RICHARD J. DAVIS

My discussion is centered around three related issues: first, to identify what some have called the “fatigue” factor in the debt-restruc tu ring process; second, to describe some effects on the process of this “fatigue” factor; and, third, to discuss some of the techniques that are used currently to deal with this growing fatigue. While other speakers will discuss potential new options in the debt crisis, the techniques I am going to discuss have been developed more or less within the traditional framework of the debt-negotiation process. I will describe how some of these techniques have worked and how some have not succeeded.

In a way, probably one of the clearest reasons why there is a “fatigue” factor is the fact that the telex that just was set out for you is probably a mere tenth of the size of the average term sheet that now routinely emerges from the negotiating process. I cannot count how many trees and forests have been lost during the restructuring process because the numbers of pages that we have ended up producing to document these transactions have been simply extraordinary.

The “fatigue” in the negotiating process is first a function of the never-ending nature of that process. From the government’s perspective there are never ending negotiations with the International Monetary Fund, with the World Bank, with the Paris Club, and truly never-ending negotiations with the bank advisory committee. This process is complicated further by the fact that, in many cases, there are cross conditions between various of these negotiations.

The Argentine commercial bank exercise of 1987, generally considered to have been done on a relatively speedy basis, provides a good example of this problem. The negotiations with the bank working committee began in the middle of February of 1987, and a term sheet was negotiated and distributed by the end of April. Voluminous implementing documents were distributed in early August, and there was a signing ceremony at the end of that month. Argentina then received the first drawdown in October of 1987. While that is considered fast, eight months were required simply to complete the commercial bank negotiations and get one disbursement. And almost as soon as that process was finished, the parties involved had to begin renegotiating with many of the same institutions.

So, the “fatigue” factor is due first to the never-ending nature of the process. It also, however, is a function of the changing perception of the “crisis.” In a sense, it may be a misnomer to describe the events of the last five years as a crisis, because that connotes something that comes to a head. What we are experiencing is more like an ongoing debt dilemma, because it just seems to go on for years and, at least from the country’s perspective, it remains unresolved. It no longer can be perceived as a passing phase or a temporary liquidity crisis, and the countries involved hardly believe that the problems are behind them. In fact, it seems for both sides that whatever is done turns out never to be enough; new efforts, new negotiations, and new financing plans always appear necessary. The result—a developing weariness with a problem that never seems to go away.

What are some of the apparent effects of this fatigue? First, on the country’s side, there obviously is a draining of political support for the process. The importance of this can never be underestimated; governments of debtor countries simply cannot continue to sustain public support for necessary economic measures if the debt crisis is perceived as a morass.

The second effect is that while large numbers of banks do participate in the process, there are increasing numbers of what are called “free riders.” A free rider is a banking institution that is perfectly willing to receive interest but is also perfectly willing to say “no, thank you” to requests for new loans. Since they do not participate in the new-money process, these banks are not helping out with the problem of financing gaps that the countries face, and thus they are not supporting an overall program which has as one of its elements the financing of the payment of interest. At the same time, these institutions generally sign the refinancing agreements, which entitles them to interest.

Free riders are a problem from two perspectives. Obviously, the problem on the banking side is that the result is a shrinking of the size of the pool of banks available to provide new money, a shrinking that can accelerate as more banks get tired of “supporting” the non-participants. The free-rider phenomenon is also a problem for the borrowing country governments, however, since it makes securing financing more difficult, and, in certain cases, the existence of the realistic option of just not answering the phone is a disincentive to the development of new approaches and solutions which provide relief to the debtors.

Having said that free riders are a big problem, I would have liked to be able to say that there is an easy solution; unfortunately, however, there is none. One approach, of course, is to consider ways in which we could “penalize” the free-riding institutions. The obvious way to do so would be to say: “We will not pay them the interest, or we will not pay them interest in the same form as we pay the other banks that do participate in the process.” Such direct discrimination raises serious legal issues, however, because all these syndicated loan agreements contain sharing clauses which would have to be amended. And my experience is that a lot of the banks that do participate remain reluctant to agree to a process which discriminates against free riders. But I think that this is an issue that is going to continue to get attention, and we may well have to seek ways to develop approaches to differentiate between free riders and those participating in the new-money loans which do not violate sharing clauses.

Also affected by the developing fatigue is the working committee process itself. Mr. Mudge described these advisory committees, and I think there is no doubt that, from my perspective, they have performed, and will continue to perform, yeoman service in terms of being focal points for negotiation and the raising of money. However, I think the process is beginning to break down as a result of fatigue among the players. It can be viewed, in some instances, in terms of the level of participation. When there is a crisis, and everyone perceives it is an immediate crisis, you can get people who are able to make decisions at the meetings, as opposed to people who primarily record information, voice positions and complaints, and make phone calls for guidance on nearly every relatively important point. Also relevant is the size of the committee, which obviously tends to be large. For Argentina, there are 11 committee members, but not just one representative from an institution, and you cannot always have the most effective negotiations with 30 or 40 people in the room.

Another developing problem with the committee process is how consensus is developed within the working committee system. First, to some extent, I think the process has always had an element of each side arguing from the precedents established for another country when it served their purpose. When it is in their interest, the banks say, “We can‘t give you X even though we gave it to another country, because you have not done the following,” or “You have to agree to Y because another country agreed to it.” And in other circumstances, when it is in their interest, the government negotiators will say, “Well, you gave it to country X, so you have to give it to us,” while resisting other points agreed to by other countries by stressing how different their country’s position is from that of those countries that acquiesced in these demands. While this has always been part of the negotiating process, we are now seeing that process disintegrate to some extent into what I describe as the lowest-common-denominator approach to negotiation. That is, you have 11 banks and maybe 4 or 5 national groups involved, and each has its own particular interests. Instead of negotiating with each other over these interests, as has been customary, participants add up their demands, at least to the extent they are not mutually inconsistent, and present the sum of everyone’s demands to the debtor country. I know I am exaggerating a little when I say this, because I think the chairman of the working committee in our situation has tried to control this process and has done so to some extent, but there is no doubt that this is a developing trend. Moreover, as a result of the growing fatigue, as Mr. Logan is going to tell us at greater length, it is becoming more difficult even to get consensus among the banks because of their differing interests.

Now, what are some of the techniques which have evolved within the more-or-less traditional structure in order to deal with the growing fatigue? One approach that has been tried is to play upon the greed factor, by using something called the “early participation fee.” In the Argentine package, where this concept first was introduced, this provision basically said that if you committed by a certain date (the date which was the goal for obtaining the critical mass of bank commitments), you would get an extra fee. If you committed by a second date, you would get an extra, but slightly smaller, fee, and if you committed after this second date, you would get no extra fee. Up to a point, that process actually worked reasonably well. While we were very nervous for a while because it seemed that we were getting no commitments, that first date became a real deadline; a lot of people took the deadline seriously because they wanted the extra fee, and an enormous number of commitments came right on the cutoff date. Despite this success in quickly getting that first 90-something percent—in a new-money exercise you can often get the first 90 or 95 percent, or even 98 percent, in a relatively short time—it often takes months to obtain commitments from the last 2 or 3 percent. And, in all honesty, I do not think the “early-bird special” really helped to get these last banks into the fold more quickly.

Another technique involves offering a “menu” of choices. There are two noteworthy parts of the menu. One is found where more or less all of the banks participate in an option. This type of option is intended to reflect the apparent view that banks simply do not want all new money to be in the form of a jumbo term loan to the central bank. While from the government’s perspective a simple term loan is, I think, both the easiest to administer and the best for dealing with balance of payments needs, providing alternatives helps make it easier to market the financial package to the banks.

Now, what are some of the options that have been included in menus? In addition to the straight term loan for some percentage of the new money, one option is a trade-deposit facility. Argentina, for example, has had first a $500 million, and then a $400 million, four-year trade-deposit facility as part of its new-money package. Under this facility, the money lent stayed with the central bank for six months, during which it could not be withdrawn. After that, banks could withdraw the money in order to finance new trade transactions. When I refer to “new” trade transactions, I mean money provided above the dollar or dollar-equivalent level of the banks’ existing trade commitments as of the designated base date. Thus, if a bank had a hundred dollars in outstanding trade to a particular country’s borrowers as of the base day, and then decided it wanted to have a hundred and ten dollars’ worth outstanding, it could use ten dollars from this trade-deposit facility. From the country’s perspective, this type of facility is shorter term and is less certain to fill financing gaps than term loans are. Banks, however, have insisted on the use of these facilities in recent packages because of their marketing advantages.

Another part of the menu, which was first introduced in the 1987 Argentine package, involves the use of “new-money bonds.” Under the Argentine program, for up to a million dollars of new-money, a bank could get a bearer bond instead of participating in a syndicated loan. In addition to creating an instrument generally perceived to be less subject to restructuring and nonpayment of interest, one reason this option was offered was to permit the advisory committee to deal with some of the smaller banks that might have become part of a syndicate even though they would have lent relatively small amounts. In terms of administering a syndicate, it would have been easier if such banks disbursed the money but were not part of this syndicate on an ongoing basis. Thus, the hope was that smaller banks would take one of the new-money bonds. In devising these instruments, there were, among other things, U.S. security-law issues (in order to address which we had to get a “no-action” letter from the Securities and Exchange Commission (SEC)) and tax issues were raised.

I believe it is fair to say that in 1987 the new-money-bond process worked adequately. That is, Argentina did issue about 70 or 80 million dollars’ worth of bonds—there was A demand for such bonds. Surprisingly, however, a number of the small banks, to the extent that these institutions participated, signed up for the syndicated loan and did not take the new-money-bond option. And once they had committed themselves, we did not want to go back to them. When a bank said that it was committed, we did not want to risk going back to it and saying “You signed up for this, but maybe you should take a new-money bond instead.”

Another part of the menu that has been developed is cofinancing with the World Bank. I am not going to discuss the numerous issues involved in cofinancing, because this subject will be discussed by another speaker.

Other parts of the menu involve debt-equity conversions and so-called on-lending, pursuant to which banks can on-lend within the country, in local currency, a portion of the amount they provided to the central bank in the form of a term loan. From the government’s perspective, such on-lending is controversial because of its effects on monetary policy and credit allocation within the domestic economy. Debt-equity conversions have some of these same economic effects. As a result, on-lending and, to some extent, debt-equity conversion, programs are hot spots in the negotiation process. The banks desire to include these programs since they can be used as marketing vehicles, while the debtor governments are more cautious because of their effects on countries’ economic and financial situations.

One of the unfortunate consequences of the menu approach is that one ends up with a multiplicity of agreements, which lengthens the negotiation process enormously. For Argentina in 1987, there were four separate new-money agreements; two maintenance agreements; a guaranteed refinancing agreement which covered all the outstanding public sector debt; a private sector program; and something, which we will talk about in a minute, called an alternate-participation instrument. Thus, the complexity of arrangements is a reality of the current negotiating process.

There is another kind of menu in which the options presented do not involve alternatives that one would expect every bank to accept. Thus, in connection with new-money loans, it is assumed that most banks will participate in new-money bonds, a term loan, a trade-deposit loan, and a cofinancing. What was tried last year in the Argentine program, however, was another option designed for a bank that did not want to lend new money. While this option often is described as an “exit bond,” it really is more of an alternative-participation instrument. The theory behind the alternative-participation instrument is that there might be some institutions that do not want to lend new money but are prepared to participate in solving the problem by accepting a lower rate of return on their debts. The idea thus was to provide an opportunity for them to exchange some of their existing debt (which, if they did not exchange it, would carr^y normal rates of interest and have the same tenor as everybody else’s), for an instrument with a meaningfully lower interest rate and a longer tenor. The holder of such a new instrument, however, would not be expected to, or even be asked to, participate in any further new-money loans, at least to the extent its debt had been reduced by exchanging it for alternative-participation instruments.

In designing an alternative-participation instrument with a lower interest rate and a longer tenor, the inevitable issue is how the alternative instrument compares with the original obligation. In the Argentine experience it did not compare favorably, since the alternative-parti ci pat ion instruments in that program did not receive particularly widespread acceptance. The fixed rate of interest on those instruments was 4 percent, and they hit the market when interest rates were going up. So, in the 1987 Argentine case, those instruments did not really work. At the same time, the idea behind their creation still has a lot of merit, even though the instruments may need some retooling. As I said before, however, free riders continue to have their own form of alternative participation—not answering the phone.

Another possible menu option, which has not been used in the past, would be some form of optional interest capitalization. While this proposal has raised all sorts of problems, particularly in the United States, including accounting and regulatory concerns, many banks might very well prefer to capitalize interest instead of lending new money. Implementing this option, in terms of assuring a pari passu treatment of those who capitalized and those who put in new money, would be extraordinarily complex. It could, however, be done.

In conclusion, while others will talk about other forms of innovative techniques and the outlook for the future, from my perspective, progress has been made, although energy is being drained from the process. This is why there is a continuing need for some of the things that Mr. Walker is going to talk about^* to be explored. The menu simply has to be expanded, and ways have to be found to deal with existing debt that do not involve just increasing the debt with increasing varieties of new-money loans.

FRANCIS D. LOGAN

I have been involved in these exercises for several years, generally on the side of the creditors. I would like to emphasize, however, that this morning I am speaking solely for myself, which may be proven by some of the non-conventional ideas I would like to voice.

What I would like to do is to take an excursion with you through the areas that concern creditors today. The community of commercial bank creditors—that is, the one excluding the public sector and the multilateral lending institutions but including private bank lenders—has participated since 1982 in the restructuring and refinancing exercises largely through the bank advisory committee process. The general view of the creditors today is that through a lot of hard work; perhaps some good luck; and—most important—an enormous amount of goodwill, cooperation, and collective effort, we have avoided disaster on the creditors’ side. There has been no systemic failure, but there has been no solution, either.

Many of our commercial banks have recently seen improvement in key balance-sheet ratios. This improvement in ratios of capital and of reserves to developing country exposure is good news. And we have had plenty of rhetoric from U.S. Secretary of the Treasury James Baker and from Citibank’s William Rhodes, who is chairman of many of these bank advisory committees, pointing out how much “progress” has been made.

But once one starts looking at what these reserves and the banks’ capital really are, one has, I think, to start questioning some of that rhetoric. Certainly, the Basle Committee on Capital Adequacy, in its definition of Tier I capital, has set out a very tight definition of equity, and the discussions in the Committee’s paper on “good” versus “bad” reserves indicate that these huge reserves allocated to developing country debt may not be treated with the same level of dignity as unallocated reserves.

In addition, as the previous speakers have shown, there has been little reduction in the aggregate stock of debt in most countries. As Mr. Walker^* has said, the indebted countries have, in general, been unable to return voluntarily to the capital markets for new financing adequate to replace their existing stock of debt. And with the exception of a very few countries (such as Venezuela), there has been no regular reduction in the principal amount of the public sector’s stock of debt.

However, I think that it is important to identify those successes we have enjoyed: I think that, in the Western Hemisphere, Chile is one, and Venezuela is perhaps another. The reason it is important not to miss the few “successes” is that it will not take many to turn the psychology around. What was it that drove the commercial banks to make those loans before 1982? They wanted to get in and do a lot of deals. What will it take to get the major commercial banks back into that mindset? Well, we are a very long way from making that happen. But perhaps we are seeing lights at the end of a few tunnels, in regard to some countries, where the ice jams may be beginning to break up.

I‘d like to expand a little bit on what Mr. Davis talked about: the factors leading to fatigue, particularly from the creditors’ standpoint. There is a growing dissatisfaction with the committee system and its consensus approach. It is becoming clear that the very large number of creditors involved have diverse objectives and favor diverse financing mechanisms. It is also important to recognize that fatigue comes from excessive effort expended over a lengthy period of time. What the other members of the panel have accomplished has required an enormous effort over a long period. The cast of characters, drawn from the principal commercial banks around the world, that has been involved is getting physically, and perhaps mentally, tired of this process.

I think another factor, again from the creditors’ standpoint, is that the developing country debt problem may no longer have the high priority it once had. There may be several reasons for this. First, the balance-sheet ratios that I mentioned before are getting better, while a lot of new problems have come to the fore in the last six years—problems that those of us who labor in the vineyards of developing country debt should appreciate. In the United States, we have had some major credit problems in several geographic sectors, and these have claimed a lot of the attention of the senior management of the creditor banks that hold the bulk of developing country debt.

Second, capital adequacy of banks has been on the front burner. I am sure that many of you have been involved in the international effort to achieve a convergence of views on what capital is and what amount of capital, including capital to back up off-balance-sheet items, is adequate.

Further, in many countries, legislative efforts have been made in the last half-dozen years—for example, efforts made in the United States to permit commercial banks to engage in different lines of business—in an attempt to solve the profitability riddle. Again, these have claimed a lot of the attention of the senior managements of the creditor banks.

The regulators in many countries have pointed out the hard times that have come to the commercial banking business, not merely because of their non-earning assets, such as developing country debts, but also because of fundamental changes in the markets. This lesson has not been lost on the banks and has resulted not only in the legislative efforts I have spoken of but also in enormous corporate restructurings.

Further, there is a great frustration with the lack of flexibility in the operation of the restructuring agreements covering developing country debt. Mr. Walker has spoken of the frustration that has been felt by the debtors when they have tried to come up with some innovative solutions, but I think that such frustration is also growing among the creditors. We have, through the creation of enormous piles of documents, created a fairly inflexible set of rules by which the developing country debt mechanism is governed. Perhaps we overdid it a little bit. And, I think, the time has come, in the view of many creditors, to re-examine some of the mechanisms that have been adopted in the legal documentation to implement what were perceived to be a set of general principles upon which the entire operation should rest. I will come back to that in a bit.

The growing complexity of the agreements themselves, of course, has helped to create fatigue. So has annoyance with “free riders”—that is, with the growing unwillingness of many banks, including both large and small ones, to provide new money. In some financial institutions, and not just those in the United States, policy decisions have been taken at the board level to stop providing credit to Latin America, for example. Marketing participations in restructuring transactions have consequently become much more difficult. The complexity of pricing issues, deal terms, and the types of instruments involved makes it very hard for the advisory committee banks to sell new deals to the universe of creditors.

There is also a significant degree of impatience, whether justified or not, with the perceived lack of help from the Paris Club, the World Bank, the International Monetary Fund, and national government institutions such as the export credit agencies. I read Under Secretary of the U.S. Treasury David Mulford’s speech to the Bankers’ Association for Foreign Trade (BAFT) down in Florida, and I noted that commercial bank irritation with some of the public sector is equaled, or perhaps exceeded, by Mr. Mulford’s irritation with the commercial banks.

There is a greater fear today of imposed solutions and a perception that the process has become politicized to a greater extent. We have learned of U.S. senators and congressmen and others, including even leaders in the financial community, proposing solutions which may be legislative, such as those found in the roughly 1,200 pages of the pending trade bill. If the bill survives the President’s veto, it will become the next solution imposed legislatively, at least on U.S creditors.

Creditors are also frustrated about the failures they perceive within the debtor countries. I think that the creditors had expected to see greater progress over the past six years than they have. Instead, they have seen failures of economic growth plans and of monetary, fiscal, and exchange rate policies; political instability; frequent changes in personnel and direction; and what is thought of as a degree of debtor country xenophobia—that is, uncooperative attitudes toward the international financial institutions; tolerance of capital flight; and rejection of foreign investment—for example, that proposed to be accomplished through the debt-equity swap mechanism.

There is also a feeling on the part of all concerned of being victimized by third parties and uncontrollable factors. The President of Venezuela put it very well, I thought, when he said his country had negotiated a contingency clause because of exogenous factors that affected, and would affect, the performance of his government under the $22 billion restructuring agreement. And, too, there has, I think, been a realization that restructuring and refinancing by themselves can never be thought of as a solution. We have, over the last six years, been temporizing, and we have to do something besides creating mountains of documents to represent developing country debt without either reducing the stock of it or enhancing the ability of the developing countries to refinance it.

Some of those observations may not strike responsive chords. You may think that they are unfair, unjustified, intolerant, or impatient, and I think that each of these criticisms is probably justified to some extent. But it is important for those of us participating in the effort and, if I may say so, for those of you who are regulating or observing the effort to understand some of these financial, economic, and psychological factors that affect performance.

I would like to be a little more specific, if I can, about reasons for strains among creditors. Because, as I mentioned before, creditors not only are fatigued with the problems of the debtors but also are finding it more and more difficult to get along with each other. The sharing clauses, the negative pledge clauses, the pari passu clauses, the unanimity for amendment clauses, and the default clauses all impose constraints on creditor behavior which may adversely affect the mutual interests of creditors and debtors. I am sure I will have those words flung back in my face as I participate in future negotiations, but I think it is nonetheless true that flexibility is going to be desired, and is going to be required, to accommodate the diversity of interests among the creditors as well as the differences among the debtors.