U.S. Federal Reserve Monetary Policy and the First Crisis of Securitization: Mexico and Latin America, 1994-1995

Abstract

The decisions of the Federal Reserve of the United States (Fed) determining interest rates have played a critical role in capital inflows/outflows toward Mexico and Latin America. The causal relationship that exists between the Fed and emerging markets is quite close; a clear example of this is the first crisis of securitization on the global level, which originated in Mexico in 1994. The monetary policy of the Fed supported the expansion of U.S. investment banks and some institutional investors, thus creating not only an enormous bubble in Mexico and other local financial markets in Latin America through the expansion of portfolio investment, but also successive financial crises during the 1990s when those financial capital flows reversed themselves. This article analyzes the factors determining the composition of international capital inflows/outflows during those years. Instead of being new commercial bank credit, these flows were propelled forward by the global movement toward securitization, which began in the second half of the eighties and became more dynamic starting in 1991, immediately after renegotiation of the external debt within the framework of the Brady Plan. The article goes on to present the first crisis of securitization in Mexico and some other Latin American countries. In Mexico specifically, U.S. investment banks and some institutional investors participated in the new surge of international financial markets through the net portfolio flows that were placed in private and public sector securities. The change in the Fed's monetary policy led to a massive shift of capital into other markets, and the most devastating banking and economic crisis in Mexico's history.