"The Debt-Bomb Threat," Time,
Summary:
The
debt-bomb refers to the situation where $706 billion in debt is held by banks,
governments and international financial institutions worldwide against troubled
developing and East bloc countries.
Most of it will not be repaid, and the consequences of a default
somewhere in the system could lead to political and economic reactions across
the world. According to British
Financier Lord Lever, “the banking system of the Western world is now
dangerously overexposed. If lending
abruptly contracts, there will be an avalanche of large-scale defaults that will
inflict damage on world trade and on the political and economic stability of
both borrowing and lending countries.”
Growing awareness of this “debt-bomb” become apparent when in the
previous 21months, Poland, Mexico, Brazil and Argentina all encountered
situations where they could not cover debt payments. Although short term rescue plans worked,
the nature of these occurrences makes it harder for borrowers to raise funds and
maintain payments, which could lead to problems for the more than two dozen
debtor countries in
The higher energy prices of the 1973 oil shock helped to plunge
developing countries into debt, which were further hurt by the 1978-79
shock. A lingering world recession,
high interest rates, slumping exports and flat trade, increased protectionism in
industrialized countries and low commodity prices have hurt developing countries
ability to pay debt through export earnings. A combination of several medium
countries encountering troubles could be more of a problem than one large
default.
A good portion of the
There is much apprehension amongst banks as well, Western European banks
are seeking to make loans to countries of questionable risk tax deductible, West
German banks are informally recommended to unofficially write off 40% of
sovereign risk loans.
The big fear lies in that a rise in the number of defaults could turn the
world recession into a depression.
Over 40% of
There has been little prior warning of debt problems, borrowers put off
admitting difficulties until the last moment in fear of breaking lender
confidence. In situations where
default is a possible, lenders try to avoid default by any means. Scheduling repayments at least secures
some stream of income. If the
debtor defaults and stops payments altogether, the bank has no choice but to
write off the loan. Too many
write-offs can lead to insolvency for the bank. Some countries require further loans to
make payments. The larger banks are
in too far to refuse these loans, but smaller banks are not. The risk lies in a lender calling the
borrower in default. This could
lead to cross-default clauses among other creditors. This would make it possible
for a small institution that loaned $100,000 to bring down a country with
$27million in debt. A default on
one loan could lead other creditors to call in their loans.
The origins of the current debt crisis lie in the first oil price
increase by OPEC. The money amassed
by these countries was funneled into the world’s major banks which made loans to
developing nations. The amount of
money flowing in was vast. Banks
were making larger profits off of loans due to deal commissions and that
developing countries paid higher than average interest rates. Competition among lenders
was high, due to the amount of money that as available. Even in 1974, the danger was present but
ignored by the banks. The loans
offered by the banks were eagerly sought out as well. Developing nations like
In late 1978, OPEC price increases were followed by a
Increased uncertainty shrank lending markets, leading to more scrutiny
and less money for borrowers.
Governments do come and go though.
Governments can lose access to world credit markets and stop making debt
payments. The possibility of
defaulting can’t be dismissed however, if IMF austerity plans would lead to
rioting in the streets and severe local unrest, defaulting and being ostracized
by the world credit markets would be preferable.
Although there have been some smaller banks that have stop international
lending, there are more who are pushing for increased lending, such as Regan,
Volcker and the Managing Director of the IMF. This attitude is echoed in a comment by
Henry Kissinger, “new loans must be in excess of [borrowing countries’ existing]
loans interest payments to allow these counties to keep growing.”
Some
Proposed Measures:
An Early
Warning System
William Ogden, vice chairman of Chase Manhattan, proposes that 31 of the
world’s largest commercial banks to set up a “private IMF.” It would collect information on debtors
and release material. This would
help banks to prepare for future crises.
A Debt
Takeover
The World Bank could take over troubled loans from commercial banks. This is unlikely to happen, not only
because the World Bank would resist this much debt, but that parliaments would
not want the banks to go unpunished.
New
International Institutions:
The main deficiency of the IMF is a lack of money. Although having its assets increased by
50% to $90billion, it might not be sufficient to cover an increase in the rate
of defaults. A richer, more
powerful IMF could lead banks to loan more, but it could also worsen the
situation through its imposed austerity measures.
The debt-bomb is not something that will go away in the near future. The best that can be hoped for is that
debtor countries practice as much austerity as is feasible and that banks
continue to support countries in debt with debt rescheduling and new loans. Of most importance, is that all those
participating understand the capabilities of the others for action in order to
better deal with later problems.
Summarized
by: Donald
Ripley