The conventional view of emerging- market crises casts them as a battle between big Western banks and poor little debtor nations. Turns out there are little victims on the lending side, too. Over the last few years individual investors throughout Europe and the United States have become more exposed to emerging-market risk than ever before. With low interest rates cutting returns on bonds in America and Western Europe, investors have been looking in ever more far-flung places for higher yields. Last year the flow of nonbank private capital into emerging-market bonds hit a five-year high of $44.7 billion, according to a report released in January by the Institute for International Finance. That figure includes individual investors represented by mutual or pension funds, as well as those buying on their own. “There are plenty of German dentists holding emerging-market bonds these days,” says Keith Savard, author of the IIF report, which cautioned that investors may be underestimating the risks in many of these markets.
That was certainly the case with Italian investors, who were easy prey for bankers selling the Argentine bonds. “Italians were generally comfortable with Argentina because of historical ties,” says Christian Stracke, an analyst with the independent research house CreditSight. “Argentina was one of the primary destinations for Italian emigrants in the late 19th and early 20th centuries, and Argentines of Italian descent make up a large percentage of the population.” Having grown used to high yields on their own bonds in the pre-EU days, many Italians saw no reason that they should settle for less.
For their part, the Argentine authorities actively targeted individual investors in the late 1990s, having already exhausted the institutional markets a few years before. They sold bonds not only to Italians, but also, to a lesser extent, to Germans, Central Europeans and Japanese. Those who bothered to research default scenarios may have been comforted by the recent defaults of Ukraine and Pakistan, which had been able to offer bondholders a relatively generous repayment of roughly 60 cents on the dollar. (By comparison, Italian investors now claim that the real value of Argentina’s repayment offer is a meager eight cents on the dollar, not 25 cents.)
Had investors dug deeper into their history books, they might have been more cautious. Despite the “big banks versus poor little people” rhetoric of anti-globalists and certain Latin American and Asian populists, there is a long trail of individual victims on the lending side, too. Two hundred years ago there were no restraints on international capital flows. Argentina, Brazil, tsarist Russia, the Ottoman Empire and even American Southern states like Mississippi regularly issued sovereign bonds to private investors in places like Britain and France–and just as regularly left them high and dry in defaults. Until the mid-1980s, an organization called the Corporation of Foreign Bondholders existed in London, pursuing decades-old claims on defaulted bonds by relatives of the original owners.
After World War II, international capital flows were tightened. When they began to loosen again in the ’70s, ’80s and ’90s, emerging-market debt became mostly the province of big institutions. Denominated in dollars, emerging-market bonds were of little interest to Americans, who preferred equities, or to Europeans, who bought bonds in their own currency, or, later, in euros. Pension funds and mutual funds looking for higher returns changed all that, spreading risk to individuals. And while the lack of organization and concise data in the emerging-bond market make it difficult to tell exactly which individuals are holding the most risk, analysts say anecdotally that in recent years European retail investors have bought into Croatian, Polish, Romanian, Turkish and Brazilian bonds.
While none of these countries look likely to default in the near term, the IIF report expressed concern that bonds from a number of emerging markets, including Argentina, Poland, Ecuador, Venezuela, Peru, Egypt, are riskier than they seem. If and when the next emerging-market default comes, there is no formal system in place to make sure that private investors get at least some money back in a timely way.
Part of the difficulty comes from the fact that the market is now so dispersed. “Back in the 1980s, when a country defaulted, you could get about 150 people from the biggest banks in a room and work it out,” says Francisco Baker, an IMF spokesperson. These days, there’s not a stadium on earth big enough to hold all affected investors. And not surprisingly, it’s the little guy who gets left outside. As investors continue to wrangle with Argentina over debt repayment, the IMF is currently considering whether to lend the beleaguered country an additional $3.1 billion. It’s a sort of math that Claudio Pugelli doesn’t understand. “We’re hoping that we might see some of our money back within the next decade,” he says. Whether the pensioners he represents can wait that long is anyone’s guess.
