The rich borrow and the poor repay: the fatal flaw in international finance.

Author:Buckley, Ross P.
 
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No national legal system allows debtors to offload their debts onto others. Internationally, however, this happens frequently, with appalling consequences for the poor in developing countries. It happens when nations assume liability for the foreign debt of their corporations, as in International Monetary Fund (IMF) bailouts and other debt workouts, and when portions of national borrowings go directly into the pockets of politicians and senior civil servants. The socialization of private-sector debt will be examined within the context of the three most serious financial crises of the past 30 years: the African and Latin American debt crisis that commenced in 1982, the East Asian economic crisis that began in 1997, and Argentina's current economic crisis.

The 1982 Debt Crisis

The principal cause of the debt crisis of 1982 was simple. The borrowers had borrowed too much and the lenders had lent too much: $277 billion by the end of 1982. The principal borrowers were African and Latin American governments and state-owned corporations. In addition, there was significant borrowing by private-sector corporations in these countries. The lenders were principally North American and European commercial banks--Citicorp, Chase Manhattan, BankAmerica, and Lloyds, among others.

The borrowers failed to put the borrowed funds to work to earn a return higher than the interest rate on the funds--as required if debt is to be repaid. Much of the lending was for poorly conceived infrastructure projects, such as steel or gas works that were unlikely ever to be efficient, or for funding budget deficits. The lenders lent knowing that the funds, in the main, were not being put to productive use and were often indifferent to the fact that significant portions of the funds were going directly into the private accounts of corrupt politicians and civil servants. (1)

Massive debt flows began in earnest to Latin America and Africa in the early 1970s and continued right through to 1982, when Mexico told its creditors it was broke. The cessation of lending that resulted meant no countries in Latin America or sub-Saharan Africa could continue to service their borrowings. The immediate response of creditors was to reschedule the debt and advance new money to enable the debtors to keep on paying interest.

The creditors appointed steering committees consisting of executives of the banks with the largest exposures to represent their interests. This was necessary as, for instance, Brazil had over 1,000 creditors and could not negotiate with each separately. In addition to the debtor nations, there were hundreds of other debtors, including provinces and state-owned and private corporations. The banks persuaded the debtor nations to represent all debtors within their borders, and to bring all their debts under the sovereign guarantee of the state. The first step was necessary. The second was not. But bringing all debts under the sovereign guarantee certainly improved the security of the creditors--particularly those who had made most of the loans to private-sector corporations. And these just happened to be the major lenders--who controlled the steering committees orchestrating the process. (2)

If private-sector debt had not been assumed by the debtor nations, many corporations would no doubt have gone bankrupt. The financially strong ones would have repaid their debts. As it was, the debtor nations assumed this corporate debt owed abroad, and then sought to recover payment from the debtors. This attempted recovery of the debt domestically usually met with poor results due to corruption, cronyism, lack of government commitment, and the inefficiency endemic to these economies.

The workings of the market were thus short-circuited by a process directed by the International Monetary Fund and the U.S. Treasury. Monies that had not been borrowed by nations ended up being owed by them, and thus assumed by the people of the debtor nations. This situation was made worse by the corruption that siphoned off funds intended for public use. The poor in Africa and Latin America suffered disproportionately as this expanded debt burden was serviced by increasing taxes and reducing spending on education, health care, and other social services.

The East Asian Economic Crisis

The...

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