Brady Plan

Brady bonds are dollar-denominated bonds, issued mostly by Latin American countries in the late 1980s. The bonds were named after U.S. Treasury Secretary Nicholas Brady, who proposed a novel debt-reduction agreement for developing countries.

Brady bonds were created in March 1989 in order to convert bank loans to mostly Latin American countries into a variety or "menu" of new bonds after many of those countries defaulted on their debt in the 1980s. At that time, the market for emerging markets' sovereign debt was small and illiquid, and the standardization of emerging-market debt facilitated risk-spreading and trading. In exchange for commercial bank loans, the countries issued new bonds for the principal sum and, in some cases, unpaid interest. Because they were tradable and came with some guarantees, in some cases they were more valuable to the creditors than the original bonds.

The key innovation behind the introduction of Brady Bonds was to allow the commercial banks to exchange their claims on developing countries into tradable instruments, allowing them to get the debt off their balance sheets. This reduced the concentration risk to these banks.

The plan included two rounds. In the first round, creditors bargained with debtors over the terms of these new claims. Loosely interpreted, the options contained different mixes of "exit" and "new money" options. The exit options were designed for creditors who wanted to reduce their exposure to a debtor country. These options allowed creditors to reduce their exposure to debtor nations, albeit at a discount. The new money options reflected the belief that those creditors who chose not to exit would experience a capital gain from the transaction, since the nominal outstanding debt obligation of the debtor would be reduced, and with it, the probability of future default. These options allowed creditors to retain their exposure, but required additional credit extension designed to "tax" the expected capital gains. The principal of many instruments was collateralized, as were "rolling interest guarantees," which guaranteed payment for fixed short periods. The first round negotiations thus involved the determination of the effective magnitude of discount on the exit options together with the amount of new lending called for under the new money options.

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