Brady Plan for Latin Debt Deserves a Second Chance : Economics: Treasury secretary’s scheme needs money and a stronger commitment from industrialized nations to make rules more favorable.

Ten years after the debt crisis first hit, a large number of Latin American countries, including all the major economies, still cannot service their liabilities and grow economically. Imports have declined by roughly $40 billion. Investment as a percentage of gross domestic product has fallen, from 23% to 16%. Clearly, the Latin debt crisis is more than a prolonged liquidity problem.

The overextended condition of borrowers and creditors was abruptly spotlighted in 1981-82, when interest rates zoomed and the prices of the region’s primary export commodities plummeted. True, many Latin Americans had recognized the problem before then. But the creditor governments acted as if the loan arrangements were between a neighborhood bank and small-town customers.

When financial crises as Gargantuan as the American savings-and-loan fiasco occur, governments usually intervene to keep the financial system solvent and sustain domestic output and employment. Though these “public bailouts” violate traditional liberal economic theory, they generally prove to be good policy if health is restored to the ailing institution.

The Latin America debt problem surely cries out for such comprehensive action. The initial efforts of the industrialized countries, however, aimed at stabilizing only one side of the international system--their domestic economies and private banks. They succeeded admirably.

Unfortunately, this success seriously impaired the economic performance of the indebted countries. When this fact was recognized by then-Secretary of the Treasury James A. Baker III in 1985, the solution he offered was too little, too late. Not until March, 1989, when Secretary of the Treasury Nicholas F. Brady announced his plan, did a more comprehensive debt-relief framework emerge. Perhaps its most important feature was to restore balance to the distribution of costs and benefits associated with managing international debt.

The Brady plan would enhance and accelerate Latin debt reduction by enabling banks to liquidate their “old debt” in one of two ways. Either a country could buy back its debt at a significant discount or take on “new debt,” again at a discount, by changing its “old debt” into creditor equity.

For this approach to work, some public funding would be needed, either to finance the buy-backs or, more important, to offer the guarantees that would make “new debt” attractive to a creditor. Private banks could also be encouraged to participate by modifying legal, regulatory, accounting and tax codes that govern them. Thus, the Brady plan intended to stimulate policy reform and economic growth in debtor countries through voluntary, case-by-case, debt and debt-service reduction.

Certainly a step in the right direction. But the Brady plan has collided with difficulties:

It is seriously underfunded. The existing pool of committed public money--$30 billion--can finance only a fraction of needed reduction. The Economic Commission for Latin America and the Caribbean estimates that at least three times that sum is needed to have an effect.

Private banks in most industrialized countries still lack any incentive, or face any punishment, that might spur them to settle their Latin American claims. It is thus essential--and practical--for the governments of creditor banks to change the regulatory, accounting and tax rules.

The Brady-inspired negotiations have been cumbersome, drawn-out affairs.

Mainly for these reasons, many observers, in debtor as well as in creditor countries, have mistakenly declared the Brady plan all but dead. Its conceptual framework is solid. Most important, the means to make it work are well within reach: By global standards, a commitment of $90 billion seems a small price to pay for putting Latin American and Caribbean nations back on their financial feet. Most of that commitment does not have to be “up front.” It need only be in the form of contingent liabilities. Further, most of the multilateral institutional framework is in place, although the International Monetary Fund should be more assertive in guaranteeing financing.

The Brady plan thus contains most of the ingredients necessary to eliminate the Latin American and Caribbean debt overhang. Its potential could be further reinforced by establishing a multilateral debt agency under the aegis of the World Bank and/or the IMF. This agency could lessen the inefficiencies of the current piecemeal approach to debt reduction and lower its ultimate public costs.