Argentina: Sovereign advisory elite in the shade

by Jules Evans

It's one of finance's most elite clubs, though its members don't accept that it exists. It's made up of the handful of heavyweight economists who advise governments in emerging-market crises while holding down senior positions at the investment banks that lend money and arrange financing for these countries. But Argentina has exposed the limits of their power and raised questions about whose interests they're serving.

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David Mulford, chairman of CSFB International; Jacob Frenkel, chairman of Merrill Lynch International; E Gerald Corrigan, managing director of Goldman Sachs; Ernest Stern, managing director of JPMorgan Chase; Bill Rhodes, vice-chairman of Citigroup - put together they have around 125 years' experience in emerging markets.

They have been close to power - rarely quite in it - for 25 years each, as central bankers, World Bank or IMF economists, under-secretaries of the US Treasury and heads of Federal Reserve banks. And now they are putting their experience to use in the private sector as roving ambassadors for the world's biggest investment banks.

If a developing country's economy looks as if it is coming unstuck, there is a very good chance the country's finance minister will soon be sitting in a room with these people, trying to work out a deal. If you see one of this exclusive club talking to a finance minister at a World Economic Forum meeting in Davos, an IMF session or the Trilateral Commission, it's a good bet that the minister is considering doing a debt swap or launching a new wave of privatizations or a new currency regime. And when they do, one of the club will be by their side, just out of the frame in the photos in the papers, advising the government and winning the fees for his bank.

Bankers such as Rhodes or Mulford grew up with emerging markets. It is not an exaggeration to say that they helped to define them as an asset class. They epitomize the skill of networking, of moving effortlessly from one high-powered meeting to another - from Davos to the IMF to the IIF emerging-market committee to the Council for Foreign Relations to finance ministries the world over. As Stern says: "We know a lot of people, we travel a good deal, we exchange views on current issues on an informal basis with government officials and private individuals in the course of our visits."

One of the first people to recognize the existence of this club was Jagdish Bhagwati, professor of economics at Columbia University and a senior fellow at the Council for Foreign Relations. Bhagwati spoke in 1998 of the existence of a "power elite" in international finance. He said: "There is a definite network of like-minded luminaries among the powerful institutions - Wall Street, the Treasury Department, the State Department, the IMF and the World Bank." Bhagwati called this phenomenon, which probably reached its height during the days when Larry Summers was US Treasury secretary, the "Wall Street-Treasury complex". He cited Ernest Stern as an example of a club member. Equally applicable for membership are Stanley Fischer of Citigroup, Sir David Walker of Morgan Stanley, and even - at a stretch - former US secretary of state Henry Kissinger, adviser to Goldman Sachs.

Members of this elite club are well positioned to sort out emerging-market crises because they know all the important figures in governments and banks and can get them into a room and try to engineer some kind of consensus. It is a world of contact capitalism, where power is exercised informally, and often effectively.

The perfect example of the effectiveness of contact capitalism was the resolution of South Korea's December 1997 loan crisis. South Korea was close to default and immediate action was needed. Representatives of most of the major investment banks were called into meetings with government officials and, thanks to the contacts and negotiation skills of such people as Bill Rhodes, a deal was hammered out and disaster was averted. As one banker said at the time: "Getting an agreement in that short space of time was a miracle. And Bill Rhodes is the chief reason it happened."

So why didn't the same thing happen in Argentina?

In part, it didn't work because emerging-market finance had fundamentally changed. At the beginning of the 1990s, most sovereign finance in emerging markets was in the form of loans. Loans lend themselves to an informal, slightly opaque method of working. They require tactful negotiators such as Rhodes. But the Brady debt plan of George Bush senior's government, which David Mulford helped to propagate when he was Bush's under-secretary of the Treasury, converted many of these loans into bonds. By the end of the 1990s, most emerging-market finance was in bonds. Bond crises, because of the large number and diversity of investors, cannot so easily be sorted out in a few private meetings. The bond market is far less relationship-driven than the loan market.

A deal too far
Argentina's finance minister, Domingo Cavallo, nonetheless tried the old method of hammering out a deal with a roomful of top bankers. Cavallo, a jet-setting graduate of Harvard Business School, relied heavily on the advice of a few banker confidants, particularly Mulford, but also Stern, Frenkel, Rhodes and others.

Within half an hour of returning to office as economy minister in April 2001, Cavallo and his friend Mulford had sketched out the preliminary details of what turned out to be the biggest debt swap ever. Half an hour later, the lead managers for the deal were informed.

The speed with which the deal was drawn up was stunning evidence of the power of contact capitalism to get things done. In June, a month after Cavallo had returned to office, six investment banks launched the mega-swap of $29.5 billion in bonds, securing a few months' grace for Argentina and enormous fees for themselves.

Seven months later and Argentina had defaulted, its banks had closed and both Cavallo and president Fernando De la Rua had resigned. The swap was heavily criticized as soon as it was launched. Mohammad El-Erian, managing director of investment management company Pimco, said at the time that it made no sense for an over-indebted country to increase its indebtedness. He says: "The mega-swap was unfortunate because it didn't take into account the longer-term interests of the country."

Bank: CSFB (chairman CSFB International)
Experience: senior investment adviser to SAMA; under-secretary of US Treasury (1984-92)
Committees MDB Committee at the Carnegie Endowment for International Peace; Council for Foreign Relations; emerging market committee at Institute of International Finance (IIF)
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