Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

199. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Mulford) to the Deputy Secretary of the Treasury (Darman)¹

Washington, undated

SUBJECT

• White House Office Of Policy Development’s International Debt Proposal²

I. SUMMARY

The proposal ignores the existence of the current U.S. debt initiative which emphasizes helping debtors work their way out of their debt problems and reestablish their creditworthiness. It presumes the need to protect U.S. banks (and depositors) from the serious and “immediate” threat of default on foreign loans and proposes to solve that by having banks swap their LDC debt for equity in a new privately owned intermediary institution—a Bank of Settlements. The proposal is naive, confused and unlikely to achieve its proposed objectives. We should sharply oppose it.

II. DISCUSSION

The paper in its tone seems slightly hysterical. Most LDCs want to be responsible and service their debts. Provided they are making adjustments, commercial bankers have been willing to roll over debt, at least thus far. What we have seen is a series of reschedulings and partial moratoria in individual countries whose situations differ and change. The paper seems to lump all LDCs together and fails to take into account that their situations will change in the future.

U.S. commercial banks would exchange problem debt for the common shares of the Bank of Settlements with par value equal to the current undiscounted value of the loans. The proposal wishes to avoid having write-offs and write-downs impact commercial bank balance sheets; it assumes the exchange of assets can avoid this.

The Bank would then renegotiate the loans, trading loan concessions (including denominating the loans in local currency, extended terms, and reduced interest) for Baker plan proposed economic reforms. Such measures would greatly ease any incentive on the part of the LDCs to adjust, but it is unclear how the Bank of Settlements would generate hard currency to pay dividends.

It is unrealistic to assume that regulators, accountants, the Securities and Exchange Commission or the stock market would fail to look through to the underlying value of the assets behind the “common shares”; share values in the market place would fairly quickly be established at a substantial discount and the banks holding the shares would almost certainly be required to mark them to market. At this point, the Bank of Settlements would have failed in its objective, which is to maintain the value of the banks’ assets.

The proposal also ignores the importance of economic reforms and the crucial role of the international financial institutions, placing instead the Bank of Settlements as the vehicle for achieving those reforms. This would reduce creditor leverage in getting reforms adopted and politicize the debt problem by concentrating debt in one U.S. institution which is to offer softer terms. Finally, the proposal fails to indicate how additional bank credits could be mobilized to support the economic policies of good adjusters.

The paper overlooks the interconnection between banks of other countries in international lending; U.S. banks hold only one-third of LDC exposure. Unless banks of other countries cooperate in the scheme to relieve debtor nations of the necessity to earn U.S. dollars to service their debts, the debtor nations could use the foreign exchange they do earn to pay off foreign banks at the expense of U.S. creditors.

Technically, the paper seems to confuse bank reserves (which are held against liabilities, i.e. deposits) with bank capital (which is held against assets). The decline in oil prices, as in the Mexican case, is forcing some countries to consider seeking interest rate concessions, but this should not be accepted by the U.S. Government as a justification for a generalized scheme that would transform commercial bank debt into local currency loans at longer maturities and reduced rates of interest. For non-oil exporting LDCs, the current price decline is a blessing.

The proposal is considered an alternative to bailing out banks through the FDIC. In concept, it is “a private intermediary institution”, whose initial operating capital would be raised by the sale of zero coupon bonds to the public. However, there apparently would be a major U.S. Government contribution (or participation) through the addition of all outstanding U.S. AID loans, which would be serviced by the bank and over which the bank would have authority to renegotiate. This in itself could be seen as a partial U.S. contribution to a commercial bank bailout and would remove U.S. Government leverage over the debtors through Paris Club negotiations.

The proposal suggests combining loans of varying degrees of risk to a variety of nations. Many banks would wish to retain their direct relationship with individual borrowers, maintain the role of their branches in foreign countries, and be unwilling to sell off loans that they considered better than others.

The concept might have some attraction if an exit vehicle were being designed for banks wishing to retire from international lending.

An attachment (Tab A) considers in more detail some of the points in the proposal that refer to the Baker Initiative.³ The proposal is also attached. (Tab B)⁴

1. Source: National Archives, RG 56, Records of the Office of the Secretary of the Treasury, Correspondence Files, 1986, UD–13W, 56–89–13, Box 30, Memos to the Secretary, International Affairs, Jan–Feb ’86. No classification marking. Sent for information. Printed from an uninitialed copy. The date 02/27/86 is handwritten at the top of the page.
2. Under a March 3 covering memorandum, Patrick Buchanan sent Shultz a copy of a February 10 memorandum from James Warner to Charles Hobbs. Buchanan explained that the Warner paper “recommending a Bank of Settlements as the answer to the recurring foreign debt crisis—is circulating through the White House and Treasury; and I thought you might want to peruse this copy.” (Reagan Library, George Shultz Papers, Executive Secretariat Super Sensitive (03/03/1986); NLR–775–4–19–3–4) Whitehead wrote on another copy of Buchanan’s March 3 covering memorandum: “GPS: This is an absolutely terrible idea! John.” (Reagan Library, George Shultz Papers, Executive Secretariat Super Sensitive (03/05/1986–03/10/1986); NLR–775–4–21–9–5)
3. Tab A is attached but not printed.
4. Tab B is attached but not printed.