Jumbo Loans, Jumbo Risks

By Charles P. Alexander

Of all the troubles threatening American bankers, none is more controversial or potentially explosive than their overseas loans. Foreign borrowers, mostly governments and companies, owe U.S. banks about $350 billion. The most dangerous loans are to such economically ailing Latin American nations as Mexico, Brazil and Argentina, which collectively owe U.S. banks $59 billion and have barely managed to avoid default over the past two years.

This foreign debt is owed primarily to nine major institutions: BankAmerica in San Francisco, First Chicago and Continental Illinois in Chicago, and Citicorp, Chemical, Chase Manhattan, Manufacturers Hanover, Morgan Guaranty and Bankers Trust in New York City. Together they have $54 billion on loan to Latin America and the Caribbean. That represents a disturbing 157% of the banks' capital, which is the portion of their assets that belongs to the institutions themselves and their shareholders, rather than depositors. In a more limited way, dozens of regional banks, including Milwaukee's First Wisconsin Corp., National Bank of Detroit and Bank of Boston, have strayed into the foreign-loan field. First Wisconsin, for example, has loaned Argentina $70 million, which amounts to 22% of the bank's capital.

These impressive numbers raise questions in the minds of worried depositors: How could a Citicorp, much less a First Wisconsin, become so deeply involved in questionable foreign lending? Who is to blame? Why did Government regulators not keep the loans from getting out of hand?

Surprisingly, bank loans to foreign governments were almost nonexistent until a decade ago. But the 350% rise in oil prices in 1973 and 1974, from $2.59 per bbl. of Arabian light to $11.65, changed the face of world finance. In the new era of costly energy, scores of countries, not all of them in the Third World, were too strapped to pay their imported-oil bills. At the same time, Western banks suddenly received a rush of deposits from oil-producing nations. It seemed only logical, even humane, that the banks should recycle petrodollars from the rich to the needy.

Some bankers were initially hesitant. Lawrence Brainard, a former vice president of Chase Manhattan, remembers the day that the bank first faced the issue: "In early 1974 I joined a small group of senior bankers discussing a request by Denmark for a balance of payments credit. The key question in the meeting was whether private commercial banks had any business making unsecured loans to sovereign borrowers [governments]. After much soul searching, we turned down the request." Next day, however, a competitor stepped in to make the loan. "Within several months," recalls Brainard, "the resistance of my banking colleagues to sovereign lending gave way."

Once the dam cracked, it crumbled, and the flood was on. It became an everyday event for one or two lead banks in the U.S. or Western Europe to round up dozens of partners by telephone to put together so-called jumbo syndicates for loans to developing countries. Some bankers were so afraid of missing out that during lunch hours they even empowered their secretaries to promise $5 million or $10 million as part of any billion-dollar loan package for Brazil or Mexico. To seal and celebrate big deals, bankers staged signing ceremonies, complete with champagne and caviar, in opulent settings, some times a British castle or a mansion in Newport, R.I.

The banks' foreign-loan officers, many of whom were M.B.A.s in their mid-twenties, became accustomed to royal treatment in capitals throughout the developing world. In a Harper's magazine article last year, S.C. Gwynne, a former loan officer for a "medium-size Midwestern bank," described a 1978 visit to Manila, where he met with representatives of a Philippine construction company with connections to the government of President Ferdinand Marcos. After being whisked through customs, Gwynne found a red Jaguar and a pretty 20-year-old woman at his disposal. "The girl was unexpected," he wrote. "Bangkok Bank gave me a silver Lincoln but no girl." After returning home, Gwynne, at the urging of his superiors, arranged for his bank to give a $10 million loan to the Philippine company, which later failed to meet its payments.

Banks argue that their foreign loans were encouraged by officials at the U.S. Treasury and Federal Reserve Board. They feared that developing countries would become economically and politically unstable if credit was denied. In 1976 Arthur Burns, chairman of the Federal Reserve, began cautioning bankers that they might be lending too much overseas, but he did nothing to curb the loans. For the most part, they ignored the warning. Financiers were confident that countries like Mexico, with its oil reserves, and Brazil, with abundant mineral resources, were good credit risks. Recalls a former Chase Manhattan banker in Asia: "The world beckoned, and there was a strong feeling that we were laying the foundations of the American century."

That feeling faded fast in August 1982, when Mexico's close call with default dramatized how unsteady the international debt structure had become. Since then, bankers have tightened their purse strings. In the first half of this year, U.S. banks managed to reduce the amount of their foreign loans by $9.4 billion, to $350 billion, by refusing to renew some credits.

Most of the cutbacks have come from regional banks that can afford to pull out because their stakes are small. The bigger banks, by contrast, are in so deep that they have no choice but to keep on lending. If they were to demand repayment, the economies of Latin America would deteriorate and defaults might result. Rimmer de Vries, chief international economist at Morgan Guaranty, projects that U.S. bank loans to developing countries will rise by about 5% annually during the next few years.

For the moment, the world economic recovery has improved the financial prospects of debtor nations by helping them boost exports. In addition, falling interest rates and increased aid from the International Monetary Fund have eased their debt burdens. But no one is convinced that the foreign-loan problem has been solved. Bankers recognize that an upsurge in interest rates or a U.S. recession could ignite the debt troubles once again.

-- By Charles P. Alexander.

Reported by Gisela Bolte/ Washington and Frederick Ungeheuer/ New York

With reporting by Gisela Bolte, Frederick Ungeheuer