(November 29, 1995) For 5O years government guarantees have allowed the World Bank and its sister development banks to amass the world’s riskiest loan portfolios. Three months ago, the weakest of these sisters, the African Development Bank, was downgraded. And now for the first time, the World Bank admits that many of its own loans can’t be paid back.

An internal World Bank document leaked recently calculates the woes of its 40 poorest clients-they owe all creditors close to $200 billion. Commissioned by the World Bank’s new chief, James Wolfensohn, soon after he joined the bank in June, the document calls for the creation of a new body, the Multilateral Debt Facility (MDF), to write off $18 billion in bad loans to 24 Third World countries made by the World Bank, the International Monetary Fund, and other multilateral institutions. The bailout body would be financed by the industrialized countries, and by multilateral institutions, including the World Bank itself. The lion’s share of the MDF funds would then return to World Bank coffers.

But the World Bank, whose triple-A bond rating depends in part on its refusal to write off bad loans, fears that financial markets and credit agencies might construe the MDF as the bank “paying itself in lieu of writing off bad loans.” To avoid such “self-entanglement,” the internal report calls for the World Bank-run facility to operate as “a separate, arms length mechanism.” The report adds that the financial markets will “need to be convinced that this approach signals no departure from the prudent financial management policies expected of the multilateral institutions, and therefore has no bearing on their preferred creditor status.”

The World Bank also fears fallout from further missteps at the African Develop ment Bank, where infighting and allegations of corruption, fraud and influence- peddling led Western governments to turn off the tap and led Standard & Poor’s to downgrade its bonds. Without Western aid to the African bank’s client states, many of these countries would be unable to resume their debt payments, raising the specter of the bank calling on its capital to repay bondholders. This call on capital, which would come from its rich-country shareholders and could represent the bank’s final act before liquidation, is a doomsday scenario that the World Bank desperately wants to avoid. The answer, according to the World Bank’s internal report, is the MDF, which offers the possibility of “resolving the conundrum of finding a way to bail out African countries, without bailing out the African Development Bank.” To date, the World Bank and its sister development banks in Africa, Asia and Latin America have dealt with precarious borrowers by lending these countries more than they must repay. Because the World Bank will not reschedule loans of countries with cash-flow problems (to do so would imply that the bank was not a preferred cred itor, a linchpin of its triple-A rating), the bank instead finances its own repayments with new loans. The World Bank calls that stop-gap strategy “defensive lending”; a less charitable description might be a Ponzi scheme. This not only harms the bank’s portfolio, it also does little for hapless Third World borrowers, who dig them selves into ever deeper debt instead of getting their financial houses in order.

The World Bank’s mismanagement has led Congress to cut back the U.S. commitment to the World gank’s soft loan fund, the International Development Association. In the future, Congress may eliminate its funding altogether. “This is not only a threat to IDA, it is a threat to the long-term viability of multilateral financing for development,” Mr. Wolfensohn, the World Bank boss, said in his inaugural speech at last month’s annual meeting. Without taxpayer dollars going to Third World coffers, and then returning to the World Bank’s Washington headquarters in debt repayment, the bank would be forced to write down its portfolio, revealing the inherent paucity of its Third World holdings.

Hence the importance of the new bailout facility and of persuading the world’s rich countries to pony up. While the World Bank believes countries such as Canada and Britain will find the idea attractive, it expects France, Germany and particularly Japan to be a tough sell, “Japan sees a fundamental inconsistency between simultaneous provision of debt stock relief and new money,” the report warns, adding that it will require, “some clever financial engineering,” to overcome Japan’s reticence.

But no amount of clever engineering can disguise the fact that the Multilatefal Debt Facility is a new mechanism for tax payer bailouts of Third World basket, cases. This is simply another attempt by the World Bank and other multilaterals. to deny the obvious: that, despite their claims of prudent investing and hard- nosed management, they have earned triple-A credit ratings based entirely on political commitments from the rich coun- tries. The lesson for bondholders is clear: As long as these institutions remain in political favor, bondholders can feel secure. The moment they fall from grace, bondholders beware.

Patricia Adams, The Wall Street Journal, November 29, 1995