1980s debt crisis

1
1980s debt crisis In the aftermath of the 1973
oil shock, many commercial banks suddenly found
themselves with sizeable amounts of funds
deposited by oil producers. In the rush to
recycle that cash, many banks lent to
governments of LDCs. 1979-1980 second OPEC oil
price increase. Another situation of excess
world savings lead to a rise in developing
countries debt.
2
U.S. federal reserve in 1979 adopts anti
inflation monetary policy that helped push the
world economy into recession by 1981. U.S.
interest rates up and dollar appreciates. Since
much developing countries debt is denominated in
dollars, developing countries real value of
debt service is up. Exports are down because of
world recession. In the early 1980s, when
commodity prices fell, the terms of trade swung
against LDCs. On August 12, 1982 Mexico declared
a temporary moratorium on interest payments.
Mexicoannounced that it has left with zero
international reserves and can no longer meet its
debt obligations.
3
Many commercial banks were left with large
amounts of defaulted syndicated loans. In 1983, a
market for swapping loans was created. European
and US banks began to swap their defaulted loans.
The transactions made economic sense in part due
to US accounting practices and to the inability
of US banks to write down their loans to their
economic value.
4
Starting in 1987, many banks began to set aside
reserves against their LDC exposure and were able
to sell those loans at a discount. The secondary
market for LDC debt was born. Debt relief
formulas were implemented Debt Buy
backs Swapping Loans into exit bonds, Conversion
of loans into local currency for equity
investment, Exchanging loans for Brady Bonds
5
Brady Bonds are securities that have resulted
from the exchange of commercial bank loans,
sometime defaulted loans, into new bonds. Many
Brady Bonds have their principal and two or three
semi-annual interest payments , which roll over,
collateralized by 30-year zero-coupon bonds and
by high quality assets.Should a Brady bond whose
principal is collateralized default, investors
can only collect the principal when the bonds
mature.
6
Costs and benefits of sovereign default
CostsSeizure of assets exclusion from future
borrowing reduction of gains from international
trade
Benefits debtor escapes paying debt -- RESURCE
TRANSFER from creditors to debtors.
7
Managing Debt Crisis Concerted lending and debt
recontracts. Muddling through. Market based debt
reductionsvoluntary market transactions.