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NEITHER A BORROWER NOR LENDER BE (PART II)

September 17, 2013

NEITHER A BORROWER NOR LENDER BE (PART II)

We saw in part I of this essay that a loan transaction involves rights and responsibilities of both borrower and lender, and that Wall Street banks were bailed out in 2008 by you and me, including those of us whose home equities (net worth) were destroyed (as collectively measured) in the trillions of dollars. We saw that those banks took their corporate welfare bailouts and ran, leaving borrowers on homes to foreclosure and economic ruin in an economy on the edge of recession with trillions more in production lost due to the global antics of Wall Street banks and the consequent slowdown in export trade and in the American economy in general.

Borrowers were left to their own devices since there was no forgiveness to be found in the bankruptcy code, but lenders were bailed out, and as a result and even though insolvent, didn’t need to take bankruptcy. Lenders (Wall Street banks) were rescued in part by the borrowers they bankrupted (though such borrowers were denied relief in bankruptcy).

This result is not only incongruous; it is morally wrong and shows a clear preference by government for lenders over borrowers. The banks should have taken bankruptcy and their shareholders should have been required to assume the losses for their banks’ irresponsible conduct and not those of us who were not complicit in such reckless if not criminal conduct of the banks. We not only did not require the banks’ shareholders to shoulder the loss for the risk they took, we bailed them (and even their insurers) out, too. How (and why) did we get into this act? Were we co-signers? Why are you and I at risk for someone else’s reckless if not criminal conduct? Did any banksters go to jail? Nay, not one!

This part will spotlight other not so well know crises caused by Wall Street banks in their greedy pursuit  of profit, oblivious to consequence, and make some suggestions to reform and reregulate the financial sector’s pursuits which only five years ago threatened to bring down the American economy. When big banks are too big to fail but America is not, then the tail is wagging the dog and we have to regulate these institutions in order to (literally) save America from Third World status. We have little choice.

Per Madrick, “The greatest model for banker irresponsibility in international lending was the Latin American debt surge of the 1970s. A sharp rise between 1973 and 1974 in the price of oil had left Citibank and many other global banks flush with cash reserves from the oil-producing nations.” Some economists, including Paul Volcker, wanted an international body to handle the recirculation of oil money, but Walter Wriston, chairman of Citicorp, quickly loaned the money to several nations in South America and Africa. Wriston asserted that “countries don’t go bust” because they always have their infrastructure, their natural resources, and their trained workforce. (Citibank made a bundle in fees and commissions – not to mention interest – with their Latin American and African loans.)

Wriston was wrong in all events. As pointed out by Australian law professor, Ross P. Buckley, nations can neglect their infrastructure, the value of natural resources can fall, and their educational systems can be allowed to erode in quality, so that they can effectively go “bust.” (We in this country are beginning to follow this model with our sure to fail austerity tactics of late.)  In the early 1980s, Volcker, then Fed chairman, raised rates precipitously to counter inflation. It was painful though it worked, but the downside problem for Latin America was that it made their exports less valuable, so they were faced with higher interest costs and lowered value of their exports – less money to pay higher bills.

When Mexico defaulted in 1982, Volcker and the IMF forced banks to take modest losses, but the banks refused to further write down their loans and take more losses until Bush the elder’s Treasury Secretary forced the banks into taking a compromise several years later. During the interim, lending to both Latin America and Africa was cut off, their recessions deepened, and the poor (as usual) paid the price. UNICEF estimates that more than half a million children under six died in Latin America and sub-Saharan Africa EACH YEAR in the late 1980s as a direct result of the debt crisis and failure to quickly resolve it. This is one of many inhumane results of our failure to timely and intelligently intervene in such crises.

Just as Germany and the EU are now undoing Greece and others with their doomed to fail austerity policies, IMF and the G7 countries imposed harsh conditions on over-indebted nations in East Asia circa 1997. Western money rushed in when high interest was available on short-term loans, but rushed back out when East Asia’s trade deficits soared and recession appeared inevitable, removing capital from economies that needed it to survive. Thailand collapsed. IMF rushed in with money but demanded harsh cuts in government spending that deepened the region’s recession, all of which did little to restrain soaring unemployment and prevent the failure of thousands of companies. More than 10 million people in Indonesia, Malaysia, the Philippines, South Korea and Thailand fell into poverty between 1996 and 1998. (Shades of current day Greece, Spain, Portugal, Italy et al.! Thanks for your help, Frau Merkel!)

IMF ad hoc interventions in national economies almost always favor lenders (bondholders) over borrowers in demanding undue sacrifices from borrowers, a prejudice that leaves poor countries poor for years, encumbered by debt but with polices made from afar which prevent timely recovery. This pattern of having IMF and other such international bodies (EU et al.) come in and dictate policies as condition for “loans” and other such assistance to the faltering economy of poor countries has its limitations. Iceland has shown that default and bankruptcy of banks may be preferable to accepting help from IMF along with the dictates of policy usually reserved to sovereign choice irrespective of financial status. Thus, as with Merkel the German leader and Greece, where do her allegiances lie? With Greek economic recovery or German bondholders of Greek debt? I think the answer is obvious.

Some international economists have suggested that we adopt a sensible bankruptcy policy for nations. I think this warrants further consideration and (perhaps) implementation. Per Madrick, there needs to be wider recognition that lenders as well as borrowers are at fault in these crises and that debt forgiveness is not charity. After all, as pointed out in Robert Kuttner’s new book, Debtors’ Prison, the Germans, who are now so tough on their common currency friends in southern Europe, owe much of their postwar prosperity to the fact that the Allies wrote off German debt after WW II, reducing their load from 675% of GDP before the war to 15% during the 1950s. It appears they are not of a mind to return the favor.

As of now, we are stuck with IMF and Merkel-like approaches to international bankruptcy matters. The world would be well-advised to by treaty adopt a single system of relief from debt so that all parties signatory could be enabled (when the need arises) to reach timely and comprehensive debt restructure  that WOULD GIVE THE DEBTOR COUNTRY ROOM TO GROW.  Greece, Spain and others are now stuck with massive unemployment, junk bond debt, policies made elsewhere etc. They cannot recover in any timely fashion under the present harsh conditions imposed on them, much less prosper.

We need to implement international rules to provide for recovery of nation states via a treaty whose provisions allow growth while recovering so that a modicum of sovereignty is retained by the debtor state. Globalization need not be a cover to protect the Wall Street raiders and IMF dictators to abdicate their roles as responsible lenders.  We can spread the losses arising from boom-bust cycles equally and fairly among capital and labor, creditors and debtors. Indeed it is arguable that the mechanisms put in place by such a treaty would make for more rather than less certainty in the lending marketplace.

Some have suggested an international “debt court” which would be vested with authority to manage negotiations between lenders and creditors, enforce agreements, make sure credit keeps flowing, and maintaining equitable sharing of losses. Others have suggested that Chapter 9 of our own bankruptcy code could be a model for international agreement.

All such ideas may have merit and should be fleshed out for treaty-ready adoption and implementation; however, I think that will take time and first things first, i.e., adoption of a treaty that sets out means of fairly spreading losses among lenders but keeps the debtor nation “in business,” so to speak. Why should a nation state be effectively shut down because it owes more money than it can currently repay and at confiscatory rates of interest (junk bonds)? It needs the flexibility to recover and not just stay mired in recession with policies of guaranteed to fail austerity made from afar which promise no relief to the debtor state’s economic recovery. Austerity has never worked in large economies, per Stiglitz.

Finally, we need transparency in these globalized lending practices. There is much room for chicanery when Wall Street banks are negotiating with corrupt African leaders for loans, for example. Since Wall Street too big to fail banks are still in a position (a la 2008) to bring the world to depression,  we the people through our government should have some say in what and how globalized lending is to be conducted. Socialism and Big Brother, you say? Hardly. We have a right to continued existence; we need not stand idly by while the tail wags the dog. We’re the dog. Let’s start acting like it.  GERALD  E

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