issue 189 - November 1988
Confessions of a loan shark
Young, hopelessly inexperienced, they roam the world like itinerant brushsellers,
peddling loans to Third World countries and living like kings. Ex-loan shark
Sam Gwynne reveals his contribution to the international debt crisis.
It is an odd business, selling money door to door on the edge of the Western world. It's odder still when the money comes not from the anonymous depths of the Eurocurrency market, but from the savings accounts of Americans in Ohio.
I used to sell their money for a living. I used to travel the world for a medium-sized Midwestern bank with five billion dollars in assets. Along the way I was engaged in some of the startling 'business as usual' banking practices that have begun to plague the world financial system.
It is 1978. Thanks to the repressive regime of President Ferdinand Marcos of the Philippines, I am happily resting in one of Manila's best hotels. I am about to set in motion a process that will result in a $10 million loan to a Philippine construction company, a bedfellow of the Marcos clan - a loan that will soon go sour. I am unaware that any of this is going to happen as I enter the hotel lobby on my way to dinner.
International banking is an interesting business anyway, but what makes it rather more interesting in this case - both to me and to the hapless Ohioans whose money I am selling - is that I am 25 years old with just one and a half years banking experience. I joined the bank as a 'credit analyst' on the strength of an MA in English. Because I happened to be fluent in French, I was promoted 11 months later to loan officer and assigned to the French-speaking Arab countries of North Africa, where I made my first international calls. This is my third extended trip, and my territory has quickly expanded. I have visited 28 countries in six months.
I am not alone in my youth and inexperience. The world of international banking is now full of aggressive, bright, but hopelessly inexperienced lenders in their mid-20s. They travel the world like itinerant brushsellers, filling loan quotas, peddling financial wares, and living high on the hog. Their bosses are often bright but similarly inexperienced 29-year-old vice presidents with wardrobes from Brooks Brothers and so little credit training they couldn't make a simple retail instalment loan.
Their bosses, sitting on the senior loan committee, are pragmatic, nuts-and-bolts bankers whose grasp of local banking is often profound, the product of 20 or 30 years experience. But the senior bankers are fish out of water when it comes to international lending. Many of them never wanted to lend overseas in the first place, but were forced into it by the internationalization of American commerce; as their local clientele expanded into foreign trade, they had no choice but to follow them or lose the business to the money-center banks.
The system is under severe strain. In 1975, US banks had $110 billion in loans overseas. By the end of 1982, the figures had risen to $451 billion. By September 1987 the top nine banks had $36 billion in loans to Mexico, Brazil and Argentina alone1 - all countries that had to 'reschedule' debt to avoid catastrophic defaults.
As I walk through the hotel lobby in Manila I know that something is up. I had arrived in the morning on a China Air flight from Taipei to be met by an 'expediter': someone who specializes in facilitating the arrivals and departures of important people. The expediter - 'Joy' - was the envoy of a client of mine: the Construction and Development Corporation of the Philippines (CDCP), a local company my bank had been courting unsuccessfully for years.
Joy had bribed the security agents at the customs and immigration line. We went through in two minutes what took other people an hour and a half. He took me to a waiting Jaguar equipped with air conditioning, stereo system, and a very pretty girl: 'at my disposal for the rest of my stay'. The girl was unexpected. Bangkok Bank gives me a silver Lincoln, but no girl. The Saudis give me a stretch Mercedes and a clandestine litre of Johnny Walker Black, but no girl. In the intricate world of Asian business, such things are done for a reason. Yes I thought, something is up
Now, hours later, I am met again by Joy. Wearing an immaculate white uniform, he takes my briefcase. It contains $5,000 in traveler's checks, a $9,000 negotiable air-line ticket, my passport and credit cards.
He disappears. We are playing the 'good faith' game. A minute later the red Jaguar slides up with my briefcase intact and the girl smiling prettily. Off we go.
I am taken to an expensive restaurant in Makati, where the president of the company, whose name is Rudy, is throwing a gala dinner in my honor. After eight courses, and enough liquor to intoxicate the Muslim population of Mindanao, Rudy announces, in slurred English, that he would like to borrow money. He says he wants to buy earth-moving equipment for a reclamation project on Manila Bay.
'How much were you thinking about?' I ask, in equally slurred English.
'Ten million,' he says, and laughs.
As a loan officer you are principally in the business of making loans. It is not your job to worry about whether you threaten the stability of the world economy. In that sense, a young banker is like a soldier on the front lines: he is obedient, aggressive, and amoral; his efficiency depends precisely on this very narrow view of the world. American banks, through the agency of loan officers like me, have made a number of questionable loans in countries whose balance of payments are so far in arrears that, according to Citicorp's Walter Wriston, 'ability to repay' is no longer the main consideration. All that matters now is access to the marketplace,' meaning the ability to borrow even more.
The theory goes something like this: as long as a country can continue to borrow money, it will effectively be able to 'roll over' its debt indefinitely. This way, the banks will be paid on schedule and the country will not become insolvent. But the banks are cornered. Unless they pump in more money, they stand to be forced into massive write-offs.
There is another curious aspect to this: even though the banks may allow a country such as Poland to 'reschedule' its debt - allowing it 20 years instead of 10 to repay for example - the interest payments keep coming. And it is interest that hits the bottom line of a bank's profit-and-loss statement. This means that Citibank can have a very good year even though many of its loans may be in serious trouble. The banks might have been imprudent in making the loans in the first place, but they are both clever and scrupulous when it comes to protecting the value of their assets.
At the root of this worldwide lending problem is a very simple concept called 'security'. When you borrow money to buy a car, the bank claims the car as 'security'. If you default on your loan, the bank can sell the car and recoup the rest of its money. But international banks cannot 'collect' a power plant in Thailand, or a hospital in Dubai. As an international loan officer, I learned to forget about security and instead to develop a set of rationales that would make head office feel good about the loan, even though, technically, it was 'unsecured'.
In Manila, I move dreamily through my appointments, fairly salivating at the prospect of a single $10 million loan. The remainder of my trip includes stops in Hong Kong, Kuala Lumpur, Tokyo and Seoul. I develop a few prospects, and a severe case of dysentery. But mainly I'm dreaming of that loan, writing pages and pages of pros and cons, imagining what it will be like inside the loan committee. In spite of my enthusiasm and my growing sense of self-importance, one con keeps cropping up and is finally given life by a fellow banker from Chase Manhattan, who I sit next to on the flight into Kuala Lumpur.
'Who do you do business with in Manila?' he asks, ordering our fifth round of scotch. I tell him.
'They're leveraged sky high,' he says.
When bankers say that a company is 'leveraged', they mean that the company's debt greatly exceeds the owners' equity or share in the company. I sneak a glance at the leverage ratio of CDCP. It is seven to one. One to one is considered healthy, two to one dangerous. It suddenly occurs to me that this loan might be pure insanity.
'You better get Marcos' signature, in blood, on that one,' the Chase banker laughs.
Back at head office in Cleveland, I am trying to remember all those three-hour lunches with five courses and two bottles of wine and what on earth I was talking about.
My telephone rings. It is the chief financial officer of the earth-moving equipment company, a subsidiary of a major auto company and an old client of the bank.
'I hear you've been talking to our friends in Manila,' he says, chattily, as though the difference in our rank means nothing.
'They want us to finance the purchase of your equipment.'
'I know. And we'd like you to give it a good, hard look,' he says, in a voice meant to remind me that his company has a great deal of money lodged with us.
I assure him that a good, hard look will be given to this proposal and hang up. Ten minutes later, the president of my bank calls about the same subject. I am again told to give it a good, hard look. What he means by this is that he wants the thing in loan committee, damn the company's leverage, and damn the balance-of-payments problems in the Philippines, period.
Debt crisis replay
Oil prices quadruple. Oil producing countries (OPEC) increase revenues which they deposit in transnational banks. The banks lend these to developing countries.
August, Friday 13 - the debt crisis begins. Mexico informs the US Government that it cannot meet the payments on its $80 billion foreign debt. Profits of the big banks continue to rise. Over the first four years of the debt crisis, after-tax profits at six big US commercial banks increase 57 per cent.
US foreign debt surpasses $100 billion, making it the world's largest debtor.
February - Brazil suspends interest payments. August - at least 10 Third World countries have stopped repaying their commercial bank creditors. October 19 - stock markets crash, representing loss of confidence in banks. Consumer wealth in developed countries is slashed by $1.5 trillion. Prospects for Third World exports dim further.
Instantly the wheels begin turning on this deal, my enthusiasm wanes. Realizing that I may well end up the whipping boy if things go wrong, I attempt, in bankers' parlance, to 'cover my ass'.
Let me explain. When the international loan you propose is less than sound, you may secure the guarantee of a third party to shore it up. The third party may be a private commercial bank, a government-owned commercial bank, or a foreign government. A government guarantee is best. If the guarantee party looks good on paper, most US loan committees will buy it. Never mind that thousands of bad loans around the world were cheerfully supported by foreign governments. American banks persist in the decades-old notion that 'banks and governments won't default'.
That's fine with me, and I set about securing a partial guarantee from the Philippines' largest bank. This strategy will both secure the affection of my president and my client, and will also advance my career.
It takes only a month and a few dozen overseas phone calls to get the guarantee from the Philippine bank, which is handing them out like free samples. Helped by a co-operative credit analyst who is three months out of an English degree, we package a stunning little credit that sweeps through the loan committees without even a flesh wound.
I am tapped on the head by innumerable vice presidents, given a small raise, taken to the opera by the client, and sent to Hong Kong for the signing of the loan.
My Philippine loan went 'bad' very quietly about 18 months later. Interest and principal payments simply stopped coming one day without notice. It was impossible to get any sort of recent financial statement from the company, and it was equally impossible to track down the principal debtors, who were ducking a host of other creditors as well. I had already moved onto a better job by then, along with all the other officers who had worked on the loan. My successor spent months on the intercontinental telephone lines trying to locate the debtors. When he did, he was assured of immediate payment. It never came.
Copyright, Harper's Magazine. All rights reserved. Reprinted by special permission.
1 Morgan Guarantee Trust.
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