The debt crisis that has taught lenders nothing

Alan Beattie
Financial Times
February 17, 2005

An economic crisis as astonishing as Argentina’s deserves a detailed forensic examination, and in Paul Blustein’s second book it receives it.

Blustein, a reporter on the Washington Post, has reprised the journalistic approach that made his first book, on the complex issue of the International Monetary Fund and the Asian crisis, unexpectedly readable. Through interviews with the leading figures in Argentina, on Wall Street and within the IMF, he reconstructs the riveting narrative of a nation that in 2001 committed the biggest sovereign debt default in history.

Out of this narrative come several important conclusions. One is that the familiar criticism of the IMF’s actions – that it capriciously imposed fundamentalist free-market policies on Argentina and abandoned it to chaos when they failed – is 180 degrees in the wrong direction. The IMF, wisely as it turned out, was initially suspicious of the dollar peg currency regime that Argentina adopted in 1991 and which proved the country’s undoing. But the fund became impressed by the peg’s early success in reducing inflation, entranced by Argentina’s dynamic but ultimately dangerous finance minister Domingo Cavallo, and breathlessly enthusiastic about the (somewhat botched) privatisation and liberalisation programme of the 1990s.

Accordingly, it suppressed its misgivings about Argentina’s inability to balance its budget and its consequent need to borrow dollars from the global capital markets at ever-higher rates to back the dollar peg. Far from imposing the “Washington Consensus” (the first component of which, let us recall, is fiscal discipline) on Argentina, the IMF was fatally complicit in its violation. As the crisis deepened in 2000 and 2001, the fund was so keen to avoid blame for pulling the plug that it continued to lend until all hope was extinguished.

One interesting revelation is the full extent of disquiet within the IMF about feeding Argentina’s borrowing habit. There is a marked contrast between the face of monolithic certainty that the IMF presented to the world and the intense private debate within.

But in truth the IMF was only a bit-part player that fed out a futile $15bn lifeline as Argentina sank into a mire of more than $100bn of sovereign debt. The crisis was not primarily made in Washington. Blustein finds the real culprits in Buenos Aires and New York: the Argentines who peddled a falsely glowing vision of their country’s economic renewal and the herd-like investors who believed the story or simply tracked the index of emerging debt. A bizarre quirk of index-tracking means that emerging market investors increase their exposure to troubled governments that issue more debt, likened by one expert to an AA programme that rewards heavy drinkers by giving them more booze.

As the book’s title implies, the capital markets gave Argentina a lot of rope with which to hang itself. (A little more sympathy is due for the thousands of relatively unsophisticated Italian and German retail investors who bought Argentine bonds because yields were high without understanding that with higher reward comes higher risk.)

Of particular note is the conflict of interest on Wall Street. In a similar fashion to the hypocrisy during the dotcom bubble, the same banks that profited from conducting Argentina’s doomed debt operations were consistently too optimistic about the country’s ability to turn itself round.

In contrast to his earlier book on the Asian crisis, which skated over the policy implications, Blustein this time examines in detail the proposals to prevent such a mess recurring. He singles out the “sovereign debt restructuring mechanism” – a kind of Chapter 11 for bankrupt governments, proposed by the IMF but blocked by the current regime at the US Treasury – as a potentially useful addition to the architecture of international finance.

Such solutions, though, today seem as remote as ever. The Argentina crisis does not seem to have provoked much soul-searching among the protagonists except, perhaps, the IMF, which has gone through one of its periodic exercises in agonised introspection. A combination of Argentina’s smart economic recovery since the 2001 default and an extraordinarily bullish mood in global capital markets has left both Argentines and international investors confident that things are not broke and that there is no need to fix them.

Whether this mood survives the embittered restructuring negotiations between Argentina and its bondholders, now nearing their final stages three years after the default, is anyone’s guess. But the destructive possibilities of delinquent governments combined with reckless investors, as revealed by Blustein’s timely book, remain worryingly potent.

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