A Strategy for Efficient Debt Reduction

F or the past seven years, the U.S. government has managed the debt crisis with the preeminent goal of sustaining the flow of debt servicing payments from the debtor countries to the commercial banks. The focus on the banks, especially in the first years of the crisis (1982–85), is easily explained. Several money-center banks had exposure of nearly 200 percent of bank capital in Latin America alone upon the outbreak of the crisis in 1982. A widespread suspension of debt-service payments could well have sunk several major banks. I have discussed the U.S. government's policy focus on the debt servicing to the commercial banks in Sachs (1986b, 1989c) and Sachs and Huizinga (1987). But today, those policies are being revised. After years of steady decline in the exposure ratios of the most heavily exposed banks, the risk of a U.S. banking crash as the result of the debt crisis is now virtually nonexistent. In addition, the burden of debt payments is contributing to profound economic crises and growing political instability in almost all of the democracies in Latin America. A wide range of analysts now concurs that the debt burden should be reduced, not only for the sake of the debtors, but also for the sake of the creditors, who have an important long-run stake in allowing the developing countries to surmount the current acute crisis. The Brady plan, unveiled by Secretary of Treasury Nicholas Brady in March 1989, is based on the need for a reduction of the debt burden.