Defaulting for Investment: Bondholders and Direct Investors in the Depression

The onset of the Great Depression Depression facilitated the end of the first American empire by breaking up the coalition between creditors and direct investors. When times were good, Latin American governments could usually manage to make debt payments while collecting enough revenues to maintain a functioning state. Under Depression conditions, however, governments faced a painful bind: they could maintain payments on their foreign debt at the cost of austerity measures that undermined political stability; or they could impose tax hikes that directly impinged upon the profitability of foreign direct investments; or they could default. Creditors wanted governments to do everything possible to earn enough revenue to continue servicing their debt. Owners of direct investments disagreed: taxes and austerity measures ate into their profits and reduced the value of their investments. Ultimately, such measures had the potential to generate instability that threatened the very survival of their investments. We show that direct investors in Latin America saw share prices rise as governments announced defaults, whereas bondholders reacted favorably to expropriations in Bolivia and Mexico.