Selling Money

One of the strangest parts of the Latin American debt crisis is how (and why) bankers were loaning huge amounts of money to corporations and governments in the region in the 1970s with seemingly little idea about creditworthiness.  As I point out in my video on the topic for MR University, “By the end of 1982, the ratio of Latin American loans to equity was in excess of 100% for 16 of the 18 leading international banks in Canada & the US.”

Even worse, “banks were unaware of the purposes for which most loans were used. Nearly 60% of all US bank lending in the 1970s devoted to “general purpose”, “purpose unknown,” or “refinancing.”

I’ve been meaning to read a book by S.C. Gwynne, who gives one of the only first hand accounts of working in this field at the time.  His book is called Selling Money:  A Young Banker’s First-Hand Account of the Rise and Extraordinary Fall of the Great International Lending Boom and I have finally gotten around to checking it out this summer.  It is really interesting and definitely worthwhile for anyone seeking to understand the period and the loan build up better.

By the age of 25, Gwynne had worked at Cleveland Trust Company for less than 2 years, but had already traveled to 25 countries on bank business and was managing $150 million worth of international loans.  As he himself notes, Gwynne was an unlikely candidate to be an international banker, given his undergraduate degree was in history, his master’s degree was in writing, and his work experience only involved teaching French for 2 years.

Sadly, this was far from unusual.  Banks were desperate to ramp up loans to developing countries in the 1970s and “expertise was thin, experience even thinner.  The volume of lending had simply outstripped the ability of smaller banks to keep pace with it.”

Here is Gwynne’s description fo Cleveland Trust Company’s international division:

“Its pool of experts in Latin American affairs consisted of one 32 year old VP with a halting fluency in Spanish and Portuguese, two 30 year old assistant VPs with a a total of 8 years banking experience between them, and me.  I was technically under the supervision of an experienced analyst in the credit department–but he spoke no foreign languages at all, and though he was well-schooled in certain areas of domestic credit, he had no idea what to do with, say, the effects of a massive currency devaluation on a Brazilian company’s balance sheet.” 

He notes that he “had only one month of formal training in a credit class when the bank assigned him to the Latin American area of the international division, although I spoke no Spanish.”  “When I joined the credit department there were 2 other analysts assigned to the international division.  Between them, they had one undergraduate economics degree, one Russian degree, and 3 months of banking experience.”

The description of how they tried to collect data on country risk and how little they actually knew about what was going on is excellent.  It’s too detailed to quote at length here but the following gives you an idea:

“The most popular intelligence-gathering grounds for most international bankers in those years were the central banks, which made sense for they were the ultimate sources of all economic and financial information on a country.  But in fact the loan salesmen couldn’t have chosen a more biased, self-serving, or bureaucratic environment to hunt for their hard facts.  The functionary did not deal in bad news:  that was counterproductive.  He purveyed only the sunnies of current statistics.  If the question you wanted answered was, Should I made a 7-year, $30 million unsecured loan in this country? then you were asking the wrong man.”

All of this reminds me a lot of what one of my former students told me before the financial crisis.  He had gotten a job with a mortgage company after high school and was shocked and appalled at the practices of the company, how skewed incentives were, and how poorly he thought things were going to turn out.  He decided that he couldn’t live with himself doing that kind of work, so decided to go to college instead.  Are there any good first hand accounts by mortgage bankers from this last bubble?

The Lost Decade of the 1980s and the current Eurozone crisis

In August, 1982, Mexico stunned the financial world by announcing it could no longer pay back its debt. Dozens of countries followed suit. The 1980s is often referred to as the “lost decade” for Latin American countries because of the harsh economic repercussions of the debt crisis and the austerity measures taken from the various governments.   It took most of the next decade before lenders and borrowers were able to negotiate a solution (called Brady Bonds after then-Treasury Secretary Nicholas Brady) that reduced debt and lengthened the time to maturity.  There was a fundamental disagreement about whether countries were suffering from a liquidity or solvency crisis.  Banks, international institutions, and rich country governments were desperate to label it as a liquidity crisis and demanded that bankrupt countries enact strict austerity measures and pay back all of the debt.  It wasn’t until later, when banks were able get on a more solid financial footing and a secondary market had opened up for discounted Latin American debt, that banks would even broach the idea that this was a solvency issue and that debt reduction was the only way to move forward.

Yesterday, one of my bright undergraduate students asked whether European governments and banks had not reached this stage as well.  The Eurozone crisis has surely been going on for long enough that it seems like a reasonable question.  It reminded me of a recent article by Eduardo Porter in the NY Times, who asks that question specifically.  He writes,

“But the most relevant parallel is one that European leaders refuse to see. If there is one overwhelming lesson from the debt crisis that struck Mexico and other Latin American countries so hard three decades ago, it is that countries that cannot grow will not pay. It is up to creditors, too, to allow them to grow. It took Mexico and its lenders seven years to figure that out. The European crisis is in its fifth year. You would think they might have learned something by now, but no.”

There are obviously large differences between the Latin American situation and the Eurozone crisis, so at first I was pretty skeptical of the analogy.  But the more I’ve thought about it, the more I think we might be getting closer to what happened in the late 80s with Mexico.  I see increasing discontent with austerity measures amongst Eurocrats and European officials, which leads me to wonder whether the analogy isn’t closer than I originally thought.

By the way, if you want to learn more about the Latin American debt crisis, and Mexico’s experience in particular, check out my videos on the topic here at Marginal Revolution University.