Money Observer: The sinister side of bank lending

The other week I went to see a play called Labyrinth at Hampstead Theatre in London. It’s impressive to see a play that manages to be engaging while explaining an issue as complex as the Latin American debt crisis.

The protagonist, John, is a young graduate who joins a US commercial bank in the late 1970s. He quickly realises that he has to make a Faustian pact in order to succeed in the business of selling loans to foreign governments in Latin America.

The 1970s saw a massive surge in private bank lending. International banks, particularly in the US and Europe, saw their deposits grow and looked for opportunities to issue profitable loans. It was a time of financial liberalisation, the rationale for which was that markets are efficient.

However, a lack of regulation and the blind desire to maximise profits proved fatal. By the second act John has established himself as a salesman when the region’s debt crisis explodes. In 1982 the Mexican government announced that it was unable to service its debt without help.

What began as a debt crisis became a growth and development crisis, and a lost decade for Latin American development. GDP fell by 9 per cent across the region and unemployment rose. Recessionary adjustments meant that the region’s resources serviced debt, rather than meeting the needs of the economy, to the cost of the general population.

Financial crises continued to occur in the 1990s and 2000s. But are they inevitable? The economist Stephany Griffith-Jones believes not: ‘Technically, it is clearly possible to avoid crises, but this requires that vision and long-term thinking are more powerful than greed. It happened once when US president Franklin D Roosevelt and a group of progressive leaders regulated the financial system properly after the Great Depression, so there is no reason why it couldn’t happen again.’

This article was published as part of the column Marina’s Imaginary Millions in Money Observer, October 2016.

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