All the Presidents' Bankers (63 page)

Federal Reserve chairman Paul Volcker saw the problems for what they were: a dangerous cocktail of nontransparency and speculation. He described the cloak around the Drysdale incident as such:

There is a firm . . . involved in highly speculative [transactions] that apparently has a large and highly leveraged position and can’t meet its bills. . . . So, we have a potentially large amount of securities overhanging in the market in a distressed situation, and we’re trying to figure out what to do about it.
Chase Manhattan is in the middle of this as the middleman in the shorted securities.
The people they borrowed the securities from claim that Chase is liable and Chase claims it is not, so we have a [mess] there. Losses are well in excess of $100 million just on that set of transactions, and we don’t know what else is involved. . . . Chase and others held a meeting this morning; they tried to make a pro bono publico contribution [by providing] money to meet this payment yesterday. Nobody else volunteered because they all think it is Chase’s liability.
²⁹

In short, no one knew what had transpired in the dark shadows of government securities trading. But Chase was central to the issue, and it could get worse.

After Drysdale went bankrupt, Chase wound up forking out the $117 million of the interest Drysdale owed on its loans, having acted as intermediary on $160 million of its deals, to contain the crisis and calm the markets. It remained somewhat of a mystery how the issue had snowballed so secretly and quickly out of control. But the incident evoked no extra regulations on the trading or shorting of government bonds.

A few months later, Chase wrote off $161 million for loans it had purchased from Penn Square Bank, which collapsed under a $2.5 billion mountain of unsecured oil and natural gas loans.
³⁰
In a subsequent lawsuit regarding the $212.2 million of Penn Square loans it had bought, Chase claimed it was “unfair to make ‘preferential distributions’ by offsetting Penn Square deposits
against Penn Square loans.”
³¹
In the Penn Square situation, Chase took a tax writeoff, rather than dipping into its client’s deposits. This was the opposite of the approach it had taken regarding Iran’s monies, wherein it had no problem taking deposits to pay off loans.

Despite the financial chicanery, Butcher was as keen, if not as skilled, as Rockefeller at establishing a relationship with Reagan and his people. Butcher’s relationship with the White House began, as many such relationships did, with a warm letter. A few days after the 1980 election, he wrote Reagan, “My personal congratulations on your stunning victory. Your campaign was thoroughly professional, as can be seen in the dimensions of your win, in the GOP capture of the Senate and in the deep inroads you made in the House.”
³²

Such niceties—and many were exchanged—contained a hidden agenda. Like Wriston, Butcher desired a nationwide banking system, with Chase sitting at the top of a connected labyrinth of little Chases in every state. Current regulations did not accommodate such an endeavor, but Butcher and other big bank leaders would keep pushing until they did.

Wriston, Head of Reagan’s Economic Advisory Board

On August 16, 1982, Reagan asked Walter Wriston to take George Shultz’s place as chairman of his Economic Advisory Board. Shultz was moving over to become secretary of state. In his new position, Shultz chose retired Goldman Sachs partner John Whitehead as his deputy secretary of state.
³³
Wriston replied, “I’d be honored to accept.”
³⁴
Wriston was officially appointed on September 3.

Thus, Wriston now balanced running Citibank and chairing Reagan’s Economic Advisory Board, all the while continuing to espouse free-market doctrine. In a November 1982 speech for the Tufts University Fletcher School of Law and Diplomacy at the Ritz Carlton Hotel, Wriston conflated a libertarian view of individual freedoms with what he characterized as a
broader
need for liberal banking policies.
³⁵

“Can we really impose fewer and fewer restrictions on our own conduct as individuals, assuring everyone’s right to a personal life style,” he demanded of his audience, “while simultaneously imposing harsher, and increasingly irrational, restriction on all of our institutions?”
³⁶
The answer from Washington to Wall Street was—of course we can’t.

Monetary Policy and Merger Fights

Meanwhile, a battle was being waged between the Federal Reserve and the White House over monetary policy. In the summer of 1981 Volcker had resisted Regan’s urging to grow the money supply (the amount of currency and liquid instruments in the country’s economy, including cash, coins, and balances in checking and savings accounts) by reducing interest rates.

Regan believed Volcker’s tight monetary policy had aggravated the early 1980s recession.
³⁷
Most bankers concurred; they wanted access to cheaper money while they awaited the deregulation that would provide greater access to customer deposits. Volcker believed that reducing rates would feed inflation, whereas Regan believed that tight policy was strangling the economy, or at least the financial system. In either case, the level of debt that the private bankers had injected into the United States and third world economies with which the United States traded was a major, and uninspected, contributor to the slowing of the US economy and high inflation. The fight between Regan and Volcker would last for years.

Reagan embodied what the
New York Times
dubbed a “hands-off policy regarding mergers unless they significantly reduced competition.”
³⁸
In practice that meant a hands-off policy toward all mergers.

Yet the way in which mergers were being approved so quickly worried North Dakota Democratic congressman Byron Dorgan, among others. William Baxter, attorney general of the antitrust division, responded to Dorgan’s letter to Reagan regarding merger activity by assuring Dorgan that he was fully committed to “vigorous enforcement of the antitrust laws.”
³⁹

Dorgan wasn’t the only one questioning the antitrust division’s liberal merger policy. Consumer advocate Ralph Nader wrote Reagan a lengthy letter on April 26, 1982, criticizing the administration for displaying “an unprecedented disregard for the most fundamental safety and economic rights of American buyers.”
⁴⁰

In his detailed list of the “Administration’s actions and inactions,” Nader noted, “William Baxter, your assistant attorney general for antitrust . . . has indicated such carte blanche support for mergers of almost any kind that many analysts believe him to be the chief ‘go-signaler’ for the current merger wave.”
⁴¹

Anticompetition wasn’t the only problem that the mergers brought to light. Bigger companies contained more places on the books to commit or hide fraud or losses. Yet the administration turned a blind eye to such possibilities.

For his part, Anthony Solomon, president of the Federal Reserve Bank of New York, rejected the very thought of tighter regulation of the securities market, noting that dealers were already scrutinizing credit risks and revising practices related to Drysdale’s activities.
⁴²
The idea was that firms were self-policing. The concept of protecting the public from securities violations hadn’t gained much traction in the face of such fraud. About a decade later, investment bank Salomon Brothers would commit another round of government bond manipulation. By 2012, JPMorgan Chase was mismarking billions of dollars of derivatives trades that future chairman Jamie Dimon would deem a mere “mistake” and for which the bank would pay an inconsequential fine.

The World Bank vs. the World’s Bankers

From an international perspective, private bankers remained reluctant to clean up their mess in the third world. They had adopted an isolationist view of responsibility that left no room for what they perceived as throwing good money after bad. Even though they had overburdened these countries with loans to begin with, they wanted other entities to deal with the fallout while they sought to mitigate their own losses. Despite his external optimism when he took the World Bank president post, Clausen knew his organization didn’t have unlimited funds to help the third world, nor would the private bankers forgive debt to make repayment viable. If anything, they would opt for “rescheduling” the debt. Worse than that, the funds that the World Bank would provide would come with austerity measures.

In a clear sign of desperation, Clausen announced his new strategy in January 1983. Despite the “shakiness of many borrowers,” he now encouraged “more commercial bank lending to Third World countries.”
⁴³
Up to that point, the World Bank had maintained a solid line between its lending and that of the commercial bankers, just as John McCloy had designed it to be back in 1947. If anything, access to World Bank loans bolstered the viability of countries to get private ones by rendering them more attractive to investors—a condition that continues to this day. Knowing the extent of the financial woes that could befall the debtor nations, though, the World Bank needed to enlist the private banks’ capital and power.

No one understood that better than Clausen, who had wanted the World Bank to help the private banks when he was a private bank chairman. Now sitting in the opposite seat, he persuaded the Reagan administration to back loan syndicates made up of the World Bank and commercial banks for the first time. He believed this combination would provide commercial banks
greater security and encouragement to lend more to developing countries, or at least enough to cover interest payments on outstanding debts.
⁴⁴

The situation was dire. According to FDIC reports, “By October 1983, 27 countries owing $239 billion had rescheduled their debts to banks or were in the process of doing so. . . . Sixteen of the nations were from Latin America.”
⁴⁵

The US government reluctantly agreed to a loose partnership, but the commercial bankers didn’t. They had no desire for an alliance on the matter. By May 29, 1984, the US government, caught in a vise-grip of Clausen’s instigation and the private bankers’ recalcitrance, announced it would provide a loan guarantee to Argentina indefinitely.
⁴⁶

To mitigate the appearance of a backhanded bank bailout, Regan explained, “The loans to Argentina have no time limit. The United States comes into play only when the Argentines get their International Monetary Fund agreement.”
⁴⁷
He had shrewdly placed the government behind the multinationals in terms of risk, though both fell behind the banks. The loan guarantee was part of a $500 million aid package extended on March 30, when Argentina’s first-quarter interest payment came due.
⁴⁸
That was the end of Clausen’s good graces with the Reagan administration.

This move put commercial banks in the driver’s seat, for the IMF controlled less of the world’s money than they did, but would subsume a disproportionate amount of the risk they had created. Third world leaders had preferred to deal with the bankers, who didn’t ask many questions and just gave them money during the 1970s. But now they saw the devil in those details. Private bankers and their speculator clients opportunistically entered and exited financing deals quickly, leaving the political and economic fallout to governments and multinationals—and the general populations.

Third World Debt Crisis

From the summer of 1982 through mid-1983, many of the Least Developed Countries—particularly in Latin America—grew less solvent. The major US banks pressed the Reagan administration to ask Congress for a sizable increase of US support for the IMF, which would, in turn, support them.

In May 1983, the world’s main finance ministers gathered at the colonial town of Williamsburg, Virginia, for an economic summit to discuss the global debt crisis. President Reagan read their seven-point concluding statement, which advocated low inflation and interest rates globally. He expressed the group’s “concern [over] the international financial situation and especially the debt burdens of many developing countries.”

Reagan said, “We view with concern the international financial situation and especially the debt burdens of many developing countries. . . . We will seek . . . increases in resources for the International Monetary Fund and the general arrangements to borrow. We encourage close cooperation and timely sharing of information among countries and the international institutions in particular, between the International Monetary Fund, IMF, the International Bank for Reconstruction and Development, known as IBRD, and the GATT.”
⁴⁹

The bankers had won. They had garnered the financial help they needed from nonprivate sources to sustain their flailing lending activities. A reckless precedent had been approved, whether wittingly or not, to use the power of the presidency to feed the power of the private bankers as they left financial landmines around the world. Two weeks later, Reagan met with members of the National Security Council, who remained concerned on a foreign policy level about the dangers of the rising debt in the developing countries.
⁵⁰

The Fed and Treasury vs. the Banks

On the domestic front, Volcker remained concerned about developments in banking. As bankers turned to lure depositors and more business from inside US borders, Volcker sent Congress a proposal to “slow the blending of banks and other types of business.”
⁵¹
He was becoming a thorn in Wall Street’s and Washington’s sides.