In an Uncertain World (5 page)

In previous discussions, Larry had laid out the analysis—and the risks—very clearly. In theory, if Mexico offered a high enough interest rate, then people—whether ordinary Mexicans or foreign investors—would choose to hold pesos rather than buy dollars at a particular exchange rate. The greater the confidence that the government's policies and IMF-led financial support would succeed in restoring financial stability, the lower the interest rate that would be needed to persuade investors to hold pesos. But if people feared that the program would not work—that their pesos might quickly lose their value as the exchange rate plunged further and inflation accelerated, putting more pressure on the peso and creating a vicious cycle—they would demand a terribly high interest rate to compensate for that risk. And as interest rates climbed, we might reach a point at which higher rates could actually become counterproductive in attracting capital. Rather than attracting capital and increasing the demand for pesos, higher rates could reduce the demand for pesos by threatening to push the government's debt burden to a level where default seemed inevitable, or trigger a collapse in the already weak banking system. In that case, the plan would fail and our billions of dollars in loans from the ESF would merely have helped finance some of the capital flight as money poured out of Mexico. Larry, Alan, the rest of the team, and I had spent endless hours trying to gauge how high interest rates could go without being too high. But what if no interest rate existed that was high enough to attract capital before rising above the level that would scare capital away?

Interest rates were the most critical issue, but other policies were also crucial to reestablishing confidence and therefore growth. These included a commitment to a floating exchange rate to avoid a rerun of the previous crisis; a budget plan that showed that the government could tackle its debt burden; reform of the banking system, revealed by the crisis to be close to insolvent; and much greater transparency so that investors felt adequately informed. The more credible the government's commitment to a strong reform program, the less pressure there would be on the exchange rate and the more leeway Mexico would have on interest rates.

As we sipped our coffee at the Jefferson, I went around the dinner table and asked all present what they thought the odds were that the plan would work. Dan Zelikow, who had seen real economic dysfunction as an adviser to the first democratically elected government in Albania, thought the odds of success were only one in three. Larry thought our chances were substantially better but didn't offer precise numbers. David Lipton gave the most optimistic specific prediction: better than a 50 percent chance. What was striking was that everyone agreed we were taking a significant risk.

In a sense, the plan had two distinct, but intertwined, risks. The first was that the Mexican government would simply be unable to follow through on the tough steps needed to rebuild confidence and attract private capital again. The second was that official money—from the United States and the IMF—would not be sufficient to provide the breathing space needed while policy reforms took hold. Ironically, the bigger and more certain the promise of official money, the less was likely to be needed.

Making matters more complicated, our G-7 allies were still protesting Camdessus's decision to add another $10 billion from the IMF. In response, Camdessus suggested restructuring our deal. On the morning of February 21, the day for signing our agreement with Mexico, Camdessus told me that the IMF could provide only $7.8 billion, plus contributions from elsewhere. That was inconsistent with his original commitment; now he wanted to go ahead with the extra $10 billion only if it came as bilateral loans from other countries, similar to our ESF commitment. That was a problem for us, since Mexico needed to have the entire $17.8 billion available and I had always told Congress that the total IMF contribution would be $17.8 billion. I sympathized with Camdessus's difficult position. But for him to do this now would harm the program and seriously undermine our credibility in Congress.

Camdessus had provided strong leadership in difficult circumstances and I had great respect for him, but this wouldn't work. With Leon sitting in my office, I called back and said, “Michel, this is not what we agreed to. And if you insist, I am going to go out and make a public statement. We are going to hold a press conference and announce that you have changed the deal. And I'm not going to go ahead with the Mexican program.”

Michel said, “You can't do that.”

I replied that, in fact, we could. The moment was dramatic, but in the end, Camdessus came around, and our strong relationship with him—so important in the years ahead—was not harmed. My approach in general is to try to see both sides and work to find common ground. But sometimes there is no good alternative to an adamant stand calmly taken.

We signed the Mexican rescue agreement as planned that day in the Cash Room at the Treasury Building. The Cash Room was where citizens once came to trade paper dollars for gold. The location seemed appropriate, since the closing of the gold window and the creation of the ESF in 1934 had made the action we were about to take possible. But we were all concerned. After the signing, I walked back to my office in worried silence with Sylvia Mathews and David Dreyer, another senior adviser. David tried to cut the tension with humor. “I guess we'll never see that money again,” he joked. Sylvia and I didn't smile. It's funny to me now, but it wasn't then.

A night or two after that, when the positive market reaction to the agreement had already dissipated and markets were once again dropping, Larry came into my office and offered to resign. It was about eleven in the evening, and we were both still at work. Larry felt personally responsible for an effort that might well fail. I told him that his talk about resigning was ridiculous. While I understood how Larry could feel his responsibility so keenly, I told him he wasn't any more responsible than the rest of us and he was taking the matter much too personally. What we were doing was right, and we were all in it together. We'd just have to hang on and get through it, one way or the other.

In the next few weeks, we all felt the pressure. Jeff Shafer told me a story somewhat later about having a drink with friends before a baseball game at Camden Yards in Baltimore on a rare evening off. When a friend asked him something about the Mexican “bailout,” the term that most irritated us, Jeff's response—“It was
not
a bailout!”—was loud enough to stop conversation in the crowded bar.

I didn't discuss my own feelings with anyone at work, but I too had focused on what the possibility of failure could mean for me. Losing $20 billion in public funds, especially on such a controversial and high-profile matter, could substantially taint how I would be seen as the Secretary of the Treasury. But even if I had to step down, I could deal with that. I felt better thinking that I'd helped set up the National Economic Council at the White House, which was working well. No one could take that away from me, no matter what happened afterward.

As markets continued to fall, Larry and I had a difficult phone call with Guillermo Ortiz. This was after we had signed the agreement but just before the first disbursement of funds. As we explained how bleak the situation looked, Guillermo, though sounding overwrought, tried to paint a rosier scenario for us. We weren't persuaded, but I understood he could do little else. After the call, we went right over to the Roosevelt Room in the White House for a meeting with Panetta and Berger. I felt, in light of the circumstances, that we had an obligation to raise the question of whether to exercise our right to withdraw from the arrangement unilaterally.

“Letting Mexico go” at this stage would turn the possibility of default into a virtual sure thing—but I thought I should raise the issue even though I personally believed we should still proceed. My question was greeted with surprise. Only Erskine Bowles, the deputy chief of staff, who, like me, had worked as an investment banker, related to why I was even posing the possibility of not following through on this program we had already agreed to. Leon said that he didn't think that option was viable. The administration was committed to a plan of action and had to stick with it even if the chance of failure had increased. The cost to the administration of reversing course—in terms of lost credibility—would be enormous. I, on the other hand, imagined the congressional hearing where I'd be called to account, with one of our very vocal critics leading the inquisition.
So, Mr. Secretary, you thought that there was only a small chance that sending billions of dollars of American taxpayers' money would help? And you sent the money anyway?

That discussion illustrates a difference between making decisions on Wall Street and in government. There is a strong impetus to stick with presidential decisions, even when circumstances change, because the world is watching to see if you keep your commitments. Credibility and reliability are powerful values. Thus, changing direction may sometimes be worse than proceeding with something that could be wrong. In the private sector, reliability and credibility are also very important, but you can change course much more easily. When a Wall Street trader decides to cut his losses or a corporate head cuts back in a troubled business, no one complains about inconsistency. Nonetheless, there are times when high-profile government decisions should be reversed despite the damage to credibility. I didn't think that was the case here, but I did think the issue should be raised.

On March 9, the day we were to release the first $3 billion loan, the peso fell dramatically, closing for the first time at more than 7 pesos per dollar. Rumors—in this case accurate—circulated on Wall Street that we were contemplating not releasing the money on schedule. Despite the commitment of additional funds from the World Bank and the policy reforms that Ortiz was about to announce in Mexico City that evening, we were all deeply concerned that market confidence simply wasn't going to rebound. But when the time came to decide, we approved the release of the money.

The roller-coaster quality of that period was caught for me by the visit Larry and I paid the next day to the hearing room of the Senate Banking Committee. As I was answering questions, including hostile ones from Senators D'Amato and Lauch Faircloth (R-NC), my staff kept slipping me notes about the peso, which was rising even more dramatically than the prior day's fall. Larry, who was testifying alongside me, passed me a note saying, “I think this thing might actually work.” While one of the senators was talking, I scribbled back a response: “I think it might.” Once again, though, our optimism was short-lived. The March 10 rally was followed by a steady decline. A month later, we went through the same agonizing decision again about whether to disburse the second $3 billion loan.

By mid-May, the Mexican central bank data we saw showed the first, very tentative signs that the program was beginning to work, although markets didn't seem to reflect much progress and still looked fragile. We sent a memo to the President that pointed to some encouraging indicators. The Mexican economy was in a severe recession, but the country's trade deficit had turned into a surplus, the stock of outstanding Tesobonos had been reduced substantially, and the peso had recovered somewhat. Anticipating the success of our rescue package, Thomas Friedman, the Pulitzer Prize–winning
New York Times
columnist, described it in his May 24 column as “the least popular, least understood, but most important foreign policy decision of the Clinton presidency.”

Alas, Friedman was getting ahead of himself just a bit. The roller coaster continued for the next few months. With the policy measures imposed by Zedillo, the financial and economic situation looked more stable by the end of the summer. But unemployment was growing, real wages had fallen significantly, and bank balance sheets were severely impaired. Chafing under the duress—and encouraged by signs that the program was taking hold—the Mexican government moved prematurely to lower interest rates. Markets resumed their slide, but the Mexicans quickly reacted and tightened policy to halt the slide.

Despite another rocky period in November, by the end of 1995 the program was taking hold. Investors started to put some money in; foreign exchange reserves started to build up; exchange rates stabilized; interest rates came down a little bit. Everything just started to work. The private sector had begun lending Mexico money again. By the beginning of 1996, the Mexican economy was growing again. The Zedillo government began to repay the U.S. and IMF loans, rolling them over into less conditional private-sector debt.

The speed of the response was remarkable. The 1982 crisis led to what has been called a “lost decade” of negative growth, financial instability, and political and social unrest throughout Latin America. The 1995 crisis caused real suffering on the part of the Mexican poor and middle class—and real wages were very slow to recover—but only one year of economic growth was lost. After the 1982 crisis, Mexico took seven years to regain access to capital markets. In 1995, it took seven months.

In August 1996, Mexico prepaid $7 billion of the $10.5 billion still outstanding from the United States and IMF. When the Zedillo government completed the repayment in January 1997, more than three years ahead of schedule, an anonymous aide of mine was quoted in
The New York Times
as saying, “This was Bob Rubin's Bosnia. And today he got the troops out.” Mexico paid us $1.4 billion dollars in interest and left the ESF with a profit of $580 million—the excess over what our money would have earned in U.S. Treasury notes. Senator D'Amato, who had already called the program a “failure,” put out a one-line press release saying he was “pleased” our program had been successful—thanks to “vigilant congressional oversight.”

   

IT SEEMS TO ME that the Mexican crisis has much to teach us about the global economy, new and heightened risks that our country is likely to confront in the future, and the challenges we face in trying to deal with these hazards. These challenges are complicated by volatile financial markets and by our own political processes. I've drawn out many of those reflections in the context of my narrative, but a few final observations depend on the whole story.