Getting Burned Abroad; How debt crises like Argentina's threaten the wealth of German dentists and Italian pensioners.(Cover Story)

Byline: Rana Foroohar, With Barbie Nadeau in Rome

Claudio Pugelli has one of the toughest jobs in Italy these days. As head of Committee Argentina, it is the Roman lawyer's duty to tell thousands of aging Italian pensioners that they may have lost their life savings. Pugelli, like 450,000 other individual investors in Italy, poured money into Argentine bonds a few years back, hoping to ride a wave of good news about the country, which the IMF was heralding as a model of free-market reform. Two years ago the dream ended when a fiscal crisis forced Argentina to stop payment on $88 billion worth of bonds, the largest such default in history. Now Pugelli and the pensioners he represents are fighting to get their money back, without much luck. The Argentine government is offering only 25 cents on the dollar, and lenders like the IMF aren't pressuring them to do much more for private investors. "A lot of our members don't know how they'll get through their retirement years," says Pugelli. "Many are having to work longer, and start over."

The conventional view of emerging- market crises casts them as a battle between big Western banks and poor little debtor nations. Turns out there are little victims on the lending side, too. Over the last few years individual investors throughout Europe and the United States have become more exposed to emerging-market risk than ever before. With low interest rates cutting returns on bonds in America and Western Europe, investors have been looking in ever more far-flung places for higher yields. Last year the flow of nonbank private capital into emerging-market bonds hit a five-year high of $44.7 billion, according to a report released in January by the Institute for International Finance. That figure includes individual investors represented by mutual or pension funds, as well as those buying on their own. "There are plenty of German dentists holding emerging-market bonds these days," says Keith Savard, author of the IIF report, which cautioned that investors may be underestimating the risks in many of these markets.

That was certainly the case with Italian investors, who were easy prey for bankers selling the Argentine bonds. "Italians were generally comfortable with Argentina because of historical ties," says Christian Stracke, an analyst with the independent research house CreditSight. "Argentina was one of the primary destinations for Italian emigrants in the late 19th and early 20th centuries, and Argentines of Italian descent make up a large percentage of the population." Having grown used to high yields on their own bonds in the pre-EU days, many Italians saw no reason that they should settle for less.

For their part, the Argentine authorities actively targeted individual investors in the late 1990s, having already exhausted the institutional markets a few years before. They sold bonds not only to Italians, but also, to a lesser extent, to Germans, Central Europeans and Japanese. Those who bothered to research default scenarios may have been comforted by the recent defaults of ...