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IMF Directors Balk

Mexican Rescue: Bitter Legacy of Battle to Bail Out Mexico

At the end of January, President Bill Clinton gave up a fight to push through Congress a package of loan guarantees to bring Mexico out of a financial crisis. He announced he would replace the guarantee with $50 billion of U.S. and foreign support.
Examining the background and implications of the decision, which is still far from resolving the crisis.

by George Graham, Peter Norman, Stephen Fidler, and Ted Bardacks

Washington, London, Mexico City; Thursday, February 16, 1995

It was around 8PM on Monday, January 30, that Leon Panetta, White House Chief of Staff, finally accepted that the administration's plan to rescue Mexico with up to $40 billion of loan guarantees was not going to work. Two phone calls in the space of a few minutes had virtually made up his mind. One was from Newt Gingrich, the new Speaker of the House of Representatives, the other from Guillermo Ortiz, the Mexican Finance Minister.

The message from Gingrich was simple and pessimistic: Congress was objecting to the loan guarantee package, and the chances of its rapid and successful package were slim and worsening. The conversation with Ortiz was also deeply worrying. Money was flowing out of Mexico so rapidly that without U.S. help it would soon have to abandon the convertibility of the peso. From a foreign investor's perspective, that was the equivalent of defaulting.

At the U.S. Treasury, officials had watched with growing alarm as the peso sank to an historic low of 6.35 to the dollar, close to half its value just over a month earlier and a level that threatened Mexican companies and banks. The previous Thursday, the International Monetary Fund [IMF] had announced the largest loan in its history for Mexico--$7.76 billion--but the peso had hardly responded. On Monday, the Mexican market was pulling down other financial markets, particularly in Latin America. On Tuesday, the U.S. Federal Reserve's policy-making committee was to start a meeting and likely to worsen things by raising U.S. interest rates.

U.S. Treasury Secretary Robert Rubin, who had taken office earlier that month, foresaw widespread and potentially disastrous consequences if Mexico--Washington's star pupil in pursuing market-based reform--defaulted. "The effect would be considerable, both on immediate capital flows and, perhaps more important, on the mindset of investors for a long time to come--and also on the mindset of politicians considering whether to reform," he said later.

Soon after Panetta hung up, he began a critical meeting with Rubin and Sandy Berger, the Deputy National Security Adviser, at the Whie House. Recognising they would be there for some time, they sent out for pizza. They were still eating when President Bill Clinton returned from dinner after 11PM.

Some time later, Clinton made a preliminary decision to abandon the loan guarantee proposal and switch to "Plan B", a new support package centering on $20 billion of finance from the U.S. Exchange Stabilization Fund [ESF]. That money would be provided on Clinton's own authority.

But Panetta and his colleagues knew they needed backing from elsewhere, both to convince the markets that enough firepower was in place to prevent a default, and to show Congress that Washington was not alone. "Because Mexico's deterioration had been so substantial and because it was our judgment that the next day, Tuesday, was likely to be substantially worse than Monday, therewas only a very short time in all likelihood in which to act to avert crisis, financial distress, and probably default in Mexico," Rubin said later. They had, he said, just a few hours before the markets opened in Mexico on Tuesday morning.

Throughout the previous week, the administration's efforts to win support for the congressional plan had been intense. Mexican and U.S. officials had been in constant contact. Foreign Minister Jose Angel Gurria had, one Mexican official said, "virtually set up shop" at... the U.S. State Department, negotiating the conditions fo rthe loan guarantees.

As support for the plan waned, former Finance Minister Pedro Aspe and Presidential Chief of Staff Luis Tellez made low-profile trips to Washington to lobby for the plan and explore alternatives.

After returning to Mexico City on Friday, January 27, with a gloomy analysis, Tellez got together with Ortiz, central bank President Miguel Mancera, and Commerce Secretary Herminio Blano.

Together, they wrote a document, sent to Washington the following day, detailing the critical condition of Mexico's financial system and the need to act quickly. Reserves were falling towards $3.5 billion, and more than $2 billion of a special $9 billion credit line from the U.S. Federal Reserve had been used.

Funds from the U.S. credit line would be necessary to redeem maturing Tesebonos--the dollar-denominated securities at the heart of the government's liquidity problems. The document also said that this money, together with the original IMF disbursement, would not be enough and would eventually be exhausted.

When the document reached Washington, it beame clear that time was running out. Alternatives to the loan guarantee program--including the use of the ESF--were explored in detail on the Saturday at a meeting of top administration officials in the Roosevelt Room at the White House.

Publicly, the administration continued to seek support for the loan guarantees. On Sunday evening, Clinton telephoned leaders of both parties in Congress and asked for a bill to be introduced in the House of Representatives "by the close of business" Monday. No mention of an alterantive plan was made in phone conversations with the leaders.

Despite this, the possibility of switching to Plan B was raised in Paris on Sunday by Lawrence Summers, U.S. Undersecretary for International Affairs, at a meeting with his opposite numbers from the Group of Seven industrialized countries, a senior G7 official said. However, the guarantee package was not dismissed as dead at the session, which was to prepare for a gathering the following weekend in Toronto of the G7 Finance Ministers and central bank Governos.

The emphasis in Washington on Monday morning was still on putting a bill on loan guarantees together. "This is obviously an unchosen issue at an unwelcome time, but that doesn't mean it's an issue that can be ducked," said Congressman Jim Leach, Chairman of the House Banking Committee and chief Republican negotiator on the loan guarantees legislation.

Leach and Barney Frank, the negotiator on the Democratic side, had done most of the work on the draft legislation, several versions of which had been bouncing back and forth between them. However, relations between Republican and Democratic legislators had soured; and the drafts were not being passed directly between the negotiators, but via the White House.

Over the weekend, Gingrich and Richard Gephardt, the House Democratic leader, had begun to take over the negotiations. Gingrich told the White House on Monday morning that prospects for putting the bill together were improving. He said that negotiators were closing in on a compromise that addressed Democratic concerns that the legislation should include protection for U.S. labor. But Frank's judgment was that the Republican draft was "a little better" but still not good enough to win over many Democratic votes.

Late in the afternoon, Gingrich postponed a meeting with Gephardt to meet a group of Republicans, including Bob Dole, the Senate Majority Leader, Governor George Bush of Texas, and Governor Fife Symington of Arizona, who were lobbying for the package.

By this time, Dole was very pessimistic: "Everyone's adrift. Support has eroded." They were still a long way from getting a bill; even further from getting votes.

Gingrich soon afterwards picked up the telephone to call Panetta at the White House. It would take at least another two weeks to line up support for the package. If the President acted on his own, Congresss would breathe "a huge sigh of relief".

Andrew Crockett, General Manager of the Basle-based Bank for International Settlements [BIS], arrived on Monday night back in Basle from Davos. The ski resort, which once a year hosts the world's economic policy establishment, had been riven with rumor about Mexico.

About 7AM on Tuesday--1AM Washington time--he received a call he had been half expecting--a Federal Reserve official told him of the tentative plan to switch to Plan B.

Through transatlantic telephone calls on Tuesday morning, Crockett learned that the U.S. was prepared to use the ESF to provide $20 billion. Largely on the strength of this, the BIS chief advised the U.S. that the White House could announce that discussions were underway for a doubling of the BIS tranche of the support package to $10 billion.

Crockett, a former senior Bank of England official who had spent time at the IMF, felt he could hold out this prospect because that level of support had been discussed in a desultory fashion for some time.

The BIS originally announced on January 3 that some member banks had agreed to a $5 billion credit facility as part of a total $18 billion aid package, also backed by the U.S., Canada, and private banks.

This move had not been popular with European central bankers, although at the time it was envisaged that the BIS credit should be largely a "bridging" credit to an IMF standby loan.

When the U.S. announced its guarantee scheme on January 12, the U.S. asked the BIS if it could raise the amount to $10 billion. Germany's Bundesbank and the Netherlands central bank were especially unhappy. Contacts between the U.S. Treasury and foreign governments had also been weak as the Mexican crisis gathered strength around Christmas. Lloyd Bentsen was quitting as U.S. Treasury Secretary and Rubin, former head of hte New York investment bank Goldman Sachs, was not yet in harness.

The Europeans felt that the Treasury team, including Summers, lacked experience in handling international problems. Some were irritated by what they saw as Summers' arrogance. The Treasury team had apparently assigned a much higher priority to informing and consulting legislators on Capitol Hill. Even on the Hill, Rubin's support for the loan guarantee package was seen as backfiring: many legislators saw Rubin as arguing for a bail-out to help out his old pals on Wall Street.

The British and others argued that the Mexican crisis did not add up to a systemic problem for the world financial system; that they were being roped into bailing out U.S. pension and mutual funds which had invested imprudently in high-yielding Mexican paper; and that the U.S. was shirking its regional responsibilities.

Longer term, they argued, the plan constituted moral hazard, an action that would encourage future unwise behavior by policymakers and investors--the very behavior that produced the crisis in the first place.

Discussions among central banks on raising the BIS contribution therefore went slowly. Some felt there was no rush because the guarantees would take some time to win Congressional approval. Although cool to the idea, Bundesbank officials had intimated that they would probably participate in a bigger package of up to $10 billion if other central banks took part.

Against this background, Crockett madeit clear at the outset that there was no final agreement on the size of its credit or on how much each central bank would contribute. He and European central bankers were surprised and, in some cases, annoyed that Clinton's announcement of the new support package later that day implied the BIS credit was sewn up.

The preliminary decision to switch to Plan B was just the start of what Rubin called a "very agonizing night". For the plan to be credible, substantial extra finance had to be brought in. The IMF was an obvious source. When teh administration informed the IMF on Monday night of the switch, it did not ask for anything specific.

Treasury officials worked all night on the detail, keeping Mexican officials in touch with developments. When they went home at 5AM, there was still no indication that there would be more money from the IMF.

The answer came around 7AM on Tuesday in a conference call between Michel Camdessus, the IMF's French Managing Director, his deputy Stanley Fischer, Rubin, and Summers.

According to the program developed by Camdessus and Fischer, the IMF stood ready to lend to Mexico a total of $17.8 billion, 3.5 times more than it has lent to any single country in an operation in its 50-year history. It would permit an unprecedented immediate disbursement of $7.8 billion. The IMF would ask central banks from non-industrialized countries to chip in, with any shortfall to be made up by the IMF.

Clinton summoned the House and Senate leaders--Gingrich, Gephardt, Dole, and Senator Tom Daschle--to an 8:45AM meeting. It was also attended by Vice-President Al Gore, Rubin, Panetta, and other top White House officials. They were given a choice of an all-out push for quick legislation, or executive action using the ESF. They opted for Plan B: they would back the President if he acted unilaterally.

Camdessus notified the IMF Board at 9AM--U.K. Treasury officials said later that this did not amount to consultation--and went back to Rubin and Summers with initial soundings.

About 11:15AM, Clinton addressed the National Governors' Association at Washington's Marriott Hotel, outlining the new package. "The leadership advised me that while they believe Congress will--or at least might--eventually act, it will not do so immediately. And therefore it will not do so in time. Because Congress cannot act now, I have worked with other countries to prepare a new package," he said.

Together with Canadian $1.5 billion already promised by Canada, and a pledge of $3 billion from international banks that Clinton did not mention, the finance available to Mexico appeared to exceed $50 billion. The President did not say that the BIS contribution was not agreed. Neither was the bank finance.

This was the first time some European officials heard of the package's details. "President Clinton goes to the press and says the IMF will do this and that. It was just not acceptable. We are not banana republics," said a senior European official.

The administration did not get around to consulting European colleagues until Tuesday afternoon in Washington. "Was there as much consultation as there would normally be among the G7, and between the [IMF] Managing Director and the Board? No, but this was an extraordinary situation," a senior U.S. official said.

Though it started slowly, transatlantic consultation became intense in the next 24 hours. But European anger was not quelled. It manifested itself in the first formal discussion on the package, at the IMF's Executive Board meeting on Wednesday.

There was deep disagreement at the meeting, put back from 2:30PM to 6:00PM because of the late arrival of documentation. Germany and Britain were sceptical that the risk of contagion to other economis constituted a systemic crisis. The French were more willing to accept the argument. "We don't know how the international marekts would have reacted, but in the end, the risk of a default by Mexico could not be run," a senior French official said.

The IMF and the U.S. saw the risks as self-evident. "If Mexico had imposed currency controls or declared a moratorium [on debt service payments] it would certainly have spread to other countries. Then the IMF would have faced an even bigger challenge: how do you deal with five or six Mexicos?" said a senior U.S. official.

The meeting stretched on to 11:20PM. At the end, Camdessus put the package to the meeting; no-one objected and he brought the gavel down. Afterwards the German and British representatives went to Camdessus and asked to be recorded as abstaining--unusual for meetings where decisions are usually taken by consensus.

"When the circumstances are exceptional, the support must be exceptional," Mr. Camdessus said at a press conference the following morning, describing Mexico's liquidity problems as "the first major crisis of our new world of globalized financial markets."

If Mexico had resorted to foreign exchnage controls, it "would have been a true world catastrophe as the pressure on others to follow would have been tremendous, whatever the quality of their fundamentals." The Executive Directors from Belgium, Switzerland, the Netherlands, and Norway--together representing 36 countries in Europe and central Asia--were not convinced. They asked Camdessus by letter to record them, too, as abstaining. Belgium later revoked its abstention.

Officials pledged to air their concerns fully at the meeting of the G7 Finance Ministers and central bank Governors in Toronto's Four Seasons Hotel. They were to meet for dinner on Friday night, with the business session on the morning of Saturday, February 4.

Originally scheduled as a getting-to-know-you session for Rubin, the new U.S. Treasury chief was going to "get an earful" according to one European official. But by the end of the meeting, the usual G7 process of papering over the cracks had been successfully achieved. The participants officially expressed "total satisfaction" with the Mexican rescue.

"There is no question that every member of the G7 supports the package fully," said Rubin after the meeting. "I really don't think we left with ill will."

A senior German official put it slightly differently: "It is in nobody's interest to see the package collapse. But it had to be made clear that this must not happen again."

The cracks may have been smoothed over for public consumption, but there remained difficult issues to resolve. One concerned the conditions under which the BIS central banks would provide finance to Mexico.

Central banks normally lend only when they have concrete guarantees they will be repaid. The original $5 billion of BIS finance for Mexico announced on January 2 was to be a bridge to the original IMF credit.

Yet when Clinton made his announcement on Tuesday, he suggested the enlarged BIS loan was separate from the new IMF financing. The new BIS financing had become a bridge to nowhere--or Clintonwas double counting.

The package thus raised the question of what would indemnify central bank support for Mexico. If the central banks were to avoid taking on a large unsecured credit to Mexico, they would need collateral or other equivalent assurance. Yet, though the details were still being worked out, it seemed the U.S. had grabbed the best collateral--Mexican oil receipts directed through the New York Federal Reserve Bank in case of default. It is not clear how--or even if--this issue has been resolved.

When Bundesbank President Hans Tietmeyer emerged this Monday afternoon at the BIS head office in Basle from a meeting of central bank Governors, he told waiting reporters that a financing of "up to $10 billion" had been "generally agreed". But the terms of the agreement were confidential and could not be disclosed.

However, one finance official in Europe said last week that the BIS financing for Mexico would be essentially a book keeping exercise. The money would stay in the home central banks and Mexico could describe it as part of its reserves--but would not be able to use it.

Whatever the status of the BIS finance, the funds from the U.S.--a mixture of credits and guarantees--constituted real money to be transferred to Mexico's reserves if necessary, though the negotiations with Mexico over terms and conditions continue.

Clinton's potentially controversial move to use the ESF has been largely supported in Congress, where legislators reacted mainly with relief that they were not asked to vote on the guarantees. But hostility to a Mexican bail-out remains strong, particularly among newly-elected members, who make up nearly a third of the Republican majority in the House.

More fundamentally, transatlantic cooperation has been sorely tested, with possible implications for the future. The perception has persisted that the U.S. was not straightforward. "To the U.S. public they say this is a matter of the national interest; to the international community they say it is a systemic risk," a senior European monetary official said.

The longer-term impact of the crisis on the IMF remains to be seen. Camdessus was late to step into the Mexican crisis. As his deputy, Fischer, indicated in an internal memorandum after the devaluation, the IMF's "surveillance" mechanisms left much to be desired. Work is now starting to improve the early warning signals, though the question of what happens when the early warning has sounded remains to be answered.

As the crisis deepened, Camdessus saw an opportunity to place the IMF at the center of a critical issue in which it had hitherto been peripheral, as his countryman Jacques de Larosiere had in the Latin American debt crisis of 1982. At the same time, Camdessus managed to please his organization's largest shareholder.

But the IMF chief has taken a big gamble with the IMF's resources without the backing of holders of around a quarter of the organization's shares. Some European governments remain angry that he promised so much with minimal consultation.

The peso's continued fall shows that market confidence in Mexico remains low, and emphasizes the risks that have been taken to put the rescue together. The Mexican economy will spend time in intensive care under the minute supervision of the IMF and the U.S. Treasury. Camdessus's fate and that of the Clinton rescue package will hang on how effectively the Mexican government manages a severe economic adjustment. If all ends happily, the controversy may be forgotten; Camdessus may even be a hero. But, as one senior European monetary official observed, "Not yet".

Peso--The Plunge and the Politics

December 1: Mexican President Ernesto Zedillo takes office.
December 20: Government lowers peso floor by15 percent: the first significant devaluation in seven years.
December 22: Government floats peso after heavy outflows follow initial devaluation; Finance Minister Jaime Serra Puche suffers hostile reception from investors in New York.
December 29: Serra Puche quits; Guillermo Ortiz takes over.
January 2: Government announces $18 billion financial support package from friendly governments and banks.
January 5: Finance Minister Ortiz announces accelerated privatization campaign as he meets investors in New York.
January 6: Government formally requests IMF finance.
January 12: U.S. President Bill Clinton announces plan to win Congressional approval for $40 billion of U.S. loan guarantees for Mexico.
January 19: Mexican markets begin to weaken as extent of U.S. Congressional hostility to loan guarantee package becomes apparent.
January 26: IMF announces readiness to provided Mexico with $7.76 billion standby credit, the IMF's largest ever.
January 31: President Clinton announces new $50 billion package.

Copyright 1995 by the Financial Times, originally printed February 16, 1995.


Created 6/24/1996
This is
Brad DeLong's Home Page

Professor of Economics J. Bradford DeLong, 601 Evans
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