Nineteen ninety-four was supposed to be a banner year for Mexico’s economy. The country had spent the last decade implementing a liberal economic adjustment program, which included restructuring its external debt, reining in the budget deficit, slowing inflation, privatizing state- owned enterprises, and reducing trade barriers. However, the biggest piece of good news came at the end of 1993 when the US Congress approved the North American Free Trade Agreement (NAFTA). The deal was slated to take effect on January 1, 1994. Mexico would now have special access to the world’s most lucrative market, a fact that would encourage foreign investment south of the US border. As it happened, what was supposed to be a new beginning for Mexico turned out to be the country’s most tumultuous year because it nearly defaulted on its external debt obligations a dozen years earlier. On New Year’s Day, 1994, an insurgent group known as the Zapatistas led a political uprising in the state of Chiapas in opposition to NAFTA. A short three months later, the PRI presidential candidate, Luis Donaldo Colosio, was shot and killed while at a campaign rally. A sense that the country’s political system was spiraling out of control combined with a large current account deficit caused many foreign investors to divest of their Mexican investments. As capital flowed out of Mexico, the government spent down $11 billion of its foreign exchange reserves to defend the peso’s fixed exchange rate. Eventually, a loss of investor confidence in the peso forced the government of Mexico to devalue on December 20. Mexico was in the midst of a full-blown financial panic and in serious need of an ILLR.
Despite the devaluation, top US economic officials still had not realized with what they were dealing. Deputy Treasury Secretary Larry Summers remained convinced that the Mexican problem was a temporary liquidity crunch that could be fixed by activating existing standing swap lines between the Fed and US Treasury with the Bank of Mexico. However, after two more weeks of volatility in Mexico and continued fears that the peso remained under attack, Mexican officials approached the IMF for assistance. Between $40 billion to $50 billion in external debt was coming due in the short term, and it appeared unlikely to be rolled over. Worse yet, the Mexican government was quickly running out of dollars to make these payments. Mexico’s foreign exchange reserves—which had stood at $28 billion in December 1993—were almost gone after the government burned through them in an unsuccessful effort to defend the peso. Summers, in consultation with the IMF, decided that Mexico needed a package of at least $25 billion in assistance. Otherwise, it was likely to default, causing the crisis to further spiral out of control. Yet the IMF could not provide the full amount Mexico needed due to its access limit policy. As Boughton explains, "It looked unlikely that the Fund could lend
Mexico more than 100 percent of its quota (about $2.5 billion) in 1995, and no other country was expected to offer very much, so the bulk of the $25 billion would have to come from elsewhere.”
The Mexican crisis and the Fund’s problem of resource insufficiency were causing growing concern within the Clinton administration. The crisis threatened the United States in myriad ways: job losses from declining exports, increased inflows of immigrants, the financial repercussions of a crashing peso, defaults that would likely follow, and the potential for social and political unrest in a border country. According to David Lipton, at the time an assistant secretary at Treasury, the administration felt the Fund program was "too small” and "inadequate both from the standpoint of the financing and the policy adjustment.” Summers argued that the nature of this new crisis required a "massive and fast” response, which the IMF was unable to provide. The figure the administration settled on was $40 billion—enough to cover nearly all of Mexico’s short-term debts. Thus, with the IMF seemingly incapable of acting as an ILLR, the administration sought $40 billion in loan guarantees from Congress. Meanwhile, Summers dispatched Lipton to Mexico to negotiate supplemental policy reforms. By the end of the month, it became clear that congressional action was unlikely as critics on the Hill charged that the administration only wanted to bail out Mexico’s creditors. Treasury made the decision on January 30—in concert with the Fed—to provide an unprecedented $20 billion ESF credit to the Mexican government. This still left a sizable shortfall in Mexico’s financing needs, but it was all that could be safely provided from the ESF’s limited resources.
Meanwhile, IMF Managing Director Michel Camdessus privately made the decision to ask the executive board to approve a $12
billion Mexican financing package. This was nearly seven times the size of Mexico’s quota—an unprecedented request at the time. According to Lipton, Camdessus’s decision was made independently. As he put it, "We had no indication that the IMF was preparing to provide such huge financing for Mexico.” On February 1, the board considered Mexico’s request for a $12 billion standby arrangement, a much larger package than had initially been expected. Karin Lissakers, the US executive director on the board, acknowledged the ESF pledge but indicated that this was not enough. She added that although the request was unprecedented, the global financial system had changed dramatically since the 1980s debt crisis and required a different kind of response:
The growing reliance on securitized international private financial flows means that the number of creditors has grown enormously. The days when [former] Managing Director de Larosiere and Federal Reserve Chairman Volcker could call together in one room six central bankers and twelve commercial bankers to solve a large problem are over. Therefore, we cannot speak to a few institutional leaders. We have to speak to an unidentifiable collection of thousands, if not millions, of investors—investors who can move with the flick of a button and transfer amounts of money that swamp this institution and potentially could swamp the resources of individual governments that stand behind this institution.
In the end, the board voted to approve the request. However, the decision was not without controversy. In particular, a number of executive directors from Europe strongly objected to the unprecedented size of the request. They also chafed at the fact that they had only been given a matter of hours to review the program details before voting. Indeed, following the vote, several directors requested to have their yea votes changed to abstentions. Ultimately, Camdessus was able to ram through a program several times the size of Mexico’s quota, but the backlash among some on the board reveals how such herculean efforts by the Fund have their limitations. Moreover, on its own, the IMF’s $12 billion rescue remained woefully shy ofMexico’s financing need. Complementary action by the United States was necessary, in this case, to fill as much of Mexico’s financing gap as possible in the hopes of shocking markets and bringing the panic under control. In retrospect, Peter Kenen has described the Mexican bailout as having "all the features of a Bagehot-style lender of last-resort operation” based on the speed with which the United States and IMF acted and the overwhelming overall size of the collective bailout.
If the Fund’s resource insufficiency generated the need for US action, a number of factors undergirded US interests behind the bailout. In his memoir, Treasury Secretary Rubin sums up the US motives behind the rescue this way: "We weren’t proposing intervention for the sake of Mexico, despite our special relationship, but to protect ourselves.” A review of FOMC transcripts reveals the central bank was willing to help the Treasury bailout to Mexico given the substantial financial risks posed by the peso crisis. In discussions, the FRBNY president, William McDonough, described the Mexican situation as being "unique, not just unusual” and that "there was very serious systemic risk involved.” At the time of the crisis, Mexico was the third-1 argest locale for cross-border claims of US banks. On its own, it totaled about 6 percent ($23 billion) of their total foreign portfolio. Moreover, the exposure of US banks represented only a portion of total US financial exposure. As of 1994, US residents held nearly $17 billion in Mexican debt securities and had invested almost $35 billion in Mexico’s equity markets. To make matters worse, it was not just Mexico that was in trouble. Policymakers were also fearful that the crisis could spread elsewhere, specifically Argentina, which was facing financial problems of its own. Indeed, the FOMC debated whether the institution should provide assistance to Buenos Aires if it came to that. McDonough noted that the Argentine government "had better policy” and was the "next deserving case” for assistance. In fact, the following year Treasury tapped the ESF to provide $250 million in loan guarantees on behalf ofArgentina as conditions there worsened. Together, the US financial system had roughly $100 billion in exposures to these two countries as reported in Figure 6.3. The economist Rudi Dornbusch, who was called to testify before Congress about the Mexican bailout, pointed to these same risks at the proceedings:
The lender of last resort does not come in to reward poorly managed debtors but rather to avoid the spillover effects of a credit system connected by confidence or
US Financial System Exposure to Mexico and Argentina, 1994
contagion. A Mexican default and collapse will spill over to our own economies and bring down other economies, most immediately Argentina.
The Republican-controlled Congress had a swift negative reaction to Treasury’s use of the ESF to rescue Mexico. Many legislators felt that the administration had performed an end-run around Congress by using the Treasury’s special "slush fund.” Others pointed to the new Treasury Secretary’s ties to the financial industry. As it had done years earlier with the Argentine rescue of 1984, Congress quickly hauled Treasury and Fed officials to Capitol Hill to question their motives. In one hearing, Representative Steve Stockton of Texas charged, "One benefactor of the Mexican bailout would be a firm called Goldman Sachs which Rubin was a part of. It was the number one underwriter of bonds to Mexico ... . It raises some very serious questions.” Rubin, of course, strongly denied these charges and argued the loan package was designed to protect Main Street rather than Wall Street’s bottom line. He pointed to the threat the Mexican crisis posed to US jobs first, immigrant flows second, and financial risks third. Referencing the motives of Rubin and other officials at Treasury, Lipton noted that "these were a bunch of people who had been involved in one way or another in the Latin American Debt Crisis and its resolution. They believed that creditors take their lumps.”
Of all ESF rescues, this is one of the most difficult cases in which to tease out the primary motivations that led to the decision by Treasury and the Fed to help the United States’ besieged neighbor to the south. While the financial threats were real and potentially systemic if the crisis were allowed to spread, the range of spillovers that threatened the US economy in light of Mexico’s troubles was broad. Thus, although concerns about financial spillovers played an important part in motivating the rescue, it is equally unlikely that financial factors alone determined the outcome. Indeed, Lipton indicated that fears concerning political tumult in Mexico were a major consideration as well. Asked whether Mexico was viewed as a "special case,” he acknowledged, "We basically had that discussion. We asked ourselves whether we would do this for anyone else and it was basically our view that Mexico was unique.” As it turns out, it was only unique until the Asian financial crisis a few years later.
-  Whitt 1996.
-  As part of NAFTA, the United States, Canada, and Mexico also agreed to the NorthAmerican Framework Agreement (NAFA) which was, in short, a trilateral swap networkbetween the central banks of the three countries as well as the US Treasury. In the agreement, Mexico would have drawing rights to up to $6 billion from the United States: $3 billionfrom the Fed, $3 billion from Treasury (Pastor 2001, p. 116). In addition, in 1994 Treasuryhad three times extended short-term bilateral credits to Mexico via the ESF. However, in nocase were these facilities drawn upon prior to their expiration.
-  Boughton 2012, pp. 469-470.
-  Lipton 2014.
-  Greenspan 2007, pp. 156-160.
-  Boughton 2012, p. 473; Henning 1999, p. 62; Rubin and Weisberg 2003, p. 14.
-  Lipton 2014.
-  Although Treasury was the key actor in the Mexican bailout, the Fed played a keybackground role without which Rubin would have been unable to make such a large commitment. The Treasury’s loan was not made official until three weeks later on February21. Unlike ESF bridge loan commitments during the 1980s debt crisis, the 1995 Mexicanrescue was intended to supplement the IMF loan. Although the ESF had roughly $25 billion in resources, only about $5 billion of this was in US dollars—the currency Mexiconeeded. Consequently, the Fed agreed to a warehousing arrangement whereby Treasurycould essentially swap its foreign exchange (German marks, Japanese yen, etc.) for dollars.The Treasury could then use those dollars from the Fed and swap them with Mexico forpesos. In short, what this entailed was a three-step currency swap between the three parties(FOMC 1995).
-  Boughton 2012, p. 475.
-  Lipton 2014.
-  Treasury also drummed up an additional $6.2 billion in contributions from the Bankof Canada and the BIS (Boughton 2012, p. 473).
-  EBM 1995, pp. 53-54.
-  Copelovitch 2010, p. 226.
-  Kenen 2001, p. 22.
-  Rubin and Weisberg 2003, p. 4.
-  FOMC 1995, p. 10.
-  US Treasury 1994.
-  FOMC 1995, p. 10. Ultimately, the committee seemed to lean away from providingassistance to Argentina. They had accepted helping Mexico because it was "unique,” and ifthey provided assistance to Argentina, as McDonough put it, "God knows where you decidethe line gets established” (FOMC 1995, p. 10). In the end, the ESF ended up providing a$250 million credit to Argentina later that year as part of a multilateral package; however,the Fed had no involvement in that loan.
-  US House 1995a, p. 401.
-  US House 1995a, p. 144.
-  Lipton 2014.
-  Ibid.