would be defeated. I am optimistic, I am not pessimistic. I wouldn't like to give the impression that I don't see a way out of this. But we have to confront reality. These years have been very severe. Take Central America. Eight years without growth. That is terrible. Everything is being wiped out. Whatever was accomplished in the previous two or three decades is being wiped out by this terrible crisis.

Monitor: What does the debt crisis do to the prospects for integration?
Cohen: Resources are being channelled to service the debt, so those resources cannot be used to import the necessary raw materials and equipment to industrialize and to invest. That issue hinders the expansion of internal demand and the generation of employment, because servicing the debt does not generate employment. On the contrary. If you service your debt by importing less, that does not generate employment.