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COLUMN-Argentina 100-year bond a lesson in market nonsense and incentives: James Saft
June 19, 2017 / 8:54 PM / 3 months ago

COLUMN-Argentina 100-year bond a lesson in market nonsense and incentives: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

June 19 (Reuters) - Once in a while the universe reaches out to explain very complex things in a very simple way.

Such is the case with news that Argentina plans to sell a 100-year bond, a story tailor-made to illustrate exactly how extreme financial market risk-taking has become.

It also shows that global investors either a) have the attention span of a gnat or b) are not paid for making good long-term decisions. I’ll vote for the latter, but am willing to listen to arguments for the former. This isn’t, at base, a story about Argentina, but about how financial intermediaries are paid.

Argentina, which just two years ago emerged from a long and tortuous period of default, a state to which it has laid claim for more than half of all days since 1980, is seeking to borrow $2.75 billion for 100 years at about 7.9 percent.

This is the same Argentina which fought tooth and nail against creditors unwilling to come to terms over its 2001 default, imposing currency controls.

To be sure Argentina has a good “story” as they say in roadshows, emerging from recession and seeing its credit ratings on the rise, though we are still talking about a credit rated “B”.

MSCI is also, according to the Financial Times, about to lift Argentina’s equities into Emerging Markets indices from Frontier ones. That must make it a good bet to borrow money some of which won’t, under the best of circumstances, be repaid until after many grandchildren of the readers of this story are no longer clipping coupons.

Since gaining independence in 1816, Argentina has defaulted at least eight times, with some debate over whether some local currency efforts should raise the tally. Sounds like a solid bet to go the distance.

And remember too that this particular borrower isn’t just acting in its own drama, but pushing this plot point at a time when global interest rates are not too far off all-time lows.

That’s important, and I am a bit abashed to feel the need to explain this, because the longer dated a debt instrument is the more sensitive its value is to movements in interest rates. I, like most investors, don’t think the Federal Reserve will be able to restore historically normal interest rates any time soon, but interest rates don’t have to rise too very much to do serious damage to the capital value of a 2017 vintage 100-year bond.

BUMPY RIDE

Any investor who is signing on for a 100-year bond, even the geniuses who intend to trade in and out at opportune moments, need to prepare themselves for potentially a very bumpy ride.

To understand why Argentina is able to finance itself for 100 years, we are going to have to look at the issue more broadly than just through the lens of Argentina’s particular set of merits and demerits.

And sure, there are entities out there with very long-term liabilities and long-dated debt can be useful for them, making them “natural buyers”.

The real story behind Argentina borrowing for 100 years is the very calm, very low-growth and low-inflation global macroeconomic background, combined with a general mood of optimism and a peculiar strain of financial markets calm. It is not a surprise that this bond comes at a time of very, very low volatility, and very, very low interest rates.

Also I suppose we should add in the perverse incentives of fund managers, who as the agents for their principals are paid to take a narrow view of outperformance and stretch to achieve it. Sober, sensible bond fund managers, the ones who don’t invest as if central bank liquidity will be endless, have had a tough few years. Their peers more willing to take risks have been right, and may well continue to be right, at least as the game they are playing judges rightness.

Capital markets do not discipline borrowers when they are dominated, as they are, by agents acting for principals. For the International Monetary Fund or any other person or body to speak as if they do or will is absurd. All that counts is how the credit looks in the time frame against which the performance of the fund manager is judged.

So, the markets are on a momentum high and risk taking, at its far reaches, is extreme.

Remember, this is the same market that brought you 800-some crypto-currencies with a value of more than $100 billion. By comparison, 100-year Argentina bonds are stolid, sensible investments appropriate to widows and very young orphans.

I wish them, and the agents acting on their behalf, and Argentina, the very best of luck. (Editing by James Dalgleish) )

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