On Tue, 20 Aug 2002, Daniel Davies wrote:
> All of which is a long winded way of saying that no, the kind of
> arrangement that some of us have with our retail banks whereby they can
> request immediate repayment of our overdraft, does not have much of a
> counterpart in the world of corporate lending. But nevertheless, I'd
> say that Stiglitz is right.
>
> The reason would be that it is a general principle of loan agreements
> that an event of default entitles to bank to "accelerate" its claims;
> ie, all the monies become payable right now. And an "event of default"
> under a loan agreement doesn't necessarily mean a missed payment; it
> could be a breach of a covenant relating to gearing, or a "material
> adverse change", or even a change of management. Basically, given any
> sort of adverse shock, the country is likely to find itself in a
> situation in which that company might end up having to repay the loan
> ahead of term, so it would indeed be prudent to set aside $x in reserves
> for every $x loan facility.
I think I understand everything you're saying, but the last sentence still doesn't seem to me to follow. What's going on now in Brazil, where credit is being almost entirely cut off, and sending the country into crisis, is not happening because of events of default -- is it? It seems rather that it's happening before them, and that the looming threat is precisely that if this goes on it will set off such a mass wave of default. This seems also to be what happened during the Asia crisis. So in this first stage, credit must be being tightened in ways other than using the events of default clause, e.g., through new loans not being made, through loans not being rolled over, through credit facilities not being renewed.
But all of that combined is not the same as saying "the bank can ask for those $100 million dollars at any time." Because, if I understand correctly, it can't. And therefore it would seem that prudence wouldn't demand a dollar for dollar set-aside by the country for reserves any more than a bank itself would put all its deposits in reserves. Rather it would demand a similarly small percentage set-aside. In which case Stiglitz's larger analysis (appended below to jog everyone's memory) would not hold: countries could conceivably grow through loans the same way banks could grow through deposits -- because only a small part is held in reserve and the rest is let out to more productive uses. (The common occurrence of balloon-style loans would increase the size of the percentage set aside but I don't see why it wouldn't still be a small percentage relative to the total loans outstanding.)
Now I would certainly give my assent to an alternative argument, which is that to the extent that countries operate like banks, and only put aside a percentage of capital to cover their loans, they are then liable to runs on the bank just like banks. And that if there is no lender of last resort in this "banking" system -- and there isn't -- then this is a disaster that is almost certain to happen to every country that participates. And that therefore the risk of loss outweighs the probability of gain and countries should be advised not to do things this way for the same reason that a poor person should be advised not to put her money in a shaky banking system that was w/o depositor insurance and prone to runs. But that's a very different argument, it seems to me, than the one Stiglitz himself is making.
One could also make a simpler argument: that a bank that paid 18% to 20% on deposits wouldn't have a chance in hell of making it either, and the idea that countries can get ahead by acting like banks on these terms is madness.
<Except from Behind the News interview with Doug Henwood (at www.leftbusinessobserver.org/radio.html)>
Joseph Stiglitz on capital market liberalization:
J.S: Capital markets are concerned with information, so the analysis of capital markets has been one of the primary foci of my research over the last 30 years. Let me give you an example of how they differ [from markets in goods]. Consider what happens in a small, developing country, say in Africa, when it opens up its capital markets freely to foreign capital. A company in the country borrows, say, a $100 million from an American bank. Well, the standard of prudence now requires that country to set aside a $100 million because it recognizes that that American bank can demand the dollars back at any time. And it has to have those dollars in reserves. With a hundred million dollars set aside for reserves, think about what this means for this poor African economy as a whole. It's borrowing $100 million from America, paying say 18 to 20 percent interest. How does it hold those reserves? In US Treasury Bills, T-Bills. In effect, it's lending to the United States. But what interest rate is it getting on the money that it's lending? About 2% today, less than 2%. So the net amount received by the country is zero. It gets $100 million from the United States, it lends $100 million to the United States. So it can't help economic growth. But think about it, it's even worse than that. Because on the $100 it lends the United States, it gets 2%, while on the $100 million it borrows from the United States, it's paying 18 or 20 percent. That means the net flow of funds from this poor African country is somewhere between 16 and 18 million dollars a year. It's good for the United States, it's good for the US Treasury, but it's not good for that poor African country.
DH: Suppose that poor country could take that $100 million and invest it in an agricultural product or a factory or something like that. Wouldn't it then have the money to service the debt?
JS: If it didn't have to put that money in reserves, it could then use that money, it could invest in education projects, it could invest in factories. It could do 101 things that would earn a far higher return than the 2% it gets in US Treasury Bills. But the point is that with capital market liberalization it's forced to put [all] that money into US Treasury Bills.
<end excerpt.