Fiscal black hole bedevils Mexico; Failed bank bailout puts Zedillo presidency at risk

July 09, 1998, Thursday

SECTION: NEWS Pg. A-1

LENGTH: 2166 words

HEADLINE: Fiscal black hole bedevils Mexico; Failed bank bailout puts Zedillo presidency at risk

SOURCE: STAFF WRITER

BYLINE: Diane Lindquist MEXICO CITY

BODY:

MEXICO CITY -- A two-pronged banking calamity is undermining President Ernesto Zedillo's political power and threatening Mexico's fragile economic recovery.

Mexican taxpayers have been asked to absorb the cost of bailing out the country's banks after the 1994 peso collapse and, in addition, bear the burden of any new bad loans the institutions have amassed since then.

In sending the Mexican Congress its bank reform proposal in April, Zedillo administration officials exposed, with one fell swoop, the failure of their post-devaluation bank bailout under Fobaproa, the government agency, as well as the bailout's failure to rehabilitate Mexico's shaky banking system.

If the disclosure was shocking, the price tag was more so: $65.5 billion for the off-the-balance-sheet Fobaproa debt.

"It is an enormous figure for a country with half its citizens living in impoverished conditions," said Santiago Creel, a congressman of the center- right National Action Party.

What's more, the cost of assuming the newest batch of bad loans would escalate the total significantly. Neither government officials nor the banks have disclosed the full scope of the black hole of losses.

At stake is the country's economic recovery. Already, falling oil prices have prodded financial ministers to cut spending, and the economy is showing signs it cannot maintain the 4.5 percent growth registered so far this year.

"Inevitably, social welfare spending will have to stop, or the budget deficit will increase," said political economist Pamela Starr of Mexico City's Autonomous Technological Institute of Mexico.

Caught in a double bind

Taxpayers, just regaining purchasing power lost in the post-devaluation recession, would be caught in a double bind. Few of the nation's 95 million inhabitants have recovered from the country's worst economic contraction in six decades. Despite 7 percent growth last year, the real wage of the average worker today remains well below the 1994 level.

"Do you want a credit card? Dream on. If you want to finance a small business, it's very hard," Starr said.

The Fobaproa burden alone could boost the public debt from a quarter of the nation's gross domestic product to nearly half Mexico's total output. According to The Financial Times, the cost is equivalent to the absorption of the retirement savings of all Mexicans over the next 25 years.

Zedillo, meanwhile, faces the most serious challenge of his presidency, a situation likened to holding a "time bomb on a short fuse."

Opposition parties on both the right and left have made the reform proposal as much about politics as economics. They promise the issue will influence Mexico's elections in 2000, thus threatening Zedillo's ruling party with its first presidential loss in 70 years.

At home the calamity has damaged the administration's credibility; internationally, it has sullied its reputation.

Only last January in Switzerland, Zedillo advised leaders of Asian nations to follow the "Mexican lesson" to solve their economic woes. Now that strategy of keeping banks intact at all costs to stimulate recovery has become a lesson in how government crisis management can backfire.

"What are we to think of a government that allowed corruption and impunity, that made this rescue without the approval of Congress, of a government that continually has said that things were going well?" Creel asked.

Looking for the money

Conversations in the capital nowadays speculate on where the money went, which business executives and banking officials might have committed fraud and whether government officials were merely incompetent, caught unawares or influenced by bribes in mishandling the Fobaproa program.

In the past, such questions would have been kept within the inner circles of the Institutional Revolutionary Party. But with the ruling party's loss of its majority in the Congress last July and Mexico's move to a more democratic system, many expect not only answers but also an accounting for those responsible.

"There is a change here that is absolutely fundamental. Now public opinion has to be heard, and we have the mechanisms in place that will avoid this being shunted aside," said Gaston Luken, chairman of Mexicali's Grupo Proxima and a figure in Mexico City financial circles.

Government officials are warning that failure to enact the reforms is not an option. Congress, said Finance undersecretary Martin Werner, seems to be weighing the choice of "governing for the future or settling old scores." But the only solution, he said, is the president's proposal.

Many financial experts say some form of rescue is needed -- and soon. Without it, they argue, Mexico could suffer an early repeat of the kind of financial crisis that has tended to follow presidential exits from office.

Any delay threatens to unsettle investors and provoke a flight of capital, the circumstances that undermined the peso in 1994.

Congressional leaders have refused to be swayed by Zedillo's call for urgent action, however. Instead, they hired a team of international auditors to probe the details of the debt accumulation and explore the government's handling of the Fobaproa operation.

Once those items are determined, said Creel, who heads the congressional governance and constitutional commission, decisions can be made on how to distribute costs, how best to have taxpayers absorb the debt, whether any of the money lent can be recovered and how to deal with the individuals responsible for the problem.

Certainly, observers say, some heads will roll. Current conjecture centers on the economic technocrats who played pivotal roles in reorienting Mexico to a free-market system.

Mentioned most often is Guillermo Ortiz, who oversaw the bank privatizations in the Salinas administration. Zedillo named Ortiz his finance minister in the wake of the peso devaluation and, most recently, the central bank governor. Also high on the list is Eduardo Fernandez, president of the National Banking & Securities Commission, the agency in charge of Fobaproa.

Just like the S&L bailout?

For their part, government officials contend their proposal is comparable to the Resolution Trust Corp.'s $180 billion bailout of the savings and loan industry in the United States.

Jeanne Del Casino, an analyst at Moody's Investor Service, said that process altered the U.S. financial sector. It took 10 years to complete, she noted, and led to many of the mega-money bank mergers occurring today.

"The Mexicans have a good chance of growing out of it, but it's not going to happen next year. When you're looking at a developing country, it's not easy at all," she said.

Solving the Fobaproa debacle is only part of the problem. Caught between the global opening of the financial sector and the constraints of coping with the peso crisis and recession, Mexico's banks are struggling, existing essentially on government life support.

Moody's, in its ranking of the banking institutions of 70 nations, has dropped Mexico to third from the bottom. The position is lower than any Latin American nation and far below the troubled systems in Japan, South Korea and Indonesia of which Zedillo spoke earlier this year.

"Banking systems in these countries are their source of blood. If the banking system is in trouble, the whole country is," Del Casino said.

Money laundering

In addition to teetering on unsound financial footing, the Mexican banking sector suffered a sharp and untimely blow with the revelation in May of the U. S. government's sting called Operation Casablanca.

The largest money laundering case ever, it exposed supposed recycling of drug proceeds through a dozen Mexican banks. Three of the largest -- Bancomer, Banca Serfin and Banco Confia -- were indicted.

From the earliest days of the republic, Mexican development has been tied to its banks. And, for the most part, the institutions have been used by the wealthiest and most powerful families for their personal benefit. Mismanagement, greed and corruption have been a prevalent part of the system.

That appears to have continued even with President Jose Lopez Portillo's 1982 nationalization of the banks and President Carlos Salinas de Gortari's return of the institutions to the private sector several years later. Under his leadership, the banks were auctioned off to the highest bidders.

It became clear soon after the sell-off that at least some banks had been snapped up by "cronies and crooks -- certainly not people who knew how to run banks," as one observer described them.

Among the most blatant outrages was that perpetrated by Angel "El Divino" Rodriguez, chairman of Banpais. The bank collapsed after the executive allegedly plucked $2 billion from the its coffers for his own ventures then fled the country, leaving behind a passel of bad debts.

Last month, after being extradited as a fugitive who had lived two years in Spain, he was set free to await a civil trial. These days, El Divino lives in comfort in Mexico City. A local hero of sorts, he's besieged on the streets by children wanting autographs.

Although the problems of Mexico's banks are rooted in the privatizations, the sudden 1994 peso crisis pushed them to the edge of insolvency. To save the operations, finance officials turned to Fobaproa, an agency that administered the country's bank deposit insurance program.

Using the $50 billion U.S.-led international bailout as backing, Fobaproa stepped in and bought up the mortgage, auto, credit card and other loans that Mexican consumers could no longer afford to honor.

Officials now acknowledge the agency paid banks too much for the bad loans and confess recovering 30 cents on the dollar would be lucky.

Many more banks

The bailout gave the banks some breathing room. But, their problems were far from solved.

Desperate to add new business, they blanketed the country with branches, adding two-thirds more outlets than just three years ago. With the country in deep recession, however, deposits did not come flowing in. And what money the banks had was lent at forbiddingly high interest rates.

Now, overbuilt, undercapitalized and with loans still going bad, the institutions are headed for more trouble unless substantial changes are made.

Zedillo's proposals would relieve the banks of their latest batch of bad loans. They would be issued monetary instruments that could be used by other financial institutions or the securities market. Such a change, it is argued, would enable the sector to grow out of its problems.

The administration's plan also would permit foreigners to take larger ownership positions in the banks. Such a prospect is distasteful to many legislators, however, who feel outsiders are snaring too many Mexican resources.

Right now, no solutions appear imminent to the dual dilemmas of strengthening the banking sector and bailing out Fobaproa.

The audit of the bailout agency is due in September. Meanwhile, key congressional members and administration officials are negotiating. But don't expect an agreement for at least two months, Creel said.

Any resolution that solves the economic problems, he said, must also address previous wrongdoings.

"What we want is the rule of law, certainty for investors, for property rights and that anyone can compete in Mexico without corruption and closeness to political officials," he said. "This won't be a deal that says things are immediately OK and we have passed a crisis. . . . But things will certainly be different in the future."

Mexico's banking woes

** Proposed Mexican bailout -- $65.5 billion

** Mexican GDP -- nearly $400 billion

** U.S. savings & loan bailout -- $180 billion.

** U.S. GDP at the time -- more than $3 trillion

** Moody's ranking of Mexican banking system -- 67th out 70 countries ranked

** Total paid for Mexican banks in reprivatization -- $13 billion to 15 billion.

** Amount of post-1994 devaluation rescue led by United States -- $50 billion

What happened

Many of Mexico's bank woes can be traced to problems in the nation's political system.

** In 1982, President Jose Lopez Portillo nationalized the nation's banks following a peso crash -- a move unlikely to have happened in a pluralistic political system with a strong Congress providing checks and balances.

** During President Carlos Salinas de Gortari's 1988-94 administration, the banks were reprivatized. But many were sold to political cronies who then made improper loans to themselves and bad loans to others.

** President Ernesto Zedillo took office in December 1994 three weeks before the peso crashed. In the recession that followed, banks were left holding many bad loans. Zedillo used Fobaproa to buy up the loans and rescue the banks. Critics charge the rescue effort benefited bankers rather than the public at large, and left Congress out of the decision-making process.

GRAPHIC: 1. (1 Mexican bank note) (Eds. 1,2,3,4,5,6,7) 2. Mexico's banking woes (A-22) 2. UNION-TRIBUNE

LANGUAGE: ENGLISH

LOAD-DATE: July 10, 1998