Journal Highlights: Roads I Have Traveled ... Transition Journal, Excerpt # 4

(continued): Brasilia, Brazil, 1986: While I was still working with Zimbabwe, the embassy in Quito, Ecuador, heard what I was doing, and I went there at their request. I had a great opportunity to research and study the concept of the debt swaps or debt-for-equity exchanges. By this time I was working under my newly formed company, International Market Exchange, (IMX).

From Quito I went to Lima, Peru, then to Caracas, Venezuela, and finally I traveled to Brazil, where I worked for nearly three years with President Jose Sarney and his chief economist, Antonio Bacelar. Our plan became known as the “Libra Proposal,” and we were joined in the effort by Mr. Dilson Funaro, the outgoing Minister of Finance, the incoming Minister of Finance, Mr. Bressler, and William Canvallo, the Secretary of the Federal District of Brazil. 

My involvement with the financial leadership in Brazil ultimately included my leading a delegation to Washington D.C. of Brazilian leaders to meet with Honorable James Baker, Secretary of the US Treasury. That was before James Baker had assumed the position of Secretary of State for the US. 

The Libra Proposal was a plan that made it possible for the repayment of Brazil’s debt back to the American banks. Brazil’s economy was at that time experiencing runaway inflation of three thousand percent. By the time the money would get into their system there was nothing left to pay the debts. 

While working on the necessary research for writing the economic sections of the book, What’cha Gonna Do with What’cha Got ?, I had run into an interesting concept. Many of the US banks had been coerced by our government, the World Bank, and United Nations to make sizable loans to foreign countries as economic relief measures. Instead of our government simply handing over large sums of additional monies to the United Nations, who in turn would hand out the monies to foreign countries, especially in Central and South America, they pressured our banks to make the loans directly to those needy countries. That sounded like a great strategy to bypass the corruption of the United Nations and the World Bank. But there was a big problem. 

The banks insisted that the sovereign countries sign legitimate promissory notes guaranteeing the repayment of the loans. Perhaps the United Nations or the World Bank could allow the foreign countries to default on the loans and just write them off as bad debts. But individual banks in America were under the tight scrutiny of the US Federal Bank Examiners and Federal agencies like FDIC. 

It was true that under the Nixon administration in the 1970s, when the US economy was cut loose from the gold standard, banks were allowed to use foreign sovereign debt instruments as credits toward their necessary Fractional Reserves. But it was high risk to make foreign sovereign loans, and utter disaster for the US banks if those foreign loans should ever go into default. 

By the mid-1980s, many of the foreign countries were in default to the US banks. South American countries simply shrugged their shoulders and said, “Sorry, we can’t make good on our loan commitments.” That threw the US banks into a crisis. Once the loans were declared non-performing loans, the US banks had to write them off, and if they had used them as part of their fractional reserves, their assets and lending powers began to implode. 

But some creative financial folks in the US came up with a clever way to take care of the problem. That program, known as Debt Swap caught my attention. It simply utilized the common elements of the old barter system to save the banking industry in America. 

Here is a common way debt swaps worked: US bank examiners would require that a certain bank would have to declare a sovereign foreign loan as a non-performing loan. The bank could no longer use the sovereign foreign debt instrument as part of its fractional reserves, and its lending ratio would shrink by approximately twenty times the amount of the non-performing loan. That would spell really big trouble. 

At that point a group of individuals or an entity would agree to purchase the bad loan at an attractive discount from the bank, and their new note would heal the bank. Thereupon, the new holders of the foreign note would take the note to the country owing the debt and agree to swap the note for assets within the country to settle the debt. 

 

Those assets could include government controlled exports, natural resources like oil concessions, mineral rights, undeveloped real estate, government-owned buildings, fishing rights, rights to ports and harbors, or any other service or commodity of equally agreed-upon value. Simply, the indebted country could use its own assets to settle the debt where it could not come up with cash to make the payments. 

Many times, as was the case in Brazil, large corporations within the country would desire to purchase portions of their own government’s debt so that they could use the credits to purchase commodities from the government within the country, or apply it to their tax obligations. The sovereign countries would end up better off, the banks would be better off, and the arbitrators would be handsomely enriched for their efforts. 

Next Week: Implications of International Debt Swaps or Debt for Equity Swaps for the trillions of dollars of U.S. international debt situation. 

© Dr. James W. Jackson 

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