(FORTUNE Magazine) – SWEET ARE THE uses of adversity,'' says the banished duke in Shakespeare's As You Like It. Hear, hear, say the companies that have been profiting from debt- equity swaps, a sweet use of the Third World debt crisis. In swaps, companies buy up troubled loans owed by Third World governments and trade them for equity investments in those countries. ''What we have,'' says MIT economist Rudiger Dornbusch, ''is a gold rush situation.'' Sit still for a banker from Santiago or New York and he will burn your ear with the virtues of swapping Latin American loans for forests, factories, hotels, even pension fund management companies. Swaps, he will explain, are a boon to Latin governments because they extinguish foreign debt, reduce crippling interest payments, boost exports, and create jobs. The companies involved in swaps profit by picking up investments at bargain prices. Both statements are often true. But as with most gold rushes, the really good pickin's are scarce, and the mines are full of pitfalls. Some $5 billion of Third World loans have been converted to equity stakes since swapping began just two years ago. That is a mere speck on the $437 billion that the 15 most troubled debtor nations owe the world's commercial banks. But hundreds of corporations are eager to get in on swaps, and conferences on the subject have been drawing SRO crowds from Mexico City to London. The excitement has been especially keen since May, when Citibank created a $3-billion reserve to cover potential losses in its Third World loan portfolio, setting off a chorus of me-too's by other U.S. banks. Citibank Chairman John Reed said he hoped to get rid of as much as $5 billion in Third World loans over the next three years, and his statements implied that the bank would use debt-equity swaps to unload a large portion of the total. Reed's pronouncements had swap promoters cheering and persuaded almost everyone that debt-equity exchanges were about to explode. Swaps are growing, but nowhere near as fast as it appeared a month ago. A senior executive involved in Citibank's swaps now says the bank plans just a dozen or so smallish deals worth a total of about $200 million a year and will participate in ''no pharaonic projects, no pyramids.'' Most of the swapping so far has been done in Chile, which organized the first formal program in 1985, and Mexico, which did its maiden deal in May 1986. By the end of this year Chile will have used swaps to retire about $2.5 & billion of the country's $20 billion in total foreign debt. Mexico, which owes $100 billion to foreign banks, has approved $1.7 billion in swaps. Virtually every other Third World borrower is devising its own version of the concept, but most are dragging their heels in implementing the plans. The Philippines, for instance, has approved only $120 million of the $360 million in swap applications it has received since last August. Swaps, which aren't for individual investors, can be numbingly complex, but the basics are fairly simple. For several years European and regional U.S. banks have been selling troubled loans in the so-called secondary market. The loans trade at deep discounts to their face value, reflecting the market's opinion that they will not be repaid in full. Chilean debt sells at about 70% of its face value, or 70 cents on the dollar. Mexican loans trade at about 60% of par, Brazilian loans at 40%, and Bolivian debt at a mere 10%. In a garden-variety deal a multinational that wants to invest in, say, Chile, hires a middleman (usually a bank) to buy Chilean loans in the secondary market. The company (again through a middleman) presents the loans, denominated in dollars, to the Chilean central bank, which redeems them for pesos. The central banks pay less than face value but more than the loans trade for in the secondary market. Chile pays about 92 cents on the dollar and Mexico an average of 88 cents. Mexico also charges a 0.25% application fee. The fee, says Jose Angel Gurria, the country's chief debt negotiator and architect of its swap program, is ''to discourage proposals that aren't serious.'' Thus, a company that wants to expand in Chile can pick up $100 million of loans in the secondary market for $70 million and swap them for $92 million in pesos. Chile gets $100 million of debt off its books and doesn't have to part with precious dollars. The company gets $92 million of investment for $70 million, which amounts to a 24% subsidy. The variations on this theme are endless. Chrysler has used some of the pesos it has got in swaps to pay off local debt owed by its Mexican subsidiary. Eastman Kodak and Unisys have used swaps to expand their operations in Chile. Club Med is building a new 1,000-bed beach resort at Bahias de Huatulco, 335 miles southeast of Acapulco. Big U.S. banks usually act only as middlemen in these deals, but a few have been swapping for themselves, trading their Third World loans for equity in Latin businesses. * THE WINDOW for debt-equity swaps is opening wider each day, but it could slam shut within a few years. For one thing, attractive investments in the Third World will get harder and harder to find. Some economists see a potential for no more than $40 billion in deals throughout Latin America. For another, swaps would not exist without a debt crisis. If the borrowers reach a point where they can service their debt comfortably, loans will no longer sell at a discount. Alvaro Saieh Bendeck, a Chilean banker, predicts that the price of Chilean loans in the secondary market will approach full face value once the country wipes out another $2.5 billion of its foreign debt.

What's more, the debtor countries have begun to wonder whether they lose more than they gain on these deals. Mexico's Gurria, for one, questions whether countries should continue paying subsidies to foreign investors. ''The latest restructuring package on our debt gives us 20 years to repay principal, with no principal payments for seven years,'' he says. ''So why are we giving money away? Why pay 88 cents for debt that is worth only 60 cents? What's the rush?'' Well might he ask. Giving money away may be a good idea for struggling Latin economies if the investments would not take place without subsidies. ''That's always a very difficult question to answer,'' Gurria concedes. Chilean authorities point out that prior to their swap program, the country was attracting less than $100 million a year in foreign investments. Some $2.5 billion in swap investments have been arranged since 1985. Swap subsidies may also make sense for countries that have not negotiated as favorable terms as Gurria was able to get from foreign banks. Swapping, which reduces the interest the countries have to pay this year, may be better than going deeper into hock just to pay interest on existing loans. Says Juan Andres Fontaine, chief economist at Chile's central bank: ''We are saving about $200 million a year in interest payments. That may sound small, but it is an amount worth fighting for.'' One potential headache for debtors is that swaps are inflationary if the government has to print new local money to redeem its loans. Problems can arise even if the central bank pays in bonds instead of cash. The government ends up a loser if the real interest rates on the local-currency bonds turn out to be higher than what it pays on foreign debt. Devising safeguards against these perils is a major conundrum for the Third World. Banks and multinational companies, which have been inundated with swap proposals from Latin promoters, are already bemoaning the dearth of good opportunities. Says Richard A. Marin, one of the chief swappers at Bankers Trust: ''Citibank's reserve announcement brought all manner of dealmakers out of the woodwork, peddling everything from corner gas stations to crummy breweries. Imagine the sifting process we have to go through now.'' Bankers Trust, a leading player in the swap business, is spoiled. It was one of the first to get into swaps and has made some of the best deals. The bank traded $43 million of its Chilean loans in early 1986 for a controlling interest in Provida, Chile's largest pension fund manager, and Consorcio, its premier life insurer. Under the country's mandatory private pension system, every Chilean employee must contribute a designated percentage of his income to one of a dozen or so fund managers, which invest the money in local financial markets. Marin says Provida and Consorcio are now worth twice what the bank paid for them. Says Julio Barriga Silva, president of Banco de Santiago, Chile's second-largest bank: ''Bankers Trust was here at 8 A.M. when the doors opened. It got our best assets. Others will get the leftovers.'' Chile tries to keep the new foreign investment in the country by prohibiting swappers from repatriating profits for four years and capital for ten. That means Bankers Trust has to reinvest its Provida bounty in Chile. So far it has used the profits to buy a piece of Pilmaiquen, a hydroelectric power company. But other attractive investments are tough to find, even with 75 professionals looking for deals. ''Most of the bargain-basement deals surfacing now are too risky for banks,'' says managing director Marin. ''We go through hundreds of proposals every week.'' New Zealand companies have developed an appetite for Chile's bountiful timberland. In the largest swap on record, Carter Holt Harvey, a forest products company, bought almost half of Copec, the largest private company in Chile and the owner of Celulosa Arauco y Constitucion, the country's leading pulp manufacturer. Carter Holt paid for its stake in January with $161 million of Chilean loans that it bought in the secondary market for $114 million. Not to be outneedled, Fletcher Challenge, another New Zealand company, is negotiating a swap for 79,000 acres of Chilean trees. Swap enthusiasts say that Chile has the most investor-friendly program, * with the least red tape. Almost anything under the country's skies is swappable except for projects that the government hopes can attract investors without subsidies. Only 5% or so of the new $1-billion Escondida copper mining project in northern Chile, for instance, will be eligible for debt-equity swaps. Mitsubishi, Rio Tinto Mining of Australia, and others will put up the bulk of the money the old-fashioned way -- by paying with cash rather than discounted loans. Codelco-Chile, the state-owned copper company and the country's crown jewel, also is off limits. Local banks in Chile are making out like bandits in swaps, or debt rescue operations, as they are called down South. ''It's like sitting on an oil well,'' says Juan Enrique Zegers, manager of international trade at Banco de Credito e Inversiones, Chile's third-largest bank. Banco de Credito, which had borrowed $280 million overseas, has cut that burden in half in the past two years. Chile sells the right to engage in swaps to its own citizens. It limits the sales, now set at $30 million a month, so that the scramble for dollars doesn't drive the exchange rate out of whack. The scheme works like this: Chilean investors buy discounted loans to local banks like Banco de Credito in the secondary market. The local banks then redeem the loans in pesos for 6% to 8% less than face value. Such ''private'' swaps, which enable the banks to wipe debt off their books at a discount, accounted for roughly $4 million of Banco de Credito's $20 million in profits last year. MEXICO'S debt-equity program is both more complicated and less ambitious than Chile's. Says Jaime Alvarez Soberanis, director of foreign investment in Mexico's ministry of trade: ''We're not trying to eliminate the Mexican debt with this program. That's absurd.'' Instead Mexico's principal aim is to spur investment. In the 15 months since the program was launched, the government has approved 250 projects. Rules for foreign investors are outlined in sometimes indecipherable language in a 44-page Manual Operativo. Later this summer Mexico plans to issue a set of rules that will let its citizens get in on the action. Says Gurria: ''We're working on draft ten right now.'' By inviting local participation the country hopes to lure back some of the flight capital that wealthy Mexicans have taken abroad -- an amount estimated as high as $50 billion, or half the country's foreign bank debt. Gurria is hoping that individuals will use some of the dollars they have ! invested in the U.S. to buy discounted loans and then swap the loans for pesos. Mexico also tailors its swap program to promote industrial policy goals. It does that by redeeming loans at different prices depending on how the proceeds will be used. If a foreign investor wants to buy shares in a nationalized company that the government is trying to privatize, the central bank redeems loans at full face value. It pays as much as 95 cents on the dollar if the pesos will be invested in tourism and other businesses that help the trade balance. But it pays only 75 cents on the dollar on deals that create no jobs, no exports, and no new technology. Chrysler, which employs more than 10,000 people in Mexico and is the country's largest private exporter, jumped at the chance to do swaps last summer and made a $100-million investment -- for $65 million. The company cashed in Mexican loans at two different rates. The government paid it about 86 cents on the dollar for some $23 million of debt that it swapped to pay off high-interest peso loans in Mexico. Chrysler redeemed another $87 million or so at about 92% of face value, according to Rosemary Werret, author of a pamphlet titled Guide to Debt-Equity Swapping in Key Latin American Countries. The company used that money to expand a Mexican plant that makes Chrysler LeBarons and for other capital investments. Chrysler says the new investment should boost its exports from Mexico by $400 million, or 40% above last year's $1 billion. With the Mexican peso at an all-time low and dropping daily, tourist- related swap proposals are pouring into Gurria's office. Says Marin of Bankers Trust: ''There's a land-rush air about it now.'' According to Jorge Martin Couttolenc, chairman of a hotel development company called Compania Hotelera Azteca, wage rates and material costs are so low that deluxe hotels can be built for about 30% of what they would cost in the U.S. The average return is at least 25% a year, he says. AMERICAN EXPRESS has been as aggressive as Bankers Trust in whittling down its $2.5-billion Third World loan portfolio through swaps. Says George Stathakis, chairman of International Capital Corp., a subsidiary of Amex's international bank: ''We want to move the risk of Third World loans to a productive enterprise.'' In March, Amex announced plans to swap $100 million of Mexican loans for investments in seven hotel deals, and it is considering other projects worth $200 million. One of its investments is the resort at Bahias de Huatulco, a joint venture with Club Med, Bancomer (a Mexican bank), and a government agency. Most big U.S. banks have avoided swapping their own loans because they want to avoid booking losses on the deal. The two biggest exceptions, Bankers Trust and American Express, both have Arthur Young as their auditor, which has maintained that banks do not automatically incur losses on swaps. Other accountants have taken harsher views, the most extreme being that banks should report losses equal to the full discount of the loans in the secondary market. But now that Citi and many other banks have already taken the hit to earnings by bolstering loan-loss reserves, more Third World creditors will probably be eager to prune their portfolios. Yankee euphoria over swaps will last until the vein of viable investments runs out. A fresh supply of deals is available in Argentina, but that country's nascent program requires investors to bring in a dollar of fresh cash for each dollar of debt swapped, thereby cutting the subsidy in half. Brazil is considering a similar policy. And some U.S. advisers to Latin American countries have been bad-mouthing swaps. Says Jeffrey Sachs, a Harvard economist who counsels the Bolivian government: ''Why repurchase loans that can be rescheduled ad infinitum and will probably be at least partially forgiven someday anyway?'' Even as debtors and creditors wrestle with such questions, they are going ahead with large deals and kicking up a lot of dust. Brazil's program isn't even official yet, but it has begun doing deals with some companies. Bankers Trust, for one, has used swaps to acquire land for a Brazilian mining subsidiary, called BT Gold. ''We bought a hill of gold there,'' says Marin. This gold rush, in other words, is just like all others. Prospectors after mother lodes will have to get there fast, and they will need a sharp eye to separate the hills of gold from the hills of beans.