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A little over 13 years ago, Argentina rocked the international financial community with the largest sovereign default in history. In the years that followed, foreign investors and the International Monetary Fund issued scathing criticism of the government’s “economic mismanagement.” What is often obscured in such criticisms is the fact that it was actually the latter – Argentina’s private and official creditors – who made the world’s largest ever national bankruptcy all but inevitable.
Argentina: From IMF Poster Child to Bankruptcy
The roots of Argentina's infamous financial crisis at the turn of the century go back to the resolution of a previous economic calamity: the Third World debt crisis of the 1980s. The government's response to this crisis triggered an episode of hyperinflation, culminating in a serious bout of rioting and looting that forced President Raul Ricardo Alfonsin – the country's first democratic head of state since the fall of the junta – to resign. The subsequent elections were won by the Peronist candidate Carlos Menem, who had run on a populist platform pledging higher wages and debt repudiation, but who ended up rescinding on every single one of his election promises the moment he assumed office.
Upon his inauguration, Menem set out to dramatically restructure the Argentine state and economy by introducing far-reaching austerity measures, liberalizing trade and capital flows, pegging the peso to the dollar, and unleashing a major privatization drive. By 1993, Menem's notoriously self-confident Economy Minister Domingo Cavallo proudly boasted that “the public debt will be insignificant by the end of the century.” Unsurprisingly, the IMF, World Bank and U.S. Treasury enthusiastically supported the neoliberal reforms pursued by Menem and Cavallo, which matched perfectly with the reigning economic ideology encapsulated in what came to be known as the Washington Consensus.
As a result, Argentina quickly established a reputation as a regional IMF poster child and the darling of Wall Street bond traders. The fund's managing director, Michel Camdessus, exclaimed that “in many respects the experience of Argentina in recent years has been exemplary … Clearly, Argentina has a story to tell the world: a story which is about the importance of fiscal discipline, of structural change, and of monetary policy rigorously maintained.” As late as 1998, the IMF invited President Menem as an honorary guest to its annual spring meeting in Washington, D.C. In his address, Menem referred to Argentina as “profoundly stable” and called on his colleagues to “defend the principles of globalization.”
Menem added, “We are convinced that in order to address the serious problems facing the world, the Argentine program [of IMF-sponsored structural adjustment], adapted to the special circumstances of each nation, is the path that leads us out of the current crisis.” He concluded, “I have every confidence that at our next annual meetings, we shall be applauding the success of our concerted policy efforts.”
Three years later, Argentina was bankrupt. Menem's “concerted policy efforts” had led to the largest sovereign default in the history of the capitalist world system. What had gone wrong?
The IMF as an Enforcer of Creditor Interests
The answer is quite simple: while the IMF's official function is to safeguard global financial stability, its actual objective ever since the Mexican debt crisis of 1982 – whose banker-friendly “resolution” set the stage for all crises that followed – has been to safeguard the interests of creditors at the expense of their debtors and overall systemic stability. Karin Lissakers, who served as US representative to the IMF Executive Board for most of the 1990s, had recognized as much when she wrote in 1983 that the Fund was acting as an “enforcer of the banks' loan contracts” in Latin America, imposing harsh austerity on the debtors with the narrow objective of “free[ing] foreign exchange in order to service debts.” The Argentine crisis of 2001 proved to be no different.
In 1999, Argentina fell into recession after its main export competitor Brazil had just devalued the real in response to the fallout of the Russian default of 1998 and the East Asian financial crisis of 1997. In late 2000, as it became clear that Argentina might go down the same road, the IMF disbursed its first bailout funds to the government of the new President, Fernando De la Rúa, so it could keep repaying its outstanding obligations to foreign creditors – mostly US-based institutional investors like mutual funds and large pension funds. The initial $14 billion lifeline evaporated in a matter of weeks as investors panicked and Argentina's borrowing costs shot up.
In December, a further US$39.7 billion package was forthcoming, this time involving a rollover of old bonds and a further extension of outstanding credit lines. After concluding the deal with the IMF, the World Bank and private domestic creditors, Economy Minister Josefu Luis Machinea proclaimed that he had obtained blindaje financiero – a financial shield – that would protect Argentina from further external shocks and set the economy on course for recovery. But the shield proved to be full of holes. Argentina soon found itself back in the midst of a full-blown crisis of confidence. A journalist at the Washington Post concluded that “the Fund's largesse had once again enabled a lucky few to pull their money out of the country ahead of a crash. Even though the IMF money was gone, Argentina was still obligated to repay it...”
Just two months later, another financial crisis struck Turkey and investors took fright again. The interest rates Argentina was forced to pay on its bonds skyrocketed, and there seemed to be very little the government or the IMF could do about it. The force of market panic was simply overwhelming. Failing to restore calm, De la Rúa – under pressure from Wall Street and Washington – reinstated his political rival and the bankers' favorite Domingo Cavallo as Economy Minister, but even that changed little. According to one economist, “financial markets seemed to have already concluded that Argentina's Fund-supported program had little chance of avoiding a de facto default and a likely collapse of [Cavallo's peso-dollar] convertibility plan. However, the IMF appeared to never seriously address this issue.”
The Fund's main objective, it seemed, was never really to resolve the Argentine crisis per se. Rather, it intended to buy time for Argentina's systemically important and politically powerful U.S.-based creditors to extricate themselves from the crisis before the inevitable default would strike. As in Europe today, the Fund's emergency loans to the Argentine government effectively took the form of an indirect bailout of private foreign bondholders – at the expense of the average Argentine citizen, who had to bear the brunt of skyrocketing unemployment, falling wages, tax hikes and eventually the government seizure of pension funds and the imposition of draconian deposit withdrawal limits.
The IMF Comes Around: Default Is Inevitable
Over the course of 2001, as the economic situation went from bad to worse, the IMF's relations with the Argentine government steadily soured. Partly, this was a result of the government's growing incapacity to stick to the fiscal targets it had agreed to as part of the IMF bailout program, but the main reasons for the sudden turnaround in Argentina's relations with the Fund appeared to lie in Washington and New York. In D.C., opposition to the IMF had been rising in Republican circles ever since Clinton's massive international bailouts of Russia and the East Asian countries. When George W. Bush took office in 2001, his administration included a number of high-ranking officials who were strongly opposed to the IMF and its international lending.
Meanwhile in Manhattan, fund managers had largely divested themselves of Argentine bonds – dumping their toxic holdings on a dispersed panoply of uninformed and unsuspecting small retail investors (mostly ordinary pensioners) in Europe and Japan. This change in the creditor composition proved to be crucial. Up to mid-2001, Argentina's debt had been highly concentrated in the US financial sector, with the Wall Street investment banks acting as key intermediaries between Cavallo and the big mutual and pension funds that bought emerging market bonds like hotcakes.
But the notorious “mega-swap” debt restructuring deal of mid-2001 (which had been sold to Cavallo by these same Wall Street investment banks), allowed the U.S.-based institutional investors to offload their worthless bonds on a geographically scattered group of retail investors – which in turn passed them on to ordinary folks, most of them simple Italian pensioners, who lacked both the financial knowledge and the political influence to defend themselves from the future losses that would ensue in the inevitable event of an Argentine default. The IMF and US Treasury Department would never come to their rescue – and the U.S. investment banks knew it. That's why they proposed the mega-swap in the first place.
After the mega-swap, the IMF made a sudden volte-face: not only did it suddenly accept the inevitability of an Argentine default; it also shed most of its previous qualms about this outcome. The Fund's deputy chief economist Carmen Reinhart reassured her colleagues that default would have only limited repercussions. In a research memo dated August 15, she wrote that “a 'credit event' in Argentina is widely anticipated and has been (partly) discounted by the markets for some time. The possibility that a default by Argentina triggers a sharp reversal of capital flows to other countries in South America is therefore relatively small.” Another IMF report showed that, while a few Spanish banks might take a hit, the risk posed to the international financial system was small.
And so, with the IMF increasingly burdened by its own exposure to Argentina, Horst Kohler, the Fund's new managing director, began investigating the possibility of private sector involvement in the burden sharing. In his book on the Argentine crisis, financial correspondent Paul Blustein remarks that Köhler “raised the possibility that the IMF and the Argentine authorities should consider something like [a] 'haircut' proposal for forcing creditors to accept reduced payment of their claims.” And so the IMF began to prepare itself for the eventuality of an Argentine default. “Amid strict secrecy,” Blustein reveals, “a few Fund staffers were busily examining what might happen if Argentina had to take that [default] option, which was dubbed 'Plan Gamma'.”
In October 2001, a meeting took place between Köhler and senior executives from some of the biggest and most powerful Wall Street banks and financial institutions, including J.P. Morgan, Goldman Sachs, Citigroup, Crédit Suisse-First Boston and AIG. According to political scientist Paul Lewis in his authoritative study of the crisis, the bankers at the meeting concluded that “Argentina was going to collapse and that nothing could be done to save it. A default was inevitable, and the best that the creditors could do would be to approve a restructuring under which they would voluntarily accept less than the face value of their claims.”
The “Little Guy” Foots the Bill – Again
By this point, more than half of Argentina's historically wealthy population had been thrown into poverty as a result of the disastrous IMF-backed austerity measures pursued by the successive governments of Menem and De la Rúa. Protest movements had been building up in intensity and creativity for years, with the piquetero movement of unemployed workers blocking off roads and bridges, with tens of thousands of workers occupying and running their own workplaces, and with ordinary citizens organizing cacerolazos (pot-banging protests) and escraches (staged actions in front of politicians' and bankers' homes) with increasing frequency.
Still, the IMF's sudden change of mind about the inevitability of an Argentine default had little to do with the plight of the Argentine people. Rather, the IMF hoped to restore Argentina's creditworthiness, to keep it in the lending game, and thereby to allow the government turn back to the same Wall Street investment banks for further (high-interest bearing) loans.
And so, toward the end of 2001, with most U.S. financial institutions now in the clear, the IMF considered it safe to finally pull the plug. On Dec. 5, 2001, a few days after the increasingly desperate Cavallo had imposed the much-hated deposit withdrawal limits in order to stem a full-blown bank run, the IMF simply abandoned Argentina and left it to its fate. It withheld a $1.24 billion loan installment, officially out of frustration over the government's failure to keep its budget under control. But in an indication that the order had come from higher up, U.S. Treasury Secretary Paul O'Neill declared that it would be “ridiculous for America's plumbers and carpenters to pay for someone else's bad decisions.” Since there were no more US bondholders to bailout, the US simply lost interest in Argentina – which was now cut off from its last-remaining financial lifeline.
Cavallo and De la Rúa limped on a few more weeks, but finally buckled as the sheer weight of the crisis provoked a spontaneous popular uprising of historic proportions. On Dec.19 and 20, 2001, as hundreds of thousands of Argentines took to the streets banging their pots and pans, riots and looting broke out across the country. Dozens lost their lives in the police violence that ensued. After forcing Cavallo to resign, eventually the thoroughly discredited De la Rúa was compelled to step down as well – famously fleeing the presidential palace by helicopter. The first official act of his interim successor was to default on all of the country’s outstanding debt.
The inevitable had finally become unstoppable.
Jerome Roos is a PhD researcher in International Political Economy at the European University Institute, and founding editor of ROAR Magazine. Follow him on Twitter at @JeromeRoos.
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