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Argentina Didn't Fall on Its Own

Calomiris's proposal was rejected by the Argentine government and the IMF as too drastic. But in the months that followed, his scenario began to unfold more or less as forecast.

Capital fled the country and interest rates skyrocketed when a political rift erupted in the cabinet of President Fernando de la Rua in November 2000.

The human scale of Argentina's crisis: People wait to search for food in garbage from a produce market outside Buenos Aires in May 2002. (File Photo/Diego Giudice -- AP)

_____Post Archive_____
Scrap by Scrap, Argentines Scratch Out a Meager Living (The Washington Post, Jun 7, 2003)
Gulf Between the Rich and the Poor Grows in Argentina (The Washington Post, May 16, 2003)
As Crime Soars, Argentines Alter Outgoing Ways (The Washington Post, Jan 27, 2003)
Argentina Defaults On Debt Payment (The Washington Post, Nov 15, 2002)
Despair in Once-Proud Argentina (The Washington Post, Aug 6, 2002)
Argentina, Shortchanged: Former World Bank economist Joseph Stiglitz explains why the once-prosperous country is in economic meltdown: because it followed the advice of the International Monetary Fund.

The IMF rushed to Argentina's aid with a $14 billion loan, but after a brief rally, the country's markets sank anew. By the spring, buyers of Argentine government bonds were demanding yields as high as 10.5 percentage points above U.S. Treasurys, which meant that interest costs would become even more burdensome for the government and the economy at large.

Wall Street had one more plan to keep Argentina going -- a profitable one, at least from the Street's standpoint.

Debt Swap

Upon being appointed Argentina's economy minister in March 2001, Domingo Cavallo had barely ensconced himself in his office before David Mulford, chairman international of Credit Suisse First Boston, arrived to make a pitch.

Cavallo, the father of Argentina's peso-convertibility system, had a long history of dealings with Mulford, going back to Cavallo's previous term as economy minister from 1991 to 1996. The men got to know each other when Mulford was Treasury undersecretary for international affairs during the first Bush administration, and their relationship deepened when Mulford joined CSFB, which handled the privatization of Argentina's state oil company and became one of the biggest underwriters of Argentine government bonds.

Mulford had an idea for a deal that would dwarf the ones he had done before. He proposed a "debt swap," in which Argentina's bondholders would be given the opportunity to exchange their old bonds for new ones, on a voluntary basis. The purpose was to eliminate a problem that was disturbing the markets -- the large amount of interest and principal payments Argentina was scheduled to make in the years 2001 through 2005. Under the swap, those interest and principal payments would be stretched out so that much more would fall due in the years after 2005. That would give Argentina "breathing space" to restart economic growth, Mulford contended.

Despite the skepticism of some analysts and policymakers, including the IMF's chief economist, who believed the deal would prolong the agony and dig Argentina into a deeper hole, Cavallo agreed to try the swap.

Mulford traveled to the world's financial capitals to pitch the swap, which he described as creating the opportunity for improvement in the economy, the fiscal situation and market sentiment. The deal was "essential to long-term success in restoring Argentine growth," he declared in Buenos Aires. Mulford declined to comment for this article.

The results, announced in June, were proclaimed a resounding success: Bondholders offered to exchange nearly $30 billion worth of bonds, considerably more than had been expected. The seven banks that managed the deal, led by CSFB and Morgan, collected nearly $100 million in fees, an amount they justified by pointing to the 60-plus experts who worked on the complex transactions.

Within weeks of the deal's completion, though, Argentine markets were again in a tailspin and another IMF loan in August provided only a temporary respite.

By late November 2001, deposits were flying out of Argentine banks. The government took the extraordinary measure of slapping controls on withdrawals.

That helped trigger street demonstrations and rioting, which led to the resignations of Cavallo and de la Rua in mid-December. Their successors soon thereafter declared default and freed the peso from its dollar anchor.

Lessons Learned

A year and a half after the crash, Argentina has begun recovering from its depression. Although the economy is still producing considerably less than before the crisis, and unemployment is much higher, growth has picked up in the past several quarters. A few Wall Street bankers are sniffing around again for deals to restructure defaulted debt, but the national government has ruled out hiring any firm that underwrote its bonds during the 1990s.

The brightening outlook in Argentina has helped attract a new inflow of funds from abroad, enough to drive the stock market and the peso sharply higher this year. This time, however, the government has responded with restrictions aimed at limiting the amount of "hot" money coming into the country. The move reflects the view of some in Argentina, notably Roberto Lavagna, the current economy minister, about the lessons that should be learned from the country's economic collapse.

"The lesson is, we must pay attention to bubbles," Lavagna said in a visit to Washington this year. "With stocks, or companies, or countries, all are part of the same phenomenon. Probably Argentina is the best example of a country."

For developing nations, "the worst period is when financial markets have the most liquidity," Lavagna said. "This is when countries make the worst mistakes. That is certainly the case in Argentina."

Special correspondents Brian Byrnes in Buenos Aires, and Sarah Delaney in Rome, contributed to this report.

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