Back from the Brink

Brazil has the dubious distinction of being the largest international debtor in the developing world; the country's public institutions and private businesses owe an estimated $87 billion to foreign creditors, $67 billion of it to banks. As TIME's Board of Economists met last week, some were fearful that the cash-strapped South American nation would default, an event that could shatter the increasingly fragile international banking system. The possibility sent world financial leaders scrambling to prevent a crisis.

Banks lend to Brazil, as to any borrower, out of confidence that they will be repaid. When that faith erodes, for whatever reason, some banks call loans as they come due or balk at granting new ones. Since Brazil, like other borrowers, is accustomed to "rolling over" its debt -- lately it has been borrowing perhaps $1 billion a month for every $400 million it repays -- any pulling back by lenders threatens to throw the nation into default. Last week that almost happened.

Brazil stumbled into its plight through the type of doomsday scenario that now haunts the world financial community. The crunch began in September, when small-and medium-size banks in the U.S. and elsewhere refused to increase their Latin American loans in the wake of Mexico's brush with bankruptcy. At the time, Brazil, like Mexico, was borrowing from well over 1,000 banks around the world. In Brazil's case, the length of the list was largely a vote of confidence in the nation's financial management, which was considered to be among the best in the world. But after Mexico had to be bailed out last August, bankers started worrying about Brazil. Referring to the problem of guilt by association, one U.S. Government official involved in overseeing the rescue remarked: "When the cops raid the red-light district, even the nice girls get taken away."

For months the cash drain was kept quiet. But eventually the lending banks began to pick up the whiff of desperation. Brazil dipped into its $5.5 billion reserve of U.S. dollars and even pledged its entire 2.5 million-oz. gold cache to secure credit. Then the government-controlled Banco do Brasil, which finances the nation's international trade, began drawing down cash, estimated at nearly $2 billion, that it ordinarily keeps on deposit with major international banks. When that was exhausted, the Brazilian bank was forced to turn to overnight borrowings to stay in business.

Banco officials were soon telephoning around the world in a frantic search for funds. But even the banks that had stood by Brazil to protect their existing investments were fearful of pouring more money into what now yawned before them as a bottomless pit.

The desperate bankers finally turned to Federal Reserve Board Chairman Paul Volcker on Dec. 7, a day before he was scheduled to meet in Germany with the central bank chiefs of Britain, West Germany, France and Japan.

The lenders' plea: arrange a rescue package at the session.

Volcker emerged believing that he had a commitment for $1.5 billion, but things quickly unraveled. "It was a game of poker to the end," said one banker later. One player was Karl Otto Poehl, president of the German Bundesbank, who refused to chip in until Brazil first reached agreement on a $5.9 billion loan from the International Monetary Fund, which oversees world finance. That commitment came last Wednesday. By week's end the central bank chiefs were willing to provide $1.2 billion through the Bank for International Settlements, pending the outcome of talks in New York City's Plaza Hotel this week between the Brazilians and some 50 bankers.

The cash infusions should come as a vast relief to those bankers, who by the way, are being asked to fork over another $4 billion. Brazil's largest private creditor, Citibank, already has $5 billion at risk in Brazil, an enormous sum that is 15% greater than the bank's shareholder equity. But Citibank Chairman Walter Wriston told TIME last month that he remains confident.

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