Los Angeles Times
February 18, 2003

The Good Life Is No More for Argentina

       The nation rode high on a free-market system, backed by the IMF and tied to the dollar. Then the global economy spun it into disaster.

       By Héctor Tobar
       Times Staff Writer

       SAN ISIDRO, Argentina -- More than any other developing nation in the 1990s, Argentina embraced the free market and the global economy.

       For top officials at the International Monetary Fund and economic gurus of the American right, Argentina was a star pupil. It sold off most
       government enterprises and loosened banking restrictions and controls on foreign investment. The IMF backed the strategy with billions of dollars
       in loans.

       For a few years, people lived better than ever. Many Argentines believed that their country, already the most prosperous in Latin America, was
       finally graduating into the First World.

       Then, in December 2001, the bottom fell out, causing a run on the banks that wiped out billions of dollars in deposits.

       Nearly six months later, on a May morning that happened to be her 59th birthday, Norma Albino stepped into her bank branch in this Buenos
       Aires suburb of cobblestone streets, famous for its affluence and the tall spires of its 100-year-old church. She asked for the third or fourth time
       since December for her family's money. When the teller told her that he couldn't help her, she blurted out: "I'm going to kill myself."

       As horrified bank employees looked on, she poured a bottle of rubbing alcohol over her head and snapped at a cigarette lighter.

       Albino became, at that instant, a symbol of the rage and hurt smoldering inside millions of Argentines. Rushed to a hospital, she survived with
       third-degree burns. Months later, she has found that the best therapy is simply to forget.

       "The politicians robbed us," she said. "But I don't care anymore. I try not to think about it."

       Argentina's official unemployment rate stands at 22%, about the same as in the United States during the Great Depression. Poverty afflicts 53% of
       Argentines, triple the rate of just five years ago.

       "We're not the poorest country. There are places that are much worse off," said Raul Queimaliños, an unemployed economist and writer. "What's
       hard for us is that we've known something better. We've lived well."

       How Argentina came to suffer such a fall is an emblematic tale of the global economy's power to spur sudden prosperity in developing countries,
       and then, even more swiftly, to bring disaster.

       It is never easy to apply the formulas of free markets to struggling countries, each with its own mix of politics and economic vulnerabilities. Some of
       the best candidates fail. In Argentina, corruption, political wrangling and a baroque system of public spending meant that reforms demanded by the
       IMF were never fully implemented. Over the course of a boom-and-bust decade, about $17 billion in IMF loans went largely to waste.

       Several economists including Nobel Memorial Prize winner Joseph Stiglitz believe that the IMF based its policies on unrealistic expectations
       of Argentina's ability to reform and that it knew trouble was coming. Still, for a decade, the IMF endorsed Argentina's economic policies, giving a seal
       of approval that built confidence in its institutions.

       "The IMF is the Arthur Andersen of Argentina," said Congressman Mario Cafiero, referring to the U.S. accounting firm that was at the center of
       the Enron scandal. "They saw the crash coming, and they had the obligation to warn us."

       Argentina has been mired in financial limbo since Dec. 23, 2001, when President Adolfo Rodriguez Saa who held the office for only a week
       declared that he would default on the government's $141-billion foreign debt, the largest sovereign debt default in history.

       Ever since, Argentine officials have said that only a new, multibillion-dollar IMF bailout can get the economy on track again. Over more than a
       year, five economy ministers and other officials have made more than a dozen trips to the IMF's Washington headquarters to negotiate such a deal,
       without success.

       On Jan. 16, the IMF agreed to defer the deadline on $6 billion in payments on previous loans but granted no new funds. The deal will keep the
       government from entering into default for a few months longer.

       "The IMF is in a process of change," Horst Kohler, the agency's top official, said at its most recent annual meeting in September, reflecting on the
       crash in Argentina and a similar crisis that is looming in Brazil. "The fact that it was not possible to avoid the current difficulties in Latin America
       shows we still have a lot to learn."

       Back to the Future

       Domingo Cavallo, a politically ambitious economist with a mercurial personality, was the architect of Argentina's reforms.

       In 1991, he staked the future of his country on a set of ideas he had first encountered as a young man. Growing up in provincial Cordoba, Cavallo
       devoured the writings of Adam Smith and other early economists. It was, he says, a form of youthful rebellion against the left-leaning ideas
       prevalent in Latin American academia. As a doctoral student at Harvard, Cavallo found mentors who encouraged his views.

       Under Cavallo's direction as economy minister, Argentina's currency became "convertible" with the U.S. dollar. The central bank would keep one
       dollar in reserve for each peso it printed. It was an idea taken straight from orthodox economics textbooks, a modern-day version of the gold standard.

       The new system prevented the government from simply printing money to cover its bills and reined in inflation that had reached 200% a month. This
       new stability gave people such as Norma Albino the confidence to put more money in banks again.

       "We thought we were building new institutions, a country with rules, where things would be more predictable," said Federico Struzenegger, an
       MIT-trained economist who was briefly a top official in the Economy Ministry. "With convertibility, we started to put our fiscal house in order." The
       system would work, however, only as long as the central bank held on to its dollars to back the peso economy and didn't use them to finance
       government programs or pay off debts.

       Banks from Boston, Madrid and New York opened branches in Argentina and took over existing banks. The Banco Rio branch in San Isidro,
       where Albino had been doing business for 30 years, was bought by Banco Santander Central Hispano of Spain. Albino converted all her savings
       about $20,000 into the world's most secure currency, the U.S. dollar.

       Eventually, 70% of all bank deposits in Argentina would be in dollars. In effect, the country had two legal currencies. With the peso-dollars'
       strengthening buying power, the Argentine economy grew 10.8% in 1991, faster than that of any other Latin American country. Now, in many
       cases, middle-class families could afford to travel and send their children on European vacations.

       Outside investors were drawn by the relatively high rates of return and new regulations that made it easier to move capital into and out of the
       country. About $800 million in foreign investment poured into Argentina every month, on average.

       But much of the investment was "hot money" speculation on the currency markets, for example that could leave the country at a moment's

       In 1994, the U.S. Federal Reserve Board announced the first in a series of increases in interest rates. That caused dollars to flow out of Argentina
       and back into the United States, where they would earn more interest. Few people here knew it, but their love affair with the global economy had
       taken a first step toward a messy divorce.

       More of what economists call "external shocks" followed: Mexico's sharp currency devaluation in 1995, soon known as the "tequila surprise"; the
       1997 financial crisis in Asia; and Russia's debt default in 1998. With each crisis, more investors turned away from risky "emerging" countries.

       Each dollar that left the country made it harder for Argentina's central bank to keep Cavallo's convertibility system working. The government was
       forced to borrow to keep the system afloat and found itself having to pay more to do so because of rising interest rates.

       Argentina's debt spiral was starting to spin.

       'Champion of Reform'

       In October 1998, nearing the end of his 10 years as Argentina's president, Carlos Menem came to Washington to declare victory against the forces
       that had kept his country in the Dark Ages.

       Argentina, the president told the annual meeting of the IMF board of governors, had pulled off an "absolute economic miracle" in the 1990s. "We
       succeeded in transforming an economy ravaged by hyperinflation, speculation and systemic corruption."

       Once a charismatic populist, Menem had embraced the theories of the "Washington consensus," a set of ideas crafted by officials at the IMF,
       World Bank and U.S. Treasury Department to bring growth to the developing world.

       In just a few years, Menem sold most government-owned enterprises. Foreign corporations bought the telephone, water and gas companies, the
       railroads, the post office and the national airline. The government oil company and its reserves in the southern region of Patagonia were all sold off

       The government-run utility where Albino's husband, Rodolfo Gonzalez, worked Electric Services of Greater Buenos Aires was divided up
       and sold to Chilean, Spanish and American investors. Gonzalez and thousands of former government employees eventually would be laid off, as the
       new, private owners made the enterprises more efficient.

       Many laid-off workers took their severance money and launched their own businesses.

       But top members of Menem's economic team knew that Argentina was at a precipice. IMF officials "more or less declared him the world
       champion of reforms," said Juan Llach, then second in command at the Economy Ministry. "It seemed to me to be a great exaggeration. I realized
       then that the fund really wasn't doing its homework."

       Argentina's economic stability had been ensured only by a steady stream of outside income from the sale of state-run industries, investment and
       international loans that provided enough dollars to back the local currency. Otherwise, the government was not able to balance its budget.
       Behind the scenes, IMF officials pressured Argentina to abandon the convertibility system. A devaluation would ease the pressure on the central
       bank's reserves, at the cost of slashing Argentines' buying power in the global market. Facing similar choices, most other countries in the region
       including Brazil and Chile had allowed their currencies to lose value relative to the dollar.

       "They told us we should devalue our currency, but we said no," recalled Llach, who was in charge of the government's negotiations with the IMF.

       Menem still had ambitions of pushing through a constitutional amendment that would allow him to run for a third term. All those dollars in Argentine
       bank accounts made him extremely popular.

       "We had three options open to us," Llach said. "We could have undertaken very serious [tax] reforms. Or we could have lowered spending. Or we
       could have devalued. But we didn't do any of those things. The decision was to allow things to continue rotting."

       'Such and Such Sent Me'

       Government jobs and subsidies have long fueled Argentina's political machinery. As factions of Menem's ruling Peronists and the opposition
       Radical Party vied for control of the federal and local governments, they spent untold millions hiring "shadow" employees who were, in fact,
       full-time political operatives.

       Bernarda Pirovano saw the system firsthand when she ran a small family welfare program.

       "People would come to my office and show me a business card and say, 'Such and such sent me,' " Pirovano recalled. Connected to high-ranking
       Peronist officials, they expected government "jobs" that didn't necessarily require showing up for work every day.

       Wiping out corruption was supposed to be a key part of Argentina's free market reforms. Instead, the good times of the early 1990s seemed to
       only inflate the patronage apparatus. Today, despite a decade of privatizations, the number of public employees about 2 million is roughly the
       same as in 1990.

       The spending spree was especially brazen in Buenos Aires province, home to a third of Argentina's population. Eduardo Duhalde, the province's
       governor, was Menem's top rival in the Peronist party. Their battle for control was fought, for the most part, with government money.

       Under Duhalde, spending in Buenos Aires province increased from $7 billion in 1996 to $9 billion in 1998. Last year, the province spent $11

       "Duhalde would go to a town and take some soundings," said Joaquin Morales Sola, a leading political columnist here. "If people wanted a
       hospital, he would build them one."

       Menem, for his part, had control of a discretionary fund called Advances From the National Treasury, or ATNs.

       " 'Friendly' city governments had access to the ATNs," said Pirovano, now a political science professor at the University of Belgrano. "They would
       find any excuse to ask for an ATN. Theoretically, they had to present a written project. But there was no accounting."

       Adding to the burgeoning deficit was the biggest, most controversial step of the privatization process: the sale of the social security system. In 1994,
       private companies took over the responsibility of collecting social security contributions from workers and investing them until they retired. But the
       government continued to pay those who had already retired. Until those retirees died, the government would be paying most of the bill, without
       collecting any of the revenue.

       The move was seen as an investment in the long-term health of the economy. But in the short term, the government would lose approximately $2.5
       billion in revenue each year, an amount double the size of annual budget deficits.

       IMF officials warned their counterparts in Buenos Aires that they were headed for disaster. But the IMF kept lending Argentina money.

       "Argentina had been the fund's best student, and they wanted the rest of the world to do the same things we had done," Llach said. "We were like
       the bad son that the parents have a certain weakness for. You don't discipline that child as much as you do the others."

       Each time the fund lent Argentina money, it was on the condition that the government reduce spending. Budget cuts caused the recession that had
       started in 1998 to deepen. When Fernando de la Rua won election as Argentina's new president in October 1999, unemployment stood at 15%.

       New Money

       From the very beginning, it became clear that De la Rua would not be the intimidating and charismatic president Menem had been. Soon, even
       members of his own center-left coalition were turning against him.

       Most of Argentina's provincial governors were flouting his budget targets. Under the country's decentralized budgeting process, there was little De
       la Rua could do to stop them. In Argentina, the provinces can spend as much as they want, and the federal government has to foot the bill.

       Finally, in 2001, De la Rua tried to reduce outlays to the provinces. But, under intense pressure, he allowed the governors to begin issuing their
       own pseudo-currencies, essentially bonds issued to pay the salaries of government workers and other provincial obligations. All the new currencies
       were equivalent to one peso and were legal tender for local transactions.

       In March 2001, De la Rua brought back Cavallo, Menem's old economy minister, to win back the confidence of international investors. Cavallo
       announced a "zero deficit" program that included a 13% reduction in government salaries and a sharp reduction in pensions. The cuts set off strikes
       and protests.

       "We didn't have money to pay these absurdly high salaries we were paying," said Struzenegger, the MIT-trained economist. "I tried to explain this
       to the media, but they would look at me like I was a Martian."

       Desperate, Cavallo negotiated a massive debt swap that gave the government short-term relief but increased its long-term debt by $66 billion.

       "It was clear that Argentina was headed toward default and devaluation," said Gustavo Cañonero, a Deutsche Bank economist. During just five
       days in July, $2.6 billion drained out of the banking system. Cavallo pinned his hopes on another IMF loan, but officials there were now turning a
       cold shoulder.

       Then, a report appeared in the Argentine media that the IMF would give Argentina another $8 billion. Michael Mussa, then the leading IMF
       researcher, said fund officials were stunned. The story was a fabrication, he said, planted by Cavallo.

       "Basically, he stampeded the fund," Mussa said in an interview. "Others have tried it without much success. But Cavallo pulled it off."

       The IMF announced in August that it would provide $8 billion in new loans. Cavallo and the central bank pumped the IMF money into the banking
       system. Within a month or two, much of the IMF money had flowed out of the country to banks in Miami, New York, the Cayman Islands and
       elsewhere. The IMF had done little more than fund the final stampede from Argentina's banks.

       "The IMF gave that money to the central bank. The central bank lent the money to the [private] banks," said Pablo Guidotti, a University of
       Chicago-trained economist and former central bank director. "And the banks used that money to pay their depositors, who then took that money
       and sent it abroad."

       Still, the IMF issued laudatory statements about De la Rua's government, in an apparent effort to calm the looming panic.

       "The new agreement [with the IMF] has already begun to restore confidence domestically," IMF spokesman Thomas C. Dawson wrote in a letter
       to The Times in September 2001.

       On Dec. 3, with the banking system still bleeding cash, the government froze most accounts, limiting withdrawals to $250 per week. A few days
       later, looting broke out. On Dec. 19, tens of thousands of people took to the streets of Buenos Aires, demanding the heads of both Cavallo and De
       la Rua. The economy minister resigned after midnight on Dec. 20. De la Rua stepped down less than 24 hours later.

       After two other men briefly occupied the presidential chair, Congress picked Rodriguez Saa, the governor of San Luis province, to be president.
       Argentina would default on the private segment of its overseas debt, he announced. The peso would float freely. Convertibility was dead.

       The Aftermath

       By the end of 2002, Argentina's gross domestic product was estimated to have fallen by 21%, according to an IMF study, twice the drop of any
       year of the Great Depression.

       According to Mussa, only one other event in the last century of Latin American history has inflicted as much damage on a country's economy: the
       Mexican Revolution, which began in 1910.

       Renegade police officers have gone on kidnapping and killing sprees. The Supreme Court, loyal to Menem's faction of the Peronist party, has tried
       to undo the economic policies of Duhalde, who is now Argentina's caretaker president.

       "The problem in Argentina has been the systematic destruction of its institutions," said Morales Sola, the columnist. "The presidency is wounded.
       Congress is one of the most discredited institutions in the country. And there is no effective judiciary. Or even a currency."

       Months of protests by disgruntled depositors have turned many Banco Rio branches into mini-bunkers, their windows lined with corrugated tin and
       armed guards posted at the doors.

       The most famous Banco Rio depositor, the woman who set herself ablaze, says she did not go to the bank that day to protest.

       She simply wanted to ask about a plan that would have allowed her to convert the dollars in her frozen account to government bonds, redeemable
       in devalued pesos at some future date. She had missed the deadline, the teller told her.

       What happened next "was a moment of craziness," she said, una locura.

       "What surprised me the most was that after we put out the fire, and before the ambulance came, she kept asking about her money," one witness
       said. "She didn't complain about the burns at all."