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The Limits of Creditors' Rights: The Case of Third World Debt

Published online by Cambridge University Press:  13 January 2009

James W. Child
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At present, Third World countries owe over one trillion dollars to the developed Western nations; much of the debt is held by the leading international commercial banks. The debt of six Latin American countries alone — Argentina, Brazil, Chile, Mexico, Peru, and Venezuela — is over $330 billion, of which $240 billion is owed to commercial banks. Let us immediately narrow our focus to loans made by the major international commercial banks to Third World governments. We shall not be concerned with government-to-government loans, or private-party-to-private-party loans, or with debt owed to the World Bank or the International Monetary Fund. The bank-to-government loans — the so-called “sovereign loans” — are the most economically troublesome and morally interesting. The largest lenders, at least with respect to the Latin American countries, are the American banks Citibank, Chase Manhattan, Bank of America, Manufacturers Hanover, and Chemical Bank. About fifteen Third World countries have serious debt problems, including the largest: Brazil, Mexico, and Argentina.

Type
Research Article
Information
Social Philosophy and Policy , Volume 9 , Issue 1 , January 1992 , pp. 114 - 140
Copyright
Copyright © Social Philosophy and Policy Foundation 1992

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References

1 Sloan, Robert, “The Third World Debt Crisis,” Washington Quarterly (Winter 1985), pp. 106–7.Google Scholar These figures have changed little in the intervening years, since the debtor countries have made negligible progress in paying principal during this time. The factual claims herein are based broadly on the excellent coverage of the issue by the Wall Street Journal, Barron's, and The New York Times. In addition, see Jahangri, Amuzegar, “Dealing with Debt,” Foreign Policy (Fall 1987), pp. 140–58CrossRefGoogle Scholar; Dornbusch, Rudiger, “International Debt and Economic Instability,” Economic Review, published by Federal Reserve Bank of Kansas City, January 1987 Google Scholar; Foreign Policy Association, “Latin American Debt: Living on Borrowed Time,” in Great Decisions, 1989, pp. 26–34 Google Scholar; Sachs, Jeffrey, “Managing the LDC Debt Crisis,” Brookings Papers on Economic Activity, no. 2 (1986), pp. 397–440 Google Scholar; Sloan, “Third World Debt Crisis,” pp. 103–18; Tarshis, Lorie, “Disarming the Debt Bomb,” Challenge (May/June 1987).CrossRefGoogle Scholar

2 These banks, privately owned and run for profit, are to be carefully distinguished from both the central banks of the major Western countries such as the Federal Reserve, the Bank of England, and the Bundesbank and from the international institutions, the World Bank and the International Monetary Fund.

3 These days, we hear a great deal more about our domestic banking problems — in particular, bad real estate loans. However, this latest problem is compounded by the earlier, and still unsolved, international debt problem. In other words, Citibank, for example, is so troubled by its new bad domestic real estate loans in large measure because of its old bad loans to Mexico and Brazil.

4 The international commercial banks have accomplished this by drastic reductions in new loans to the Third World and, through exercising influence upon the International Monetary Fund, imposition of severe austerity upon their Third World debtors. However, they have also improved their situation by prudent, if belatedly applied, banking practices including increasing reserves for loan losses, building retained earnings (improving their debt-equity ratio) and increasing their asset base. See Economic Policy Council of UNA-USA, “Third World Debt: A Reexamination of Long-Term Management” (September 7, 1988), p. 6 Google Scholar; Jahangri, “Dealing with Debt,” p. 144, and Sloan, “Third World Debt Crisis,” p. 103.At the same time, things have perhaps not improved as much as we have been led to believe. The banks have been the beneficiaries of (and perhaps have politically influenced) very lax and favorable interpretations of federal banking regulations. For example, they have been allowed to count “interest payments” as income even when those amounts are immediately reloaned to the borrowers as “new loans.” See Sachs, “LDC Debt Crisis,” p. 406. Such practices would never be allowed with domestic loans. Lastly, it appears that a certain amount of creative, though legal, accounting has taken place to make loans appear to be paid down which are merely refinanced. See “Citicorp's Incredible Shrinking Debt, Has It Really Cut Its Foreign Risk?,” Business Week (February 8, 1988).

5 See Foreign Policy Association, “Latin American Debt,” p. 29.

6 Sloan, “Third World Debt Crisis,” chart 3, p. 110.

7 “Debtor Nations Fall Behind on Payments, as New Bank Loans Get Harder to Obtain,” Wall Street Journal (April 24, 1989).

8 Sloan, “Third World Debt Crisis,” p. 110.

9 See Sachs, “LDC Debt Crisis,” p. 409.

10 The Brazilian figure comes from “Brazil Lifts Wages and Resumes Indexing as Anti-Inflation Plan Ends in Failure,” Wall Street Journal (April 21, 1989).

11 “Dozens of Venezuelans Killed in Riots Over Price Increases,” New York Times (March 1, 1989).

12 “Jordan's Premier Quits Office as King Moves to End Crisis,” New York Times (April 27, 1989).

13 “Principal forgiveness” means exactly what one would expect. The principal of the loan owed is reduced. If I owe $1,000 and am unable to pay you, you might be happy with a repayment of $600. An “interest moratorium” is a period in which the borrower does not pay interest. In the typical case, the interest accrues to be paid later. In the most severe case, it does not even accrue for future payment, but is completely forgiven. In the least severe case, a creditor might accept a below-market rate of interest. All of these measures are loosely called “debt relief” or “forgiveness.”

14 Reviews of the Baker plan, along with criticism of it, can be found in A Report of the Inter-American Dialogue, “The Debt Trap: Still No Escape,” The Americas in 1988 (Washington: Aspen Institute for Humanistic Studies, 1988), pp. 24–33; Sachs, “LDC Debt Crisis,” pp. 400–404; and Sloan, “Third World Debt Crisis,” pp. 106–10. Sloan does not refer to the Baker plan by name, but he covers the history of the policy (and the period during which it was in effect) well.

15 This would require that the banks actually accept losses on their books in the form of lower profits or, more probably, operating losses and substantial impairment of net worth. Sloan, a conservative, calls for forgiveness: “Third World Debt Crisis,” p. 111. A center position requiring forgiveness is taken by the Inter-American Dialogue, “The Debt Trap,” pp. 33–37; Sachs, “LDC Debt Crisis,” pp. 424–27; and Tarshis, “Disarming the Debt Bomb,” p. 21. Payer, Cheryl, “Repudiating the Past,” Report on the Americas (March/April, 1985), p. 24 CrossRefGoogle Scholar, takes a much more radical position which includes both forgiveness and a drastic reordering of U.S. policy toward the Third World.

16 “Shift Is Seen in U.S. Policy to Ease Repayment Costs for Third World,” New York Times (March 5, 1989).

17 One interesting exception is a short argument in Sachs, “LDC Debt Crisis,” pp. 420–21, using principles from contract law. However, he nowhere considers moral wrongs or any other categories here employed.

18 Throughout, I shall make the Hohfeldian assumption that claim rights and duties are correlative and, where not noted otherwise, I shall mean by “rights” claim rights. This is not to say there are not noncorrelative kinds of rights and duties; there surely are. Indeed, there are problems with the whole correlativity thesis. For our purposes, however, we can safely assume it without complication. An excellent recent theoretical discussion of this issue, taking account of all the nuances, is found in Thomson, Judith Jarvis, The Realm of Rights (Cambridge: Harvard University Press, 1990)Google Scholar, chs. 1 and 2.

19 This is not to say that individual cases of terrible exploitation have never occurred. Of course they have. But they invariably involve multinational corporations which have obtained monopoly rights or other exclusive or limiting licenses which enable them to manipulate or destroy free markets for resources, other export products, labor, or imported goods. It is worth noting that when this occurs, it is not capitalism at work but something much closer to mercantilism. Moreover, it is almost always done in league with a highly corrupt, or dictatorial, or state socialist regime in the host country (usually one with all three characteristics). Such behavior is, of course, grossly immoral. It is also typical of at least some of the practices of the international commercial banks. That, of course, is the subject of this paper.

20 As a convenient facon de parler, we shall speak of the Pareto-improvement as if it could be scaled and interpersonally measured as a transaction surplus resulting from the sum of the benefit to the two parties. In a “good” transaction, the parties to the transaction share in the surplus, based on the outcome of bargaining. However, all that we say ought to be reducible to a good, hard-headed microeconomic model, most especially that set out in the Edgeworth box. See Shubik, Martin, Game Theory and the Social Sciences (Cambridge: M.I.T. Press, 1983), pp. 142–45Google Scholar, or Varian, Hal, Microeconomic Analysis (2nd ed.; New York: Norton, 1984), pp. 190–91.Google Scholar There are other possible moral theories of market transactions. One, which we might call the libertarian one, would hew strictly to a theory of right, rejecting a consequential or welfare criterion altogether. Moreover, it would stress the liberty of the parties rather than their autonomy, a much more ampliative notion. Thus, the moral conditions I impose upon a transaction are clearly not as spare as a rigorously libertarian set, such as that set out in Nozick, Robert, Anarchy, State, and Utopia (New York: Basic Books, 1974), ch. 7, especially pp. 150–74.Google Scholar Nozick does not include coercive offers as coercion, nor does he add any criterion governing the moral value of outcomes.

There is yet another moral theory of market transactions, which I call the ‘zero-sum theory.’ It was espoused by Aristotle and Marx, among many others. This intensely anti-market view holds rather equivocally, and perhaps incoherently, that all profit is immoral, and morally permissible transactions only occur when no one's position is improved. For an interesting discussion, see Georgesuc-Rogen, Nicholas, “Utility,” International Encyclopedia of the Social Sciences (New York: 1968), vol. 16, pp. 236–67.Google Scholar I have given no substantial argument in favor of my moral theory of market transactions, particularly against the more serious contender: the libertarian theory. That is a much larger theoretical project upon which I am presently embarked. Suffice it to say here that most of what I say about Third World debt and creditors’ rights would hold under the libertarian theory, as well as my own.

21 One sort of negative externality inevitably follows from otherwise Pareto-improving transactions in a market context. These are the so-called pecuniary externalities imposed upon B's competitors in (say) the widget-making industry. We will follow traditional welfare economics in ignoring these. Of course, this does not deal with the moral issue produced by the imposition of such externalities. However, I do believe that significant moral differences do exist between these pecuniary externalities and other, more traditional negative externalities. Among other things, they involve an assumption of risk. Of course, we do not have the leisure to work these differences out here.

22 I say “typically” because there are cases in which the rational expectation of a very large increase in one's income or wealth would rationally warrant the loan, even with a small discount for time. Other events could rationally warrant one heavily discounting one's future. One's impending death is an obvious example.

23 For a fascinating but depressing account of the long, unhappy history of sovereign lending, see James, Harold, “Deep Red: The International Debt Crisis and Its Historical Precedents,” American Scholar (Summer 1987), pp. 331–41.Google Scholar

24 Ibid., pp. 335–36.

25 Ibid., pp. 336–38. See also Jahangri, “Dealing with Debt,” p. 140.

26 Sloan, “Third World Debt Crisis,” p. 105. For a discussion of both the historical and legal ignorance and the lack of due diligence that this approach manifested, see Sloan, pp. 104–5.

27 Of course, no government is utterly without its own interests (so-called agency costs). We must not impose standards of behavior drawn from a Utopian conception of government upon Third World governments; they are standards which even the most responsible governments in the world cannot reach. Nonetheless, we can certainly divide governments into two rough categories, with a very fuzzy boundary between them. There are those which generally attempt to represent the interests of their people most of the time and those which totally disregard their people's interests, or are completely incompetent to serve them, or both. An unargued-for premise here is that typically the possession of democratic political institutions and the rule of law correlate highly with the first class of governments and dictatorship correlates highly with the second. (As the reader might suspect, I would be inclined to add the qualification of possessing essentially market-based economies to the first class of governments and the possession of planned or state socialist economies to the second. But that proviso need not be, and is not, presupposed here. Indeed, our next example will assume otherwise.)

28 Hereafter, we will treat the bank as a corporate individual. However, this should be considered shorthand for a group of individual persons set in an institutional framework. This would include the top executives of the bank plus the lending officers who actually make the loan. While I believe that we can talk meaningfully about the moral, as well as the legal, duties, rights, and general culpability of corporate individuals (states as well as banks), we assume a methodological individualism which allows us ultimately to reduce such talk to talk about human persons acting in institutionally defined roles.

29 Feinberg, Joel, Social Philosophy (Englewood Cliffs: Prentice Hall, 1973), p. 15.Google Scholar

30 Ibid.

31 Harm to Self (New York: Oxford University Press, 1986), p. 28.

32 “Competent Judgment of the Competence to Consent,” unpublished, pp. 3–4. See also Faden, Ruth F. and Beauchamp, Tom L., A History and Theory of Informed Consent (New York: Oxford University Press, 1986), chs. 7 and 8, especially pp. 288–90.Google Scholar

33 Haworth, Lawrence, Autonomy (New Haven: Yale University Press, 1986)Google Scholar, chs. 1 and 2.

34 Beauchamp, “Competent Judgment of the Competence to Consent,” p. 4.

35 Daniel Wikler has worked out some of these same notions. His is an especially good analysis of the threshold nature of this sense of general competence. See “Paternalism and the Mildly Retarded,” Philosophy and Public Affairs vol. 8, no. 4, reprinted in Paternalism, ed. Rolf Sartorius, (Minneapolis: University of Minnesota Press, 1983), pp. 83–94. See also Faden and Beauchamp, Informed Consent, pp. 290–91.

36 We shall ignore, due to considerations of both space and relevance, the notions of the authenticity of one's values. Feinberg, Harm to Self, discusses this issue, pp. 32–33.

37 A particularly rich conception of goals, projects, and their intimate relation to autonomy is contained in Raz, Joseph, The Morality of Freedom (Oxford: Clarendon Press, 1986), pp. 154 Google Scholar, 280–94, and ch. 14.

These six abilities, which are constitutive of general competence and are thus prerequisites for a capacity for autonomy, depend heavily on discussions in Beauchamp, “Competent Judgment,” p. 13; Feinberg, Harm to Self, ch. 18; Haworth, Autonomy, ch. 2; and Davis, Lawrence H., Theory of Action (Englewood Cliffs: 1979), ch. 5, especially p. 114.Google Scholar

38 Here we follow Anglo-American legal theory in treating knowledge of an outcome of one's act as intending that outcome. Thus, A intends the death of B where A knowingly caused the death of B, even though A's purpose was some other consequence of his action and the death of B was a contemplated double effect.

39 Bank A still has special duties if the incompetence of B is specific to this project. The possible presence of such project-specific conditions would require special investigation by A, which is part of its due diligence requirement in any case. Moreover, were A to know about these conditions, it would be required to provide notice to B as to the likely failure of its project. Should B persist with its errant project, A ought both prudentially and morally to withdraw the offered loan. Note that these simple obligations incumbent upon A in the domestic context are minimal requirements of prudent, as well as ethical, banking. It is inconceivable that a bank would make a loan to a corporation to build a factory based on mistaken technological assumptions known to the bank, for example. Why would an international bank ever do the analogous thing? As we shall see, one reason may be contained in the key term “sovereign.”

40 If this has ominous consequences in a normative assessment of the huge fiscal deficits that the United States ran throughout the 1980s, I would not be surprised.

Note, however, that we do not want to exclude all deficit spending for consumption by competent and autonomous governments. I, for one, want to permit competent Keynesian management of fiscal policy to end a depression, for example. A people can be presumed to want to end a depression.

41 The reader will note that another party to the transaction has appeared: the people. Here we risk multiplying abstract entities beyond necessity. We have the government, the state, and now the people (though our analysis makes little use of the state as a legal entity). While hypothesizing so many abstract entities is perhaps not completely felicitous, I believe it is coherent and meaningful. Hereafter, we shall use the distinction between “the people” and the government in much the same way Michael Walzer uses the distinction between the “political community” and the government in Just and Unjust Wars (New York: Basic Books, 1977), chs. 4 and 6. See especially his discussion of Mill's use of the same distinction, pp. 87–91.

42 Clear cases of this sort exist. Loans to the Argentine generals and to Ferdinand Marcos were of this type. Although we are not discussing loans to Communist countries (the “Second World”), this seems often, if not always, to apply to those cases as well. It is impossible for me to make a distinction between the above-cited cases and loans made (and there were many) to the government of Poland in the early 1980s, even as it crushed Solidarity and its top police officials were murdering dissident Roman Catholic priests.

43 Indeed, a distinguished international economist, Rudiger Dornbusch, in an eminently respectable forum, the Economic Review of the Federal Reserve Bank of Kansas City, speaks of the various forms of coercion used by the banks to obtain payment with uncharacteristic heat. He claims that the banks have implicated the United States government in their collection schemes in a way “that had gone out of fashion after 19th century gunboat diplomacy and the International Monetary Fund… [is] the administrator of the mugging,” p. 15.

Though at first this seems intemperate, if many instances like our case III have occurred it seems an honest assessment of all parties concerned with the collection of these loans. This is particularly true in (for instance) Argentina or the Philippines, where a legitimate democracy struggles with the debts run up by corrupt dictators.

Unfortunately, international law strongly supports the doctrine that a state remains responsible for its contracts, including loans, when a change of government occurs. A well-known international arbitration, the Tinoco case, clearly establishes this. See Akehurst, Michael, A Modern Introduction to International Law (5th ed.; London: George Allen and Unwin, 1984), pp. 56–57 Google Scholar, 60–61. It would seem that the Tinoco doctrine supports continuing responsibility, no matter how great the break with the past regime is or how terrible the debtor regime was. An alternative, but related, approach to attack the viability of much Third World debt might be to question Tinoco doctrine. It is not at all clear to me that the notion of a state is strong enough to support imposing Marcos's debts on Aquino's government, for example. Still, we must hold the Reagan Administration responsible for the Carter Administration's contracts, lest international anarchy result. Needless to say, drawing the line between these cases is a project unto itself.

44 We will here ignore the complexities of the order of priority of creditors’ claims, a terribly complicated issue.

45 Here, the Federal Deposit Insurance Corporation insurance would do no good. In the failure of Continental Bank, then the nation's seventh largest, it was the large depositors (with deposits of over $100,000 which are not insured by FDIC) who ran on the bank and brought it down (or, more accurately, brought on a preemptive governmental takeover). The large depositors included major corporations, Saudi princes, philanthropic foundations, and other banks. See Zweig, Phillip L., Belly Up: The Collapse of the Penn Square Bank (New York: Crown, 1985), pp. 438–39.Google Scholar The Penn Square Bank was a relatively small Oklahoma bank which virtually “manufactured” bad, and often fraudulent, energy loans and sold them to a number of bigger banks. Continental was one of its most avid customers. When the scams at Penn Square were revealed, the confidence in Continental — by then an owner of millions of dollars worth of Penn Square loans — collapsed and the run began.

Zweig's book is as much a story of the demise of two huge banks, Continental and Seattle First National Bank, as it is of one relatively small bank, the Penn Square. It is also an object lesson in how interconnected the American banking system is. The failure of one bank can easily cause the failure or severe impairment of others. Thus, the failure of a large bank can severely strain the whole system, as the Continental failure did. A simultaneous failure or severe impairment of all of the five largest banks in the United States would be catastrophic compared to the Continental failure.

46 For an excellent discussion of this issue in historical perspective, see Solomon, Robert, The International Monetary System, 1945–1981 (New York: Harper and Row, 1982)Google Scholar, ch. XVII. See also Jahangri, “Dealing with Debt,” pp. 141–43.

47 Although prudent domestic banking requires, as a matter of course, the financial modeling of the borrowing corporation, including various “worst case scenarios.” Even the most elementary analysis includes dramatically increased interest rates — a parameter banks are especially attuned to, given their own sensitivity to that variable.

48 Foreign Policy Association, “Latin American Debt,” p. 30.