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A purely analytical perception...




Continued from page 4

A bit of analysis would show the anomalies that are part of day to day life in that country. For example, government workers do not pay taxes, and yet assuredly make up the largest single segment of the workforce. On the other hand, they also make up the largest coherent voting block in the country. Thus, Brazil's leaders have had weakness of the heart when it has come to rectifying the situation. Another interesting problem, is the fact that Brazil is extremely interested in fostering emerging companies and products and in doing so has enacted protective tariffs so that foreign competition will not snuff out these nascent industries for tomorrow.

Importers of foreign goods evade these restrictions by bringing in the products illegally from Asuncion in Paraguay. Thus, Brazil has lost the ability to collect reasonable taxes while the protection that it sought to offer its new industry falls by the wayside. Yet, no one seems to want to do anything about the black market that exists in Paraguay, which could be stopped in a second if authorities determined to do so. Importation can- not compete with the black market but even if it could, effectively, Brazil adds insult to injury by forcing imported products to set high minimum prices and obtain hard or impossible to acquire licenses before products can be brought in.

Brazil has poured money into its infrastructure, or should we say, the World Bank has poured money into Brazil's infrastructure, and yet it is so expensive to transport goods from one part of the country to another that most companies don't even try. In Brazil, FedEx is so expensive that it is a hot topic in board meetings and at time director's come to blows over its use. Worse yet, every check written by anyone in the country is taxed at a relatively substantially rate, and it appears that this tax is on its way higher.

In the old days, when inflation was running at a rate of 20% percent or more each month, wages had to quickly be turned into hard goods or the money would disappear. Businesses were loathe to allow long term financing (over a week) on credit purchases because as their the currency (the real) depreciated, they were being paid back with less and less money. If they allowed the financing to go out too far, they built a loss into the transaction. Yet, if retail was a disaster because of inflation, what about banking. The majority of the banking that goes on in Brazil is conducted by government-owned institutions whose only reason for existence in inflationary times, is supplying money to governmental agencies against their future tax collections (anticpacoes de receita orcamentaria) for the use of politicians to run for office. Since Brazil usually does not allow its senior politicians to hold office more than one term, it is important to the office holder's power base that a person of his choosing gets the post, assuring his assistance in your run for a higher office. Thus, incredible amounts of money are spent on new projects just before election time to get the new guy elected and most of the campaigning is paid for by borrowings at government banks.

Each new Brazilian President appoints a new finance minister, who immediately has his hands tied behind his back. These guys have all been only window dressing for decades. Since 1985, Brazil has had the equivalent of a new finance minister each and every year. Presidents have found it much easier to blame the finance ministers for the country's problems than to admit that they have some culpability.

The same may be said of Central Bank heads whose job life expectancy has been a tad worse. These folks have no independent life whatsoever and are overruled whenever the Brazilian President has another, more pressing agenda. They do what they are told or are summarily dismissed. Thus by alternatively firing the finance minister and the central bank head every six months, the President has had a constant source of new material when he addresses his constituents at blame laying time.

Being the President of Brazil is a job that starts off bad and only gets worse. How would you like to walk into office and start the day with a request from twelve of your twenty-seven state governments for financial relief just to make it possible for them to pay their bills? Solvency is not the issue; for the most part, they have all been insolvent for decades. In one case, that of the state of Mato Grosso, the Governor had a nervous breakdown and disappeared from site when he was informed that employees could no longer be paid. At Mato Grosso's worst, the state was five months delinquent in salaries to state employees. Ultimately, the governor sacrificed the state's power company and the state bank to privatization to stop the bleeding.

Subsequently, other states have announced their inability to service their debts, creating a global crisis. In 1995, 19 states had to be saved from going into a state of suspended animation. All nineteen were unable to pay their bills and pleaded with the Central Government for a tithing to stay in business. Among the supplicants was the state of Alagoas, which was just as bad of as that of Mato Grosso in not having paid their employees in five months. If it were not for the fact that the Brazilian State Banks are in reality, arms of the government, which roll state loans over on demand, the states would probably all be out of business. The State Banks already are out of business, they have just have not figured it out yet. Interestingly enough, national regulations were very precise about stating that neither loan concentration nor self dealing by controlling interests could be entered within the entire banking system of Brazil, but as with all else in the wondrous country, state banks were exempted and self dealing is a way of life here.

Thus we have a system that has been historically biased towards inflation, where the economy is governed by finance ministers chosen because they have graduated from a top school, look good on television and know how to make an excellent resignation speech when the president has decided that their tour of duty is over. This system allowed the Brazilian Banks to profit handsomely from the float. This so-called inflation tax was almost $10 billion in 1993 and fell to less than $500 million in 1995. Can you imaging what Citicorp would have made in Brazil in 1994 when inflation was zooming out of control at 48% a month? It become critically clear that Brazil, had supported the banking industry with inflation for decades. When inflation ended, the profit on float dropped to levels that no longer produced a profit for the bank essentially because of the bank's built in bureaucracy. (When one person would suffice, wouldn't two do an even better job)? The banks had to look elsewhere for profits.

Being put in a corner, they did the unthinkable and started making loans. This shift came about so suddenly that the banks that heretofore had only dealt with political situations really were at a loss as to what to do. They did what comes naturally and really screwed it up. They made loans to real people and real businesses, but they didn't know how to get their money back. There was literally no installment business in Brazil during the days of hyperinflation; thus the back office systems that banks usually rely on to service loans did not exist. Thus, default became the order of the day and most government banks became critically insolvent. An interesting study was done, a cross section of banks (Big Six Banks) that showed, from the last year of hyperinflation to the first year of relatively low inflation (1993-1995) provisions for bad loans rose 1200 percent.

An industry that has supplied almost 60 percent of all loans in Brazil, now has a situation where in the private sector, almost 20 percent of their loans are in default. In the public sector, only the wildest of optimists would think that there is any chance at all for repayment of literally anything. As an excellent example of the foregoing, in the state of Sao Paulo, when the new governor, Mario Covas came to office, he found that the state's obligations exceeded its assets by a horrific ten times. With interest continuing to compound, any solution other than re-inflating will just not work. Picture the new governor being told upon entering office that the state had only several hundred thousand dollars in the bank and a payroll or $800 million due in the next several days. No wonder that some of the people are already referring to the good old days, as those days when hyperinflation was running rampant.

Covas was determined to set the affairs of Sao Paulo in order and in doing so may have come up with a new form of financing. He determined that the best way to get a fresh start was to sell of the state's airports and railroads. He was convinced that this would bring the necessary $15 billion to settle the more egregious of the Sao Paulo's debts. He proposed a transaction to the central government in which he would issue a tax anticipation privatization note to the government banks in exchange for the money, but he needed government permission to complete the transaction. In the six months period that it took to get a majority vote from the Brazilian Senate, the debt had increased by $3 billion, an amount which Covas had no way of getting and the deal was called off.

Things got even worse, Brazil stopped defending its currency in January of 1999 and in order that inflation not be allowed to take hold again, they literally raised interest rates for prime borrowers to an annualized 40 percent. Thus, small borrowers were tossed to the wolves and rates of over 200% a year became common. The program to create a middle-class in Brazil, died stillborn. The default of several Brazilian States coupled with the collapse of the real created international panic. Globally, economist's felt that the crises had spread from the Pacific Rim to Latin America, and that Argentina and Mexico would soon be next. In short order the IMF stepped up to the plate and arranged a bailout package of $41.5 billion. Brazil wasn't sure that they could afford the harsh medicine proposed by the IMF, but after some substantial miscues agreed to the terms.

Brazil has as part of its heritage, an almost suicidal aversion to bankruptcy, and the closing of public institutions no matter what their problems are is unheard of. Even the word for public reorganization does not exist in the Brazilian vocabulary. Rather than even consider the liquidation of these failed banks; Brazil has taken the line of least resistance and determined to throw good money after bad by throwing money after a system of the worst managed banks in the world. The IMF, as part of their arrangement with Brazil, will no longer abide the support of mismanaged and corrupt financial institutions. The problem is, when they finally get a closer look at the size of the problem, $41 billion is going to even scratch the surface.




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