In an Uncertain World (3 page)

As the negative reaction mounted, congressional leaders who had agreed to support us at the outset seemed to grow more wary. They weren't persuading skeptical colleagues and appeared to be reducing their efforts to do so. Even some of our committed backers seemed worried about looking too enthusiastic. One prominent supporter kept sending us letters raising “concerns” about our proposal. I later realized that this was a paper trail qualifying his endorsement that he could point to if we failed. But for Greenspan's credibility, the reaction from the GOP would have been even more negative.

One legislator who did grasp the full dimension of the problem was the new Speaker of the House, Newt Gingrich. Gingrich was concerned enough about populist opposition to the rescue that he asked Alan to phone Rush Limbaugh on his behalf, which Alan did. When Larry and I went up to Capitol Hill to meet with him the first time, Gingrich really seemed to get it. Toward the end of our meeting, he described Mexico as “the first crisis of the twenty-first century.”

GINGRICH MAY NOT HAVE BEEN the first to use such a phrase—the IMF's Michel Camdessus described the crisis using the same words—but he effectively captured the reality we faced. Many elements of the Mexican crisis had been present in previous events, such as the Latin American debt crisis of 1982. Then, as in 1995, the Mexican government essentially ran out of foreign reserves. In 1982, Mexico's default triggered an economic decline that spread throughout much of Latin America and beyond. Banks that had lent heavily to developing countries in the preceding years pulled back dramatically, pushing one country after another into default. We did not want Mexico's difficulties this time around to precipitate another global debt crisis. But the world had changed over the preceding dozen years in ways that made this crisis very different and, in some respects, even more dangerous and difficult to contain. The international financial system had grown in scale, complexity, and velocity, so that the developed and developing worlds were now tied together as never before. Simply put, the potential for financial contagion across developing countries seemed considerably greater, and their economic health affected ours in more complex ways.

The most obvious change was the growth of international trade with developing countries. Many people don't realize that these countries purchase 40 percent of our exports. As a result, millions of American jobs now depend on the ability of consumers in the developing world to buy what we produce. Capital flows have increased even more dramatically. It's no longer just banks but investment banks, endowments, pension funds, mutual funds, and, through them, retail investors who have assets in the developing world. In the twelve years from 1982 to 1994, private capital flows to emerging markets had increased more than six times, from $24 billion to $148 billion. I had been at Goldman Sachs during the earlier crisis in 1982 and it had barely registered with me. The 1995 Mexican crisis was a high-profile event throughout the financial system.

By 1995, global finance had become immensely more complex than in 1982, as emerging-market debt shifted from banks to widely held securities. The 1980s debt crisis took considerable arm-twisting by the United States and other governments to make commercial banks renegotiate their bad loans to Mexico and other debtors. But that was in many ways a large-scale version of a “workout” session that banks hold all the time with troubled borrowers. With Mexico in 1995, some people proposed that we again “coordinate the banks,” but the banks were now far from the only creditors. In place of bank loans, a vast variety of debt instruments and derivatives had been devised in the intervening years. Mexican debt was diffused, with bearer bonds—which are not registered in the name of the owner, thus making the owners difficult to identify—held privately by various institutional and individual investors all over the world. In addition, portfolio investors held stock in Mexican companies, which few had in the early 1980s.

With many participants in the financial system, including the big investment banks, holding an array of emerging-market securities, a financial crisis in Mexico could spread much more widely and less predictably, creating a potentially powerful ripple effect. People facing large trading losses in one emerging market might suddenly decide that other emerging markets seemed more risky and liquidate positions in all their securities, even if the countries were apparently unrelated, such as, for example, Mexico and Poland. Firms might also have to raise capital to cover the initial losses, forcing the sale of other positions. Massive downward pressure could develop in other developing markets and even create pressure in industrial-country markets.

A final change was the extraordinary acceleration of market reactions. Throughout most of the 1980s, emerging-market sovereign debt had been illiquid, changing hands only in privately negotiated transactions with large point spreads. In 1995, highly liquid capital moved at the speed of light through fiber-optic cables. Traders had an array of terminals on their desks, with complete information about all prices at all times. Orders could be executed at any hour. The result was that developments in markets in one place could have instantaneous effects in any other place, and crises could spread much more rapidly.

The combination of these factors made the Mexican crisis different in kind from anything anyone had experienced before and made Gingrich's phrase memorable. Almost as soon as the crisis broke, I began picking up reports that the loss of confidence was affecting markets as far from Mexico City as Warsaw and Bangkok. There was no rational economic tie between Mexico's liquidity crisis and the Eastern European financial markets. But the psychology of markets is that investors who are far too complacent one day may quickly change and become a stampeding herd the next. In a world of instantaneous reactions, the tendency to react rather than to think is not necessarily irrational. In the race to an exit that not all will fit through, speed can be lifesaving.

In describing what was happening, I found myself trapped in a kind of Catch-22. On the one hand, I needed to underscore the dangers in order to motivate reluctant legislators—and the public—to support our rescue package. On the other hand, frank talk about what might happen could provoke the very reaction we most wanted to avoid. Explicitly raising our worst fears about global contagion could create a self-fulfilling prophecy. Some people at the time pointed out that I lacked the experience of my predecessor, Lloyd Bentsen, in dealing with Congress. That was true but not my real problem. My real problem was relinquishing our strongest tool: fear. The only way to navigate the twin hazards of complacency and panic was by choosing my words very, very carefully, softening concerns and using calculated ambiguity.

When Alan Greenspan, Secretary of State Warren Christopher, and I testified before the House Banking Committee on January 25, the hostility was typical of the whole process. I had to answer charges that our proposal was a bailout for Wall Street and big investment banks disguised as help for a neighbor. Bernie Sanders (I-VT) said I should “go back to your Wall Street friends, tell them to take the risk and not ask the American taxpayers.” I tried to explain that I wouldn't spend a nickel of taxpayer money for the sake of rescuing investors. Again and again, I returned to my arguments that our proposal to help Mexico was driven by our national interest. These numbers are always hard to calculate, but we made a rough judgment about the potential costs of a prolonged Mexican crisis to the United States—700,000 jobs affected, a 30 percent increase in illegal immigration, and so on.

Ross Perot, who testified to the Senate the following week and danced on what he took to be NAFTA's tomb, received a much warmer reception. And Senate Banking Committee chair D'Amato had gone from supportive to antagonistic. It was around this time that Pat Griffin, the White House's highly capable liaison with Congress, expressed annoyance with me at a meeting in the chief of staff's office for putting the President in a box. He felt that the decision to help Mexico had been made without adequate focus on the political risks and had left Clinton in an untenable position. I answered that the President had understood the political risk and decided to take it. As markets began to recognize the extent of congressional opposition to our proposal, they weakened further, not only in Mexico but also in Argentina, Brazil, and other emerging-market countries that tended to move in sympathy. And again, emerging-market countries as far away as Asia and Eastern Europe were affected.

In my office at Treasury, we embarked on a constant process of analysis and discussion. Included in our regular meetings was a group of officials who would become the core Mexican team: Jeff Shafer, David Lipton, and Tim Geithner, as well as my chief of staff, Sylvia Mathews, and Dan Zelikow, who became head of our Mexico task force. I got in the habit of referring to this group as “we” and “us” because in most cases our decisions were reached together after long days and nights of vigorous exchange of views. The Fed's top international official, Ted Truman, often joined us, as did Greenspan at important moments. Treasury and Fed officials were in turn consulting closely with top IMF officials, especially Michel Camdessus and his highly respected deputy, Stanley Fischer, a former chairman of the Economics Department at MIT.

Our Treasury meetings were characterized by searching questioning and debate, all for the sake of the fullest possible exploration of alternatives. This was a discussion, rather unusual for Washington, in which rank hardly mattered. A thirty-four-year-old deputy assistant secretary and the Treasury Secretary both felt fully entitled to express their views. That informality reflected my experience both on Wall Street and inside the White House about what kind of discussions tended to be the most illuminating and productive. So if someone, particularly someone junior, who was often closest to an issue, seemed to be holding back, I tried to draw out his or her view. What mattered to me was the merit of the argument, not the title of the person who made it.

Meetings produced the best results if those who disagreed with the accepted view were encouraged to speak out. So if a meeting seemed to be moving toward a consensus, I would make a point of soliciting dissenting views. Disagreeing with me was socially approved rather than discouraged. If no one disagreed, I would encourage someone to play the role of devil's advocate. I might say, “This is where we're heading, but we need to know the contrary view so we can consider it.” And I, or someone else, would take up the other side. Just as important as the freedom to disagree, I think, was that this group of high-powered intellects in large measure avoided investing their egos in their arguments. It was a common search for the best answer in the midst of a worsening crisis.

As congressional opposition solidified, our group naturally began to consider alternatives. One possibility was acting unilaterally, without a vote by Congress, by drawing from the Exchange Stabilization Fund (ESF), the pot of money that the Treasury uses for currency interventions. Congress created the ESF at the time of America's departure from the gold standard in 1934 to allow the Treasury to stabilize exchange rates. At that time, no one envisioned a crisis like Mexico's, but in our view responding to the Mexican crisis fit within the purpose of the ESF. The fund had about $35 billion and, as Treasury Secretary, I had considerable discretion over when and whether to use it, subject to the President's approval.

Senator Bob Bennett—who supported us throughout this crisis—had suggested the ESF early on, but we had initially decided not to use it in part because we thought Congress should be involved in a decision of this magnitude for the country. However, as Congress clearly showed no disposition to endorse our decision, we belatedly focused on the ESF as a potential alternative. Some in Treasury captured one problem in this approach with the phrase that the ESF was “a weapon you could use only once.” Our concern was that members of Congress might be so outraged by unilateral action that they might legally disarm us from using the ESF again. But with the package we called “Mexico I” struggling in Congress, the option of tapping the ESF gained force.

As this discussion continued at Treasury, I was in frequent contact with my Mexican counterpart, Guillermo Ortiz, who had been brought in after the managed devaluation had failed in December. I had gotten to know Ortiz a bit in the late 1980s, when, as an official at the Hacienda, as the Mexican Finance Ministry is known, he had handled bank privatizations. Like many of Mexico's senior economic officials, he was a highly capable economist, with a Ph.D. from Stanford University. A thin, serious fellow with a taut demeanor, he looked even thinner and more serious than I remembered when he visited the Treasury as the newly installed Mexican finance minister. Ortiz was not given to overstatement or self-dramatization, so when he told me on January 28 that despite the formal announcement of a $7.8 billion IMF program two days earlier, the situation was worsening, I took him very seriously. More than a billion dollars' worth of Tesobonos were coming due the following week, and the Bank of Mexico's currency reserves were running out. That meant default was getting very close.

Tony Lake, the President's national security advisor, had deputized Sandy Berger, his number two, to take the lead for the National Security Council (NSC) on dealing with Mexico. That evening, Sandy, Leon Panetta, and I met in Leon's office in the West Wing. After some discussion, we decided to press ahead with our effort to rally congressional support, setting a deadline of Monday, the thirtieth. On Sunday, when he got back from church services, Clinton again made calls to leaders in both parties. We still thought we might be able to convince Congress to act.

I woke up on Monday with a sense of deep concern. As I had feared, the Mexican markets began to sell off sharply, with the peso dropping almost 10 percent to more than 6 pesos per dollar, its lowest level yet. We had originally assumed that Mexico could remain solvent at least through February. But despite the assumption many people make that government has better information than the private sector, the opposite is often true. Mexico informed us that its reserves had fallen to around $2 billion on the same day the
International Herald Tribune
reported it. That could have meant a generalized financial collapse within days in Mexico.