Congress Pushing Covert Bailout to Save Big Finance and Screw Homeowners

By Zach Carter, AlterNet. Posted April 9, 2009.

"Insolvency is a somewhat kind word," Darity says, referring to both the foreign debt crisis of the '80s and the current financial mess. "Really, the banks are bankrupt." 

In August 1982, Mexico's minister of finance told U.S. Treasury officials and the International Monetary Fund that his country would not be able to make an interest payment on an $80 billion debt. Several other countries, including Brazil, Argentina, Chile and Venezuela soon announced that they too would not be paying interest on loans from Wall Street. It was obvious that the national economies of these highly indebted countries could not generate the funds necessary to pay off the U.S. banks. 

The government has a non-bailout solution for this problem, but it simply refused to use it with big banks during the Latin American debt crisis and in today's mortgage implosion. When banks destroy themselves with predatory loans, the government is supposed to take them over and work out their troubled loans with borrowers.

Shareholders who made bad bets on a busted bank get wiped out, and the management team responsible for the problem is shown the door. Eventually, the rehabilitated loans that borrowers can now afford get sold to a new set of investors and borrowers get relief. 

In the '80s, instead of requiring Citibank, Bank of America and JPMorgan to write off loans that were obviously never going to be paid back in full, regulators adopted a policy of simply looking the other way. Regulators knowingly allowed banks to pretend that their loans to foreign governments were perfectly healthy, ignoring the fact that the banks had not only suffered losses, but were essentially kaput.

It would be nearly five years after the debt crisis began before banks started accounting for losses on their loans to Latin American governments, according to the FDIC, with Citibank becoming the first to do so in May 1987. 

This proved extraordinarily destructive to the economies of developing nations, particularly in Latin America. Accounting giveaways made it unnecessary for banks to acknowledge reality, so instead of reducing the overall size of the loans, they only haggled over individual interest payments. 

"That was a major economic and political disaster," says Luiz Carlos Bresser-Pereira, who served as finance minister of Brazil during the debt crisis. Bresser-Pereira was at the heart of Brazil's debt negotiations with the U.S. Treasury Department, major U.S. banks, the IMF and the World Bank. 

Enormous portions of the national economy in countries like Brazil became completely devoted to meeting one-off interest payments.  Once each payment was made, a new round of negotiations would begin for the next payment.

Long-term solutions that allowed the economies of countries like Brazil to recover were off the table. Actually reducing how much Brazil owed would have required the banks to take losses, but regulators would allow banks to value the original bad loans at full price. In several cases, banks even issued more debt to countries to help them pay the interest on old loans, building up an even bigger mountain of debt and putting even more pressure on their economies. 

"This meant that they didn't work out the loans for years and years and years, and so the interest carry got bigger and bigger," Black says. "When they were paying high interest, people are actually suffering malnutrition. It's a big deal in that context." 

When Bresser-Pereira initially began discussions with big U.S. commercial banks and the IMF, his country had imposed a "moratorium" on its debt -- it was refusing to make interest payments until banks agreed to a long-term solution that would allow Brazil to get moving again. But banks were focused exclusively on short-term fixes. 

See more stories tagged with: economic crisis, mark-to-market

Zach Carter writes a weekly blog on the economy for the Media Consortium. His work has appeared in the American Prospect, the Atlanta Journal-Constitution and on CNBC.

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