Posted by: Dirk | April 27, 2010

The LDC debt crisis

History of the Eighties — Lessons for the Future, a study prepared by the FDIC’s Division of Research and Statistics, provides us with an interesting study on the LDC debt crisis. Vol. I, Part 2, ch. 5 (1997) concludes:

From the middle to late 1970s, a number of economists, government officials, and journalists expressed concerns that the volume of lending to less-developed countries could entail serious problems for U.S. money-center banks and the international financial system. At the same time, however, the market – as reflected in both money-center bank equity prices and corporate bond ratings – apparently did not perceive a problem until the crisis actually broke out. Regulators’ attempts to urge banks to curtail LDC lending appeared to have had no significant effect on lending practices, even as evidence suggested that Latin American nations were having increasing difficulty meeting current debt obligations. The regulatory system therefore broke down and was unable to forestall the crisis. In the final stages, the realization that banks would not recover the full principal value of existing loans turned international efforts from debt rescheduling to debt relief, and substantial funds were raised through the IMF and the World Bank to facilitate debt reduction. The shareholders of the world’s largest banks assumed the losses under the Brady Plan, which ended the crisis after a decade of negotiations.

This means that we have been there before. The international economic order, using Arthur Lewis’ vocabulary, led to global capital misallocation and the banks were happy until the end because – they made profits until the end. Realizing that the full principal value of existing loans would not be recovered was bad news for savers, not for bankers. Also, the turn from debt rescheduling to debt relief is something which we are likely to see as a consequence of the Greek tragedy.

The story unfolding today is not without precedent – again, we have been there before. Today just as the early 80s, banks and politicians are in denial until they are forced to act. I would like to see somebody from the field of political economy to explain why or point out a paper which does so. Suggestions welcome!

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