Econ 161-Lecture 16

Econ 161-Lecture 16 - GlobalIntegrationofLatinAmerica...

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Unformatted text preview: GlobalIntegrationofLatinAmerica Lecture16 c Marc-AndreasMuendler UniversityofCalifornia,SanDiego May26,2011 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler SolutionstotheDebtCrisisofthe1980s Twomajorpolicyinitiativestoresolvethedebtcrisis Market-basedmechanismsfordebtreduction Examples .Debtrenegotiationsamongcreditorsandlendersin ParisClub;BakerPlan CreationofanInternationalDebtFacilitythatbuysprivatedebt atdiscountedpricesandsubsequentlyoffersdebtorsrelief Example .BradyPlan TheBradyPlanopenedthedoortodebtbuybacksandsimilartrans- actions,beyondcommonmethodsofdebtrestructuring 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler TheBakerandBradyPlans BakerPlan,1985(JamesBaker,UStreasurysecretary)fails $20billionnewprivatecredit,$9fromIMF&WorldBank,15debtorcountries Commercialbanksrefuse,seekingtoreducenotincreasetheirexposure BradyPlan,1989(NicholasBrady,UStreasurysecretary)succeeds inbringingcapitalflowsbacktoLatinAmerica Creditorsrepackagebadloansintolonger-termBradyBonds BradyBondsarepartlyorwhollybackedbyUSTreasuryBonds Debtorsreducefacevalueofdebtthroughbuybacksfromsecondarymarket 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler InternationalPolicyPrescriptions Reducedfiscalspending,tightermonetarypolicy,opentraderegimes IMFConditionality :Releaseoffundsconditionalonadherenceto prescriptions Problems .Domesticeconomiescontract,structuralproblemsunre- solved,lackinggrowthtorepaydebt DebtRestructuring .Market-basedmechanismsfordebtreduction andcreationofInternationalDebtFacilities 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler DebtOverhang Ratherthandecidingaboutforeignborrowingforthefirsttime,incom- inggovernmentsoftenfacelargeamountsofpreviouslyaccumulated debt Debtoverhangmaybesoseverethatgovernmentshavelittlein- centivestoimprovetheirinvestmentsandkeepunder-investing,thus jeopardizingtheirrepaymentprospectsevenfurther Reason .Whetherornotacountrywithdebtoverhanginvestsin projectswithgoodprospects,payoffswillbesmall. Debtburdensohighthatevenunderbestofallcircumstancesdebt servicewillconsumemostresources 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler BondValues,YieldsandInterestRates FaceValue ofabond:A$1bondwith1yearmaturityhas$1face valueandreturnsthecontractedinterestrate R * R * =10% ,say MarketValue :Bondscantradeatdiscountsoftheir FaceValue Example :Ata20%discount,a$1bondcosts80cents(80%of$1) Yieldofabondata20%discount: 1+ R * . 8 =1 . 25(1+ R * ) Whenmanyforeignlendersdemandacountrysbonds,theyreduce theyield.Thismakesnewdebtlessexpensivefortheborrower. Reason .Thelendersbidupthe MarketValue andreducethediscount Example :Ata10%discount,the$1bondyieldsonly 1+ R * . 9 1 . 11(1+ R * ) 16.DebtOverhang,DebtBuybacksandDebtForgiveness Econ161, c M.Muendler Brazils40-yearBenchmarkBond...
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This note was uploaded on 08/14/2011 for the course ECON 161 taught by Professor Muendler during the Spring '11 term at San Diego.

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Econ 161-Lecture 16 - GlobalIntegrationofLatinAmerica...

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