January 14, 2004
From the desk of Jane Galt:Robbing from the rich . . .
Argentinian president Nestor Kirchner won adoration from his populace for wresting a sweet deal from the IMF by allowing his country to default on its IMF obligations, causing the IMF to come running, double-quick, with an offer more to his liking.
Now he's trying to pull the same deal with private bondholders. He -- and many of his supporters in the west -- like to talk a good game about how Argentina shouldn't have to make its people suffer to pay obligations to rich investors. And a lot of us are sympathetic: why should some poor Argentinian who makes his living scavenging garbage piles go hungry to fatten the pockets of rich Western investment bankers?
But as the WSJ points out (subscription required), the investors aren't all rich investment-firm types:
About 44% of Argentina's private debt is held by small investors, including 450,000 Italians, 35,000 Japanese and 150,000 Germans and Central Europeans. Europeans such as Mr. Lucifora have long had a preference for fixed-income investments over stock.In the late 1990s, local banks began promoting Argentine bonds as an alternative to Italian T-bills, whose yields declined as Italy adopted the euro. Since the IMF and major Western governments held up Argentina as a model of free-market reform during the 1990s, Mr. Lucifora said he thought the bonds were safe, and put $150,000 in Argentina.
With his Argentine bonds now worth only a fraction of what he paid for them, Mr. Lucifora has cut every nonessential expense -- including vacations, eating out and newspaper subscriptions -- and keeps the thermostat low. He spends hours logged onto a bondholders' chat room, attends seminars on suing Argentina and studies Spanish so that he can fire off e-mails to the Argentine media.
Mr. Lucifora and other bondholders don't know where to turn. Banks in Italy, Central Europe and Japan have formed negotiating groups to represent holders of Argentine bonds. But in Italy, where retail investors poured $14 billion into Argentine bonds, many of the retail investors are infuriated at the banks for having sold them the shaky bonds in the first place. "The doctor who gave me the poison now says he's going to give me the cure," says Raimondo Iallonardo, a graphic designer from Milan, who lost his son's college-tuition money in Argentine bonds.
Some individual bondholders have formed negotiating groups of their own. Other European bondholders have challenged Argentina in court, with little success. German creditors tried unsuccessfully to obtain a court order seizing an Argentine naval training vessel, La Libertad, that was due to dock in Bremerhaven in 2002. When Argentina's Mr. Kirchner was preparing to visit Italy last year, a provincial lawyer, Mauro Sandri, threatened to have the presidential plane, Tango 01, impounded. Bondholders claimed credit when Mr. Kirchner cancelled his visit, though Argentine officials attributed it to scheduling conflicts.
Mr. Kirchner's tight-fisted stance has made Argentina a bad word in Japan, as well. Japanese investors were attracted to Argentine bonds during the late 1990s, after Japan's real-estate and stock bubbles popped and local interest rates dropped to virtually zero. When an Argentine official visited Japan last year to discuss the debt restructuring, an investor demanded that part of Patagonia be ceded in lieu of debt payments.
Argentina's efforts to justify its position have often made matters worse. On a trip to Germany last year, Argentine debt negotiator Guillermo Nielsen said that, given the magnitude of the economic catastrophe that rocked Argentina, it should get the same treatment as post-World War II Germany, which received a 77% debt write-down. Investor Stefan Engelsberger presented Mr. Nielsen with a photograph of the bombed-out city of Frankfurt to show how much more dire Germany's situation had been.
In America, most bond investors are indeed wealthy. But in Europe, bonds are more normal than stocks, and a lot of these guys are the equivalent of the local middle manager who got raped when his broker put him into dotcoms. Argentina wants them to accept a deal worth only about 25% of the value of the bonds before the default.
It's not so great for Argentina either. It's good in the short run -- Mr Kirchner gets to spend more. But in the long run, for Argentina to grow, it's going to need capital. And if Mr Kirchner succeeds in his quest to make them eat Argentina's losses, international investors are going to be very leery indeed of providing it.
Posted by Jane Galt at January 14, 2004 5:28 PM | TrackBack | Technorati inbound linksIt's tough to feel sorry for someone who bought foreign bonds that paid higher coupons than domestic bonds.
Did he think the extra yield was free?
More proof that foolish investors know no borders.
Smallish investor or big bank, the next investor will not be fooled. Capital will not be as readily available in the future. Investors have many places to invest around the world. Who do you think that will hurt?
Argentina has vast and high-quality natural resources. It's unfortunate their defective culture has, so far, prevented them from succeeding as a nation. Historical accidents prevent another round of invasion and colonization, so they'll have to make do with what they've got. The comparable inferiority of their neighboring cultures will, as in China's case, insulate them only too well against paying full price for their mistakes. Ergo, it will take at least another 3 to 5 generations before Argentina begins to live up to its potential. Caveat emptor!
Argentina has been a serial abuser of creditors for over a century. If this deal makes them a pariah in the marketplace, so much the better. perhaps it willend the repeated cycles of borrow, boom, bust, default that have been Argentina's curse.
Argentina has been a serial abuser of creditors for over a century. If this deal makes them a pariah in the marketplace, so much the better. perhaps it willend the repeated cycles of borrow, boom, bust, default that have been Argentina's curse.
That last paragraph is certainly true but the point of the sob story escapes me. If you're going to speculate in junk bonds you either diversify or you invest only money you can afford to lose.
Without wanting to state the bleeding obvious, if "Mr Kirchner" is going to pay the middle managers of Italy and Germany, he's only going to be able to do it by taking the money away from people who are a lot poorer. So spare us the sob stories.
In related news, Argentina has defaulted roughly once every twenty years since the invention of international finance. So the bland assertion "international investors are going to be very leery" is a perfect example of what Ronald Coase called "blackboard economics"; the elevation of a theoretical assertion above an empirical fact.
"Argentina has defaulted roughly once every twenty years since the invention of international finance." A link would be nice, but I'll take your word for it for now.
So what is really happening?
1) Investors never learn? or,
2) First world governments (that is, their taxpayers) keep guaranteeing international loans and bailing out the losers?
Personally, it makes me feel like an idiot for actually keeping my bills paid up. When do I get to irresponsible? (and will I get an international bailout for running my family into trouble)
Personally, it makes me feel like an idiot for actually keeping my bills paid up. When do I get to irresponsible? (and will I get an international bailout for running my family into trouble)
Maybe every twenty years is a bit much but there were large Latin American financial crises in the 1820s, 1870s, 1890s, 1920s, 1980s and 2000s. As Kipling said, the dog returns to his vomit, the sow returns to her mire/ and the burnt fool's bandaged finger goes trembling back to the fire.
Nobody told the people of Argentina to listen to Evita and Juan Peron. It's time to pull the plug on this nation of losers. Argentina is a prime example of how socialism destroys viable economies. This country was among the wealthiest early in the 20th Century.
People who make high risk, high return investments sometimes lose money. Where's the story here? Are we somehow supposed to be more sympathetic to people who don't understand the difference between a savings account and a South American junkbond than to Argentina's poor?
dsquared: "Latin American crisis" is not, of course, an "Argentine crisis", no? What's the actual pattern for defaults in Argentina itself?
(As for "taking money from the poor" to pay off creditors... why? The money that Argentina borrowed wasn't, evidently, given to the poor, so how can it be taken back? Perhaps you mean "actually paying debts will leave less money for handouts"? Indeed it would. Of course, not paying debts will also hurt the poor, by hurting all of Argentina and its economy. So, cut the "sob-story" for the poor, too, since they're screwed both ways, in the short term, and arguably more screwed in the long term under a default.)
umm... the thing is that argentina wasn't supposed to be a junk bond play!!!
it was supposed to be safe, "dollarised" embracing capitalism
except it was a scam, a lie, and wasn't really dollarised
this just shows how we should re-institute gunboat diplomacy
allow countries to foreclose on sovereign debt by taking chunks of the country as payment...
stupid liberals screwing up capitalism as always (and im actually serious)
People who bought Argentine bonds were obviously misinformed.
Argentina will suffer the consequences of the default but they donīt have financial capacity to perform, even if they wanted to.
In my opinion, agressive retoric from Kirchner and other officials are just a form of psycological compensation for their collective bankrupticy.
But I think brokers and investors who bought these bonds are as reproachable as Argentinians themselves.Argentinians were reckless. Investors were greedy or misinformed, at best.
People who bought Argentine bonds were obviously misinformed.
Argentina will suffer the consequences of the default but they donīt have financial capacity to perform, even if they wanted to.
In my opinion, agressive retoric from Kirchner and other officials are just a form of psycological compensation for their collective bankrupticy.
But I think brokers and investors who bought these bonds are as reproachable as Argentinians themselves.Argentinians were reckless. Investors were greedy or misinformed, at best.
I don't have a WSJ subscription, so I haven't seen the whole story. But there's no mention of what the actual yield on the Argentine bonds was, just that it was higher than EU-denominated Italian debt. If the choice was, say, 20% yield vs 4%, then the bondholders (a) have already received a significant fraction of their principal back, and (b) should have realized the risk involved.
Also, were these bonds denominated in Argentine Pesos or in Euros? If the former, there was also the foreign exchange risk. I got Yahoo to cough up this chart. In 1999, the peso was worth about 0.9 euros, and was strengthening gradually; in early 2002, it was at 1.1 euros. Then it collapsed, and is now only worth 0.3 euros. Mr Lucifora's $150k is only worth about 50k now even if the bonds were still paying interest. (I'm guessing from the lack of foreign currency mention that the Argentine bonds were denominated in euros, which moves the exchange rate risk to the Argentine government... and obviously increases the default risk.)
PJ
There were bonds in Euros but most were denominated in dollars.
Sorry for the double posting above.
As far as I know (which isn't all that far...), Argentina's bonds were denominated in US dollars, required to maintain their ill-conceived fixed currency board scheme. Otherwise, there would be no reason to default - a soverign issuer of currency can always meet all obligations in that currency. It's only when you borrow money issued by someone else that you have a risk of not being able to pay it back...
I'd add this to what Dsquared said. The best time to lend to Argentina is clearly just after it has screwed current bondholders. There is a much higher probability of getting money back from a country with few debts than a country drowning in them. International investors will be lining up to lend.
Lots of smugness here about "foolish investors," "greed," etc. All those who have never made a losing investment can continue to comment in this vein.
The fact is that buying Argentinian bonds was not, ex ante, a foolish investment if the bonds were part of a diversified portfolio. If they weren't, as is apparently the case with the unfortunate Signor Lucifora, then the mistake was the failure to diversify, not the purchase of the bonds per se. I'm guessing there are lots of people making the same mistake, (including perhaps some of the commenters here?) but who haven't been nailed quite as severely as this. If so, they would be wise to consider themselves lucky (so far) rather than smart.
"The fact is that buying Argentinian bonds was not, ex ante, a foolish investment if the bonds were part of a diversified portfolio."
I think the above setence is true depending on how "ex ante" you are talking.
The emerging markets crisis began in 1997 in Asia, then next year Russia and Brazil were very badly impacted. Nevertheless, if I recall correctly, Argentina was issuing bonds as late as 1998. When Brazil devalued in 1999, most professionals would agree that Argentina stability woul not last. It took almost 3 years before it collapsed, with IMF rescuing them at least once.
You didn't see the highly speculative fund managers being hurt by this event in Argentina, not because they are risk averse but because they had plenty of time to get out (some even went short those bonds).
Concerning diversifying, that would be wise, but I think most of the bond holders did not do it. Why not ? Maybe because it is not that easy to diversify when you are a small investor.
Bernard-
Anyone who purchases individual high-yield or emerging-market debt is either:
a) a professional, and not entitled to my sympathy
b) an amateur who purchased the bonds from a broker who inappropriately deemed the investment suitable, and who, unless he completely disclosed the risks, ought to be liable for the investor's losses, or
c) an amateur who, like scores of others, thought he could navigate the complex world of financial instruments alone. He is the greatest fool of all.
If one wants to own EM debt, there are plenty of mutual funds out there for his purchase.
To efficiently build a portfolio of individual EM or junk bonds, an investor will need about $3 million. Anything less will result in odd lots (high markups and markdowns) or insufficient diversification.
And, yes, I've picked the wrong pony more than once, and I claim no immunity from foolishness.
not sure how it applies to foreign bondholders, but us dollar accounts in argentina were forcibly converted to pesos at the "official" exchange rate (which bore no relation to the actual exchange rate)
foreign companies were also restricted from converting pesos to dollars..
a very typical tyrannical move
we really need a wall street expeditionary force to deal with these types
Mauro,
The WSJ article implies that 56% of the bonds were held institutionally, and surely a fair share of those held by individuals were held by wealthy people with large portfolios. So "most professionals knew," is an overstatement. Certainly "some professionals suspected," but there clearly were a lot of bonds held by professionals. Indeed, the fact that there was a market at all tells us that.
It is difficult for a small individual investor to diversify, which is a good reason not to buy these sorts of securities. There are, however, bond funds, as Bob points out.
Bob,
I really don't disagree with you except that I would take even a stronger stance toward advisors than you do. My point was that the error was not the purchase of the bonds, but the failure to diversify. The criticism being directed at investors for failing to understand the intricacies of Argentina's economic situation and currency problems are, as I said, both smug and misdirected. Lots of professionals got burned too. That doesn't mean that they didn't know what they were doing. It means that this time the dice came up wrong.
Mauro, it is perfectly simple for a small investor, via a mutual fund, to buy a diverse mix of bonds, both investment grade and non-investment grade (or "junk"). Hundreds of investment firms sell tax-deductible corporate bond and government bond funds all the time.
Argentina has been in a hole for the last hundred years or so and has yet to decide to stop digging. A country which was more prosperous than Belgium or Italy at the start of the last century has been on the brink of bankrupcy, or past it, for most of the last fifty years.Most of the blame is to be laid at the feet of the populist trash( peron...) who have been in power during most of this period.
Quite exceptionally a few years ago, I heard a BBC reporter say that the overwhelming majority of Argentinian elected people were totally corrupt and were interested only in filling their own pockets. Until this situation is reversed, no financial manipulations whether of internal or external origin will make a scrap of difference
Argentina has been in a hole for the last hundred years or so and has yet to decide to stop digging. A country which was more prosperous than Belgium or Italy at the start of the last century has been on the brink of bankrupcy, or past it, for most of the last fifty years.Most of the blame is to be laid at the feet of the populist trash( peron...) who have been in power during most of this period.
Quite exceptionally a few years ago, I heard a BBC reporter say that the overwhelming majority of Argentinian elected people were totally corrupt and were interested only in filling their own pockets. Until this situation is reversed, no financial manipulations whether of internal or external origin will make a scrap of difference
Bernad,
You are correct, off course.
But I suspect many of the professionals who bought Argentine bonds after 1998, bought them at huge discounts. So, they had a different risk/return expectation.
Tom,
Altough you are theoretically right that it is possible to diversify through buying mutual funds quotas, I think, in practical terms, it is not easy.
Many mutual funds have minimum entry investments of 25 thousand, 100 thousand or even 1 million, which make diversification more dificult for small investors.
And above all, diversification makes sense when it reduces the risk without reducing the expected return of the portfolio. If the investor in these mutual funds quotas gets returns of 3 or 4% per year, his investments might be diversified but the diversification is not paying off.
Mauro: the degree to which an investor should balance risk with return should depend upon the degree of risk aversion of that particular investor. Further, diversification for diversification's sake isn't, in general, much use. The value of variety lies in the independence of the factors determining the observed distribution of returns. In this sense, it may be entirely rational for a risk averse individual (or person, as Deirdre McCloskey would insist) to hold investments for which the expected return is zero.
Dsquared: your comment to Jane of her assertion that people will likely be more unwilling to invest invest in Argentina seems out of place. "The elevation of a theoretical assertion above an empirical fact" doesn't apply here.
Jane didn't say that people wouldn't invest in Argentina at all. Her comment only states, correctly, that this signals greater risk on investing in Argentina. The fundamental implication is that Argentina will have to acquire capital at higher interest rates in the future.
Argentina's ostensive apathy regarding the pace of growth and investment vs. their demands for current consumption may stem directly from the fact that they probably won't have as much trouble acquiring capital as they should: the World Bank, IMF, etc. have shown repeatedly that out of the goodness of their hearts, they'll give billions. They have in the past and Argentina's officials likely believe they will in the future. Why then should they give a damn about foreign private investors?
Jane: contact me ASAP, I'm in Manhattan right now. Mobile is +44-7802-188325. Tonight, Jan 17, will be out meeting with some people at a local pub in lower East, just in case you are around.
Dale Amon,
Samizdata,
Asst Editor
Er, make that mid-east. 47th St area. I'll be in lower East *later* in the night.
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