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Mexico’s Financial Crisis.

Extracts from this document...

Introduction

MEXICO'S FINANCIAL CRISIS This essay is engineered at discussing and analyzing the Financial Sector Crisis experienced by Mexico in late 1994, labeled the 'PESO CRISIS'. The crisis of international investor confidence in Mexico expanded to several other Latin American countries, notably Argentina. In analyzing this particular event, we will first examine what caused the collapse. We will proceed to look at situations that may have led to this event. The discussion will be formulated into multiple aspects, namely factors surrounding policies in place, the economic and non-economic environment prior to, during and after the crisis. However, the broader aspect of our discussion will reflect a macro and then a micro economic perspective. When we speak of Macro, we will be specifically referring to Government policies and Macro-economic indicators i.e. Inflation, Exchange rate, Interest rates. From a Micro- perspective, we shall look at the effects on financial institutions, as well as the management practices exercised by some of these institution's leaders. In addition, we will delve into other factors that may have led, whether directly or indirectly, to what some analysts have termed the worst crisis of the 20th century. We shall open our discussion by first defining what is a financial sector crisis and the importance of a strong economy to the general well being of a country. The financial Sector is an integral part of any country's development and stability (or presumed stability) in this area the financial sector is a very important factor that leads to any form of confidence and most importantly potential investment. Any fears or concerns can lead to a domino effect on the stability and confidence in the sector and the entire economy on a whole. There may be a reduction in, say, consumer spending which may lead to a reduction potential income thus a reduction in investment and interest. We shall first examine the crisis of Mexico from the Macro Economic perspective, then we shall enter into the micro economic aspects of things. ...read more.

Middle

This most recent point puts us to a very important conclusion as to why it was wrong of the authorities to think that adequate regulations were in place to prevent inevitable catastrophe. Additionally; Bankers had found ways of circumventing regulation (which some saw as just plain 'red tape') to facilitate further credit extension thus when the peso devaluation of late 1994 had occurred, most of the authorities, who were downplaying the impact on the banking sector that this would have, were surprised at the extent of exposure the Mexican banks were experiencing. The banking sector was, through the massive expansion of credit and the privatization of banks, experiencing an influx of credit. There, also, was not a proper regulatory framework in place, this maybe due to the fact that these banks were for years owned by the public sector, so the necessary expertise were not in place to exercise prudent screening of potential borrowers and excessive risky business was acquired by these lending institutions. Thus, was the banking sector not due for a crisis eventually, considering the apparent situation? Additionally, however, there was the peso crisis which would prove even more detrimental for the sector as most of the loans were under foreign currency arrangements thus when the peso fell in value most borrowers, expectedly, defaulted on their loans. Even though most banks were able to cover their exchange-risk there were the borrowers which, as mentioned, had taken foreign denominated loans and thus were unable to service their own loans thus what occurred for the banks was the transformation of foreign exchange risk to credit risk. The main impact on banks came through devaluation of interest rates and inflation where increased inflation and interest rates parallel with a reduction in real income proved most borrowers unable in the servicing of their loans. In essence, we see what the real cause was for the crisis. ...read more.

Conclusion

FOBAPROA. This institution is somewhat similar to FINSAC of Jamaica and the U.S.'s resolution trust company. However, as with Finsac, Fobaproa faced the problem of the every increasing cost of operating. The Mexican administration, in its effort to deal with this problem; the bad debt was converted into public debt and the reason behind this decisions was the argument put forward by some analyst that if this was not done then there would have been extensive pressures on the domestic banking industry. It must be argued however that the public cannot be held responsible for the bad management practices of a few institution heads. Analyst have put forward the argument that proper measures should be put in place to make these heads pay or face prosecution, as in the case of Enron in the United States where a few of the ceo's of the failed energy giant were giving jail time for illegal accounting practices. In concluding we see that a deliberate attempt was made to offer a qualitative analysis of the crisis Mexico faced and the measures that were put in place. The underlying problem involved in all countries experiencing or who had experience a crisis; South East Asian countries, Jamaica, Argentina all in the 1990s, United States in the form of the energy giant Enron (2001), and the Dominican Republic (presently), are accounting mismanagement practices. The continued maneuvering of regulation to expand asset base carelessly and the undertaking of high-risk ventures without prudent investigating will always lead to disaster. Regulations that are put in place must be above board transparency is a must. The cost to the sector is too enormous to allow the attitudes of a few institution heads as the cost of bailing out a sector usually rests on the shoulders of the tax-payer as in the case of Jamaica where the cost to the economy of the financial crisis is estimated at 353 billion dollars which has been converted from private debt to public debt. ...read more.

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