1980’s 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 second OPEC oil price increase. Another situation of excess world savings lead to a rise in developing countries’ debt.

U.S. federal reserve in 1979 adopts anti inflation monetary policy that helped push the world economy into recession by 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 1980’s, 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.

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.

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

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.

Costs and benefits of sovereign default Costs:Seizure of assets exclusion from future borrowing reduction of gains from international trade Benefits debtor escapes paying debt -- RESURCE TRANSFER from creditors to debtors.

Managing Debt Crisis Concerted lending and debt recontracts. Muddling through. Market based debt reductions:voluntary market transactions.