Preying on Pensions?

As Argentina's economy lost access to credit in late 2001, the government resorted to desperate measures in a vain attempt to avert disaster. Privatized pension funds--created in 1994 as a result of a Social Security reform based on individual accounts vested in bonds and equities--were one casualty. The government forcibly rescheduled the public debt holdings of these funds, known locally as AFJP. It also "pesofied" these holdings, which in mid-2001 amounted to more than 60% of the pension funds' portfolios, in effect converting dollar-denominated assets into local pesos overnight.

This "confiscation" occurred after several years in which high-risk government securities obtained very large returns. Between September 1994 (the year of their inception) and January 2001, the AFJP yielded an average annual rate of return of 10.9% in US dollars--nearly 600 basis points above the return obtainable from US Treasury Bills.

There is an obvious lesson to be learned from Argentina's experience: if pension funds invest heavily in risky public-sector obligations--a common strategy in Latin America throughout the transition from state-funded pay-as-you-go systems to schemes based on individual capitalized accounts--repayment will be at risk from the outset. Pension funds might be subjected to arbitrary treatment. But this is precisely the situation that Social Security reform was supposed to eliminate.

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