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In their own words. (Guillermo Ortiz)

Jul 1, 1998

Guillermo Ortiz, Mexico's Central Bank Governor
Guillermo Ortiz, who stepped into Manuel Mancera's shoes at the end of 1997 as governor of Mexico's central bank, was named in March 1997 as LatinFinance's Man of the Year for his accomplishments as finance secretary in the wake of the peso crisis. During that time, he skillfully returned Mexico to the international capital markets-raising $14 billion in 1996 alone-and rapidly paid off the US Treasury's rescue loan. Ortiz was appointed undersecretary of finance and public credit under the Salinas administration, during which time he negotiated directly with the IMF as part of Mexico's Brady restructuring. After weathering controversy over his involvement in the 1991-1992 privatization of the Mexican banking system, Ortiz has since been targeted by critics of the terms of the post-devaluation bailout of the country's banking system.
How did you develop a model for the privatization of Mexico's banks?
We spent a year doing two things. First was a review of how bank privatizations had been conducted in other countries. Specifically, we reviewed extensively the French privatization of the 1980s, as well as that of Portugal, which was in the process of privatizing its banking system. Second, the privatization committee hired both Booz Allen and McKinsey to assess the financial conditions of each one of the banks to be privatized, and to value the banks for the privatization committee. We also hired CS First Boston as a consultant for the overall sales process, and we prepared the rules and proceedings for the privatization for about a year. The privatization process took about 13 or 14 months after the first bank was sold. The privatization at that time was widely considered a successful process both in Mexico and abroad. It was conducted with transparency and generated sizable public revenues. In retrospect, looking with the vantage point of time, we would have done a few things differently.
What would you have done differently?
First of all it's clear that the screening process for the groups that participated in the privatization process could have been tighter; a few of the institutions fell into the hands of people who later turned out to be irresponsible managers, some of which undertook fraudulent actions and, ultimately, they were prosecuted. A second point to be considered was that the privatization of the banking system started a few years after Mexico had initiated a deep process of financial liberalization. Interest rates were liberalized in Mexico in the late 1980s. The government succeeded in balancing its budget, and therefore a large amount of resources that had been previously channeled from the banking system to the government became available for loans to the private sector. Hence, credit expansion began at a very rapid pace starting in 1989-1990 and continuing until 1994.The simultaneous effects of financial liberalization, rapid credit expansion and the process of privatization in which banks were bought at high prices, induced bankers to high-risk lending with insufficient risk evaluation techniques. This was all exacerbated by the peso devaluation, the 1995 crisis and the rapid deterioration of banks' asset quality.Although we hired the best consultants we could find to assess the situation of individual banks, it's clear today the asset quality of the banks at the time they were privatized was probably not assessed accurately enough. The loan portfolios had begun to grow very rapidly from the early 1990s, and at the time the bank privatization was undertaken, the amount of past-due loans was very small because most of the credit expansion had occurred very recently, so it hadn't yet shown any problems. With the benefit of hindsight, I think perhaps we should have been more prudent in terms of devoting part of the resources from the privatization to strengthening both capital and provisions of the banks.
How concerned were you about the escalating level of risk?
In those years we were concerned with the speed at which credit expanded, but the reports that came out of the banks indicated that the underlying asset quality was good. The reports regarding overdue obligations, capitalization ratios and provisions then indicated that the system was consolidating apparently at a satisfactory pace. We did not realize at the time that our banking supervision board was unprepared to deal with a situation of very fast credit growth. In retrospect, and with the recent experience of other countries, particularly in Asia, it seems obvious that no banking system, however sound, can withstand growth rates of real credit in excess of 30% in real terms per year over a prolonged period.
You've said there should have been stronger supervision before the bank sell-off. What prevented that?
I think it's very difficult to have effective supervision in a system where the banks are government owned. This is partly a result of the operation of the system itself and political realities. For example, the CEOs of the banks were appointed by the president, through the ministry of finance; they frequently carried a lot more weight than the supervisors. So it was very difficult to have effective supervision when you had a nationalized banking system. You cannot build up a supervisory board overnight. It takes years to build a team and train people, particularly regarding modern techniques in risk assessments and credit overexposure. We did not realize at the time the shortcomings that we had in supervision.
How much concern was there in 1994 about the overvaluation of the peso and the large current account deficit?
There were discussions regarding the current account deficit, its sustainability and its financing. The prevailing view, however, was that the current account deficit was responding to private capital inflows, since the government was not running fiscal deficits that would be prompting a current account imbalance; that it was basically the private sector that was spending more both in consumption and investment and generating the current account deficit; and that this was an expected outcome, given the attractiveness of Mexico. Mexico was not the only case where countries had been growing large current account deficits for several years. There were arguments made at the time that the current account deficit was again reflecting the increased investment opportunities that investors were perceiving in Mexico. It was thought that if those opportunities ceased to be attractive, then the capital inflows would diminish and the deficit would automatically be reduced. Those were the arguments that were put forward at the time, not only in Mexico, but in other countries that were running current account deficits.
What were some of the causes of the peso devaluation?
There's still a view that Mexico actually devalued in order to gain competitiveness. That is not accurate. We had to devalue because the international reserves were very rapidly being depleted. This same process has happened in several other Asian countries that have gotten into crises recently. The authorities first resisted the devaluation through the issuance of Tesobonos and then by using international reserves-up to the point where Mexico was running out of reserves and that's when the devaluation occurred.
What was the logic behind issuing Tesobonos?
The Tesobonos had been in existence since 1989. The balance of Tesobonos was pretty low. It's not, as in many aspects of life, that the instrument was bad in itself-it was the abuse, the excessive issuance of something that (was) potentially a useful instrument. The balance of the Tesobonos at the beginning of 1994 was very low, probably less than $2.5 billion-and it ended up being close to $30 billion. The assassination of Colosio generated a lot of uncertainty. In the case of investors, the decision was to provide them with an instrument that would allow them to hedge against devaluation risk. That is why the issues of Tesobonos grew so quickly after April 1994. Otherwise we would have experienced a much larger loss of international reserves-that was the point. It was thought that when normal conditions were restored, investors would switch back to pesos.
How was Mexico able to pull out of the early-1995 peso tailspin?
At the time, the issue was whether Mexico was going to default or not. And this is why it was essential to put together very quickly a program with two basic components. One, was a sufficiently large financial package to assure investors that Mexico would not default; (the other), an economic program that addressed the macroeconomic imbalances and re-established confidence in the viability of the Mexican economy.In the first days of January, the diagnosis made was that we needed massive amounts of financial resources to insure investors that Mexico would not default and to start working quickly on the recovery program. Mr. Rubin had not yet been appointed in the early part of January, and I hadn't had discussions with Mr. Rubin; my conversations were with Mr. Frank Newman, who was acting secretary. US Federal Reserve Chairman Alan Greenspan asked me (during a January 1995 meeting in Washington), "How can we help?" I said "We need the full faith and credit of the United States." Newman replied, "Well, Guillermo, at least you can have our full faith." After a small pause, I said, "I am glad we got halfway through the negotiations as quickly as we did." A fundamental key to addressing the crisis was that President Zedillo did not minimize the problem. He actually went to the people in a straightforward manner and told them the situation was very bad and that harsh corrective measures were needed. And he also acted very quickly. I was appointed finance minister December 29, 1994 and seven weeks later, on February 21, we had already concluded the negotiations. We signed the agreement with the US government and already had an IMF program. The financial package included IMF commitments and US commitments from the currency stabilization fund.
What were the most difficult moments during the crisis?
I think one of the most difficult moments was during the first weeks in January 1995. We were trying to put together the whole deal and we saw that the markets were tumbling everyday. And then there was a second period of anxiety, because after the deal was completed and the program was announced it took several weeks to take hold. The markets did not immediately buy the program. We had to have some evidence of actual results and follow up on implementation before it started to take hold. It was not until mid-April when markets began to stabilize and believe that the program was more or less in place. I went to New York in May of that year and had a meeting with George Soros. And he told me that he thought at the time that there was a 50/50 chance that the program would actually work and it was already May. I came out of that meeting a bit discouraged-as you can imagine. Afterwards, there was a second difficult episode after the GDP figures for the second quarter were released. At the time, there was a 9% drop in GDP and the market took it very badly and we had a big shakeup, I would say, between September and November. We went through a very difficult period, with a good dose of market instability. The main concern about the basic economic program was the cost in terms of output loss, unemployment, reduced wages and consumption. Undoubtedly, this was the most difficult of all, seeing the number of unemployed increasing month after month, that real wages were tumbling and that factories were closing. This was extremely unnerving because nobody had guarantees that the program was going to work. And we didn't have a second "bullet."

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