![]() ![]() Instead of eliminating subsidies to state-owned enterprises, many LDC countries instead cut spending on infrastructure, health, and education, and froze wages or laid off state employees. The hope was that these reforms would enable the LDCs to increase exports and generate the trade surpluses and dollars necessary to pay down their external debt (Devlin and Ffrench-Davis 1995).Īlthough this program averted an immediate crisis, it allowed the problem to fester. In return, the LDCs agreed to undertake structural reforms of their economies and to eliminate budget deficits. Under the program, commercial banks agreed to restructure the countries’ debt, and the IMF and other official agencies lent the LDCs sufficient funds to pay the interest, but not principal, on their loans. Fed officials also encouraged US banks to participate in a program to reschedule Mexico’s loans (Aggarwal 2000).Īs the crisis spread beyond Mexico, the United States took the lead in organizing an “international lender of last resort,” a cooperative rescue effort among commercial banks, central banks, and the IMF. In August, the Fed convened an emergency meeting of central bankers from around the world to provide a bridge loan to Mexico. Working Toward a Resolution: IMF and Central Bank InvolvementĪs transcripts from the July 1982 Federal Open Market Committee (FOMC) meeting illustrate, committee members felt it was necessary to take action (FOMC 1982). as based on “high domestic consumption, heavy borrowing from abroad, unsustainable currency levels, and excessive intervention by government into the economy” (Ferguson 1999). The abrupt cut-off in bank financing plunged many Latin American countries into deep recession and laid bare the shortcomings of previous economic policies, described by former Federal Reserve Governor Roger W. In response, many banks stopped new overseas lending and tried to collect on and restructure existing loan portfolios. Ultimately, sixteen Latin American countries rescheduled their debts, as well as eleven LDCs in other parts of the world (FDIC 1997). The spark for the crisis occurred in August 1982, when Mexican Finance Minister Jesús Silva Herzog informed the Federal Reserve chairman, the US Treasury secretary, and the International Monetary Fund (IMF) managing director that Mexico would no longer be able to service its debt, which at that point totaled $80 billion. The Latin American countries soon found their debt burdens unsustainable (Devlin and Ffrench-Davis 1995). At the same time, commercial banks began to shorten re-payment periods and charge higher interest rates for loans. Nominal interest rates rose globally, and in 1981 the world economy entered a recession. By late in the decade, however, the priority of the industrialized world was lowering inflation, which led to a tightening of monetary policy in the United States and Europe. The near-zero real rates of interest on short-term loans along with world economic expansion made this situation tenable in the early part of the 1970s. Still, by 1982, the nine largest US money-center banks held Latin American debt amounting to 176 percent of their capital their total LDC debt was nearly 290 percent of capital (Sachs 1988). In 1977, during a speech at the Columbia University Graduate School of Business, then-Fed Chairman Arthur Burns criticized commercial banks for assuming excessive risk in their Third World lending (FDIC 1997). The potential risk of the growing involvement of US banks in Latin American and other less-developed country (LDC) debt didn’t go unnoticed. By 1982, the debt level reached $327 billion (FDIC 1997). At the end of 1970, total outstanding debt from all sources totaled only $29 billion, but by the end of 1978, that number had skyrocketed to $159 billion. Latin American borrowing from US commercial banks and other creditors increased dramatically during the 1970s. With the encouragement of the US government, large US money-center banks were willing intermediaries between the two groups, providing the exporting countries with a safe, liquid place for their funds and then lending those funds to Latin America (FDIC 1997). At the same time, these shocks created current account surpluses among oil-exporting countries. The Origins of the Debt Crisisĭuring the 1970s, two large oil price shocks created current account deficits in many Latin American countries. The Federal Reserve and other international institutions responded to the crisis with a number of actions that ultimately helped alleviate the situation, albeit with some unintended consequences. Working Toward a Resolution: IMF and Central Bank Involvementĭuring the Latin American debt crisis of the 1980s-a period often referred to as the “lost decade”-many Latin American countries became unable to service their foreign debt. ![]()
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