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THE CASES

The nine cases are presented here in chronological order. This is helpful as some of these rescues occurred within months of each other. Thus, the conditions surrounding cases sometimes coincide. Individual cases are sometimes discussed in conjunction with other rescues that occurred proximate to one another.

Mexico, Brazil, and Argentina, 1982-1983

The notion of the Reagan administration bailing out a foreign country in crisis would have seemed far-fetched to an educated observer in 1980. As one Washington Post reporter at the time put it, the Reagan administration came into office "dedicated to the 'magic of the marketplace’ as a cure for troubled economies and deeply suspicious of international financial institutions and the aid they dispense.”[1] Miles Khaler noted that Reagan was initially quite skeptical of intergovernmental cooperation in international financial and monetary affairs.[2] In fact, this skepticism was sufficient to make the administration oppose an IMF quota increase in its first year in office. The administration’s position would soon change, however. In August 1982, the Mexican government learned that its foreign lenders were no longer willing to roll over its debts. On August 12, Mexican Finance Minister Silva Herzog called Fed Chairman Paul Volcker and Treasury Secretary Donald Regan. He informed them he was immediately putting in place a moratorium on servicing Mexico’s external sovereign debts, effectively defaulting on those obligations. The majority of Mexican debt was held by Western banks, which had been rapidly expanding their foreign lending operations over the previous decade. The Mexican announcement immediately generated fears in financial markets that other countries, especially the debt-ridden economies of Latin America, might soon follow suit. The worst-case scenario facing exposed banks was the possibility that the major debtor economies might form a cartel and collectively repudiate their debts. Such a move would have been cataclysmic. Multiple systemically important US banks would have faced the real prospect of bankruptcy.

In the words of one administration official, the Mexican default had "a major effect” on the Reagan White House’s view of the IMF as well as the role of Treasury in managing international financial crises. Mexico’s external debt stood at more than $80 billion, $25 billion of which was owed to US financial institutions—a sum that made up more than 7 percent of all US banks’ foreign claims and, even more staggering, represented more than one-third of their total capital stock. Mexican officials, who had been in close contact with Treasury since April, explained that they needed roughly $3 billion immediately simply to restart making the minimum payments on their debts.[3] As Jeffrey Sachs put it, "Even the ostensibly laissez-fair Reagan administration went swiftly into action” when faced with the Mexican default.[4] On August 15, Treasury Secretary Don Regan authorized a $1 billion ESF loan to the Mexican government, which, at that time, was only just beginning its negotiations with IMF officials about a loan package. With an IMF loan still up in the air, the

United States agreed to record the loan as prepayments for Mexican oil purchases. Treasury then drummed up a $1.85 billion multilateral bridge loan package via the Bank for International Settlements (BIS). This included an additional $600 million contribution from the ESF on August 26. Meanwhile, the Fed chipped in another $325 million by expanding the size of an existing $700 million swap line with the Bank of Mexico. That deal dated back to 1967 as part of the Fed’s Bretton Woods-era lending network.

Meanwhile, Mexican authorities remained in the consultation stage with IMF staff. It was not until November 8 that they formally submitted their letter of intent to the executive board requesting an Extended Fund Facility (EFF) arrangement.[5] [6] Thus, the initial emergency loan from the United States reached Mexico a full 86 days before their authorities had even submitted a formal request for Fund assistance. Yet, despite the dire circumstances facing Mexico and the threat this posed to the global financial system, submission ofthe letter did not lead to a speedy approval by the board. Rather, IMF Managing DirectorJacques de Larosiere informed the major commercial banks at a meeting that month in New York that the loan request would not be approved by the board until they provided him with "written assurances that they would increase their exposure by enough to cover a substantial fraction ($5 billion) of Mexico’s scheduled interest payments for 1983.”11 This marked the beginning of the Fund’s concerted lending strategy (discussed at length in chapter 4). Once banks agreed to increase their exposure to Mexico, the board scheduled the letter for consideration. Ultimately, the board approved the request on January 1, 1983—54 days after the letter was submitted and a full 142 days after the Mexican moratorium began! This case clearly shows that although concerted lending may have been effective at promoting (or, perhaps more appropriately, coercing) private-market participation in the management of the debt crisis, it further slowed down an already slothful IMF. Fed and ESF financing was vital in enabling Mexico to begin meeting its obligations. The credit simultaneously protected US banks from suffering substantial losses, gave Mexico and the IMF time to hammer out a long-term financing deal, and allowed de Larosiere to press the commercial banks to reschedule Mexican debt, making the burden less onerous.

Mexico was not the only Latin American economy in trouble in 1982. Once Silva Herzog’s decision went public, commercial bank lending to other heavily indebted developing economies rapidly retrenched. Argentina and Brazil were both now firmly in the crosshairs of the debt crisis as banks began refusing to roll over their debts as well. Like Mexico, the government of Brazil had borrowed heavily from US banks to a tune of more than $21 billion as of 1982. This represented more than 6 percent of US financial institutions’ total foreign claims and 31 percent of total bank capital. With the US financial system on the hook once more, Treasury was again called to action. At the General Agreements on Tariffs and Trade (GATT) ministerial meetings in October 1982, Brazilian Finance Minister Ernane Galveas met with US Deputy Treasury Secretary Timothy McNamar, where the two negotiated a rescue deal. The ESF would provide $500 million in immediate, short-term assistance to Brasilia.[7] By the end of November, Treasury added two additional bilateral credits, bringing the total commitment to $1.24 billion. These loans were kept secret until December 1 when President Reagan unveiled them amid the "fanfare” of a state visit to Brasilia.[8] Describing the loan as "government to government,” Reagan indicated that Treasury’s involvement should encourage commercial banks in the United States and beyond to roll over Brazil’s debts while the country worked to reestablish solvency.[9] Days later, Treasury made it clear that its commitment was by no means maxed out. It was "standing by as necessary to be of further assistance” in rounding up short-term assistance to Brazil via the BIS.[10]

As was the case with Mexico, the ESF commitment to Brazil was intended to buy that government time to work out a long-term EFF financing program with the IMF and to negotiate a rescheduled debt deal with commercial banks. It was also a way to keep the severity of Brazil’s crisis under wraps until these negotiations could get under way. In a November meeting of the Federal Open Market Committee (FOMC), Chairman Paul Volcker noted that Treasury’s emergency packages to Brazil were intended "just to keep them afloat until the timing is right for them to go to the Fund and try to deal with the problem more openly, which is certainly going to have to be done. It is still a very uneasy situation.”[11] Brazil did not formally enter into discussions with Fund staff regarding the loan program until the end of November. Those negotiations were completed on January 6 when Brazil formally submitted its letter to the executive board. In keeping with its concerted lending strategy, the board did not approve the request until commercial banks agreed to put up new money for Brazil. Ultimately, the IMF loan was not approved until March 1,

1983—nearly six months after Brazil first requested official assistance.[12] By the time the dust had settled, the ESF had extended a total of six separate emergency credits to Brasilia—five bilateral loans and one multilateral package the United States pushed through the BIS—bringing Treasury’s net contribution to $2.38 billion between October 1982 and February 1983.

Argentina was the third large Latin American economy that ran into problems rolling over its debts in 1982. In fact, strains in Argentina preceded those in Brazil. Although the United States considered coming to Argentina’s aid, according to the Treasury’s records, direct assistance was not provided in this case.[13] The ESF did not provide a credit despite the fact that the country was facing the same problems as Mexico and Brazil and despite the fact that its crisis threatened US banks at a time when systemic risk facing the US financial system was high. Given these conditions, why was Argentina passed over? Several factors likely played a role. First, US banks—while vulnerable to an Argentine default—were relatively less exposed to Argentina when compared to Brazil and Mexico.[14] After the Mexican moratorium, US policymakers knew all three countries were going to need assistance.[15] Treasury appears to have decided that assisting the two biggest threats to the US financial system—Brazil and Mexico—was the top priority. Argentina was left without a chair when the music stopped. As discussed in chapter 2, unlike the Fed’s swap lines, ESF resources are finite. Consequently, Treasury had to weigh the prospect of overextending its limited financial resources. A report in the New York Times makes a similar implication, noting that although Argentina was in need of help, "[US] monetary authorities said the Brazilian request had a higher priority.”[10]

Second, it is unclear if Argentine authorities ever directly requested Treasury assistance. Argentina, however, did seek emergency assistance from the BIS. That institution’s annual report for 1983 reveals that Argentina approached the BIS in September 1982 to request a bridge loan. Negotiations successfully ended in January, resulting in a $500 million credit through that organization.[17] According to official Treasury records, the United States did not contribute to that multilateral package. However, the Federal Reserve may have been involved indirectly through a standing $1.85 billion swap line it maintained with the BIS. A 1982 Federal Reserve Bank of New York (FRBNY) report on foreign exchange operations documents that the BIS drew $124 billion from its swap line with the Fed around the time it provided the credit to Argentina. The report indicates that the BIS drawing was used in the multilateral package for Mexico. Yet, it also adds, "During the period, the U.S. monetary authorities provided or participated in the provision of short-term bridging credits to Brazil and Argentina also.”13 Similarly, when discussing the 1982 BIS bridge loan to Argentina, James Boughton adds, "The BIS, led by the United States, granted a short-term stand-by credit in late January to serve as a bridge to the scheduled May drawing under the Fund agreement.”14 Thus, although Treasury’s official position indicates that it did not provide direct assistance, it appears likely that the Federal Reserve provided indirect assistance to Buenos Aires by routing a loan through the BIS.

These three cases illustrate the factors that motivated US economic policymakers to act outside of the IMF as an ILLR by providing emergency liquidity to foreign governments in crisis. The IMF could not provide credits in a timely manner and employ the concerted lending strategy at the same time. Concerted lending was effective at forcing the hands of commercial banks to increase exposures to the heavily indebted countries. However, it had the adverse effect of delaying the disbursement of emergency financing. Due to the Fund’s limitations, the United States stepped in as an ILLR by tapping the ESF and providing Mexico and Brazil with emergency, short-term loans. Moreover, the United States deliberately selected these two countries to protect the US financial system. Figure 6.1 compares the total adjusted claims of US banks in the five Latin American economies where those totals were highest.15 In fact, the United Kingdom and Japan were the only two countries where US banks were more exposed at that time. US inaction would have forced both countries to wait several months for IMF financing, resulting in the suspension of debt servicing. This would have complicated, and potentially derailed, negotiations with the banks and allowed the crisis to spread more rapidly to other countries. The threat of contagion was both real and severe. Sachs [18] [19] [20]

Figure 6.2

Adjusted Foreign Claims of US Banks, 1982

summed up the motivation behind US foreign bailouts during the initial year of the debt crisis in two words: "gut fear.” He continued,

At the end of 1983, the [Least Developed Country] LDC exposure of the nine U.S. [systemically important] banks was $83.4 billion, or 287.7 percent of bank capital. In Latin America alone, the exposure was 176.6 percent of bank capital . . . . It seemed obvious that if the largest debtor countries unilaterally repudiated their debt, then the largest U.S. banks could fail, with dire consequences for the U.S. and world economies.[21]

In short, without US involvement, its own banking system might have collapsed.

These cases illustrate how US ILLR actions can be viewed as an extension of the domestic lender of last resort mechanism in a world where the US financial system is global. That is, the provision of liquidity to a foreign economy is designed to protect the "general interest” of the US economy, in line with Walter Bagehot’s ideal. Despite the clear and present risks these crises posed for the broader US economy, it is worth considering the argument that Treasury stepped in to protect the private interests of US banks. Indeed, banks had much to gain from any international rescue as this would allow the indebted governments to continue making interest and principal payments to these institutions.[22] To what extent did private banking interests play a role in the US decision to bail out Mexico and Brazil? Without first hand knowledge of all potential backroom discussions, there is, of course, no way to know the answer with complete certainty. In chapter 5, I argued that the banking lobby should be expected to lobby Treasury for protection when the industry’s interests are threatened. It is not difficult to imagine CEOs of major American banks calling contacts at Treasury or the Fed in order to make them aware of their exposure and even requesting that such credits be provided. Indeed, it seems likely that such conversations would have taken place during such extraordinary times. Moreover, bank lobbying for foreign bailouts would have been an important source of information for policymakers—helping them grasp the full extent of the financial system’s exposure.

Yet, given the severity of the risks facing the heart of the US financial system, it seems incongruous to suggest that policymakers were motivated to provide foreign bailouts to protect bank profits and equity values in isolation. Without question, any bailout would benefit the banks since much of the money provided would be paid back to those institutions as interest payments. Yet such a result is unavoidable if foreign credits are the only way to protect the US financial system from catastrophe. FOMC transcripts indicate that protecting bank profits was not a top priority of policymakers—quite the opposite, in fact. This is evident in one telling exchange during a committee meeting in December 1982 that begins with Chairman Volcker explaining to the other members what needs to happen in order to steady the crisis:

chairman volcker: If we can get the Mexican and Brazilian situations stabilized, and Argentina is also big, I think we will have the whole situation stabilized because there’s nothing else big enough and they’ll never sell it to—

mr. boehne: In other words, if there is a default in one of the smaller countries, the banks could eat it. chairman volcker: Right. mr. boehne: Maybe they even should eat a little. chairman volcker: Exactly.[23]

  • [1] Oberdorfer 1983.
  • [2] Khaler 1992, p. 69.
  • [3] Oberdorfer 1983, p. A1.
  • [4] Sachs 1988, p. 233.
  • [5] Boughton 2001, p. 307.
  • [6] Ibid., p. 405.
  • [7] Aggarwal 1996, p. 462.
  • [8] Boughton 2001, p. 339.
  • [9] Weisman 1982.
  • [10] Farnsworth 1982.
  • [11] FOMC 1982b, p. 24.
  • [12] Boughton 2001, p. 338.
  • [13] At the December 21, 1982, FOMC meeting, the committee openly discussed the possibility of extending a swap line to Argentina. It also debated whether or not the Fed orTreasury should aid Argentina should the country need assistance, which it viewed as likely.Ultimately, the committee balked at setting a precedent of opening Fed swap lines withcountries outside of those it already had established relationships with (FOMC 1982c, 62).
  • [14] Indeed, US bank claims in Argentina were roughly half as large as claims in each of theother troubled economies.
  • [15] FOMC 1982a, p. 9.
  • [16] Farnsworth 1982.
  • [17] BIS 1983, p. 128.
  • [18] FRBNY 1983, p. 59. Emphasis added.
  • [19] Boughton 2001, p. 335. Emphasis added.
  • [20] Data are collected by the author from relevant Country Exposure Lending Surveys(CELS) via the Federal Reserve archive available at http://fraser.stlouisfed.org/publica-tion/?pid=333.
  • [21] Sachs 1988, p. 253.
  • [22] Sachs and Williamson 1986.
  • [23] FOMC 1982c, p. 70. This is not the only example of Volcker’s lack of love for the bigbanks. For instance, Volcker played an active role in assisting the Fund’s efforts to makethe concerted lending strategy succeed. Based on one account, “Although Volcker neverexplicitly said he would use his powers as a bank regulator to exact retribution from a bankthat refused to follow his moral suasion, the implication was not lost on bank executives”(Blustein 2001, p. 188). In a 1984 FOMC meeting, Volcker went on record saying that hehad not “made any great secret” of the fact that he thought banks ought to make interest-rateconcessions to the indebted countries where there had been signs of improvement, something the banks opposed (FOMC 1984, p. 28).
 
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