IOU: The Debt Threat and Why We Must Defuse It. Noreena Hertz

cement of such a poor quality that years later many of the buildings constructed with it had to be demolished. Building after building made with that material was simply collapsing.

      Ziegler may not have known at the time about the inadequacy of the concrete, but he was well aware of the corruption that brought about the cement scandal. But back then cement wasn’t the issue. ‘My job was to sell money,’ he told me. And his $1.4 billion deal was all about that: selling money, and making money, too. As the lead bank in the syndicate, First Chicago would make 0.25 per cent of the $1.4 billion up front – $3.5 million. And if all went to plan, it wouldn’t carry the risk. That would be passed on to other banks in the syndicate. ‘To some schmuck in Des Moines, or some smaller bank in the North’, to quote Ziegler:

      Doing the deal was, he explains to me now, what it was all about. ‘First Chicago came along and we won, and I felt eternally grateful for that,’ he told me. I asked him about the corruption. ‘It worried some of us more than others,’ he replied, but ‘it was great kudos…The important thing was to win the mandate…[And when we did]…I was on a high. It was enormously exciting…We were young guys with the world at our feet.’

      I pressed him on the corruption issue, and he smiled wryly, perhaps because he now heads a centre whose mission it is to fight corruption and stamp it out. ‘As long as the country’s flag wasn’t black with a skull and crossbones on it or with a yellow banana on it,’ Karl tells me, ‘it was eligible for a loan.’

      Ziegler’s experience wasn’t unique. Throughout most of the 1970s, a host of banks – large banks (Chase, Citicorp, First Chicago, JP Morgan, Lloyds, Union Bank of Switzerland, the Banks of Montreal, Tokyo, Japan, and the French Banque National de Paris) and small rural American banks, too – lined up indiscriminately to push their loans to developing countries. It wasn’t only the Cold War players and other developed world governments getting in on the lending game.

      With memories stretching back to the widespread defaults on Latin American bonds in the 1930s, commercial banks had, on the whole, stayed away from lending to the developing world since World War II. But, in 1973, the banks returned to those shores with a bang. Eurodollar syndicated loans to Latin America jumped from $2 billion in 1972 to over $22 billion in 1982: 1,600 banks were involved in loans to Mexico alone. Commercial lending to Africa was significantly more limited, never reaching the poorest sub-Saharan countries, but, by 1982, it accounted for 35 per cent of regional debt.

      Many countries which had already seen their bilateral debts rise earlier in the Cold War now saw their financial obligations really explode. Argentina saw its debt rise by 544 per cent, for example, between 1976 and 1983. And while, in 1970, the combined external public debt of Algeria, Argentina, Bolivia, Brazil, Bulgaria, Congo, the Ivory Coast, Ecuador, Mexico, Morocco, Nicaragua, Peru, Poland, Syria and Venezuela was $18 billion (10 per cent of their GNP), by 1987, once the commercial banks had entered the picture, these countries owed $402 billion (almost 50 per cent of their GNP), with most of the monies being owed to the banks.

      What accounted for this sudden desire to lend on the part of commercial banks? As in so many geopolitical cases, you just have to follow the oil. In the wake of the Yom Kippur War of 1973, oil-producing countries perpetrated a massive hike in oil prices, sending them skyrocketing up by 400 per cent, almost overnight. The oil producers were suddenly extremely rich, and the surplus was far too much for them to be able to spend in their own countries. Furthermore, Islamic sharia law forbade the practice of usury and prevented the Arab oil producers from earning interest in their own banks. They needed somewhere else to invest their petrodollars and Western banks seemed the perfect choice.

      This meant that overnight a huge new supply of credit emerged – $333.5 billion, to be exact. 40 per cent went to banks in the US and the UK, and the remaining, but still significant, portion to banks in France, Germany and Japan.

      The banks were desperate to put this windfall to productive use. The highly competitive banking industry of that time required the recycling of funds; it was absolutely key to staying at the top. Lending the petrodollars out again was a clear money spinner. Banks benefited doubly, from the fees they charged to arrange the loans and also from the interest they would make on the loans themselves.

      But simply lending to the developed world wasn’t going to satisfy the bankers given that the demand for loans from borrowers there had failed to keep pace with the expansion of available credit. So the banks actively sought out new lending targets in the developing world, especially in those places where they felt there was an opportunity to establish a close relationship with a burgeoning economy. A market for commercial debt was created where there had not been one for decades. And once the big banks started lending, medium and smaller banks had no option but to follow suit.

      It was another round of borrow, borrow, borrow – this time courtesy of the commercial banks. ‘The banks were hot to get in,’ Jose Angel Gurria, then head of Mexico’s Office of Public Credit recalls. ‘All the banks in the US and Europe and Japan stepped forward. They showed no foresight. They didn’t do any credit analysis. It was wild. In August 1979, for instance, Bank of America planned a loan of $1 billion. They figured they would put up $350 million themselves and sell off the rest. As it turned out, they only had to put up $100 million themselves. They raised $2.5 billion on the loan in total.’ Other loans were similarly over-subscribed, and developing governments often found themselves offered more money than they had requested; that is, if they had even requested the loan in the first place.

      The commercial loan pushers soon created commercial debt junkies. Money was lent under terms that were hard to turn down. In the mid-1970s loans actually had a negative real interest rate, which meant that a borrower could pay less than they borrowed, and although the rates were variable, no one expected them to rise significantly. Unlike funds from governments, which often had strings attached such as having to be spent on imports of that country’s goods or having political colours firmly attached, these loans usually came obligation-free.

      It was easy for developing countries to rationalize their new addiction. For some, the decision to borrow more was based upon a belief that they needed to incur these commercial debts in order to ensure their country’s future development. During the 19th century, the United States went through a massive period of development, driven by a period of indebtedness to commercial banks, an example held up as a shining path for poorer countries to follow, despite the fact that many states never actually paid the loans back.

      For others, like oil-importing countries who had suffered under the particularly harsh blow of oil price hikes, it was basically a huge relief to be offered these loans. What they were being offered by other governments didn’t always suffice. As for the oilexporting countries such as Colombia, Ecuador, Mexico, Nigeria and Venezuela, the loans were a way to capitalize on their much improved financial status, at very reasonable interest rates. Likewise, African commodity exporters, seeing an increase in revenues thanks to the commodity price boom which initially accompanied the oil price increase, and anticipating a continuation of this enhanced income, were delighted to increase their level of borrowing.

      For others, the fact that these loans were being sold so hard was just too much of an allure to be able to resist. A Latin American Minister of Finance in the 1970s put it this way: ‘I remember how the bankers tried to corner me at conferences to offer me loans. They would not leave me alone. If you’re trying to balance your budget it’s very tempting to borrow money instead of raising taxes to put off the agony.’ The surplus of offers was often overwhelming. And for poor countries in general, borrowing money made sense in theory at least, providing them with the potential to address the economic plight of their citizens.

      Moreover the IMF, the World Bank, and the governments of the industrialized countries, actively encouraged the developing world to borrow from these private banks, with the World Bank preaching