The Inter-American Development Bank failed to rein in managers who made losing bets in the U.S. mortgage market, including investments in securities issued by Countrywide Financial Corp., according to an outside consultant’s findings reviewed by the IDB board yesterday.
The Washington-based bank, the biggest lender for infrastructure projects in Latin America, took a nearly $1 billion loss last year after plowing as much as 60 percent of its cash reserves into mortgage-backed securities, an unusually aggressive investment strategy that went “largely undetected” by agency officials, according to the review by Oliver Wyman, the consulting unit of Marsh & McLennan Cos.
The findings, coming as the IDB prepares for its 50th annual meeting next week in Medellin, Colombia, may undermine the bank’s case for obtaining more funds from the U.S. Congress to meet surging loan demand from the region’s poor, credit- starved countries.
“The same hard questions we’re asking our major financial institutions in the U.S. we’re going to ask the directors of IDB” before deciding on any funding request, Representative Gregory Meeks, a New York Democrat who chairs a House subcommittee overseeing multilateral lenders, said in an interview yesterday. “Clearly there needs to be lots of reform if they are to receive any additional funds.”
At Risk
The weaknesses allowed the IDB to risk twice as much of its cash portfolio in asset-backed securities as the World Bank does, and 10 times as much as the Asian Development Bank, the consultant’s review found.
“You can’t run these things like a hedge fund,” said Morris Goldstein, a former deputy director of the International Monetary Fund’s research department and senior fellow at the Peterson Institute for International Economics in Washington. “Portfolios of official lenders have to be very conservative.”
Wyman recommended possibly hiring outside financial managers, the “urgent” improvement of oversight and the establishment of guidelines so assets have a “high probability of being liquid in the most adverse market conditions.”
IDB Chief Financial Officer Ed Bartholomew disputed the consultant’s findings, saying the mortgage and asset-backed securities peaked at 42 percent, not 60 percent, of its investment portfolio. After writing down the securities by an average 25 percent, the figure fell to 26 percent at the end of 2008, he said. More than 99 percent continue to perform and about 85 percent carry the top AAA credit ratings, he said.
‘No Material Effect’
“The magnitude of these unrealized losses has no material effect” on the bank’s ability to lend, Bartholomew said in an interview after the board’s meeting yesterday. “Any capital increase would be driven by a long-term vision about the kind of lending we want to support.”
The IDB’s bets were fueled by pressure to increase returns on what were supposed to be highly liquid investments, the consultant’s review found. That led to the purchase of two Countrywide Financial mortgage-backed securities in October 2007, after the collapse of the subprime mortgage market had already caused the mortgage lender’s shares to plunge more than 50 percent, according to the review.
“It’s surprising how far they invested in these toxic assets,” said Claudio Loser, former director of International Monetary Fund’s Western Hemisphere department and now a fellow at the Inter-American Dialogue in Washington. “In hindsight it was a stupid decision.”
Lugar’s Concern
Senator Richard Lugar of Indiana, the ranking Republican on the Foreign Relations Committee, said the strategy was of “grave concern” and sought explanations in a Feb. 5 letter to IDB President Luis Alberto Moreno. A copy was provided by Lugar’s office.
“It would be premature to consider a capital increase before Congress is assured that the IDB’s financial structures and controls are robust and that necessary reforms have been implemented,” Lugar said in an e-mailed statement yesterday.
The IDB is making a “tremendous effort” to increase donations from members this year so it can approve a record $18 billion in loans, Moreno, 55, said in a March 5 interview published on the IDB website. A commission of outside experts headed by former Peruvian finance minister Pedro Pablo Kuczynski will present its recommendations at the annual meeting.
“The IDB faces an uphill battle,” Clay Lowery, a former assistant U.S. Treasury secretary for international affairs who is now a managing director of the Glover Park Group in Washington, said in an interview yesterday. “They are asking for a capital increase, which is important to Latin America, at a time when it appears that they had taken significant risks in their trading book.”
Lowery said the Treasury first raised concerns about the IDB’s investment strategy in late 2007.
Funding Needs
Bartholomew said he couldn’t discuss any plans for the capital increase request until they were discussed by the IDB’s board.
“Whenever you have a crisis, you can always look back and see warning signs,” he said, adding that the funding request, the first in 15 years, had no connection to the losses. “People can ask questions and we’ll try to address those questions to give them comfort that we are managing this well.”
The IDB needs more funding because Latin American and Caribbean countries are increasingly turning to the lender as the credit crisis deepens. Jamaica, on Jan. 16, became the third country following Costa Rica and El Salvador to tap a $6 billion emergency liquidity line the bank created last October.
Remittances to Latin America and the Caribbean from migrant workers are forecast to fall this year for the first time on record, as unemployment rises in wealthier nations. If the crisis persists two years, poverty could swell by as much as 12.7 million people, according to IDB estimates.
To help relieve some of the strain on social services, the IDB is aiming to approve a record $18 billion in loans, compared with last year’s previous record of $11.1 billion.
“The IDB is very worried,” said Loser. “For the first time in seven years, credit markets are closed to Latin America. They know they’ll be called on to increase lending for the next two to three years.”
To contact the reporters on this story: Joshua Goodman in Rio de Janeiro [email protected]
