By Pete Engardio It almost seemed like Paul O'Neill's inner Bono was speaking. The U.S. Treasury Secretary, a conservative Republican, has changed his tune dramatically since his May visit to four African nations with Bono, the Irish rock star who crusades against poor nations' debt burdens.
O'Neill's new, more compassionate message was obvious on Sept. 28 at the annual meetings of the International Monetary Fund and World Bank in Washington. At a private dinner meeting attended by many of the world's most powerful bankers and money managers, O'Neill launched into an impassioned appeal for rich nations to do more to help the world's poor. "For too long, we have settled for a vision that is only one-third or halfway up the mountain," O'Neill declared.
What struck me was the difference in how the American and European bankers reacted. I felt like shouting "Bravo!" -- and many of the Europeans present seemed to have the same reaction. "I think I've misjudged the man," said an official from one European central bank.
A COMING CLASH? The American bankers in the audience, however, seemed dumbfounded that O'Neill had wasted their time. "If he wants to help the poor, if he wants to reduce the foreign debts of these countries, then just do it!" fumed the CEO of a major global investment firm. "I don't need to listen to that for a half-hour." Snapped another American: "Weird. Doesn't he realize these guys answer to shareholders?"
Of course he does -- O'Neill is a former big-time corporate CEO himself. But the Americans' reaction to his positions signals a coming clash between the Bush Administration and Wall Street, because what really separated O'Neill's admirers and detractors were his remarks about the foreign-debt problems of developing nations. He still talks tough on reforming foreign aid and still opposes bailouts of emerging markets. But he now also seriously views himself as a champion of the Third World's poor.
O'Neill is a strong advocate of a new system to restructure the debts of countries that slip into financial crisis. The U.S. Treasury and IMF back two reform proposals: One is to have "collective-action clauses" written into all new syndicated loan and bond contracts for emerging markets, specifying procedures for restructuring the debt should a country near default.
CHAPTER 11 FOR NATIONS. The other proposal is a "structural" reform. IMF bylines and each nation's security laws would be amended to set up a new international system similar to the U.S.'s Chapter 11 bankruptcy process. After a country is declared unable to meet its obligations, the government and a committee of creditors would agree on a debt-restructuring plan. If the plan is backed by a majority of about 75% to 85% of debt holders, the deal would be binding on all lenders and bond investors.
The country also would have to adhere to fiscal policies and a reform package negotiated with the IMF. Many creditors would end up taking big losses, but presumably the process would prevent far more devastating financial damages.
The proposal for structural reforms was roundly endorsed in late September by the Group of Seven finance ministers, who instructed the IMF to draw up specific language in time for the annual IMF/World Bank spring meeting in April, 2003. Canada, Britain, and Germany have been particularly supportive of a bankruptcy-like system for countries that would allow for an orderly workout of debt problems. But U.S. associations representing banks, bond investors, and bond issuers strongly oppose such a system as overly complex and a threat to creditor rights. The Institute of International Finance, the Washington think thank that hosted the dinner O'Neill spoke at, is leading the opposition. The IIF's 320 members include the world's biggest banks and investment houses.
The poorest people are innocent victims of economic failure
In an attempt to make his case, O'Neill went for the heartstrings. Without explicitly calling for a Chapter 11 system, he reminded the bankers of the havoc that's wrought on the poor in countries whose financial systems collapse due to an investor panic, such as Indonesia in 1997, Russia in 1998, Argentina earlier in 2002, and perhaps Brazil next. "Always think of the guy making $100 a year," O'Neill admonished. Because of a currency crash, "his income can go down to $50." People at the bottom, he reminded his audience, are innocent victims.
IMPOSSIBLE CHOICE. Western banks and investors, O'Neill implied, share a big portion of the blame for getting poor countries to take on unsustainable debt loads and therefore share responsibility for solving the problem. "With our eyes wide open, we have made piles of loans to countries knowing they can't service them. We knew it. They knew it." It's immoral to keep making loans to countries "that we know will make them financially derelict," he said. "We need to grow up and be honest with ourselves about what [emerging-market debt issue] is and isn't investment-grade."
When a country ends up in financial crisis, O'Neill said, that leaves the IMF and G-7 countries with an almost impossible choice: "To use taxpayer money to pay off the sins of the past, or tell [countries] to take a hike." O'Neill also suggested that bankers and investors have an opportunity to help devise a new system to prevent countries from running up debts that can't be repaid and for resolving crises so that they don't end in economic collapse. "My plea is for you to help us with this," O'Neill said to the bankers.
The problem is that until now industry groups such as the IIF have been willing to talk only about milder reforms, such as adopting collective-action clauses. Even then, they advise that any changes in international capital markets be phased in over many years and be done voluntarily. But they've wanted nothing to do with structural reforms or developing a system for restructuring sovereign debts.
TILTING AT WINDMILLS? There's little evidence that O'Neill's emotional pleas have changed the minds of the plan's staunchest opponents. "We don't want a bankruptcy system," huffed the investment firm exec. "About 300 years ago, a man named Miguel de Cervantes Saavedra wrote a very interesting book," quipped IIF Managing Director Charles H. Dallara, referring to the novel Don Quixote. "It told stories about a man who tilted at windmills. I think these people should read that book."
As a result of the annual meeting, the IMF now has a clear mandate from the U.S. and other G-7 nations to press ahead on a sovereign-debt restructuring system. The next step is to draft legal language to amend its bylaws to allow for a formal debt-restructuring system. The U.S. and other IMF members will need to amend their own securities laws accordingly. Vows the manager of a big U.S. hedge fund: "If this comes up for hearings in Congress, we'll kill it."
The financial community could well succeed in burying the idea on Capitol Hill. But that would be a mistake. Except for financiers who are able to collect their debts after the IMF intervenes, it's hard to see how the current situation of repeated emerging-market crises and meltdowns can be described as anything but dysfunctional. For the innocent victims, the poor and middle-class of the developing world, the results are catastrophic.
Right now, the financial industry seems to hope proposals for reform will simply go away. It's unlikely that will happen. The more prudent -- no, more moral -- position for bankers would be to help search for solutions. Engardio is senior news editor for BusinessWeek in New York