The Syndicate, episode four: IBM and the birth of the swap market

4 min read
Gareth Gore

In May 1981, the US Federal Reserve raised interest rates to a level never seen before – or since. It was harsh medicine for the US economy. But, with inflation in the double digits, chair Paul Volcker and the rest of the board saw no real alternative. It didn’t take long for the pain to feed through to the economy. As the cost of borrowing shot up, companies laid off millions of workers and soon the largest economy in the world was plunged into its worst recession since the 1930s.

The hike was particularly bad news for the World Bank. Over the previous decade or so, its president Robert McNamara had been on a mission to transform the institution into a real force for tackling global poverty – as atonement for his role in the Vietnam War, many suspected. He’d overseen a quadrupling of its lending programme to poor countries – all of it financed through borrowing. By the early 1980s, the World Bank was one of the biggest borrowers on the planet.

Volcker’s rate hikes were a disaster for the World Bank’s efforts to combat poverty. Even before the rate rises, it was paying US$2bn a year in interest. Under its statutes, those costs had to be passed on to the poor countries borrowing from it. As the rate hikes pushed up its cost of funding – the World Bank was paying 14% to borrow two-year money despite being an ultra-safe credit – McNamara began to worry that its lending programme was fast becoming unsustainable.

With 140 vital projects in 50 countries across the developing world under threat, McNamara turned to his treasurer Eugene Rotberg and asked him to find a solution. Initially, Rotberg tried to simply borrow more money overseas – especially in European countries such as Germany and Switzerland where rates were much lower. But those countries weren’t happy about the vast sums being borrowed and taken out of their money markets and soon started to clamp down

Rotberg then turned to John Rosenstreich, a banker he knew at Salomon Brothers. The two men came up with a solution that was ingenious in its simplicity. Rosenstreich had a client – technology giant IBM – that also had a problem. It had borrowed money in Germany at much cheaper rates. The mark had sunk against the dollar and IBM wanted to pay off the money earlier to lock in gains. But it couldn’t. What if, Rosenstreich suggested, the World Bank and IBM simply swap liabilities?

This episode tells the story of how a quest to save vital projects in the developing world ended up changing markets forever. It’s the story of how the World Bank turned to a relatively unknown corner of finance and helped bring it into the mainstream, helping develop the swaps market that today is linked to hundreds of trillions of dollars of assets. But it’s also the story of how the World Bank helped create a monster that a generation later would bring the global economy to collapse.

We talk to Rotberg, the man behind the deal, as well as other people involved. They reminisce about how it happened and opine on the legacy of that ground-breaking trade. “My main concern at the time was about the next bond transaction … I wasn't looking at the future,” Rotberg tells The Syndicate. “But within a year, I began to worry that the expertise was enormous in the hands of the investment bankers. The CFTC the SEC, and the Fed had no idea what was going on.”

To hear this episode – and more like it – for free and in full, click one of the links below or search your podcast provider of choice for "IFR the Syndicate".