Readjustable Obligations of the National Treasury (ORTN) : The ORTN were undoubtedly one of the cleverest and most successful financial instruments to be invented during the 20th century, ranking with asset-backed securities, money market funds, and Brady bonds.

Following the Revolution of 1964, Finance Minister Bulhões took charge of an economy with rampant inflation and with a long history of government defaults on public debt. The IMF recommended its standard dose of bitter medicine which would have only acerbated the situation.

Inflation in Brazil had been endemic, stretching back to colonial times with periodic attempts to reform that had all been short-lived ending with defaults.

Rather than repeat the same mistake of attempting to cure inflation by shock treatment, Minister Bulhões decided to invent a government bond that would please investors even in an inflationary environment.

Furthermore, recognizing the profound distrust investors had of government promises, the new Treasury Bonds would have an iron-clad guarantee that made default virtually impossible.

Here are the terms of the first ORTNs:

• The par value would be adjusted monthly, based on the cost of living index calculated by the Fundação Getúlio Vargas, or based on the dollar-cruzeiro rate, at the option of the investor.
• The readjustment in par value would be exempt from income tax.
• Interest coupons would be calculated on the readjusted par value.
• The bonds would be accepted at readjusted par value in payment for all federal taxes or as performance bonds on government contracts.
• The bonds were issued to bearer and income tax was deducted at a fixed rate from the interest only.

The initial bonds were distributed as part of the proceeds of government financing to the private sector, with the borrowers obliged to sell the bonds in the open market.

In 1964, there were no government bond dealers in Brazil and the bond market had to be created from scratch. Furthermore, there were no benchmarks or guidelines as to pricing.

In 1965 and 1966, John Schroy, through S-N Investimentos, pioneered trading in these new government bonds.

At first, it was difficult to trade these bonds since dealers had to be convinced to get into the business, but as investors realized that the discounts at which borrowers were dumping this paper on the market were producing yields of 40% a year in dollars, with virtually no risk (because the bonds were legal tender at par to pay taxes), an active market quickly developed.

In 1967 S-N Investimentos pioneered money trading in overnight bank call loans to finance dealer positions in these bonds.

About the same time, Jorge Paulo Lemann and others began to develop an active repo market in these bonds.

Jorge Paulo Lemann, using capital accumulated from bond trading, went on to form Garantia Investment Bank and later, by shrewd acquisitions of old line companies in the tumultuous markets of 1980s, became one of the richest men in Latin America.

By 1970, the ORTN market was the largest bond market in Latin America and these instruments were used to hold cruzeiro cash positions of almost all major international companies operating in Brazil.

[Return]