Chapter 14 – Corruption in High and not-so High Places

Corruption in High and not-so High Places

A YEAR AFTER PHILIPPINE President Marcos and his first lady were forced from office, the U.S. Public Broadcasting System interviewed Jose Mari Velez, a governor of the Development Bank of the Philippines, for a program called “In Search of the Marcos Millions.” During the interview, Velez described how his bank — a state-owned bank which borrowed from foreign banks and aid agencies to relend to Filipino entrepreneurs — made decisions: “Persons seeking the loan would just come around here and say that we need $100 to $200 million for this project which looks viable. It’s not viable but Marcos says it is viable. When he says that then it better be viable.”

These loans were known as “behest loans” or loans issued at the behest of Mr. and Mrs. Marcos.

State-owned development finance banks also issued behest guarantees. Because foreign lenders considered the Philippines a very high risk country, they would not lend to Filipino entrepreneurs unless the government guaranteed repayment. So the state-owned development banks issued guarantees at the express instructions of the ruling couple. Those of the Development Bank of the Philippines alone totaled $2.54 billion.

To illustrate behest accounting, Velez described a $65 million loan guarantee his bank provided for a steel mill. When the mill failed to repay its loan his bank was asked to honor its guarantee. “[The bank] asked to see where the factory is, and to this day, after several months, nobody has found it,” Velez said. “In short, this factory does not exist.” But the $65 million loan, unlike the steel mill it supposedly financed, wasn’t a phantom, and still had to be paid back.

The Marcos system of crony capitalism pervaded his government. Many of the country’s 500 state enterprises were first formed as private ventures by Marcos’s friends, who used them to accumulate large personal gains. After they had been drained of their state-guaranteed financing, and defaulted on their debts, they would then be taken over by the state.

In this way Herminio Disini, who helped Marcos collect $80 million in kickbacks from the Bataan nuclear power contract, was himself helped by Marcos. Without the president, Disini, an accountant in a cigarette factory, could never have acquired his empire of 52 companies with assets of roughly $400 million. When a number of his companies finally went bankrupt in 1982, Disini left for his castle near Vienna, leaving the government banks to pay off his creditors.

Crony capitalism amounted to a parallel economy run by and for the president and his close associates. Typically, the foreign loans aided selected entrepreneurs in gaining control of specific sectors, which would also be favored by presidential decrees. Many loans exceeded business requirements, with the difference — less the presidential tithe — diverted into the pockets of the borrowers. A senior Central Bank official explained crony capitalism’s logic in describing why sugar mills were built in areas unsuitable for sugar production, or in places where adequate milling capacity already existed: “The profit was not in the operation of the mill — it was in the procurement of the milling equipment.”

The development banks of other countries, too, became renowned for their corruption and monumental losses.

In Bangladesh the Asian Development Bank investigated $300 million in defaults on loans it and two other banks had provided to two nationalized Bangladeshi banks. It found that local businessmen had borrowed cash for projects “without any serious intention of pursuing such projects.” Although the businessmen were only required to put down 5 per cent to 7.5 per cent of a project’s cost themselves, even the down payment could be borrowed. The Asian Development Bank found a “lack of motivation and indifference to successful operation” because fund-raising was so easy. Repayments by companies were extremely rare, with 90 per cent of industrial loans rescheduled.

Similarly, the Inter-American Development Bank now admits that government-distributed development funds are too susceptible to political influence, and too immune from the principles of economy and efficiency.

Government finance is also prone to misappropriation. Late in 1986, Argentina’s Central Bank announced that it had been defrauded of $110 million in export credits by Banco Alas, the thirteenth-largest private bank in the country. With seven senior Banco Alas officials under arrest, including the president and vice-president, the Central Bank informed Argentineans that of Banco Alas’s $110 million in export credits, only $300,000 could be verified. An investigation found that 16 of the 20 exporters receiving Banco Alas credits did not exist, and that the other four denied doing business with the bank. The police did find $750,000 in cash in the bank vice-president’s Mercedes-Benz, and several Swiss and American bank accounts in the names of bank officials. Suspicions that the scam required the collaboration of high government officials led to the arrest of three senior Argentine Central Bank officials. The Central Bank admitted “deficiencies” in its internal control structure, adding “corruption continues to exist in the financial system.”

The Banco Alas scandal was just the tip of the iceberg: a month after it broke the state prosecutor accused the entire former board of the Central Bank of fraud.

Nigeria may top all countries for corruption. With about $30 billion in debt, it is also Africa’s most indebted nation, thanks to a succession of military and civilian regimes that have governed the country and its enormous oil wealth inefficiently and corruptly. Corrupt politicians used a variety of conduits to hijack the proceeds of the “national patrimony,” with invoicing fraud a common method.

Over-invoicing is especially favored in countries which inflate the value of their currency, creating a large gap between the currency’s worth and its official exchange rate. To prevent their citizens from changing their currency for dollars or another convertible currency, the government attempts to control all transactions, allowing only a favored few to purchase convertible currencies at an artificial exchange rate. The right to buy foreign currencies — or foreign exchange as such currencies are called in a country that manipulates its currency — thus becomes something of value, and those who control access to foreign exchange become powerful bureaucrats.

With over-invoicing, an importer asks a foreign supplier to inflate the price of his product, allowing the importer to ask his government for an inflated amount of foreign exchange, the difference going into the importer’s own foreign bank account. Sometimes the importer doesn’t even import the goods. The government official who grants permission for the inflated foreign exchange request, meanwhile, receives something for his trouble too.

Import licenses — because they provided access to foreign currencies — were so valuable in themselves that Nigerian government officials treated them as patronage to reward political service, with the recipients then selling them to genuine importers of goods. By 1983, estimates of the foreign exchange siphoned out of the country ran as high as $7.5 billion, or about 40 per cent of the Nigerian foreign debt. In Ghana, a government investigation in the early 1980s revealed that the country was losing at least $60 million a year through over-invoicing imports. And in Asia, according to Morgan Guaranty Trust Company, the value of Malaysia’s reported exports between 1976 and 1984 fell roughly $10 billion short of their value as recorded by Malaysia’s trading partners.

While importers over-invoiced, exporters under-invoiced. An exporter would bill foreign purchasers less than the agreed price, with the difference being deposited in the exporter’s foreign bank account.

Under- or over-invoicing aside, many of the “exports” vanished without arriving at their destination. Nigeria became the world’s most frequent victim of maritime fraud, with oil cargoes hijacked and sold, the proceeds laundered through Swiss and Hong Kong bank accounts. For the privilege, oil traders routinely put kick-backs into the foreign bank accounts of government officials.

One of Nigeria’s most profligate projects involved a new national capital at Abuja, estimated to cost $24 billion, or the equivalent of the country’s total sovereign foreign debt. Between 1980 and 1983, the government spent over $2 billion on the new capital without the completion of any road, building, or other construction project. Corruption became so rife that at the fall of the country’s second republic in 1984, several of the buildings, including the tallest building in Africa and the Accounts section of the federal Capital Development Authority in Abuja, were all burnt, apparently to conceal widespread fraud.

Nigeria’s administrations became so flagrant that a country with a healthy flow of oil earnings — $25 billion per year throughout the 1970s — by 1983 had only enough foreign exchange to cover one month’s imports. A Nigerian government investigation estimated that, at the height of the oil boom in 1978, corrupt politicians were transferring $25 million abroad every day, or $10 billion a year — almost 40 per cent of the nation’s foreign exchange earnings.

In Venezuela, the aluminum industry served as a vehicle for the appropriation of public funds. Polished up with subsidies to provide a luster of efficiency, Venezuela’s aluminum industry in reality has administrative costs double the world-wide average. According to the Wall Street Journal, “payoffs are allegedly built into every construction project.” The country’s controller general has complained about numerous examples of irregular practices of the government’s huge Venezuelan Guayana Corporation (CVG) and its subsidiaries (including aluminum, bauxite and hydroelectricity companies). An investigation of CVG by the opposition party found: “There are no controls. Everybody participates in the corruption…. In each of the 10 cases we looked at there was a payoff.” Multinationals bidding for CVG projects complain of protracted delays during which CVG executives allegedly fight among themselves over who will receive the bribes. “Telexes get stolen and contracts get copied by rival groups within the CVG.”

In Argentina, corruption reached a peak under the generals, coinciding with the astronomical rise in debt. While everyone had his hand in the till, no one had his hand on the controls. By the end of 1982 no one really knew for sure what the total debt was. The economy minister, Jorge Wehbe, declared a $43 billion debt. The air force insisted it was no more than $37.8 billion. In 1983 AmEx Bank estimated it at $43.7 billion, adding that of the $63 billion of debt “missing” among the twenty-four largest debtor countries, Argentina had “lost” a quarter of the total.

Debts were “lost” because they had been contracted by the government, state-controlled companies, and the military on their own authority, bypassing the notice of government departments that normally would track them. Determining after the fact the volume and purpose of the loans, the interest rates charged, and the dates the loans matured proved to be difficult.

Argentina’s military was particularly lax with public funds, running up a $9 billion arms bill in a bout of words with Chile over the disputed Beagle Channel. The $6 billion nuclear program, also under military control, was mainly financed by foreign borrowing. After the Malvinas (or Falklands) War, more military expenditures for replacement equipment added another $1.5 billion to the military component of the debt. This “military” component, however, functioned mainly to create sinecures for officers. In other cases, suspicions ran high that the military had run up debts without the money ever entering the country. As an investigating judge put it, “It is not clear whether we are dealing with the results of massive looting or chaos or both.”

The opportunity to appropriate funds became an incentive to the powerful to approve unneeded and ill-considered projects, creating a system in which decisions on public expenditure were based not on their value to taxpayers but on payoffs to decision-makers. The coincidence of large debts, political corruption, and the absence of democratic institutions in countries with decreasing standards of living is therefore unsurprising. Business and economic theorists construct elaborate models to explain what is common sense: civilian and military elites unchecked by legislative rules and the ballot box, and free of personal financial liability for their actions, know no limits when borrowing money in their peoples’ name.

The constellation of ruinous economic policies can hardly be attributed to well-meaning, perhaps naive, and possibly incompetent Third World leaders. Instead, these policies generally represented deliberate acts by those in power to aggrandize or enrich themselves. The upper classes in developing countries controlled not only the borrowing and spending of foreign loans, most of them publicly guaranteed, but also the economic policies and financial regulations that made it lucrative, and possible, for them to pillage their national treasuries for their personal gain.

“Local elites do not just react passively to the local governments. In many cases they are the local governments, or at least the executive committees,” explained James Henry, an American economist and expert in capital flight. In Mexico, for example, “a basic method of taking money out … has been to exploit overvalued official exchange rates with the help of foreign banks. The preservation of this exchange rate system even in the face of massive capital flight is very hard to understand unless we take into account the profits made from it by people in positions to influence policy.”

In Argentina, swapping pesos for foreign currencies was not only legal, it was subsidized by the state and aptly called “the bicycle” by Argentineans. The public sector would borrow money from foreign banks, then sell the foreign currency to private individuals and companies who deposited it abroad.

In Nigeria, only the elite had access to central bank-issued exchange forms. With them they would buy heavily subsidized dollars from the Nigerian central bank and export the dollars to neighboring countries in which a black market in foreign currencies existed to serve the hundreds of thousands of immigrant workers who were traveling back and forth. There they would purchase nairas with dollars at the real market rate (dollars were worth much more than the Nigerian central bank recognized), deposit their left-over dollars in foreign bank accounts, then smuggle enough nairas into Nigeria so they could pay back the Nigerian central bank.

The ways to get capital out of a country are as diverse as human beings are ingenious. The degree of foreign exchange restrictions would determine the method.

Money would be smuggled out in suitcases with false bottoms, and even in poultry, as a Filipino customs officer discovered when he found a frozen duck stuffed with $29,000 bound for Hong Kong. In 1981 Venezuelans entering Miami reported — on treasury forms handed entrants to the U.S. — that they were carrying over two billion dollars in cash. In other cases, the commercial banks themselves would engineer an exit route via the bank accounts of intermediaries in tax havens, making a paper trail impossible to follow.

For those in positions of power — those who award public contracts, issue import licenses, and set government regulations — the possibilities for misappropriating borrowed funds and then sending them abroad have been endless: phony intermediary companies would recontract with foreign suppliers and take a hefty spread in the transaction; developers would get public loans for projects that didn’t exist; local “consultants” would be paid by foreign suppliers in foreign accounts, and outright smuggling of goods. Diamond smuggling from Angola — 75 per cent of which is done through the VIP lounge at the Luanda airport — cost the Marxist government some $70 million a year in lost foreign exchange.

Corruption in undemocratic governments has few checks and generally spreads to the institutions with which they deal, and from which they draw support. In Mexico, corruption in this periphery reached extraordinary heights in the person of Joaquín Hernández Galicia, for three decades the union boss of the 170,000 workers in Mexico’s nationalized oil industry. With the complicity of five successive Mexican administrations who dared not take him on, La Quina, as the union leader was known, was allowed to run the oil-rich Gulf coast almost as a private fief, enjoying a power that rivaled that of government leaders. Through control of jobs in Pemex, the hugely overmanned state oil monopoly, and kickbacks from the oil giant’s construction contracts, La Quina probably controlled over a billion dollars. The La Quina empire encompassed everything from farms to subsidized food outlets to funeral parlors, enabling him to create a cradle to grave existence for “his” workers.

La Quina’s right-hand man, Sergio Bolaños, fronted a 27-company industrial empire for the union, and profited enough from running La Quina’s businesses to make the highest offer — in cold cash — for the Government’s stake in Mexicana de Aviación, one of the two flagship airlines being privatized. Mexican authorities have found Bolaños to hold foreign real-estate worth about $84 million, including a castle in France and a lavish compound in Vail, Colorado. When an elite Mexico City school denied his daughter entry, Bolaños bought it.

La Quina did not tolerate dissidents, rivals usually meeting their fate in a hail of bullets. One government attempt to rein him in was followed by a chain of 13 explosions in oil installations across Mexico. Always fearful of the consequences should Pemex workers go on strike — Pemex is Mexico’s major foreign exchange earner — successive governments treated La Quina with kid gloves, until January 10, 1989. On that morning, the army forced entry into La Quina’s Gulf Coast headquarters with a bazooka round, found 200 Uzi submachine guns and 40,000 cartridges in the raid, and arrested 45 close associates, including Bolaños. La Quina and his henchmen have been charged with illegal arms possession, murder, conspiracy against the state, and, through Bolaños, tax evasion.

THE ONLY LIMIT to unchecked governments can come from the lenders themselves, yet they are as unreliable as any corrupt leader: financiers didn’t just tolerate irregularities in foreign-financed public projects, they were ready participants. Canada’s Atomic Energy of Canada Limited, a crown corporation that markets the country’s CANDU nuclear reactor, paid $18 million to an “agent” to clinch the sale of reactors to South Korea and Argentina. An investigation by Canada’s auditor general discovered payments that had all the characteristics of a bribe. In response to the public furor that followed, the Canadian government stated that not only was it legal for a Canadian to bribe a foreign official, but that bribes could also be deducted as an expense from his taxable income, provided the briber receives a receipt. Then Trade Minister Jean Chrétien explained: “Commercial practices in other countries sometimes are different from ours. I am not about to condemn the morals of anybody. It would be very presumptuous for Canadians to tell other people how to conduct their morals.” Chrétien urged Canadians not to put their “head in the sand” and pass up overseas sales by being rigidly moralistic.

The World Bank and Inter-American Development Bank have also turned deaf ears to tales of corruption involving an Argentine project to which they have both lent millions of dollars. The Yacyretá hydro dam on the Paraná River between Argentina and Paraguay, one of the largest public works projects under way in the world, was conceived under the government of Juan Perón. But only under the military government of the late 1970s did money start to really flow. Within a few years, more than $1 billion had been spent without land being broken for the main project. Most of the money went to build two towns to house 7,000 workers and for other preliminary work. The dam is now expected to cost $12 billion, 800 per cent of its original cost estimate. Although the Inter-American Development Bank and the World Bank sometimes raised questions about accounting and record-keeping procedures, they eschewed extensive oversight. Nor was the Inter-American Bank deterred in 1990 when, just minutes before its officials were about to sign a new $250 million loan to the dam, Argentinean President Menem called for the dam to be canceled, saying, “Here’s a monument to corruption.” The bank decided to overlook the presidential gaffe and went ahead with the signing ceremony anyway.

Corruption in the Third World required complicity from those in the West who, one way or the other, benefited from the Third World’s status quo. Thanks to secrecy and a public perception in France that “power gives you the right to accept certain things,” it may never be known whether the Giscard d’Estaing family’s extensive overseas business interests received favors from kin who occupied the nation’s most important public posts. In late 1975, President Valery Giscard d’Estaing paid a state visit to Zaire’s President Mobutu Sese Seko. In a country in which few have electricity and a third of the populace live close to starvation levels, work soon began on a new national telecommunications system, complete with TV studios, at a cost of $500 million. The French president’s first cousin headed the company that received most of the contracts to build the microwave system, and another cousin headed the state-owned export credit agency, Banque Française du Commerce Exterieur, that provided much of the scheme’s financing.

“Gossip or not,” reported the Wall Street Journal in a front-page exposé of France’s most enterprising family, “public records indicate that companies in which members of the Giscard d’Estaing family hold high positions have had extensive business dealings in Gabon, Morocco, Chad, the Central African Republic, the Cameroons, the Ivory Coast, Mauritania, Niger and Upper Volta. In many of these countries, the existing regimes are heavily obligated to President Valery Giscard d’Estaing’s government for the French military support that keeps them in power.”

With such obliging financiers, it can hardly come as a surprise that borrowing country officials should treat public borrowings as private assets. Mobutu rewarded loyal lieutenants with spectacular gifts, such as Mercedes cars and houses, and allowed them “to misappropriate state funds at will.” He nationalized various foreign-owned enterprises only to hand them over to his cronies — not the state — who swiftly set about stripping them of their assets. Before too long, they could pay neither taxes nor the debts of their newly-acquired enterprises. Yet “every time Mobutu stole money, [Western donors] gave him more. It was like supporting a junkie,” says Stephen Lewis, editor of London-based Africa Confidential.

Foreign financiers coddled Third World corruption willingly and knowingly, fueling what Octavio Paz, the Mexican poet and Nobel prize winner, described as the typical Latin American “patrimonial state” in which “the Prince governs with his servants, his slaves and his family — in other words, where he regards the realm as his personal property.”

Sources and Further Commentary

The Public Broadcasting System ran their program “In Search of the Marcos Millions” on Frontline in 1987. See transcript no. 511 from the Public Broadcasting System/WGBH-Boston. This interview, plus various details about the workings of behest loans, are contained in The Revolving Door? External Debt and Capital Flight: A Philippine Case Study by James Boyce, Department of Economics, University of Massachusetts, June 1990.

For details of how money went astray through state finance development banks in Bangladesh, see “Bad loans cast cloud over Bangladesh” by John Elliot in The Globe and Mail, Toronto, February 13, 1984. And in Latin America, see “A Case Against Coddled Credit” in The IDB, the Inter-American Development Bank, January-February 1990. Also see “A Private Quarrel” in Euromoney, U.K., September 1990; “Escalating the War on Third World Poverty” by Samantha Sparks, in Global Finance, New York, September 1990; “Lending institutions stall Latin American progress,” by Manuel F. Ayau, in The Wall Street Journal, November 18, 1983; “Report cites high level of insolvencies in financial area in developing nations” by Peter Truell, in The Wall Street Journal, July 5, 1989; “Lenders Repent at Leisure” in South, London, September 1989.

Details on corruption in Argentina come from “Argentine bankers in £78m scandal” by Eduardo Cué in The Times, U.K., September 30, 1986; Hot Money by R.T. Naylor, McClelland and Stewart, 1987; The Debt Threat by Tim Congdon, Basil Blackwell, 1988. The “lost” Argentinean debt is described in Hot Money, and also in “Argentina: Menem Ditches The Dogma” in A Supplement to Euromoney, U.K., September 1990.

On Nigeria’s corruption, material comes from The African Debt Crisis by Trevor W. Parfitt and Stephen P. Riley. Also see Hot Money by R.T. Naylor and “The real foreign debt problem” by George B.N. Ayittey in The Wall Street Journal, April 8, 1986. Details on Malaysia’s use of over-invoicing can be found in World Financial Markets, Morgan Guaranty Trust Company, March 1986.

Details on corruption in Venezuela came from several sources: “Venezuelan aluminum project wrapped in profligacy” by Tyler Bridges in The Wall Street Journal, November 11, 1988; “Venezuela’s cleanup” editorial in The Globe and Mail, Toronto, August 26, 1989; “Calm After The Storm?” in Euromoney, U.K., September 1989; “Venezuelan scandal may involve billions of dollars” by Simon Fisher in The Globe and Mail, Toronto, May 1, 1989; “Many executives flee Venezuela in scandal of foreign exchange” by Jose de Cordoba, in The Wall Street Journal, August 24, 1989.

The importance to corruption of state vanity projects, especially those financed with foreign funds, is described in “World debt woes spring from lack of democracy” by Arvind K. Jain in The Globe and Mail, Toronto, April 4, 1988.

An excellent source of information on capital flight is “Where The Money Went: Third World Debt Hoax” by James Henry in The New Republic, April 14, 1986. See this article also for details of how many U.S. dollars Venezuelans reported carrying on entering the U.S.

The apt description of swapping pesos for foreign currencies as “the bicycle” comes from The Debt Squads: The U.S., the Banks and Latin America by Sue Branford and Bernardo Kucinski, Zed Books Ltd., London, 1988.

The story about the frozen duck stuffed with cash is from “How Hot Money Has Beggared The Third World” by Lenny Glynn in Report on Business Magazine from The Globe and Mail, Toronto, September 1985.

Details of diamond smuggling come from “The real foreign debt problem” by George B.N. Ayittey in The Wall Street Journal, April 8, 1986.

The story of La Quina in Mexico comes from “Modernization at Gunpoint” by David Gardner in Latin Finance, U.K., February, 1989.

The extraordinary tale of Canadian bribes in connection with the sale of a Candu nuclear reactor to Argentina comes from the following sources: “The Big Payoffs: Good Business? Or Bad?” in Maclean’s, Toronto, December 13, 1976; Vote and Proceedings, Third Session, 30th Parliament, No. 69, House of Commons, Canada, Monday, February 27, 1978; “$4 million bribe given on Candu Argentina says” in The Toronto Star, June 14, 1985; “AECL’s Argentina deal over nuclear reactors netted minister millions” by Ross Howard in The Globe and Mail, Toronto, June 14, 1985.

Information on the Yacyretá dam in Argentina comes especially from “Billions flow to dam (and billions down drain?)” by Shirley Christian in The New York Times, May 4, 1990.

For details of France’s enterprising first family see “Besides the presidency, Giscard d’Estaings holds other key posts, companies run by relatives of the French president play big role in Africa” by Jonathan Kwinty in The Wall Street Journal, April 23, 1981.

Stephen Lewis’s quotation is from “Redistributing the Blame in Africa” by Stephanie Cooke, in Institutional Investor, New York, September 1990.

Octavio Paz’s quotation is from The Debt Threat by Tim Congdon, Basil Blackwell, 1988 but originally from “After the Cultural Delirium” in Encounter, July/August, 1986.