Tuesday, October 14, 2008

U.S. Learning From Mexican Financial Crisis

While it is nearly impossible to accurately compare the largest economy in the world to that of a developing nation, there are many lessons to be learned by the U.S. from the Mexican financial crisis of 1994 and 1995. Ben Bernanke realized this and met with Mexican Central Banker Guillermo Ortiz last week to talk through Ortiz’s experience with their financial crisis, according to the Wall Street Journal. While Mexico certainly did not do everything perfectly to exit their crisis, they were able to restore order and return to growth within a couple years, which sounds much better than some of the doom scenarios being thrown around right about the U.S. economic forecast. The Wall Street Journal did an excellent piece about the lessons we can learn, so let’s look at some of the things they brought up:

“Don't be ruled by ideology -- stay flexible and act decisively. Help those with mortgages they can't pay. Take stakes in troubled banks. Don't expect to turn a profit on government investment.”

“’Do whatever it takes to restore confidence,’ Mr. Ortiz said in an interview. ‘Once you lose it, it's very difficult to get it back.’”

“In today's globalized financial markets, once trust is blown, the markets will often overreact and the crisis will spin out of control. As a result, policy makers may need to take steps they never imagined taking. The longer they wait, the worse the pain. We are already learning this lesson the hard way.”

“Mr. Ortiz said in remarks Sunday to the Institute of International Finance in Washington. ‘It's better to err on the side of doing too much rather than doing too little.’”

“In the end, Mexico acted directly to tackle the underlying problem of bad debt by launching a program to restructure mortgages, with banks, borrowers and the government all sharing loses.”

“The key to a mortgage restructuring: ‘Keep it simple,’ says Vicente Corta, who led Mexico's bank bailout program for several years. ‘We tried fancy schemes that didn't work.’”

“The Mexican and U.S. bank rescue plans have both involved the government taking bad loans from bank books in order to get credit flowing again. Much like Washington, the Mexican government expected to break even and possibly make some money on the bad loans that it purchased.”

“The reality: The government lost money -- lots of it. The bailout's final price tag of about $75 billion was three times what the Mexican government expected. In other words, the $700 billion U.S. rescue plan could be just the beginning of the final cost.”

“A government stake in banks might help ease the inevitable political fallout.”

The last one here is a lesson Mexico learned after taxpayers nearly revolted. Mexico had basically kept to buying up the bad assets from banks (Paulson plan) without taking equity positions. Years later when these banks got healthy and sold for billions of dollars, taxpayers got nothing. Since the banks wouldn’t have stayed in business without taxpayer money, this was understandably not looked highly upon by taxpayers.

I think the biggest lesson we can learn from all this, though, is that the $700 billion bailout package is just the beginning. Some people just don’t get this point, and even think we are going to turn a profit from all of this. I’m hearing all sorts of people say that this isn’t a bailout deal, it is an investment, and we are going to make loads of money. When I hear that I just chuckle to myself, because I know that it isn’t going to happen that way. Of course that won’t stop politicians and supporters from telling people that in an effort to ease objections, but hopefully you see through these false hopes. This isn’t an investment where we hope to make money; it is an investment to stave off danger and save our financial system. The final price tag is likely to be in the trillions and we are going to be paying for this for years.

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