ONCE UPON A TIME

...THERE WAS A COUNTRY CALLED Mexico which existed right next to a much bigger country called The States. Now Mexico was a beautiful country with wonderful people but compared to its much bigger neighbor it was very underdeveloped. It was also much poorer which was always a source of frustration to its President, Ho Low Po. One day one of the President's men came to him and said;
"Mr President we have oil."
"Oil?"
"Yes sir, a LOT of oil!"
"A LOT?"
"A whole lot!!!"

Well, Ho Low Po, being not a dummy quickly realized that here was a way to bring his country out of what was then called,"The Third World" and right into El Primero Mundo as he had always promised he would do because his neighbor, The States, had an insatiable demand for oil and God had put them right next door.

Ho Low Po was an impatient man, however, and he knew that selling the amount of oil needed to fulfill the dream of Primero Mundo would take a long time but he was a pretty smart guy and he knew about finance having once been the Secretary of the Treasury. He was also a gambler and he knew about come-line bets.

"I know what I will do," said Ho Low Po to himself. "I'll get the money right away by borrowing from those dopy bankers around the world who, now that we have oil will be falling all over themselves to do business with us" I'll make it a gift of ...oh...$800,000,000 to my people and they will worship me forever." And that's exactly what he did.

Well, the bankers around the world were just awash in money from the oil boom in the middle east and their national governments, terrified of inflation at home, were screaming at them to "recycle" these funds and what better place was there to do that than sovereign loans because as the Head Banker of the day had proclaimed, "Countries don't go broke." And lend they did, not only Ho Low Po's $800,000,000 but millions and billions more creating boom time in Mexico and joy on Wall Street and Park Avenue and in The City and on the Bahnhofstrasses of the world and on The Ginza as well. Even the boys around The Madelaine were thrilled; they were selling subways to every city in Mexico and EVERYONE was financing them.

There was one minor problem at the time that few people noticed. Bank loans in those days (and hey were all bank loans) were made generally with a maturity of not much longer than seven years and at a rate of interest that was set in accordance with something called the London Interbank Offered Rate (which still exists today) and which floated or reset, every three or six months. That meant in January you could be paying 5% but in March 6%....or 3% for that matter. Historically, rates hadn't fluctuated all that much so no one paid the method of finance too much concern and essentially ignored the fact that if interest rates moved substantially in the wrong direction over seven years, there might be hell to pay from a debt servicing standpoint. Enter Paul Volker.

Paul Volker was appointed Secretary of the Treasury by the benighted Jimmy Carter in 1978 and acting like the exterminator that all central bankers are by nature went out to exterminate the cockroach of inflation which by the time ol' Jimmy had finished with the country (and the country with him) had ticked up to 12%. Volker crushed it but not before in 1982 interest rates had reached 19%. If you were a borrower on a floating rate basis, you had a serious case of tsuris.

Ho Low Po's successor was in serious trouble. Mexico was in a position of having to borrow more money at incredibly high rates just to pay the interest on previous loans. Further, no one would extend unsecured finance any longer. But these were smart guys and they came up with a scheme whereby they would obtaining financing by pledging the earnings on oil exports (not the oil itself as that was unconstitutional) over a period of years. This facility anticipated the payment for the oil to by routed to a special account a the bank who originated the transaction who would then service the loan through the proceeds to a large number of banks who had participate in the facility through a syndication process. This bank was to be known as the "Agent," and in addition to its mechanical duties of receipt and payment it was the job of that bank to look after the interests of the banks in the syndicate. A certain amount of Mexico's oil exports were to be set aside to insure there was enough product to make the scheme work.

It was a fine idea...not particularly novel...but a good idea nevertheless. What wasn't such a good idea was when the Mexicans, without the knowledge of the agent bank, repeated the scheme on seven separate occasions with five different banks identifying the same oil as that which would supply the cash flow. They were running a Ponzi scheme or as we in the banking business liked to say, a "kite." Mrs. Banker's little boy Charlie doesn't like that one bit.

In October of 1982 the music stopped with the total reserves of a country of 80,000,000 people standing at about $20,000,000. Shock and Horror--and the formation of the Bank Advisory Committee for Mexico. Keep in mind this little oil facility because what happened could be cut out of today's headlines. We shall continue our tale tomorrow.