In line with previous posts on the financialization of the economy, and on the doubtful usefulness of this aspect for productive purposes, I am now reporting on a curious episode involving the sale of Argentinian bonds, as an example of a financial operation that basically benefitted only the investment bank that managed the deal, to the detriment of all other unsuspecting investors that were involved in this unfortunate venture. This example is reported in Ugo Mattei and Laura Nader’s book “Plunder: Where the Rule of Law is Illegal”. This post builds on that report, by adding additional background information.
In 1992, Argentina issued a “debt consolidation” bond, which took the name of BOCONs. A “debt consolidation” bond, in a nutshell, is a financial instrument which serves to give a defined legal regime to pre-existing, heterogenous liabilities incurred by a State. The reasons behind the issuance of BOCONs are exposed in Alberto Ramos’ paper: “Government Expenditure Arrears: Securitization and Other Solutions” in the following terms:
During the 1980s, the Argentine government, and Social Security System especially, experienced difficulties in meeting current obligations, in an environment of very high inflation. Consequently, the government accumulated considerable arrears to suppliers and, in particular, did not recognize the legal right of pensioners to indexation of their payments to inflation. In 1991, a series of lawsuits against the Argentine government for its failure to index pensions to inflation were successfully concluded. These binding legal decisions left the Argentine Social Security System alone with a liability of around 5 percent of GDP and no current resources to comply with them. At the time, it would have been impossible to settle all these claims in cash concurrently, while repudiation was not an option due to the court rulings [printing more currency would have also made the very problem behind the accumulation of arrears, ie inflation, worse]. Faced with stringent budget constraints, the government decided to settle a very small amount in cash and to issue bearer Consolidation Bonds-BOCONs- with a maturity of 10 years to pensioners and 16 years to suppliers.
One characteristic of BOCONs was the difficulty in estimating their worth. In fact, no payments, either for capital or interest, were to be made for a period of six years. However, interest payments would be added to the principal during this time. As interests would start to be paid out after the first six years, the principal would then begin decreasing as well. This complex structure made it very difficult to determine the present value of such an asset. So difficult that, besides those creditors whom the bond was issued by the Argentinian government, the secondary market was not flourishing.
This, until the case came to a famous investment bank, Morgan Stanley. Morgan Stanley suggested the establishment of an offshore trust. The trust would serve as a vehicle to swap the BOCONs unfavorable cash flow with a steady one. In fact, payments from BOCONs would flow into the trust (this, I am guessing, because the trust would be the legal holder of such bonds) and, through the latter, be transferred to Morgan Stanley in exchange for a steady interest rate.
“Dressing” BOCONs this way allowed the investment bank to make an otherwise unattractive investment look attractive, as this repackaged bond would
pay interest immediately, … appear not to have a fluctuating principal, and seemed very safe, backed as [it was] by Morgan Stanley, who would disclose (if at all) only in very tiny obfuscatory print , that [it was] in fact [a] highly complicated and risky derivative[].
Mattei and Nader, Plunder: When the Rule of Law is Illegal, 41-42
Investors were then made to purchase a “unit” of this offshore trust, the value of which, however, was still linked to the value of the underlying bonds. With subsequent decreases in bond value, investors were left with an asset worth very little, while the investment bank was able to maximize its profits in terms of fees from the immediate sale of such instrument, in a very sophisticated variant of the good old motto “pump and dump”.
Hence, besides the lack of a genuine productive motivation in all of this financial machinery (as, basically, the bank’s earnings effected a “zero sum game”, by extracting wealth from investors, while creating none), a broader point can be made, regarding the need for Argentina to issue this bond in the first place, as – arguably – a bond with a value too difficult to determine creates as much uncertainty as it purportedly eliminates. If anything, by “selling” the bond as a promising asset from an expanding economy, it just becomes an excuse to inflate market expectations, offering an extra profit opportunity for big financial players, like investment banks.
