香蕉视频

While the recent financial crisis had unique features, it could have been avoided or significantly mitigated聽if only some lessons from recent mistakes would have been absorbed.聽 Here is a brief reminder of the Mexican situation in 1994, which, surprisingly perhaps, has parallels with both what led to the crisis and what is now plaguing the U.S.

A massive printing of pesos preceded the steady outflow of capital and the devaluation at that time.聽 Why did the Mexican government allow this to happen?聽 And once financial markets unearthed the policy, why did the central bank not sell bonds and absorb the unwanted peso liquidity?聽 It is not the case that Mexico's central bankers did not know what they were doing.聽 The story was different.

The Mexican government faced a dilemma,聽a very inconvenient one.聽 And just before elections.聽 Between June 1991 and July 1992, the government sold 18 banks that it owned.聽The government provided full insurance coverage for almost all depositors under FOBAPROA (Fondo Bancario de Proteccion al Ahorro), but did not impose regulations on the quality of the bank loans.聽 The consequences were as expected: delinquent loans increased, and, to keep the banks solvent, the government faced an unexpected US $70 billion bill. This sum seems like peanuts now, but not then, and certainly not for Mexico.

One lesson seems straightforward.聽 Either governments do not insure deposits and loans, or, if they do, they must regulate the way bankers invest the insured funds. Otherwise, partially deregulated financial institutions will quickly get into expanding credit to low quality borrowers.聽 This sequence of events also led to the Savings and Loan debacle too, whose lessons were 聽equally ignored.

When financial institutions are regulated on both ends, their management may be "bankers" by name, but they do not really practise "banking" since they do not have to do any real due diligence.聽Once governments insure deposits, but allow management to put the money anywhere they wish, experience suggests that "bankers" in these now partially regulated institutions fall for all kinds of half-baked ideas promising magical returns.

Before the recent crisis, Washington guaranteed not only demand deposits in banks, but also, implicitly, money markets funds and vast amount of mortgages through Freddie Mac and Fannie Mae. The magnitude of the crisis has reflected the government's unprecedented assurances.

One lesson of the Mexican experience should have been that if聽 the U.S. government maintains explicit or, at times, implicit deposit insurance, Freddie's and Fannie's obligations, and relies on unreliable rating agencies, then the financial institutions must be regulated severely.

However, if government is taking the deregulation route, then the guarantees must go too. The lesson of this experience was not learned.聽 U.S. voters were offered only one option of heavy-handed regulation with the alternative of getting government out of the explicit insurance for deposits and mortgages, with聽the implicit one for money market funds hardly being brought up.

Other mistakes of those 1994 events went unexamined too.

Mexican politicians at the time faced other unpleasant choices: tell the soon-to-vote-public that they made a big mistake and that the taxpayers聽would pick up the tab.聽 Or alternatively print 聽pesos to fulfill the deposit insurance commitment.

The Mexican government and central bank opted for the latter. Devaluation followed, which did 聽not solve any of Mexico's problems.

Another lesson not learned follows.聽聽 Once the printing presses were in high gear, the Mexican central bank managed to hide it 聽for a short while.聽 This allowed well-connected Mexicans to take their聽money out of the country at still favorable rates. 聽An estimated $20 billion of foreign currency in Mexico was quickly lost聽over a short聽timefram. At the time, though, gullible observers (Paul Krugman among them)聽 blamed "short-term, foreign speculators" for the outflow. The flows were closer to political-type insider trading, as opposed to聽"speculation."

Mexican insiders pulled out their money first.聽 Once investors at the time noted the abundance of unwanted pesos, devaluation followed.聽聽 Here the parallel with the U.S. is to follow the money and not trust any academic or journalistic superficial theorizing.

So what did QE achieve once we look at the money flows?

This policy has been replenishing the banks' coffers though not quite in the Mexican and Savings and Loan manner.聽 Instead of printing money to fulfill nominal commitments, the government and the Fed have been taking toxic credits away from the 聽financial institutions' balance sheets.聽 The government and the Fed have been "validating" the lousy credit already created.

And if that's not enough, banks can borrow from the Fed at extremely low rates and buy Treasuries. The generous spread between these rates is allowing them to record the profits that are rebuilding their balance sheets with no risk or effort.

But how much "validation" is needed to prevent deflation?

The large expansion of toxic credit created over the years was reflected not only in house prices but in many other prices too.聽 When it turned out that these prices were a result of misperceptions rather than reality, they fell.聽 How much QE should the Fed聽engage in聽to prevent collapse and to sustain the nominal prices reached during the misguided credit expansion?聽 The answer is not clear.聽 After all, home prices continue to drop.

Probably the most important lesson from the Mexican experience is that monetary issues dominated the discussion.聽 The fiscal and regulatory ones should have been intimately linked to it as next week's column will show.

Reuven Brenner holds the Repap Chair at 香蕉视频's Desautels Faculty of Managment.聽 The article draws on his book, The Force of Finance.

Read full article: , June 2, 2011