The Brady bunch

Citibank's John Reed gave a push in the right direction with a unilateral move, in May 1987, to take a
$3 billion reserve on his bank's emerging-market debt. Reed knew he would be hated: he was forcing
other banks, such as the crippled Manufacturers Hanover, to follow suit.
Mulford, who was then treasury under-secretary, wanted to take things to the next stage, passing on
that write-off to reduce the overall debt of the countries themselves. He feared that otherwise the
nominal amount of the debt would simply be capitalized and passed from the private to the public
sector. "There had to be some kind of debt relief for these countries," he said.
Origins of the Brady Plan
The October 1987 stock market crash showed that there was no escape for investors besides US,
Japanese or German government bonds. Nicholas Brady, who completed a report on that crash, was
appointed treasury secretary the next year. At a G7 meeting in Bonn there were the first discussions of
what later became the Brady Plan - a refinancing that forced banks to provide some debt relief to the
borrower. "I produced the 'truth serum paper'," recalls Mulford, "- my plan to get everyone to recognize
the problem."
The Brady Plan was announced in September. It would involve debt reduction, although the terms
hadn't been hammered out. Towards the end of that year JP Morgan put together a deal for Mexico
which anticipated Brady bonds. Creditor banks could exchange their loans at a discount for 20-year
bonds whose principal was guaranteed by a US treasury zero-coupon note. Mexico, the guinea-pig, did
its first Brady deal in February 1990. Some sources credit Gerald Corrigan, then president of the New
York Federal Reserve, with the real brainwork. Others mention Angel Gurria, the technical wizard at
the Mexican treasury, now finance minister. Still others call it the Mulford Plan. Certainly Mulford was
the figure who browbeat the financial community into accepting debt reduction.
Other countries followed Mexico: the Philippines, Uruguay, Nigeria, Brazil, Argentina, Jordan,
Bulgaria, Poland, Ecuador, Peru. But there was a catch. The debt had passed from bank balance sheets
to a wider investor universe. Bondholders had rights that couldn't so easily be modified by borrowers
and central banks. Heaven and earth - that is 17 billion of US taxpayers' dollars - were moved, in the
1995 tequila crisis, to prevent Mexico from defaulting on its Bradys.
Of course, the bonds could be marked down to their guaranteed zero-coupon value, but thereafter
Mexico's ability to refinance would be severely impaired. Some countries have bought back their
Bradys, to capture the discount. But the first Brady default will send shockwaves through the market.
Russia refused to do a Brady refinancing in 1994, showing foresight, since in 1999 it came within an
ace of defaulting on its ordinary Eurobonds. So did Pakistan. A default would deal a severe blow to a
market that has never seen a sovereign failure.
A tug on the reins
"We monitored the huge development of international bank lending at the BIS," says Lamfalussy. "It
was very difficult to slow down the enthusiasm of the banks." But apart from monitoring, the BIS was
only marginally involved in working through the debt crisis. It turned its attention to making sense of
the innovation in the financial markets, the risks of derivatives and netting schemes, and the roller-
coaster of exchange rate and interest rate volatility.
That same year, 1974, Franklin National Bank in New York collapsed because of currency speculation
by its major shareholder, Michele Sindona, the same who later hastened the collapse of Banco
Ambrosiano in Italy and Luxembourg. At the end of 1979 came the scandal of Bernie Cornfeld's
pyramid fund management scheme Investors Overseas Services, from which Robert Vesco allegedly
absconded with $240 million. Vesco was last heard of in a jail in Cuba.