TCH: Latin America in New York’s 1920s Bond Market

??????????? During the 1920s stock market bubble, there were many listings of companies whose purpose was to profit from rising share prices. Some of the most notable of these were investment trusts raising money they could then leverage with debt or preferred stock to profit from rising prices for the securities they held. They were not the only issuers new to the American markets in that decade. Latin American governments and government-backed companies were also coming to the United States to raise money and this was an entirely novel development.

1920s

??????????? In the 19th century, the United States borrowed considerably more from the rest of the world, particularly from Britain, than it lent abroad. However, the First World War changed this. Even before the war, the United States was investing enough abroad that its status as firmly a large debtor country was less clear. This early foreign investment by the United States was largely in the form of direct investment in assets like railways, sugar mills, and mines; Americans did not tend to invest in the securities of foreign issuers.

???????????While the U.S. owed $3.8 billion more to foreigners than it was owed by foreigners just before the war, it became a net creditor of similar magnitude after the war. This was the result of European investors liquidating their American investments and growing American lending to European governments in need of money to fund their war spending. After the war, Europeans were largely investing domestically, partly to rebuild. This meant that there was less capacity for Europeans to invest abroad.

???????????Filling the gap, the extent of American foreign lending grew. This was largely enabled by rising American incomes and, to a still significant (but lesser) extent, a reduction in domestic investment freeing up money for deployment abroad. As it happens, the savings rate of Americans changed little so this did not contribute to the change underway. In any case, in the eleven years ending in 1930, American investors lent $10 billion abroad; 40% was still in the form of direct investment but 45% was made up of purchases of foreign securities, a rather new development. By 1930, America was a net creditor to the rest of the world to the tune of $8.8 billion.

Rates

???????????Driving much of this foreign investment was declining interest rates on domestic investments, encouraging money to go abroad.? American interest rates were falling in the 1920s. As an example, rates on medium-grade bonds, those rated Baa by Moody’s, was just a bit above 7% in 1922 and 1923 and fell to approximately 5.5% in 1927 and 1928.

???????????Investors were drawn to foreign securities, and Latin American ones in particular, because of their higher yields. Having to offer investors particularly high rates were both new countries, like those created in the aftermath of the war in Europe, and Latin American countries with a history of defaults on debt, like Bolivia and Peru. That said, some other South American countries did enjoy much lower costs of capital in their American borrowings. In any case, investors felt adequately compensated because, in the 1920s, there were virtually no defaults on the over eight hundred foreign bonds issued in the United States.

Latin American Bonds

??????????? While this increase in American foreign lending was underway, Latin American issuers became more frequent borrowers in American markets. Whereas they made up only 8.9% of American foreign security issues in 1919 and 10.1% in 1920, they made up 38.6% in 1921 and 31.2% the following year. In each of these latter two years, Latin American bond issues in America came to about $230 million. Almost all Latin American bond issues in the United States were government bonds or bonds for private entities guaranteed by governments. True private bond issuance was rare.

??????????? Large American banks underwrote these offerings and syndicated them to investors. More American banks were underwriting foreign loans after 1924, no doubt drawn by robust demand and high fees. On average, the bankers would earn a selling commission of 4% and profited from an average discount of 3% on the bonds.

??????????? ?There was a reduced share of foreign lending to Latin America in the mid-1920s as European issuers returned to America to borrow in larger numbers. However, there was a second boom in Latin American borrowing in the second half of the decade. The proportion of American purchases of foreign securities comprised of Latin American investments grew back to 33.1% in 1926 and remained around 26% for the rest of the decade. Remarkably perhaps, the total sum of long-term American investments in Latin America amounted to $5.35 billion at the end of 1930 and this exceeded the value of American investment in Europe.

??????????? ?Also, while the market share of Latin American securities in America may seem smaller in the late 1920s than in 1921 and 2022, note that the market for these bonds was a lot bigger in 1926-1929 than in either of those earlier years. Indeed, total issuance of foreign securities in America grew from just $580.5 million in 1921 to $1.3 billion in 1927, in each case in 1929 dollars to adjust for inflation.

??????????? ?With respect to Latin American borrowing in the United States, the principal destinations for this capital were Chile, Argentina, Brazil, and Colombia. In some countries, like Argentina and Brazil, most of the American money invested there was in the form of a bond. Besides all this money raised by the sale of securities, foreign direct investment into Latin America from the United States continued to remain substantial. In fact, it would make up two-thirds of invested American capital in Latin America at the end of 1930. For some countries, like Venezuela and Cuba, this manner of investment greatly exceeded investment in securities.

Crash and Defaults

??????????? The boom in American investment in Latin America would not outlive the buoyant atmosphere of the 1920s. Starting in 1928, some American banks stopped underwriting foreign loans. In 1929, the volume of Latin American bond issuance nearly halved and it remained depressed the following year. In 1930 and 1931, the onset of the Great Depression also inflicted financial trouble on Latin American countries.

??????????? The Depression was exported to this part of the world through the decline in the prices of, and the level of demand for, Latin American countries’ principal export commodities. The collapse in the market was remarkable; some prices fell by between 50-75%. Important affected commodities for the region included coffee, oil, wheat, and tin.

??????????? Many of these countries’ governments depended on taxes levied on the export of these commodities. These taxes were levied in proportion to the value of exports, meaning that the public finances were hampered by both the falling prices and the falling volumes of these exports. Thus, the prospects for repayment on the bonds dimmed. Making matters even worse though were falling exchange rates for these countries’ currencies, making it more difficult for them to service their debts which had to be repaid in dollars linked to gold.

??????????? Clearly, future prospects looked bleak. Accordingly, spreads on Latin American bonds, essentially the premium paid considering their riskiness, rose markedly in 1930. Various bonds issued by Colombia and Brazil whose spreads seemed to imply an expected loss rate of 4% or less in 1929 were implying a loss rate of more like 8% by the end of 1930. The following year, spreads on Argentine bonds, generally regarded as safer, also rose as the market for foreign bonds decisively turned. It was this year when the first defaults came, starting with Bolivia in January. Then, Peru and Chile defaulted on their debts in March and July 1931 respectively. By year-end 1931, $1.2 billion in bonds were in default.

??????????? A recovery would come but it was very uneven. Argentine bond spreads began to fall in 1933 as it became clear that government would not default. Chile, which did miss payments, was able to restructure its debts in the 1930s. However, Bolivia was in default for decades and efforts to restructure their debt proceeded very slowly.

Lesson

??????????? ?In the 1920s, American lending abroad was increasing, enabling foreign issuers to borrow money from this new market.? Exactly a century earlier, there was another boom in foreign lending to Latin America. In the 1820s, the new independent countries there turned to London to borrow after an earlier global war left London as Europe’s premier center for international sovereign lending. Investors in the city were searching for higher yielding investments as local interest rates fell. Banks were eager to introduce new securities and, just as in New York, several countries ended up defaulting on their foreign loans. A century and three thousand miles distance mattered little to the story’s arc.

More from the Tontine Coffee-House

???????????Read?about?the 1820s boom in British lending to Latin America and British investments in mining companies, predominantly in Latin America (Part I and Part II). Consider subscribing to this blog’s?newsletter?or checking out?book recommendations, which include many of the sources often referenced in my posts.

Further Reading

1.????? Jorgensen, Erika & Sachs, Jeffrey. "Default and Renegotiation of Latin American Foreign Bonds in the Interwar Period," NBER Working Papers 2636, National Bureau of Economic Research, Inc. 1988.

2.????? Eichengreen, Barry “The U.S. Capital Market and Foreign Lending, 1920–1955” found in “Developing Country Debt and Economic Performance, Volume 1: The International Financial System.” Edited by Sachs, Jeffrey D, University of Chicago Press, 1989, pp. 107–156.

3.????? Scroggs, William O. “The American Investment in Latin America.” Foreign Affairs, vol. 10, no. 3, Apr. 1932, pp. 502–04.