The Business of America/The Debt Presidency
Stelzer, Irwin M.
THE BUSINESS OF AMERICA THE DEBT PRESIDENCY by Irwin M. Stelzer D ebt. That's the word President-elect Bush is likely to hear most often in his meetings with his economic advisers before he is...
...The first is that debtor countries are increasingly reluctant to adopt the economic reforms that Baker sees as the necessary predicate to new bank loans...
...government loan (Reagan cares more about the impact of low oil prices in Mexico than in the U.S., charged the Independent PetroIrwin M Stelzer is director of the Energy and Environmental Policy Center of the John F Kennedy School, Harvard University, and an American correspondent for the London Sunday Times...
...the money it needs to finance the deficit, on reasonable terms...
...That's the word President-elect Bush is likely to hear most often in his meetings with his economic advisers before he is sworn in on January 20...
...The problem is that such a plan has no independent existence: it is not a magic formula, waiting to be discovered...
...Bush has asked us to read his lips...
...Of course, some individual banks may be over-exposed to LBO loans, just as some Texas banks—but not the banking system as a whole—were brought to ruin by an over-weighting of energy loans in their portfolios...
...If all recipients of federal largesse more or less continue to get what they have been getting (with perhaps a bit, too small to notice, shaved off in real terms), and if the economy keeps growing at a real annual rate of anything like 3 percent, the increase in government revenues should begin to whittle away the deficit...
...Second, banks are not really over-exposed...
...Ronald Reagan and Jim Wright didn't disagree about bookkeeping: they disagreed about whether resources should be spent on the Strategic Defense Initiative and the Nicaraguan contras, on the one hand, or middle-income entitlements and bailing out Texas savings and loan associations, on the other...
...There is already talk at Wall Street luncheon tables that Senator Bob Dole has expressed a willingness to consider merger-discouraging changes in the tax laws, such as ending the deductibility of interest paid for money borrowed to finance takeovers...
...So an argument can be made (I won't bore everyone with the counter-arguments) that eliminating the tax-deductible feature of debt would remove the artificial incentive corporate managers now have to rely on debt financing...
...Not exactly a committed band of free marketeers...
...But if Bush indeed has a visceral feeling in favor of letting entrepreneurs take risks in pursuit of profit, and bear the consequences of any bad judgments, he will let the LBO game run its course...
...Corporate debt will force him to choose between greater regulation of entrepreneurial risk-taking, and a hands-off policy that may produce a few spectacular bankruptcies...
...So, if Bush holds the line on taxes—which is far from certain—military spending will have to bear the brunt of any deficit-reduction program...
...A major investment bank, working with data from the Federal Reserve Board and the American Banker, has provided some interesting numbers, in return for a promise of anonymity...
...After all, the world's money men have already fired a shot across the Bush bow: they sold the dollar down immediately after his election...
...If he is the pragmatist that some conservatives fear him to be, he may decide to intervene to avoid the possibility that a few banks may run into trouble...
...One must always respect Greenspan's judgment—he was, after all, decisive and, more important, right in moving to expand credit in the face of the October 1987 stock market debacle...
...Clearly, no consensus on deficit reduction exists...
...The banks now know better—Brazil and Peru for a long time suspended interest payments—and even in the absence of defaults, loans to foreign governments often can be sold only at substantial discounts (up to 80 percent) from face value...
...For one thing, it assumes that Congress is prepared to keep social spending more or less constant in real terms...
...consumers and the federal government . . . " Some cut in spending and increase in taxes—almost all Europeans with whom I meet favor higher gasoline taxes in the U.S...
...And, by initially refusing to intervene, the Japanese central bank let it be known that it could not be counted on, indefinitely, to support the dollar in the absence of some move by the new administration to stanch the flow of red ink...
...Morgan Stanley's Byron Wien recently visited European money managers and noted "a consistently expressed suspicion that the economic problems facing the United States will grow worse over the next year . . . " Foreign investors, he reports, fear the consequences of "the long period of overspending by U.S...
...After all, the ratio of debt to equity in American corporations (75 percent) is still well below the 106 percent level reached in the 1974 bear market, and shares of highly leveraged companies continue to out-perform the averages...
...Chancellor Nigel Lawson, sitting atop a growing budget surplus, has already renewed his unsolicited warnings to America that its continuing budget deficit could eventually cause a run on the dollar, and force it to raise interest rates to recession-producing levels...
...National Debt Finally, the President-elect will have to contend with nervous international bankers and finance ministers...
...Remember: like Dukakis, Bush called for greater "burden sharing" during the campaign...
...A third problem facing Baker is that bank lenders are not enthusiastic about making new loans to debtor countries...
...One banker says that "three or four banks...
...Rather, a deficit reduction plan, if one could be found, would reflect a consensus on how the nation's resources should be allocated between defense and social programs, and between current consumption and saving...
...He will, after all, have at his elbow Jim Baker, who specializes in trying to manage currency markets, and also Secretary of the Treasury Nicholas Brady, who thinks stock markets should be closed if they rise or fall too much...
...Bush's natural inclination will be to ignore business leaders' requests to rein in these deals...
...Baker will undoubtedly urge Bush to continue pushing this plan...
...A second problem for the Baker plan is an emerging consensus among liberal academics and Democratic congressmen that some form of debt forgiveness, rather than a new payment stretch-out, is required...
...For one thing, they no longer believe these countries' promises to get their economic houses in order...
...This means that, on average, the banks have not allowed LBO loans to become too prominent in their portfolios...
...Third World debt will force him to choose between those who would improve the lot of debtor nations by forgiving past loans, and those who feel that genuine economic salvation requires replacement of statist with free-market economies...
...Since many such takeovers are financed by heavy borrowing, America's corpocracy would like to see that borrowing become more expensive...
...But, with Europe enthralled by Gorbachev's "reforms'?—the Germans are rushing in with credits to finance their new-found friends, Berlin Wall or no Berlin Wall—our allies are unlikely to increase the portion of their GNPs devoted to defense...
...leum Association of America), is about to swear in a president who faces a powerful left-wing opposition calling for repudiation of past debts...
...Corporate Debt Perhaps an even more important factor in the banks' reluctance to make new loans to debtor countries is the emergence of a more profitable alternative: the financing of leveraged buyouts...
...This group, led by Senator Bill Bradley (already considered a leading prospect for the Democratic presidential nomination in 1992), argues that debt forgiveness isnecessary to prevent social upheaval in debtor countries, and to enable them to buy more American goods...
...Argentina, only recently arrived in the democratic camp after years of misrule by a military junta, is witnessing the resurgence of Peronism...
...it would have to pay investors twice as much to get them to part with equity capital...
...In October Greenspan sent a letter to Senator William Proxmire (retiring chairman of the Senate Banking Committee) informing him that "the Federal Reserve Board . . . has cautioned banks . . . that they should . . . examine the prospects for LBO loans under a range of economic and financial circumstances...
...So we should soon know more about our new President's basic philosophy—if, indeed, he has one...
...With Bush himself calling for an expanded war on drugs, stepped-up help for AIDS sufferers, a so-called day-care program, and greater environmental protection, the upward trend in social spending is likely to continue...
...If the banks think the returns warrant the risks associated with these merger deals, they should be left free to make the necessary capital available (subject, of course, to such restrictions as the Federal Reserve Board may impose to ensure the banking system's solvency...
...And Venezuela is about to elect as its new president a self-styled populist whose claim to fame is that, when last in office, he nationalized the country's oil industry...
...No instinctive privatizer, Carlos Andres Perez has been telling American bankers, in a series of private meetings (one was arranged for him in Boston by his admirers, the Kennedys), that his resource-rich country simply cannot afford to meet its existing obligations...
...A company borrowing money at 11 percent has an after-tax cost of about 7.26 percent...
...The second idea, if it can be called that, is that America's corpocrats see hostile takeovers as a threat to their perquisite-laden life-styles, and ultimately to their jobs...
...But this is easier than reading his mind, wherein thoughts about some compromise with Congress may be lurking—witness the chummy meetings the President-elect has held with House Speaker Jim Wright...
...George Bush will be under pressure from the business establishment and from Congress to restrict bank participation in such deals, and to take other steps to reduce the number of takeovers...
...This will give us an excuse to cut back our overseas commitments: in the interests of balancing our budget we may increase the imbalance of military power in the world...
...Such gradual reduction of the deficit should encourage foreign investors to continue to lend the U.S...
...Mexico, the recent recipient of a new $3.5 billion U.S...
...have over 50 percent of their LBO paper in retail companies," which he rates "the most risky because they're cash flow sensitive, with not a lot of assets behind the debt...
...The first, and one worth careful consideration, is that the deductibility of interest payments makes debt excessively attractive in financing Amer26 THE AMERICAN SPECTATOR JANUARY 1989 ica's corporations...
...For another, they no longer accept the notion that foreign governments are safe risks because they never default...
...These proposals reflect two underlying ideas...
...There are, of course, several problems with this scenario...
...But three problems lurk not far beneath the surface...
...Given his eminence as the next Secretary of State and as the President-elect's closest adviser, Baker should prevail, at least for a while...
...privatization), and adopt a host of other free-market reforms...
...This means that Europe and Japan will be asked to increase their defense expenditures so that we may reduce ours...
...All this, while a multibillion dollar savings and loan time bomb is ticking in the closet...
...Like the Democrats, and some Doleful Republicans, international finance ministers would like Bush to raise taxes...
...on the misery-loves-company theory—is, in this view, clearly required...
...I n short, when Bush confronts the three debts—Third World, corporate, and national—he will be confronting most of the important issues of his presidency...
...In 1987, 9.1 per-cent of all commercial bank loans went to LBO borrowers...
...Here is where we may get some idea of Bush's policy preferences...
...But close examination of the available data suggests that he will ultimately decide that the words of caution he has already spoken are sufficient for two reasons...
...the leader of that movement, Carlos Menem, also wants to renege on his country's debts...
...He will hear it in discussions of Third World problems, corporate restructurings, and America's budget deficit...
...THE AMERICAN SPECTATOR JANUARY 1989 27...
...First, the markets are already taking corrective measures: lenders are demanding stiffer terms, and some have closed their books on these loans altogether...
...Everyone agrees that what is needed is a bipartisan, credible long-term plan for reducing the budget deficit...
...But he will have to give weight to Federal Reserve Board Chairman Alan Greenspan's recently expressed concerns...
...His concern appears to be that a recession might reduce borrowers' cash flow to such a point that, like Third World debtors before them, they will be unable to meet their interest payments, perhaps threatening the solvency of some banks...
...As Ronald Reagan's Secretary of the Treasury he devised the so-called Baker plan, offering debtors new loans and easier terms in return for promises to bring public spending under control, reduce the size of the public sector (i.e...
...In its absence, Bush's proposed (and, so far, suitably vague) "flexible freeze" may provide the onlyavailable route through the budget thicket...
...Third World Debt Secretary of State-designate James Baker is no stranger to Third World debt...
...And national debt will force him to decide on his priorities—on how to allocate the nation's limited resources among competing claimants...
Vol. 22 • January 1989 • No. 1
