ARGENTINE DEBT Playing by the Rules

September 25, 2007

U.S. banks got another last minute
reprieve in June, when Argentina
agreed to implement yet another IMF
adjustment program. The program re-
quired the Argentine government to
reduce its budget deficit from 10% of
GDP to 3% of GDP by year end and to
cut the monthly inflation rate from
30% in May to 12% by December. In
a closely related development, Presi-
dent Ratil Alfonsin announced tough
new anti-inflation measures, includ-
ing a freeze on all wages and prices, a
promise by the government to stop
financing its deficit by printing money
and the creation of a new currency,
the austral.
Without an IMF agreement, the fi-
nancial equivalent of a "Good House-
keeping Seal of Approval," U.S.
bank regulators would be required to
classify U.S. bank loans to Argentina
as "value impaired." For banks, this
would mean considerably lower prof-
its. It would also mean that a $14 bil-
lion refinancing package, announced
only last December, might unravel,
leaving banks little choice but to de-
clare Argentina in default.
The immediate impetus for this
latest episode in the Argentine debt
drama was a regularly scheduled
meeting of the Interagency Country
Exposure Review Committee (ICERC).
ICERC members--officials from the
Federal Reserve Board, the Comptrol-
ler of the Currency and the Federal
Deposit Insurance Corporation-meet
several times a year to review the
status of commercial bank loans to
developing nations.
Under the terms of the International
Lending and Supervision Act of 1983
(Title IX, P.L. 98-181), passed in
conjunction with the IMF quota in-
Alfred J. Watkins, a Washington
economist, was a co-author of the
MarchlApril Report on the Americas,
"Debt-Latin America Hangs in the
crease, banks are required to establish
special reserves whenever there is "a
protracted inability of public or pri-
vate borrowers in a foreign country to
make payments on their external inde-
btedness." Symptoms of a "prot-
racted inability" include a failure to
make payments on their external in-
debtedness." Symptoms of a "pro-
tracted inability" include a failure to
make full interest payments or to
adhere to an IMF adjustment pro-
Argentina was guilty on both counts.
As of June 10, the date of the ICERC
meeting, Argentina, with an overdue
interest bill totalling approximately
$1.2 billion, was seven months be-
hind on its interest payments. Also,
the IMF announced in mid-February
that Argentina had fallen out of com-
pliance with an adjustment program
it had signed only last September.
Consequently, without persuasive evi-
dence that Argentina was mending its
ways, ICERC would have little choice
but to declare bank loans to Argentina
"value impaired" and to require banks
to establish special reserves.
Once special reserves are man-
dated, each bank must deduct from its
income-and place into the special re-
serve-an amount equal to at least
10% of its loans to that country. In ad-
dition, it must write down--or reduce
the value on its books-of its loan to
that country by the amount of the spe-
cial reserve. For U.S. banks with the
largest exposure to Argentina, special
reserves would have a major impact
on both bank profits and the value of
stockholders' equity. According to a
June report in The American Banker,
a financial daily, Manufacturers Han-
over Trust Company, Citicorp, Chase
Manhattan and Morgan Guaranty
Trust Company have each lent ap-
proximately $1 billion to Argentina.
Consequently, a 10% special reserve
would reduce reported profits and the
value of stockholders' equity at each
bank by at least $100 million.
Consortium Offers New Money
Lower profits might be the least of
the problems caused by a value im-
paired ruling. Last December, a
negotiating committee representing all
320 banks with loans to Argentina an-
nounced plans to lend an additional
$4.2 billion so Argentina would have
enough cash to continue paying inter-
est on old loans. The committee also
agreed to reschedule-to postpone for
up to 12 years-principal payments
that were orginally due in 1984 and
However, plans to disburse the
$4.2 billion new loan and to re-
schedule the old loans were put on
hold in February, after the IMF an-
nounced that it was suspending its
agreement with Argentina. For the big
multinational banks with the greatest
amount at stake, a temporary delay in
implementing the refinancing agree-
ment would not be fatal. But the big
banks were fearful that many small
banks in the rescheduling syndicate
would use the ICERC ruling as an ex-
cuse to scuttle the agreement.
Many of these smaller banks had
been reluctant participants from the
beginning. They had relatively little
money at stake, so an interruption of
interest payments, or even a default,
would not threaten their viability.
Rather than make new loans to a
country that bank regulators had
deemed uncreditworthy, they would
just as soon write off their loans al-
together. This would reduce their
profits even more than establishing a
special reserve. But if their profits
were going to suffer anyway, many
officers at small banks believed that
declaring a default might be better
than trying to justify to their boards of
directors and stockholders endless
rounds of new loans.
If the small banks refused to partici-
pate in the rescheduling agreement,
they would leave Argentina without
enough cash either to continue paying
interest or to repay old loans that were
rapidly coming due. And they would
leave the banks, which could not af-
ford to walk away from their Argen-
tine loans without imperiling their
own solvency, with only two options.
The big banks could buy Argentine
loans from the small banks, knowing
7full well that the small banks would
probably demand 100 cents on the
dollar for a loan that the regulators
would immediately value at only 90
cents on the dollar. Barring that, the
big banks could let the small banks
scuttle the rescheduling agreement
and precipitate a default. Either way,
the big banks were facing major
Successful Week for Banks
Argentina's latest IMF agreement
spared the big banks, at least for the
moment. And to add luster to the
banks' apparent victory, the United
States and several other governments
agreed to lend Argentina $470 million
so it could make an immediate install-
ment on overdue interest payments. In
addition to this so-called bridge loan,
the banks received two additional in-
terest payments totalling $570 mil-
lion, after Argentina announced it
would use some of its own cash to
further reduce its interest arrears.
All told, it seemed to be a success-
ful week for the banks. Not only did
they avoid a potential double-barrel
disaster, but they received nearly $1
billion for their troubles. However,
despite the appearance of total victory
for the banks and total capitulation by
the Argentines, these events are just
one more example of how little lever-
age the banks really have, and how
easily the Argentine government can
orchestrate events to suit its own
Argentina's power comes from a
basic fact that no IMF agreement can
alter: its interest payments are running
at a $6 billion annual rate while its
trade surplus is only $4 billion. The
Alfonsin government has been insist-
ing that Argentina will not spend more
than $4 billion of its own funds to pay
interest; so either someone gives
Argentina $2 billion to pay interest, or
the banks forego income totalling $2
As long as Argentina receives an
adequate amount of new money--
perhaps through a combination of
IMF funds, bridge loans from creditor
governments and new bank loans-in-
terest can be paid and the appearance
of bank profitability can be preserved.
And as the Argentines are demonstrat-
ing to everyone, bank regulators,
who are supposed to be preserving the
integrity of the financial system, are
quite willing to participate in this
charade. For their part, all the Argen-
tines have to do is give the appearance
of capitulating to the banks and the
IMF. And as long as it is in the coun-
try's interest to do so, the banks can
count on compliance from Argentina.
Playing by the Banks' Rules
Approximately one month before
Argentina signed its agreement with
the IMF, an Argentine official with
close ties to the ongoing negotiations
told me, "We'll sign with the IMF in
June because it's not convenient for us
to have our credit rating downgraded
at this time." Presumably, there will
be a time when a credit downgrading
will be more convenient. But at least
for the next few months, Argentina
stands to make a tidy profit if it suc-
ceeds in convincing everyone that it
has reformed and can now be trusted
to play by the financial community's
The profit comes from the fact that
the rescheduling agreement, which
provides Argentina with $4.2 billion
of fresh loans, stipulates that Argen-
tina will receive almost $2 billion in
the first disbursement, scheduled for
later this year. Thus, for the price of
signing an agreement that it has re-
peatedly violated in the past, plus the
immediate expenditure of somewhat
more than $500 million, the Argentine
government will receive several bil-
lion dollars from the banks and sev-
eral hundred million dollars more
from the IMF.
Seen from this perspective, even
Alfonsin's strict anti-inflationary
measures are not an indication that
Argentina has suddenly decided to
play by the banks' rules. As Argentine
officials are quick to point out, a
1000% annual inflation rate is a
symptom of intolerable social disin-
tegration. Curbing inflation, they ex-
plain, would be necessary even if the
debt crisis did not exist. Under no cir-
cumstances did the government an-
nounce these tough measures simply
so the country would be in a better fi-
nancial position to pay interest. In
fact, in a nationally televised speech
spelling out the details of the govern-
ment's new economic policies, Eco-
nomics Minister Juan V. Sourrouille
alluded to the fact that curbing infla-
tion is a prerequisite for making new
demands on the banks. "A country
with a weak economy overrun by in-
flation is a country that cannot defend
its national interests and make its just
demands for a more equitable interna-
tional order respected," he said.
"Negative on Argentina"
Apparently, even the U.S. financial
community expects that more troubles
are looming just over the horizon. At
the same time that Argentina was
signing its agreement with the IMF,
Moody's, a private credit rating
agency that assesses the risk as-
sociated with various investments, an-
nounced that it was lowering its credit
rating of Manufacturers Hanover
Trust Company, the bank with the
largest exposure in Argentina. In its
announcement, Moody's declared,
"Loans to Argentina have diminished
further in value. Manufacturer Han-
over's considerable exposure to
Argentina will depress future profita-
bility and limit capital adequacy to
levels that may be inconsistent with
current ratings." An official later
explained that Moody's is "more
negative on Argentina than it has been
in the past."
Bank regulators are becoming more
negative too, even though they de-
clined to require special reserves.
After the IMF agreement was an-
nounced and President Alfonsin had
announced the new round of austerity
measures, the regulators issued a
cryptic ruling requiring banks to "uti-
lize conservative accounting treatment
of interest payments received from
Argentina." While bank officials are
still trying to devine precisely what
this means, one interpretation is that
banks will no longer be allowed to
count interest payments from Argen-
tina as profits. Instead they must be
used to reduce the outstanding princi-
Normally, this accounting treat-
ment is reserved for payments from
domestic debtors encountering severe
repayment difficulties. It is a har-
binger of bankruptcy.

Tags: Argentina, debt crisis, austerity, banking, IMF deal

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