Lessons From The Peso Scare

It was a financial Desert Storm. A multinational bailout force, marshaled by the U.S. and armed with $52.8 billion, rode to the rescue of Mexico's economy. It was close, but with the stabilization of the peso and the sharp snapback of foreign stock markets, the world has now weathered its first liquidity crisis in securitized capital. Never before had a crisis occurred in a global financial system where individually owned mutual funds, not banks, played so significant a role in financing emerging countries. Never before had the world's top multilateral financial institutions, the International Monetary Fund, and the Bank for International Settlements, played the savior in this strange new land of people's capitalism.

Two lessons emerge. First, Congress, political animal that it is, refuses to be a lender of last resort to the global financial system. Partisan politics and a parochial viewpoint prevented the legislative branch from shouldering international obligations in a crisis. It is now clear that however legitimate populist issues may be at home, the parochialism that fuels them has no place in international financial affairs. In the end, it fell to the tried-and-true, politically insulated, international monetary institutions to do the job. The IMF and the BIS gave more than half the resources--in effect, providing the cover for the U.S. Treasury to play its role.

One can only ask why this obvious solution to the Mexican peso crisis was not set in motion on Jan. 1 instead of Jan. 31. Had steps been taken earlier, the world would not have been brought to the brink of financial meltdown. Bumbling of this magnitude hasn't been seen since the savings-and-loan crisis.

The second lesson is that a multilateral safety net is even more important in a world where markets, rather than banks, provide the bulk of international financing. Markets are even more sensitive to risk, and they reacted more quickly than the banks did in the 1970s. Banks didn't have to mark their loans to market when OPEC devastated the Third World. Mutual funds do, and the risk is visible every minute. If they are to continue investing in Latin America and Asia, individuals, like the banks before them, require a lender of last resort. The world financial system was far closer to the edge in January than most people in Congress chose to realize. Mexico needed help. If help hadn't materialized, a global liquidity crisis would certainly have followed--and with it, a sharp slowdown in world economic growth.

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