An Inevitable Move

It must be 12 years ago now that we first pointed out the ridiculousness of the World Bank-inspired private pension industry scheme in Argentina. This week has brought their demise but not before enormous amounts of contributors’ money has gone up on the bonfire.

Reform of the industry is something that we have wailed for like a voice in the wilderness. We even had the temerity to suggest that change came from inside the industry to avoid an action like that which has occurred this week. All to no avail. We personally opted out of the AFJP in 2001 before the economy went over the waterfall.

The actions of the Kirchner regime have various roots, nothing is simple in Argentina.

Stick to the Script!

Someone claimed that the actions of this week were straight out of the Peronist playbook. Lets get this straight. The Peronist playbook was written in Rome in the 1930s when Peron was military attaché to the court of Il Duce. The Peronist playbook is a fascist corporatist playbook written with the Italo-Spanish accent the Argentines speak. The rules go: vilify, generate outrage, seize. Hitler and Mussolini would have thought this week’s actions to be amateurish. Peron would have thought them amateurish. By skipping the first two phases of the strategy, the outrage is not turned on the AFJPs but on the Kirchners.  Amateurs…

But why? Generating outrage would have produced a defence. The Kirchners tried to paint the big-time farmers as oligarchs ripping off the masses (which they were via the fuel subsidies and weak currency that the Kirchnerite policies gifted to them) and yet the public sided with the farmers. Having learnt their lesson from that, this time they have come out of left-field with a totally unexpected attack for which the public and the enemy (the AFJPs… and the public if one thinks about it…) were totally unprepared. This avoids all that messy business of debate before an action. Now the debate begins and if a retreat is forced then it becomes even more embarrassing. The Kirchners would rather be embarrassed than have to explain themselves. There is good reason for Nestor Kirchner never liking press conferences. Frankly if he had brought us on board we could have given him a volumes on why the AFJP system was not working and should be changed. Instead they run with a gut-reaction and a few flimsy excuses, the main one being some variant on “this is what is needed due to the international financial crisis, and anyway the US is nationalizing financial institutions so why can’t we”.  The difference here being that the public do not perceive the AFJPs to be in crisis, one of the few institutions free of doubts these days. There is a crisis in the AFJPs, basically that they are so badly structured that they will never be able to deliver adequate income for retirees when the serious wave of retirements begins in the next ten years, but the public do not know or comprehend this information. The AFJPs, as originally structured were a Ponzi scheme, but aren’t most State-run pension schemes, including that of the US?

Irredeemably Broken

Why do we say this? Take one dollar you contribute to a pension scheme in Argentina and deduct 30-36% on the first day of its thirty-year journey towards coming back to you upon retirement. That means you are left with 70cts at best to start with. At 5% return per annum, it will take you years to even get back to the $1 you first contributed. That in a nutshell is how the Argentine scheme worked. The World Bank cooked it so the scheme would be front end loaded. The managers get paid on Day One and then manage the remnant 70 cts for free for the next thirty years.

In another system the $1 would come in. At the end of Year One the $1 would be $1.04 (after deducting a 1% management fee). Note the difference? At the end of ten years, the contributor’s first dollar would be around $1.48 for the AFJP holder it would be $1.14.. oops!! So the non-Argentine pensioner-wannabe would be worth $1.48 after ten years whereas the Argentine contributor would be worth the same as the other guy was after two years. Talk about starting off behind the eightball!!

Big is Better!

On the day of the announcement, the employees of the Superintendencia de los AFJP went out in protest. A representative claimed that this move would throw 11,000 people out of work. What??? There are eleven thousand people involved in managing/administering a mere $29bn! That is like a large hedge fund or the pension fund of a smallish state in the US Midwest. Either of these might have a few hundred employees. Why so many? How are they paid? Need you ask where the 30% upfront fee goes! The industry is bloated. The funds have justified their enormous fees by the appearance of having a plethora of street-level outlets that have no foot traffic going through them. The performance of the funds has been nothing to write home about either. All of the funds had less than 15% in equities during the early years of this decade in which Argentina was the top performing equity market in the world. Moreover back in the 1990s there was the practice of mutual backscratching, which we highlighted repeatedly, involving funds investing in the mutual funds and CDs of their “competitors’” parent banks in a quid pro quo manner to get around the provisions prohibiting the AFJPs investing in their own parent banks funds. Six of one, half a dozen of the other. The fund structure was corrupt, bloated and deleterious to the contributors.

Cherchez l’argent

So why have the Kirchners made this daring move? We suspect it’s a misinterpretation of the global mood on the moment. They have been listening to too much Chavista propaganda. Ironically some of their interpretation of events may be inspired by the far right in the US that is opposed to the bank bailout. Having read that  “nationalization is respectable” in the US they have seemingly thought that this was something they could slip through in the general hubbub. How wrong they were…

The motivation here has nothing to do with protecting the poor contributors from rapacious funds. The Kirchners have been in power for five years and have done nothing to reform AFJPs. In fact the only time they even turned to the subject was last year when they introduced a rule change forcing money to be invested onshore only. This forced funds to repatriate from the their outside investments (and ironically from a tendency to invest in the riprroaring (now battered) Bovespa! The rationale was that the funds repatriated would go into infrastructure bonds. Ironically they are now talking of using pension contributions for infrastructure again. However there is no reason they could not have issued the bonds they had first mooted and stuck to Plan A. Indeed the reason they didn’t was because they preferred the funds to max out buying sovereign debt rather than get distracted by bridges and tunnel schemes. The talk is that the new infrastructure strategy is directed towards getting CFK or Nestor re-elected.

The merging of the funds’ bond assets back into the general treasury gives an opportunity to remove around US$16bn from the amount of bonds outstanding while adding AR$300-400mn in monthly flows from contributors into the general budget, plus the saving of servicing. This would seem to be the real land grab here. With the value of Argentine bonds plunging in recent days on this news, we wouldn’t be surprised to hear that the regime may have been using reserves to snap up more in their buyback campaign. Not entirely stupid…

The Kirchner Curse

Hamfisted would be a charitable term for the policy decisions since CFK took power. It is obvious that Kirchnerite economic policies are only good in fair weather. Though even then we might argue that the inflation problem of today is the logical outcome of the husband being asleep at the wheel during the “good years”. His problems have come to haunt her and neither of them has dealt well with them. The agricultural showdown of last year was a debacle on the political and PR front. It also spawned an opposition movement, and one with a feeling of empowerment. Julio Cobos, the renegade vice-president is vowing to lead the charge against the AFJP nationalization that could end up being an embarrassment for CFK. For the first time today we have heard references to a “helicopter on the lawn at Olivos” the classic Argentine “early departure” mechanism for toppled Presidents. Frankly there are now a lot of people pining for this outcome, no matter what short-term trauma it might bring. As confidence in Cobos, as their champion grows, so will the dangers for Cristina. This may be her Waterloo.

What might have been…

A long time back we posited that there were some quick fixes for the AFJP system. These were:

– Divide the AUM. Old AUM would be managed gratis (as they had paid the upfront fee), while new AUM would be charged a 1% annual fee

– Liberate funds to compete on performance (currently outperformers have to “donate” to underperformers)!

– Force a reduction in overheads, all marketing costs come out of the 1% fee (this should shrink people involved down to less than 2,000

– Either remove the death and disability premium component on the 30% (and shift to State) or turn it into an annual premium (maybe 0.5%)

This is not a complex proposal at all. If the funds and the opposition grabbed onto it, they could totally emasculate Cristina’s proposal (if we can mix our metaphors).

A Justified Reaction?

Investors are clearly working in an information vacuum. The government is lying about its rationale for this action, but it’s pretty obvious what the rationale is. The sell-off has been massive and just when Argentina was looking like a relative island protected from currency instability, if not equity instability. The fate of the equity holdings is unclear, but the bond sell-off is clearly unjustified as the takeover will enhance Argentina’s ability to service the remaining debt. Investors should be worried that this heralds instability on the political front and yet heartened that the regime is now more embattled than ever. Before the farmers were disgruntled with some urban sympathy. Now the government has put the middle class, the upper class and the upper working class offside. That takes a degree of stunning ineptitude.

Ironically, CFK has shot herself in the foot again, just as other countries (Iceland, Byelorussia et al.) are joining the pariah club where Argentina spent so much time in solitary confinement. Investors (and the Argentine populace) should take comfort that this is probably the beginning of the end of the Kirchner regime.

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