Cucurrucucú Paloma – If Only We Had Listened To The Dove’s Cry

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Let’s reminisce for a moment…

…As in prior election cycles, a pre-election disposition to stimulate the economy, temporarily and unsustainably, led to post-election economic instability. There were concerns about the level and quality of credit extended by banks during the preceding low-interest rate period, as well as the standards for extending credit…. The government’s finances and cash availability were further hampered by two decades of increasing spending, debt loads, and low oil prices. Its ability to absorb shocks was hampered by its commitments to finance past spending.

Economists Hufbauer and Schott (2005) have commented on the macroeconomic policy mistakes that precipitated the crisis:

-[It] was the last year of the… administration who, following the tradition on an election year, launched a high spending splurge and a high deficit.
– In order to finance the deficit (7% of GDP current account deficit), the government issued [debt].
-[We] experienced lax banking or corrupt practices; moreover, some members of the [ruling party] collected enormous illicit payoffs

-…an insurgent rebellion, officially declared war on the government on January 1; even though the armed conflict ended two weeks later, the grievances and petitions remained a cause of concern, especially amongst some investors.

All of the above concerns, along with increasing current account deficit fostered by consumer binding and government spending, caused alarm among those who bought the [government debt]. The investors sold the [government debt] rapidly, depleting the already low central bank reserves.


Given the fact that it was an election year, whose outcome might have changed as a result of a pre-election-day economic downturn, [central bank] decided to buy Treasury Securities to maintain the monetary base, thus keeping the interest rates from rising. This caused an even bigger decline in the dollar reserves. However, nothing was done during the last 5 months of lame duck administration. Some critics affirm this maintained The new president took office on December 1, 1994.

A few days after a private meeting with major entrepreneurs, in which his administration asked them for their opinion of a planned devaluation the new president announced his government would let the fixed rate band increase to 15 percent (up to 4 pesos per US dollar), by stopping the previous administration’s measures to keep it at the previous fixed level. The government, being unable even to hold this line, decided to let it float.

While critics agree a devaluation was necessary, some critics of the new president’s incumbent 22-day-old administration, argue that although economically coherent, the way it was handled was politically incorrect. They argue that many foreigners withdrew their investments, aggravating the situation. The peso crashed under a floating regime from four pesos to the dollar to 7.2 to the dollar in the space of a week.

The United States intervened rapidly, first by buying pesos in the open market, and then by granting assistance in the form of $50 billion in loan guarantees. The dollar stabilized at the rate of 6 pesos per dollar. By 1996, the economy was growing (peaked at 7% growth in 1999). In 1997, Mexico repaid, ahead of schedule, all US Treasury loans.

By extending loans to the Mexican government the Clinton administration stopped US banks collapsing as a result of the Mexican default. Thus US banks were protected from the effects of giving excessive loans to a poor creditor while the Mexican economy was saddled with further debt

Yes, this is an account of the 1994-1995 economic crisis in Mexico, whose reverberations in the rest of Latin America are called the “Tequila Effect.”

As my friends from Mexico  reminded me this weekend, the solution in Mexico was to nationalize all the banks.  Legislation such as we are seeing being considered by the US Congress to “lend” $700 billion to Wall Street today is in effect a nationalization, given the constraints and intervention that will be effected, whether we admit it or not.
And is the situation so different?  If only we could learn from mistakes, mistakes that the US was in a position not so long ago to help others reverse.  Now we are the ones that should be ashamed at the “fracaso” that greed and hubris has gotten us into.  And the price tag for getting out of it has increased 15-fold in almost as many years.
If it’s still not clear that US political and financial system “leadership”  has put our country and the rest of the world in a position no better than Mexico circa 1994-1995,  let’s take a look at a paper by Francisco Gil-Diaz, (a gentleman I have had the pleasure of meeting more than once,) the former Vice-Governor of the Central Bank of Mexico:
…The financial sector also underwent a substantial liberalization, which, when combined with other factors, encouraged an increase in the supply of credit of such magnitude and speed that it overwhelmed weak supervisors, the scant capital of some banks, and even borrowers.[1]

Several factors contributed to facilitate the abundance of credit: (1) improved economic expectations; (2) a substantial reduction in the public debt;[2] (3) a phenomenal international availability of securitized debt (see Hale 1995);(4) a boom in real estate and in the stock market; and (5) a strong private-investment response.

Poor borrower screening, credit-volume excesses, and the slowdown of economic growth in 1993 turned the debt of many into an excessive burden. Nonperforming loans started to increase rapidly. A process of adjustment of the balance-sheet position of the private sector, underway by the second half of 1993, and the late adoption by some commercial banks of prudent policies were signs that nonperforming loans had exceeded reasonable dimensions before 1994.[3]

The substantive causes of the debt increase were:[4]

1. The financial sector was liberalized: lending and borrowing rates were freed, the forced channeling of credit was abolished, and bank reserve requirements were eliminated.

2. Banks were hastily privatized, in some instances with no due respect to “fit and proper” criteria, either in the selection of new shareholders or top officers (see Honohan 1997: 13, and Ort z 1997). It must be noted, however, that on average the banks remained in government hands for half of the expansionary period.

3. Several banks were purchased without their owners proceeding to their proper capitalization. Shareholders often leveraged their stock acquisitions, sometimes with loans provided by the very banks bought out or from other reciprocally collaborating institutions.

4. The expropriation of the commercial banks in 1982 contributed to their loss of a substantial amount of human capital during the years in which they were under the government. With these officials institutional memory migrated as well.

5. Moral hazard was increased by the unlimited backing of bank liabilities.

6. There were no capitalization rules based on market risk. This encouraged asset-liability mismatches that in turn led to a highly liquid liability structure.

7. Banking supervision capacity was weak to begin with, and it became overwhelmed by the great increase in the portfolios of banks. Part of this weakness originated in the political stature of government-appointed CEOs when banks were still government owned.

8. There was a substantial expansion of credit from the development banks.

9. From December 1990 on, foreigners were allowed to purchase “domestic” (short-term) government debt. Since domestic public debt decreased during this period, the purchases of Cetes by foreigners enhanced the purchasing power of their domestic sellers.

10. Short-term, dollar-indexed, peso-denominated Mexican government securities, Tesobonos, were issued at the end of 1991, although not in large amounts except during certain periods.

From a report on September 17, 2008 in Marketwatch:
The increase in the deficit was accounted for by a decrease in the surplus on income and an increase in the deficit on goods.

The current account is the broadest measure of international flows of goods, services and capital in and out of the United States. In essence, the current account deficit measures how much Americans need to borrow from or sell to foreigners to fund their consumption and investment. The figures are not adjusted for price changes.

The current account deficit has narrowed in the past year, largely because imports have fallen and exports have increased as the dollar weakened. It was as high as 6.6% of GDP a year ago.

The dollar depreciated 2% in the second quarter against seven major currencies.

Few economists believe a current account deficit of 5% of GDP is sustainable. Global economic policymakers have said the U.S. current account deficit (and corresponding surpluses in China and elsewhere) represent a major threat to global growth.

In a separate report, the Commerce Department said housing building weakened again in August, with permits for single-family homes falling to a 26-year low.