Federal Reserve, monetary policy and first securitization crisis: Mexico and Latin America, 1994-1995

Abstract

The decisions of the the Federal Reserve (Fed) of the United States (US), through its determination of the interest rate and its monetary policy, have played a determinant role in the course of capital flows towards Mexico and Latin America.  It's the history of the past and the present. The causal relationship that exists between the Fed and emerging markets is quite narrow, and a clear example of this was the first crisis of securitization on the global level originated in Mexico in 1994.  The monetary policy of the Fed supported the expansion of investment banks and institutional investors, creating an enourmous bubble in local market with foreing capital portfolio investment, but with expectations of short term profitability in dollar, creating successive crises of great magnitude in the decade of the nineties when these flows  reversed.

At the beginning of the nineties, the major Latin American economies change from negative net capital transfers that accumulated amount of 221 billion dollars between1982-1990, towards huge net flows between that amount 264 billion dollars between 1991-1995.  This partially is explained by the decrease in the public external debt obligations, but also is linked with the new dynamism in the securitization of these flows. This article analyzes the determining factors in these international capital flows composition to and from Latin America. More than commercial banks new credits, this flows were impulsed by the global movement towards securitization which begun in the second half of the eighties and which began to become more dynamic from 1991 onwards, immediately after the renegotiations of the external debt in the framework of the Brady Plan.  The article goes on to present the first crisis of securitization in Mexico and in the rest of Latin America.  In Mexico specifically, investment banks and institutional investors participated in the new surge of international financial markets through the net portfolio flows placemented in private and public sector securities. The change in the Fed's monetary policy led to a massive reshifting of capital into other markets, and the most devastating banking and economic crisis in Mexico's history.