by Nomi Prins
On March 16, 2008, JPMorgan Chase got a $30 billion bailout from the Fed in the form of a guarantee to purchase Bear Stearns (my former firm). That figure was five times the Mexican stimulus amount. It was a sign of worse to follow. In a March 18, 2008, press release, the Fed noted, “Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.”18 That understatement opened the door for emergency monetary policies and greenlighted the blueprint for central bank collusion later on. The financial crisis was brewing, big Wall Street banks were frantically selling their worst assets to the least sophisticated investors. The Fed was slowly reducing rates in anticipation of a liquidity squeeze. The world noticed.
About a month later, on April 22, 2008, the three NAFTA leaders, US president George W. Bush, Canadian prime minister Stephen Harper, and Mexican president Calderón, gathered in New Orleans to discuss the impact on Mexico of the impending financial crisis. As President George W. Bush’s numbers plummeted to the lowest of his administration, he told his counterparts, “Now is not the time to renegotiate NAFTA.” Bush emphasized, “Now is the time to strengthen free trade.”19 He believed the three were stronger together and that, with the banking system buckling, strength was definitely in order.
Harper, seeing the light at the end of the tunnel with the Bush administration, said Canada would consider a renegotiation of NAFTA—but with the next US president. He took the opportunity to say that his government would not want to restrict NAFTA’s major trade cornerstones. For Canada, that meant oil—it was the largest single supplier of oil to the American economy.
Calderón concurred: “This is the time to strengthen and reinvigorate this free trade agreement among our three countries.… We talked a lot about the NAFTA, and of course we agreed that this is not the time to even think about amending it or canceling it.”20
During the press conference, a reporter asked Bush how deep and how long the US economic recession would be and how it would affect Mexico.21 His response was, “I—we’re not in a recession, we’re in a slowdown.… I’m probably the most concerned about the slowdown.… That’s why we passed… a significant pro-growth economic package.”
Calderón had also passed a growth package in Mexico. As Bush said, “The President is plenty capable of handling reform.… And he’ll do what he thinks is right for the country of Mexico.”22 The United States didn’t interfere much with Mexico, as long as it stayed in line with what the United States wanted it to do. In the eyes of American policymakers, if Mexico was to succeed, it would be because of the US government. However, if it was to fail, it would be because it remained obstinate to US guidance.
LEADING TO CRISIS, FIGHTING INFLATION
By mid-2008, Mexico, Latin America’s second-largest economy after Brazil, faced a problem of its own: inflation.23 Usually, rising prices solicited one monetary policy remedy, that of raising rates. Making it more expensive to buy things in turn reduces demand and decreases prices.
That’s exactly what Ortiz proposed. Banco de México increased its benchmark overnight interest rate on June 21, 2008, from 7.5 percent to 7.75 percent.24 As a rate move, it was an insignificant increment. Its deeper meaning was more substantial, however: it was the first such move by Banco de México governor Ortiz since October 2007.25 Concerned about runaway prices caused by a world food supply crisis, Ortiz raised the bank’s key interest rate mere days after President Calderón publicly pressured him to cut borrowing costs to boost growth, per Fed policy.26
Ortiz further raised rates to 8.25 percent by August 15, 2008.27 The move helped the peso strengthen to a near six-year high versus the US dollar.28 It demonstrated a degree of independence from Mexico’s central bank leaders in contrast to the Federal Reserve’s headquarters at the Eccles Building in Washington. Mexico was deviating its monetary policy from the Fed’s. The US central bank had cut its federal funds rate to 2 percent from 5.25 percent the prior September.29
The decision would return to haunt Ortiz. The act of raising rates, even a little, flew in the face of the Fed’s new protocol of flooding the financial system with cheap money in the guise of “stabilizing” its shaky economy and looming credit crisis. The key rules in this artisans of money game were the unwritten ones—international collusion on monetary policy, especially by a “friendly” neighbor, was to exhibit a united front. Dissention in the ranks had consequences.
It was natural for Ortiz to weigh international etiquette against national need and pick the latter. Yet his rate-hike decision lay in contrast to the wishes of President Calderón,30 who did not want to raise rates but rather wanted to follow US policy. Three days earlier, Calderón had chosen a different path to provide relief, freezing food prices on 150 staple food items.31
The rate hike pitted former friends—Calderón and Ortiz—against each other. Ortiz wanted to keep Mexico’s central bank independent of politicians and was dead set on anti-inflation measures in an autonomous manner. Calderón wanted to follow the Fed’s lead.
CREDIT SQUEEZES AND US BAILOUTS HIT MEXICO
By August 2008, Mexico faced a double whammy: a credit crunch at the hands of US banks operating there, and increasing volatility in the foreign exchange market. Ortiz took decisive action. Banco de México altered its auction mechanism—in place since May 2003—to prevent worried banks from stockpiling reserves with the central bank and instead encouraging them to loosen up and allow for domestic capital flow.32 If the Mexican peso depreciated by more than 2 percent on any day, various mechanisms unleashed the auctioning of reserves to prevent a “free fall.” A strong peso signified foreign investor confidence. (It also meant exports would be more expensive, which would mean less money to Mexico from US tourism or business flows.) The preemptive move occurred a week before financial Armageddon.
On September 14, 2008, US Treasury secretary Hank Paulson, Fed chair Ben Bernanke, and NY Fed president Timothy Geithner pressed Bank of America to purchase Merrill Lynch (run by Paulson’s Goldman Sachs protégé John Thain) for $50 billion.33 On September 15, Lehman Brothers declared bankruptcy for reasons similar to Bear Stearns’s. On September 16, insurance giant and Wall Street guarantor AIG received an $85 billion federal bailout. The government gift indirectly saved the group of big Wall Street banks with tight political connections, including Goldman Sachs and JPMorgan Chase.
The Fed’s unprecedented intervention in the private sector coupled with the demise of Lehman Brothers caused a death in liquidity that ran southward like a mudslide. The contagion barely even blinked for the $700 billion bank bailout package passed by the US Congress on October 3. Ultimately, the Fed would cut rates to zero on December 16, 2008. The era of limitless cheap money had arrived.
Stakes and tempers rose. At the National Association for Business Economics 50th Annual Meeting on October 7, 2008, Bernanke tried desperately to diffuse the damage the United States was causing, but for which it was taking no responsibility, by offering the world US dollars. “To address dollar funding pressures worldwide,” he said, “we have significantly expanded reciprocal currency arrangements (so-called swap agreements) with foreign central banks… which helps to improve the functioning of dollar funding markets globally.”34 The swaps were with South Korea, Singapore, and Mexico. Bernanke proliferating dollars throughout the world demonstrated his overall confidence in the dollar. Beyond the need to keep up with dollar demand as the major world reserve currency was a play for survival. If his central banking colleagues around the globe believed in the dollar, they would believe in the crafting of money. Mexico, connected as ever to that scheme, had to believe—its economy depended on it.
By that time, Mexico had spent a tenth of its foreign exchange reserves defending the peso. The cost of credit was soaring for local Mexican companies.35 Several large firms began selling pesos to cover their hedges on the exchange rate, making matters worse. Mexico hadn’t experience
d such currency depreciation since the “tequila crisis” in the early 1990s,36 when the rapid devaluation of the peso to US dollar caused massive capital flight from Mexico by foreign investors seeking a shield from volatility in the country. According to the Economist, “The peso’s slide was exacerbated by the unwinding of derivatives contracts that had been profitable while the currency was steady.”37
The siesta was over quickly. Mexico was no longer independent from the crisis and its currency was unraveling fast. In August 2008, the peso stood at 10 per dollar—its strongest level since 2002. By October 2008, it had bled 30 percent of its value, plunging to a level of 13.2 per dollar.38 That was just the beginning.
FOUR FATEFUL DAYS
The rest of Latin America fared no better. On October 8, 2008, stocks in Colombia crumbled 5.9 percent; Argentina’s major index shed 4.3 percent. Stocks in Brazil shed 3.1 percent.39
Mexico’s Foreign Exchange Commission40 accelerated its intervention. This was noteworthy. Since its establishment in 1994, when the Foreign Exchange Commission allowed the central bank to begin floating the peso, the commission had executed only minor interventions.41 By late October, the peso was down 18 percent against the dollar from the start of the year.42 The US subprime crisis had become Mexico’s currency crisis.
The Fed was in its own crisis mode. It cut rates half a point and cited “intensification” of the crisis as its reasoning. It would not operate alone in response to the US banking catastrophe. The Fed knew it would take an international full-court press. So Bernanke urged five other central banks to cut rates, too.
The Bank of England cut its rate by a half point. So did the Canadian, Swiss, and Swedish central banks. The Bank of Japan expressed support but because its rates were already so low took no further action. It was the Fed’s eighth cut since September 2007.43 When Alan Greenspan ran the Fed, he was dubbed the maestro.44 Bernanke, on the other hand, was the consummate magician. He provided the illusion of competence in his orchestration of global monetary policy collusion—so long as no one looked behind the curtain.
The joint cuts by that group of central banks were exceptional and rare, and these orchestrated efforts foreshadowed global collusion beyond prevailing imagination.
Ortiz had to act fast. In Mexico City, he and the secretary of finance and public credit, Agustín Carstens, called a press conference at the presidential palace to calm national nerves.45 Ortiz opened the event. Carstens sat pensively to his right.46
Ortiz announced Banco de México would sell US dollars into the market through two types of “extraordinary” auctions. These indirectly helped the Fed in its liquidity drive. US dollars would be sold directly into the market to meet demand for this “safe-haven” currency. If all went right, selling dollars would prevent further deterioration of the peso. The first type of auction totaled $11 billion between October 10 and October 23.47 The second was to reduce exchange rate volatility.48 In all, Mexico sold $15.18 billion worth of US dollars in late 2008 alone. Mexico would not only act in the spirit of confidence with the United States but also sell its currency.
Mexico was leaking money on diminished trade and capital outflows. Poverty began rising significantly after 2007 as food prices jumped.49 The underemployment rate rose by 3.5 percentage points between the second quarter of 2008 and second quarter of 2009, from 6.5 percent to 10 percent.50 From September to October of 2008, Mexican stocks shed 21 percent.51
In the world of high finance, what cures the markets does not always offer relief to real people. However, Ortiz’s actions did soothe Mexican markets. He calmed international investors to retain foreign capital. (In 2010, the BIS would call Ortiz’s moves “stabilizing” for tempering the foreign exchange market during late 2008.)52 Then Ortiz flew to Washington, DC. He was hell-bent on saving the system, despite the perception that Mexico and other Latin American countries were shielded from the worst of the US crisis or that they were not integral players when it came to solving problems.
On the morning of October 9, 2008, Ortiz and Bernanke conducted a thirty-minute closed-door meeting at the Eccles Building, which housed the Fed’s chambers.53 The Wall Street Journal reported, “Mr. Ortiz declined to discuss details of the discussions, but the fact that officials in Washington are talking to foreign officials such as Mr. Ortiz suggests they are open to learning from other countries’ experiences—even as the current crisis roiled those very nations.”54
That these two individuals were meeting was in itself significant. Either Ortiz was consulting with Bernanke, or the other way around, but it was a departure from the norm. Ortiz had more experience with crisis than the Fed chairman, though Bernanke, a self-titled “student of the Great Depression,” would never give him credit for his opinions. Bernanke mentioned Ortiz and the Bank of Mexico just once, in a sentence fragment unrelated to the crisis, in his memoirs of the crisis period, The Courage to Act55 (he did not mention Ortiz’s successor, Agustín Carstens, at all). During the crisis, Ortiz was an important, underrated figure critical to the United States. Had Ortiz completely failed in Mexico, the situation north of the border could have been catastrophic. Bernanke needed to secure his friends, as any military commander would.
While Ortiz was in Washington, a normally optimistic Calderón, who had run for office on an “employment” pledge, gave a somber nationally televised speech to announce his $4.3 billion spending plan. His plan, he assured, was “not a financial rescue.” (His statements reflected those of Brazil’s President Lula and its central bank head, Henrique Meirelles.) He promised to focus on “strengthening the motors of our economy,” on emergency infrastructure plans (roads, schools, houses), oil, and small businesses.56 He emphasized sustaining Mexico’s “main street” economy.
In paternalistic tones, Calderón underscored the central bank’s strength. “Unlike in the past, when a lack of dollars led us into terrible crises,” he said, “today we have foreign reserves of more than $90 billion and we practically have our external debt paid through the next year and a half.”57 Regardless of those reserves, the peso was feeling the heat.
On October 10, 2008, the Bretton Woods Committee’s International Council hosted its annual Luncheon for World Financial Leaders at the prestigious Willard hotel in Washington. Keynote speaker former US Treasury secretary Larry Summers gave a talk titled “Renewing the Bretton Woods Compact.” He outlined the elements he felt were important to a successful financial rescue package.58
The United States amplified its control over the existing system during the crisis US banks caused. This arrogance would rip that system apart. Other countries, such as China, uninvolved in the crafting of Bretton Woods hierarchy, saw opportunity in a new financial order.
For his part, Ortiz observed a glaring absence of political leadership. He cautioned that central banks should be proactive, but not overstep their role. “Central banks have been thrown into a role they should not be playing. They are not political actors—and do not have the legitimacy to act in this capacity.”59 Little did he know.
Central bank leaders clashed over what to do about the escalating global crisis, alternating between blaming each other and seeking solutions. The Dow posted its worst week ever, falling more than 1,874 points, or 18 percent.60
Early Saturday morning, October 11, President Bush, in the Rose Garden flanked by Treasury secretary Henry Paulson, announced, “We’re in this together.” He said the G7 nations had agreed to a plan of action that would help “systemically important financial institutions and prevent their failure.”61
The next day, while the Fed was approving the mega-acquisition of Wachovia by Wells Fargo, Ortiz and Dallas Federal Reserve Bank president Richard Fisher sat among a group of central bank heads at the Institute of International Finance (IIF) conference in Washington. They discussed the crisis and its consequences for the global economy.62 Confidence in the international monetary system was fading fast.
Ortiz stressed, “It’s better to err on the side of doing too much
rather than doing too little.”63 He admonished the US government and his US counterparts for their handling of the US banking system. It was imperative to stop its bloodletting because the wounded animal to the north had the propensity to starve the south to save itself. “Do whatever it takes to restore confidence,” he warned from experience. “Once you lose it, it’s very difficult to get it back.”64 Meetings with Bernanke and the Fed likely had not been as conducive as Ortiz would have liked, hence the harsh tone. He couldn’t cross the top dog at the water bowl, but he could bark loud enough to get attention.
While Calderón deployed government stimulus, Ortiz returned to Mexico to craft market intervention techniques to both replicate and defend against those of the Fed. The Fed, meanwhile, opened copious lines of credit to demonstrate its commitment to “large well-managed emerging markets” that were bearing the brunt of financial collapse.65
By that time, it was clear to the world’s top central bankers and finance ministers that the US Fed had placed them in a precarious position. No one was happy about it. The painful irony was that they had to take direction from the Fed in order to exit the crisis that the Fed’s enabling of Wall Street speculation had caused. Mexico, too, was forced to take part of the financial crisis on the chin.
On October 19, 2008, at a Bank of Mexico conference, Ortiz spoke beside the IMF first deputy managing director and former vice chairman of JPMorgan Investment Bank, John Lipsky, a man sporting a sizable mustache to accent his elite résumé. Regarding implications for emerging markets (EMs), Lipsky said, “Structural improvements—and the improvement in the management of fiscal and monetary policies—bolstered the resilience of most large emerging market economies to external shocks, allowing them more perspective on their response to the crisis.”66