QiCtiHet) States Senate
BfCCIAt. CO MM II IU ON , Afi.NO
William J. Casey Director of Central Intelligence.
Dear Mr. Casey:
For moreear, with Poland on the brink of financial default, the Western world has become sharply aware of the potential risks posed by our lending to members of the Sovietut the debate surrounding East-West economic relations has eclipsod an equally important message of the Polish debt crisisthe world financial system may be vulnerable to theizeable sovereign default.
The prospect of losingart of theillion in Western assets held as loans to Poland, should spur theof the major financial powers to plan collectively for contingencies. ontingency program should spell out possible scenariosolish default and trace, step-by-step, how the system can be expected to cope with each possible danger. Unfortunately,ear that such an exercise would expose several points of vulnerability in the world financial system.
Here are some of the factors that spur my concern:
the huge international debt Incurred by Eastern European and Third World countries which are in precarious economic health;
the shaky financial conditions of many major international corporations;
the chain reactions and systemic problems which will develop if one or more of these shaky players should start to-fall, including breaks in bank lendingace
to call in loans; withdrawal of deposits from banks perceived as risky;ush of new deposits to "safe" currencies;
Honorable William J.age 2
a failure to define lines of authority among central banks for crises in overseas affiliates and consortia banks, and to change domestic laws which would inhibit effective actioniquidity or currency crisis;
a lackechanism to handle severe, system-wide foreign currency shortages.
My impression is thatrisis spurred by these factors several gaps in the system could develop. At best, there is uncertainty about how existing institutions would perform to close them. ontingency program to increase certainty could play an important role.
If my concerns are not warranted,ope you will detail for me how we and our major allies would effectively protect Western banking systems, and hence economies,risis. If no such plans exist, or if you lack confidence in them,rge you totudy of this problem.
Assuming that adequate protections do not currently exist,ould like toew steps that might be considered. First, we couldultilateral fund from which central banks could borrow, under agreed conditions, the foreign exchange they need to cover endangered banks. The fund would need authority to borrow from the central bank of the country whose foreign exchange was in high demand in order to relend to the central bank in need. Of course, the fund would have to set rigorous conditions to deter anything but emergency use. It appears to me that the International Monetary Fund would bo the appropriate agency to administer- this fund, but there are other possible candidates such as the Bank for International Settlements in Geneva. In connection with thisould like to know whether the lending of dollars in any amount by the Federal Reserve to the
or BIS for this purpose would require Congressional authorization.
We might also considerinancial contingency program which couldormal agreement clarifying and reaffirming4 central bankers Basle declaration on the allocation of lender of last resorttoulnerable currency;reparations to coordinate the operations of the lender of last resort facilities of major industrialized nations.
Honorable William J-age 3
These suggestions are at best partial solutions to difficult questions. ecognize that responses to the questions raised are not easily prepared. However,now you appreciate that the matter is of great Importance.
o not intend to create undue public alarm. The desire to assure public confidenceulnerable financial system, willhabby excuse if an uncontrollable crisis should develop. We must guarantee stability against any reasonable doubt. Equally important, allied threats to cut off credits to Poland would weigh more heavily with Poland's generals (and Soviet Politburo members) if they knew that our economies were braced against the potential repercussionsefault. ontingency programrerequisiteredible credit sanction policy. Without it, our hands are tied by our own economic vulnerability.
I offer these comments and questionspirit ofand in the belief that our country will be better off if weeliable framework for minimizing the vulnerability of. economy. security Interests to the repercussions of large sovereign defaults. Because of the urgency of thisouldimely response,inimum informing me of the progress being made in preparing answersope, ontingency program.