In April 2002 thenU.S. Treasury secretary Paul O’Neill gave a blunt assessment of the likelihood that Washington would lead a bailout of Argentina, which three months earlier had stopped paying interest or principal on about $90 billion of its thenroughly $145 billion in public debt -- the biggest default in history. The outspoken O’Neill explained that a U.S.-arranged rescue would never happen, because the “plumbers and carpenters around the nation who earn $50,000 a year and send 25 percent of it to Washington expect us to use their money wisely.”
That sound bite from O’Neill, who resigned six months later, resonated with Guillermo Nielsen, whose grim task as Argentina’s Finance secretary is to negotiate with those who hold the defaulted debt, almost all of it government bonds. “We are having to restructure without the money of ‘the plumbers and carpenters,’” Nielsen tells Institutional Investor (see box, page 62). “This is a much healthier situation, but clearly more difficult for the market to understand.”
For investors, grasping the situation really isn’t all that difficult: They want their money back; Buenos Aires wants to return only a tiny portion of it -- the equivalent of 25 cents on the dollar, or 10 cents, according to some analysts, if you figure in such factors as the interest that investors have lost out on since the default.
Bondholder, can you spare a dime?
“We are faced with the most difficult and aggressive restructuring in financial history without new money,” laments Nielsen, an affable 52-year-old economist who is a longtime colleague of Argentina’s powerful Economy minister, Roberto Lavagna. Without lots of financial assistance from the U.S. or the International Monetary Fund, the debt negotiator contends, Argentina can’t afford to be any more generous with the tens of thousands of bondholders around the world who hold its sovereign securities. As it is, Buenos Aires’s proposed repayment represents the biggest “haircut,” or discount to face value, ever on government bonds. Russia, for instance, repaid 58 cents on the dollar following its default in 1998.
Nielsen’s message to banks and the IMF and other supranational lending agencies, whose combined $84 billion in outstanding loans to Argentina is being repaid, is equally unyielding. They must assure Buenos Aires that they will maintain existing lending facilities without imposing too many restrictions on the money, lest they hamper Argentina’s remarkable, but fragile, economic recovery. Otherwise, the implied threat is that no one will get repaid. (The amount that needs to be repaid is a moving target because of the sharp drop in the value of Argentina’s peso, other exchange rate changes, new defaults and ongoing restructuring. Projections vary, but the most recent estimates put Argentina’s total public debt at roughly $185 billion, with $101 billion in default.)
Adding to bondholders’ pique, ironically, is Argentina’s strong economic performance, because the recovery should make it easier for Buenos Aires to pay back creditors on reasonable terms. Low interest rates, strong demand from China for local commodities like soybeans and a weaker Argentinean peso powered the country’s GDP to an 8.4 percent gain in 2003; a 6.5 percent rise is expected this year. At the end of 2003, the country was sitting on foreign reserves of $14 billion and record nominal tax receipts of $2.4 billion. Its current-account balance equals a solid 4.2 percent of GDP. Meanwhile, Argentina’s stock market, the Merval, rose a healthy 104 percent in 2003 and gained a further 11 percent through February. Nielsen and Lavagna have tried to capitalize on Argentina’s recovery by floating the idea of swapping GDP-linked bonds for the defaulted debt.
A showdown loomed on March 9. Argentina was scheduled to make a $3.1 billion payment to its largest creditor, the IMF, which is owed $15 billion, but Economy Minister Lavagna and President Néstor Kirchner were threatening to withhold the money. Lavagna warned that the country wouldn’t jeopardize its financial position by digging into its foreign reserves to make the payment unless it could be assured beforehand that the IMF would deliver a positive progress report on Argentina later in the month, thereby freeing up a second tranche of funds under Buenos Aires’s three-year standby loan agreement with the Fund. Lavagna insisted, however, that Argentina had met all its budget and other IMF targets and that confidential talks with the Fund were going well. In the end, Argentina did pay the IMF on time, but nevertheless, Buenos Aires can count on intense pressure to give their bondholders a better deal.
Bondholders will likely have to decide sometime later this year whether to swap their bad bonds for fresh, but deeply discounted, Argentinean securities. Nielsen’s unenviable job -- assuming he doesn’t succumb to kill-the-messenger syndrome and find himself replaced -- will be to persuade those bondholders that Buenos Aires’s offer is as good as it’s going to get.
Nielsen’s boss, Lavagna, stunned the bond markets when he announced Argentina’s harsh settlement terms last September at the annual meetings of the IMF and World Bank in Dubai. And the Economy minister didn’t stop there. He also discombobulated delegates when he declared that Argentina would not heed the IMF’s usual advice to debtor countries to raise their primary surplus -- the proportion of their GDP set aside to meet external liabilities -- beyond a meager 3 percent. By contrast, Ecuador, Turkey and Uruguay all recently agreed to maintain primary surpluses of 4 to 6 percent.
Creditors were shocked. Throughout 2002 and well into 2003, they’d heard Nielsen say in forum after forum, in Germany, Italy, Japan, Switzerland and the U.S. that Argentina would take into account their concerns in formulating a repayment plan. Instead, says Michael Chamberlin, head of the EMTA, a trade group for the emerging-markets trading and investment community, the events in Dubai made creditors fearful that Buenos Aires had adopted a “unilateral approach.”
By default, as it were, Nielsen became the object of bondholder anger that should have been directed at Lavagna and, perhaps even more, at Kirchner. In early February the president and his cabinet chief, Alberto Fernández, actually exhorted Argentineans to make the rejection of bondholders’ demands for more money a “national cause.” Kirchner dismissed bondholders as “casino gamblers,” inadvertently implying that Argentina was a casino.
The nationalist rhetoric may have horrified bondholders, but it played well at home. Kirchner, who was elected in April 2003 with just 22 percent of the popular vote, saw his approval rating soar above 80 percent by late last year.
“Politics have taken the flexibility out of the negotiations,” says Mohamed El-Erian, a director of giant bond manager Pimco, which sold its Argentinean bonds before the crisis erupted. “The question now is, ‘Can the president ever stand back?’”
Understandably, creditors are also digging in their heels. At the end of January, the IMF delivered a generally positive assessment of Argentina’s economic performance; the kind words were followed by the customary doling out of more Fund money. Nevertheless, an unusually large number of the IMF’s 24 board members -- reportedly as many as eight -- abstained from approving the Fund’s actions. That should have served as a clear warning to Argentina to back off its aggressive debt negotiation tactics. A few weeks later at the Group of Seven meeting in Boca Raton, Florida, finance ministers from the world’s leading countries underscored that message when they pointedly urged Buenos Aires to demonstrate “good faith” and constructively negotiate with bondholders.
How strained is Argentina’s relationship with its creditors? In recent months ten investment banks -- among them, Citigroup; Goldman, Sachs & Co.; J.P. Morgan Chase & Co. and Lehman Brothers -- in effect acknowledged that things had gotten so bad that they would not even serve on the advisory syndicate to help prepare the debt restructuring. An official at one of the banks that turned down Argentina’s invitation says his firm did not believe that the country had spelled out clearly enough the conditions under which the banks could exit the restructuring (with a fee) if it got bogged down. His bank, he explains, didn’t think the time and effort required were worth it, given this uncertainty. The banks’ rejections sparked speculation that Nielsen would be forced out; the rumors had died down by early March, but another blow to the bond swap could cost him his job. Barclays, Merrill Lynch & Co. and UBS, meanwhile, have signed on to the Argentinean advisory team, although their contracts were not finalized as of early March.
Apart from the billions of dollars at stake, what makes the impasse between Argentina and its creditors so unsettling to the markets is that Buenos Aires’s tactics may represent not just political grandstanding by Kirchner but a new approach for Latin American sovereign borrowers -- or so some analysts say, with a shudder. In early January, Lavagna penned an op-ed piece in the newspaper La Nación that called traditional debt talks the “old paradigm.” Daniel Marx, who led previous debt negotiations for Argentina, says, “The problem is that, unlike the days of the Plan Baker or the Plan Brady, it’s not clear how the world functions at this moment.”
In the 1980s and ‘90s, creditors -- a coterie of big banks -- negotiated directly with governments to hammer out agreements that usually relied on outside funding from the U.S. or big multilateral lenders like the IMF. The explosion in the number and type of investors has made that relatively orderly process inconceivable. As Nielsen says, “We must deal, but with whom?” The “atomization” of bondholders’ interests, he adds, means that he must deal with investor groups whose interests conflict -- a “great complication” in working out terms.
Meanwhile, fragmentation undercuts creditors’ leverage, so they must band together and employ tough countermeasures to neutralize borrowers’ size advantage. Hans Humes, a New Yorkbased fixed-income manager at Van Eck Global and a co-founder of the Global Committee of Argentina Bondholders, says that if Buenos Aires doesn’t soften its take-it-or-leave-it stance, “investors a year from now will be seeking satisfaction through the courts.” That means, Humes says, “Kirchner may find himself playing defense on every asset that leaves the country, including the presidential plane.”
Nielsen, however, is adamant that Argentina is in no position to make concessions to bondholders. “Everything that we are doing has the purpose of supporting Argentina’s economic growth, precisely because growth is the only guarantee of repayment capacity,” he explains. If an overly burdensome repayment scheme stifles the country’s growth, he adds, “Argentina will be back in default in a short time.”
HOW DID A NICE GUY LIKE NIELSEN END UP IN what’s arguably the most difficult, thankless job in international finance? His government experience is modest. Before joining the administration of Kirchner’s predecessor, Eduardo Duhalde, in April 2002, Nielsen spent 11 months in 2000 as director of Argentina’s National Security Administration, which regulates the social security system. Earlier in his intermittent government career, he did gain important on-the-job training as a negotiator. Nielsen was posted to Brussels from 1983 to 1990 as agricultural trade negotiator for Argentina with the European Economic Community and at the Uruguay Round of trade talks.
Nielsen was best known in Argentina for his noble role in the notorious “Swiftgate” scandal. In November 1990 he was a strategic planner for Campbell/Swift-Armour, a local company then owned by the famed U.S. soup maker. According to Argentinean press reports and a book by journalist Horacio Verbitsky, Nielsen told officials at the U.S. embassy in Buenos Aires that someone close to the government of thenpresident Carlos Saúl Menem had asked him to pay a bribe to obtain a tax break Campbell was seeking. When Nielsen and his family later received death threats, Campbell sent them to Uruguay for safekeeping. No charges were ever brought. Verbitsky, whose book Robo Para la Corona (“I Rob for the Crown”) chronicles the incident, says that by bringing the alleged bribe request to the attention of government officials, Nielsen was “the only one who walked away with honor.”
The hero of Swiftgate came from humble origins. Nielsen’s grandfather was a Danish immigrant who arrived in Buenos Aires in the 1920s and put his mastery of several languages to work managing dockside bars frequented by foreign sailors. Nielsen’s father was a Coast Guard administrator. “When I went to university, I really wanted to study agricultural engineering,” Nielsen recalls, “but that was an extremely demanding field, and, as I had to work [while attending school], I switched to economics,” which required less time away from home.
From an early age Nielsen dreamed of traveling to the U.S. Hugo Medina, who heads the Comisión Nacional de Valores, Argentina’s stock exchange commission, recalls hitchhiking to Brazil with his childhood pal Nielsen when they were about 13. “We got a ride, but we couldn’t make ourselves understood to the driver,” Medina says. “All of a sudden, Guillermo says to the guy, ‘How about if we try English?’ I couldn’t believe it. He just started speaking in English.” Nielsen had been studying the language on his own.
At the University of Buenos Aires in the late 1960s and early ‘70s, Nielsen got caught up in the charged political atmosphere that preceded the country’s 1976 military coup. He joined Argentina’s centrist social democratic party, Unión Cívica Radical, and kept up his affiliation until early 2002, when he joined Duhalde’s Peronist administration. Nielsen advised UCR presidential candidates on trade issues in 1988 and again in 2001.
He got his chance to see the U.S. when he won a Fulbright-Hays scholarship to study economics at Boston University. He specialized in international trade and development, earning a master’s in 1978. Nielsen considered moving to Washington to take a job at the World Bank’s International Finance Corp., for which he’d already briefly worked, conducting a study of tourism in Mexico. But he says: “I began to feel that the time had come to go back to Buenos Aires. I missed my family, and also I wanted to have some experience at an Argentinean think tank.”
With a recommendation from José María Dagnino Pastore, a future Economy minister he’d met in a professional training program, Nielsen got a job with the Foundation for Latin American Economic Research in 1979. A hotbed of free-market economists, the foundation was where Nielsen became acquainted with Lavagna. The pair teamed up on international trade studies and worked so seamlessly together at the foundation, and later in government, that many assumed they were close friends. In fact, they and their families don’t socialize much.
The debt negotiations have been a trial for Nielsen’s and Lavagna’s good working relationship. Stories of personality conflicts and disagreements within the debt negotiating team, which includes more than a dozen members, have been rife. Like Nielsen, Lavagna has been the subject of rumors that he may be on his way out. Creditors, however, shouldn’t get their hopes up, say those familiar with the situation. Replacements for either of the two would likely push an even harder bargain.
Increasingly complicating the negotiations on both sides is the conflict that recovery inevitably poses: What’s good for a country’s direct investors is not necessarily good for its creditors. Consider one local farmer whose 1,000-hectare soybean crop netted him $800,000 in revenue last year. “Do you think I’m going to be jumping up and down about paying the debt?” he asks. “I’m jumping up and down because the countryside hasn’t made this kind of money since the 1920s.”
Lavagna and Nielsen have a controversial scheme to address this dichotomy: Give bondholders a stake in the real economy by cutting them in on Argentina’s growth. They propose a swap that would replace the defaulted bonds with new ones whose coupon payments are tied to Argentina’s GDP growth. The faster the economy grew, the bigger the payout would be, and vice versa, within certain limits. “We want to assure our creditors that they will get paid, and we invite them to share in the future growth of Argentina, which is why we are elaborating the concept of GDP-linked coupons,” says Nielsen.
Still vague in conception (details won’t be released for another month or so), the proposed GDP bonds would appear to have an obvious drawback. Argentina’s volatile economy lost more than 25 percent of its value between 1998 and 2001 and remains smaller than it was precrisis: What would have happened to holders of GDP-linked bonds during this dismal spell?
The IMF wants, in theory, to be a fair and impartial referee in the fight between Buenos Aires and bondholders. But its role has been seriously compromised by many missteps in Argentina. The Fund spent a lost decade propping up the Convertibility Plan, a disastrous fixed-currency regime that pegged the Argentinean peso to the U.S. dollar on a one-to-one basis. Buenos Aires was left powerless to counter a severe recession with real fiscal stimulus, and despite pouring billions into the country in 2001, the IMF couldn’t avert a collapse. “Increasing IMF exposure to postpone the collapse of convertibility was not a market decision but a political decision,” Nielsen states. More recently, the Fund has confessed to being “surprised” by Argentina’s economic resurgence.
“The Fund can’t seem to get it right in Argentina,” concedes Michael Mussa, former economic counselor and director of research at the IMF. Eduardo Amadeo, who was Argentina’s U.S. ambassador during the worst of the crisis, adds that “the Fund’s lack of leverage is payment for its mistakes.”
The IMF’s Argentina pratfalls have emboldened Kirchner. Despite behind-the-scenes as well as very public cajoling by the Fund to be more accommodating to bondholders, he repeated his vow of a 75 percent write-off in late February and again in early March. Lavagna made the same declaration.
Longer term, blowing off bondholders could be catastrophic for Argentina. It could be cut off entirely from the international bond market or forced to pay sky-high rates. Arturo Porzecanski, chief economist for emerging markets at ABN Amro, notes that even if Nielsen can persuade a substantial majority of the bondholders to swap for the discounted securities, Argentina faces a significant financing gap every year between 2005 and 2010. And his calculations don’t account for private sector needs. “Argentina will have to go back to the capital markets, if only to repay the IMF,” says Porzecanski. With limited access to the markets, the country will find it impossible to meet its massive long-term infrastructure and development needs.
Some critics say Kirchner is too starry-eyed from his glowing opinion polls to make the kind of tough political decision on debt negotiations that is now needed. Warns a member of the Duhalde government, “To be prepared for when market conditions aren’t as rosy as they are now and to still be able to borrow at the level that is socially and politically necessary, he needs to show he is not just popular but that he can also be a leader.”
Nielsen: ‘A concrete limit to what Argentina can pay’
Guillermo Nielsen became Argentina’s Finance secretary in March 2002, right after the country’s economy had collapsed and it had announced that it would be unable to make interest or principal payments on about $90 billion of its $145 billion in public debt -- the biggest default in history. Two years later the economy is growing again, but almost all of Argentina’s defaulted debt remains unpaid.
As Buenos Aires’s chief debt negotiator, Nielsen faces a knock-down-drag-out battle with tens of thousands of Argentinean bondholders scattered around the world. At the IMFWorld Bank meetings in Dubai last fall, Nielsen’s boss, Economy Minister Roberto Lavagna, disclosed that Argentina will repay only 25 cents on the dollar (by some estimates, closer to 10 cents after forgone interest is figured in). Argentinean President Néstor Kirchner vows not to back down -- and is enjoying new popularity at home because of his tough stance. Other recent defaulting countries have offered much more generous terms. Russia, for instance, agreed to repay bondholders 58 cents on the dollar after its default in 1998.
The International Monetary Fund (which is owed $15 billion by Argentina) and the Group of Seven finance ministers are pressuring Buenos Aires to give bondholders a better deal. Some of those bondholders have already sued Argentina and others are threatening to do so. Nevertheless, Nielsen contends that Buenos Aires based its 25 cent offer strictly on what the country could afford to repay without swamping its economy. “Closing a deal we know we can’t honor would be not only negligent,” he says, “but a willful and unjustifiable breach of trust.” Nielsen spoke with Institutional Investor Contributor Judith Evans at his Ministry of Economy office in Buenos Aires on January 29 and responded to additional questions by phone in February.
Institutional Investor: How did you arrive at a figure of 75 percent for your debt write-off?
Nielsen: The proposal was the result of a significant amount of econometric work. We created a performing-debt profile based on the history of the three key variables: GDP growth, the real exchange rate and the primary surplus (the proportion of GDP set aside to meet external liabilities), which averaged 2.03 percent throughout the 1990s. We had a thorough discussion about the primary surplus target throughout the government. It was extremely difficult, but we arrived at a reasonable budget allocation. It has to be emphasized that we are dealing with decades here. It’s not just a question of whether we had good GDP growth last year or will this year. In reality, we are talking about 30-year projections. Now we are incorporating dynamic factors into the projections, and so far the results support worst-case-scenario conclusions.
Why use this approach?
Because to have more positive results, we have to produce a change from Argentina’s volatile economic history. We need more consistency in the variables. The amount we put forward was based on the amount of the primary surplus that is required to service the Boden and Bocon bonds [issued to local institutions like banks and pension funds after the crisis to replace existing government bonds] and the amount required to service debt to the multilaterals. Whatever remains is available to service foreign private creditors.
What are your most pressing problems?
We are faced with the difficult issue of acceptance [of an upcoming bond swap by holders of defaulted debt]. Our early meetings with bondholders created awareness of the problem. After the Dubai guidelines were put out, there was a realization of the magnitude of the discounts, and, to a certain extent, a process of denial of that harsh reality.
What about the negotiating?
We must negotiate, but negotiate with whom? In today’s world there are different types of creditors and different degrees of representativeness that have to be taken into account. The atomization of the bondholders and the formation of self-appointed groups whose authenticity and transparency have to be verified is a great complication. In turn, if certain institutions are pointed out as having a role in the loss suffered by, say, retail investors, then in the negotiations the incentives for such actors are toward a rapid and relatively soft restructuring so as to avoid the continued finger-pointing at them.
And once you’ve worked out swap terms?
Last but not least is bringing this transaction to market. Most investment banks are well equipped to deal with placements in the traditional way or with restructurings in which international financial institutions help by putting in new money, but few have the leadership to undertake our restructuring. We are faced with the most difficult and aggressive restructuring in financial history without new money. We are in the new paradigm of having to restructure without the money of “the plumbers and carpenters,” as former U.S. Treasury secretary Paul O’Neill said. This is a much healthier situation but clearly much more difficult for the market to understand.
Critics say Argentina acts as if it were convinced that the longer it can postpone serious discussions with creditors, the better off it will be. How do you answer that?
No way! We need to get rid of this problem as quickly as possible. But let’s not forget: There are 152 different bonds, eight different legal jurisdictions, and there is the whole dimension of the retail market.
What about litigation from bondholders?
The idea that litigation leads to claim satisfaction is a remnant of an economy that no longer exists in Argentina. In this postprivatization world there are, in fact, very few state assets that can be attached. The Argentinean debt problem cannot be solved through the courts, because the courts cannot grant satisfaction to the claims. Only participation in the forthcoming debt exchange can lead to value recovery.
Are you disturbed about the role of vulture funds and potential holdouts?
We talk to everyone, including the vulture funds; they are part of the landscape, certainly not a sympathetic one. Historically, vulture funds managed to be paid par value. But that will not be the case this time; this situation is not comparable to prior situations. Obviously, with the proliferation of bond types, legal structures and currencies, Argentinean debt is a magnet for speculation. But at the same time, there is no margin of maneuver for paying the holdouts. Simply, there is a concrete limit to what Argentina can pay.
What are the implications of Argentina’s approach for future restructurings?
First, the sustainability of an agreement may contradict the imperative of market acceptance. This is because some participants in the process have a hard time dealing with the magnitude of the loss. Some think about past restructurings, or their own expectations, or the value at which their bonds are traded every day. Currently, few are disposed to analyze repayment capacity. The two concepts -- acceptability and sustainability -- will tend to meet when participants in the process assess real repayment capacity as a variable in an acceptable restructuring. In coming years I’m sure we will see the redesign of the international financial architecture, and I suspect a lot of attention will be given to the Argentinean debt restructuring.
Define a successful restructuring.
Our definition of a successful restructuring is one that paves the way for sustainable growth. The repayment capacity of Argentina is not determined solely by the 3 percent primary surplus. It also depends on the size of the GDP and the nominal exchange rate. It is the relationship, the interaction among these variables, that produces our capacity to pay.
How can Argentina prove it is negotiating in good faith?
I feel a bit uneasy with the immense focus on and coverage of the good-faith issue. It implies that we have not been negotiating in good faith, or that we have not been working on the basis of a thorough analysis of the repayment capacity of Argentina, or that we have neglected the concern of how to -- within the constraints we face -- minimize the loss to our creditors. The truth is that we have been doing all the things I just mentioned.
The basic principle of good faith, basic in any successful resolution of conflict, is not to lie, not to overpromise. Sometimes I feel people would like us to lie -- but no way!
What can you tell creditors?
We want to assure our creditors that they will get paid, and we invite them to share in the future growth of Argentina, which is why we are elaborating the concept of GDP-linked coupons for our new bonds. Focusing on repayment capacity so as to ensure future compliance and earnestly proposing that our creditors share in the upside of the future growth of Argentina is to negotiate in good faith. Moreover, closing a deal we know we can’t honor would be not only negligent but a willful and unjustifiable breach of trust.
