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.

How badly were the AFJP's actually treated? As the dust settles, it is becoming apparent that they have fared rather well. The rate of return on their portfolio holdings from September 1994 to December 2002 is around 9.5% per year in real terms, which appears more than reasonable by any account. Even accounting for the very large peso devaluation, the US dollar rate of return varies between -2.5% and 4% per year, depending on the real exchange rate used to value the peso assets of AFJP's after the devaluation in January 2002.