Policy Analysis No. 23

The Causes and Risks of Excessive Foreign Lending

By Mark Hulbert
April 20, 1983

Executive Summary

Banks…who lend too much too fast know there will be a bailout, no question about it. They scoff at bankers who create large loan loss reserves and those who in general are more conservative. They know that come the revolution in Mexico, or wherever, their banks will have the highest earnings and pay the highest dividends, and that they personally will receive the highest bonuses.

— Officer of large New York City bank, describing his attitude toward Third World lending.[1]

Commercial banks have indeed lent too much too fast to Third World nations and are in dire need of being rescued. In just three countries (Mexico, Brazil, and Argentina) the loan exposure of the top nine U.S. banks exceeds their combined equity capital. If just one of these countries’ governments were to repudiate their bank debt, the largest banks, as well as the banking system as a whole, could well collapse.

Is this bank officer’s confidence in a bailout widespread within the banking community? William Cline, formerly a Senior Fellow at the Brookings Institution and now with the Institute for International Economics, believes that it is. “The banks do not fully incorporate through their own business calculations the inherent risks to their lending because they anticipate that if there is a problem there will be a bailout.”[2]

The wisdom of bailouts, and what Congress’s attitude toward excessive foreign lending by commercial banks ought to be, are crucial issues right now because Congress is once again being asked to increase the U.S. contribution to the International Monetary Fund (IMF) — this time by more than $8 billion. It was little more than two years ago when Congress was last asked to increase the IMF’s resources, amid assurances from the U.S. Treasury that that increase would be sufficient to keep the international monetary system functioning for at least five years — until the next regularly scheduled review of the size of quotas. The chairman and ranking minority member of the House Banking Committee were so confident of this, in fact, that they wrote to all members of Congress arguing that a vote against that quota increase would “precipitate a world financial crisis that will bring these matters [of Third World debt] off the business pages of the newspapers and onto the front pages with ‘disaster’ headlines.”[3]

The fact that the present quota increase is coming more than two years ahead of schedule, and that Third World debt problems have jumped into the headlines despite 1980’s 50 percent increase in IMF resources, is clear evidence that our government’s response to foreign lending — and, in turn, its understanding of the causes of debt crises — is fundamentally flawed. These failings are inexcusable because there is a wealth of historical experience with foreign debt crises. Some governmental approaches to foreign lending in the past have been successful, for example, while others have failed. Repudiation of sovereign debt, furthermore, has been more prevalent under certain circumstances than others. What does historical experience suggest will be the likely outcome of current government policies concerning foreign debt? Are we doomed to repeat the mistakes of the past due to nothing more than ignorance of them?

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Mark Hulbert is editor of the Washington-based Hulbert Financial Digest and author ofInterlock (New York: Richardson & Snyder, 1982), a book examining the international financial aspects of the Iranian crisis.