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

staunchly defended the system, claiming that higher foreign indebtedness was sound policy for both lender and borrower because the higher level of investment financed by foreign borrowing would eventually be reflected in additional net export capacity. As a result, commercial loans increased at much higher rates than those from governments or multilateral institutions during this period: while loans from official sources decreased from 54 to 34 per cent between 1979 and 1981, the percentage coming from private banks rose from 25 to 30 per cent.

      Down the hatch

      And just as when governments lent out monies to serve their geopolitical interests or the interests of their domestic industries, commercial banks also turned a blind eye to how and where their money was spent. As long as the money kept on flowing, the bankers didn’t care.

      Most of the Latin American loans were granted ‘for general purposes’, like the bulk of the Ziegler Nigerian loan, rather than for specific projects. In the best cases, governments chose to use this money to invest in the structures needed to support growth. Argentina, Brazil and Mexico, for example, used some of the monies for infrastructure – roads and transportation systems and communications. More usually, the loans were used for debt servicing or supporting domestic financial policy, enabling the borrowing government to retain popular support by avoiding raising taxes, cutting jobs or increasing prices, even though such moves might have been in the long-term interest of the country and its currency. In the worst, but by no means atypical, cases, these loans were simply another type of borrowing being siphoned off by the ruling elites. Between 1974 and 1982, the external debt of Argentina, Brazil, Chile, Mexico and Venezuela grew by $252 billion (most of which was owed to banks), about a third of that money went to buy real estate abroad and into offshore personal bank accounts.

      Similar scenarios played themselves out in Africa where much of the debt simply went unaccounted for, usually the victim of false invoicing, capital flight or other techniques to send funds to ‘more secure’ havens outside the country. In an alarming number of cases, the loans went into projects that had no chance of generating the income necessary to pay the loans back. Commercial banks lent monies hand-in-hand with ECAs, for a ghostly parade of white elephants. The Inga-Shaba hydroelectric project and power transmission line in Zaire, for example, originally estimated to cost $450 million – a loan which the US Export-Import Bank guaranteed the initial bill for while commercial banks covered cost overruns – ended up costing over $1 billion, equivalent to 20 per cent of Zaire’s debt. ‘It’s taking so long,’ one US embassy official noted, ‘that a lot of the equipment they’re putting at the two ends is deteriorating.’ In fact, by the time the project was finally completed, the need for power in Zaire’s rich copper mines, the whole reason for the project in the first place, had already been met. The Belgians who were running the mines for the Zaire government had tapped their own sources of external finance, as well as locally available hydroelectric power, to keep themselves afloat.

      In Togo, a combination of export credits and a loan syndicated by German commercial banks was used to build a steel mill. When the Togolese government realized that no iron ore was available to start production, it ordered the German technicians to dismantle an iron pier located at the port – a pier that had been constructed by Germany prior to WWI and which still functioned well. Once the steel mill had exhausted the pier as a feedstock, it closed down.

      And, once again, dictators, tyrants and military juntas were bankrolled by Western money. In Argentina, the debt contracted by the military dictatorship between 1976 and 1983 (the vast majority of which was commercial) went from $7.9 billion up to $45.1 billion. With half of the money lent by commercial banks between 1976 and 1983 remaining abroad, often with the knowledge of the lending banks themselves. In Brazil, it was also the military that contracted most of the roaring commercial debt – jumping from $3.9 billion in 1968 to $48 billion in 1978. In 1970s Africa, the corrupt Mobutu ran up $579 million of commercial debt.

      How did these loans make it through the banks’ due diligence? Investigations the banks carried out before they made their loans ranged from the minimal to the actively negligent. A loan is said to have been granted to Costa Rica in 1973 on the basis of a single Time magazine article on the country. Chase Manhattan and many other banks tried to lend to countries which were already in default to them: when Chase offered Bolivia a new loan in 1976, for example, it did so in complete disregard of the fact that it was a creditor on another loan for which Bolivia was already in default. Mexico was offered additional loans even though it had already committed 65.5 per cent of its export revenues to paying debt service charges, which indicated a pre-existing level of commitment that was already very high and extremely difficult to service. And many bankers making the loans just didn’t know what they were doing. As one of the bank executives involved in the negotiations said at the time, ‘I am far from alone in my youth and inexperience. The world of international banking is now full of aggressive, bright but hopelessly inexperienced 29-year-old vice presidents with wardrobes from Brooks Brothers [and] MBAs from Wharton or Stanford.’

      Inexperienced they might have been, but they were sure making money. A Salomon Brothers’ report, published in 1976, revealed that the 13 largest US banks had quintupled their earnings from $177 million to $836 million during the first half of the 1970s, with a significant share coming from developing country loans. By 1976, Citibank was earning 72 per cent of its income abroad, Bank of America 40 per cent, Chase 78 per cent, First Boston 68 per cent, Morgan Guaranty 53 per cent and Manufacturers Hanover 56 per cent. In the 1970s, Banque National de Paris, one of the world’s largest banking houses, profited more from its various African affiliates than from its extensive branch network in France. Nigeria alone came to account for up to 20 per cent of the bank’s after-tax earnings in the late 1970s.

      All this lending appeared to have no potential downside at all. Walter Wriston, former president of Citibank and perhaps the greatest recycler of them all, famously said during the wild lending period, that there was no danger in foreign lending because ‘sovereign nations do not go bankrupt.’ This was a maxim which essentially became the rallying cry for a whole generation of bankers. Lending, lending and more lending was held up as a huge achievement: ‘It was the greatest transfer of wealth,’ Wriston said, ‘in the shortest time and with the least casualties in the history of the world…[it is] something to be proud of. It was a terrifically difficult thing to do. We did it. It was also hard to-put the guy on the moon. We did that.’

      And this was the accepted position. ‘We reject the view that international lending activities of American banks are posing grave risks to the American economy or the banking system,’ said C Fred Bergsten, Assistant Secretary of the Treasury for International Affairs, when he testified in 1977 before the House Banking Committee. ‘We believe to the contrary, that they have been remarkably successful in playing a vital role in helping to finance an unprecedented level of international trade, capital flows and payments imbalances – and that they continue to enjoy such success.’

      To some extent, this exuberance was understandable. Countries such as Argentina, Brazil, Nigeria and Mexico had natural resources and enough trade to cope, at least initially, with a certain degree of indebtedness. Interest rates were low, which meant that servicing the debts should have been manageable in theory. Countries which could not pay back their debts were just given even more new loans to pay off the old ones. And even if countries couldn’t service these loans, bankers believed that when push came to shove they would be bailed out, that geopolitical interests would as ever hold sway.

      ‘Banks who lend too much too fast know there will be a bailout, no question about it,’ the officer of a large New York City bank said at the time. ‘They scoff