(en)The Politics of Bailouts

Ewald (ewald@ctaz.com)
Fri, 31 Jan 1997 18:29:46 -0700

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From: Survival Center <survival@gladstone.uoregon.edu> To: The Student Insurgent <insurgnt@gladstone.uoregon.edu> Cc: CURRENCY@pimacc.pima.edu, econ-lets@mailbase.ac.uk Reply-to: CURRENCY@pimacc.pima.edu Comments: Discussion list for complementary currency and exchange systems

The Politics of Bailouts

By Christopher Whalen

The Clinton Administration announced on January 15 that Mexico would repay the remaining funds owed to the U.S. Treasury following the February 1995 bailout by Washington. President Bill Clinton took the opportunity to celebrate the early retirement of the $12.5 billion loan and chide his critics, saying that those who opposed the bailout of Mexico early in 1995 "were wrong."

Clinton, Vice President Al Gore, Secretary of the Treasury Robert Rubin, and Mexican ambassador to the U.S. Jesus Silva-Herzog signed a protocol ending the 1995 Mexican bailout loan agreement. They also announced that Mexico would pay back the last $3.5 billion owed to the Treasury this week, as well as $1.5 billion owed to the IMF (Mexico still owes the IMF $11.5 billion). It must be said that virtually all of the funds used by Mexico to repay the loans were borrowed from private investors in the Eurobond market and elsewhere, adding to that country's crippling foreign debt, but such distinctions seemingly are unimportant in Washington.

Coincidentally, just days before the Clinton Administration announced the repayment by Mexico, the U.S. Court of Appeals for the Second Circuit scheduled oral argument in a case challenging the Mexican bailout and the mechanism used by the Treasury to provide the funds without a congressional appropriation, Schultz v. State of New York. The arguments will take place on Friday., January 31 at 10:00 a.m., in the Second Circuit's courtroom at 40 Foley Square, in Lower Manhattan, New York.

Another interesting coincidence: Just after the White House ceremony to retire the Mexico loan, Treasury Under Secretary Jeffrey Schaffer, one of the main architects of the 1995 bailout, announced that he will be joining Salomon Brothers. Schaffer's affidavit is the Treasury's main piece of evidence in the Second Circuit case Indeed, without Schaffer's direct participation in the legal process, Assistant Secretary Lawrence Summers or even Secretary Rubin himself may be forced to appear in court to defend against the lawsuit. So far, despite having reached the appeals court level, there has not yet been a hearing on the basic facts in the case and the Treasury has only conceded on the question of sovereign immunity.

Of course only a supremely cynical observer would believe that the U.S. Treasury would attempt to circumvent a court challenge to the Treasury's bailout mechanism (which it certainly wants to use again) by arranging an early payoff of a loan to Mexico; a loan outstanding for almost two years that was repaid only two weeks before oral argument in federal court. Surely our democratic government in Washington does not work this way. Better think again.

The fact is that the bailout loan to Mexico in February of 1995 was made through the Exchange Stabilization Fund (ESF), a legally suspect and Constitutionally questionable financing mechanism that is, by law, specifically excluded from the federal budget and over which Congress has no authority. FDR sought and received authorization for creating the ESF as part of the Gold Reserve Act of 1934. Subsequent legislation enlarged the scope of the ESF to include intervention to support the dollar and, in 1977, emergency loans to foreign governments. Yet even today, the statute provides no explicit authority for the type of currency market intervention regularly conducted by the Federal Reserve and Treasury.

Some observers might suppose that the decision to repay the U.S. rescue loan was part of the larger Administration effort to convince the investment community that the Mexican economy is recovering, but in fact there are other factors at play. From time to time, members of Congress have questioned the need for the ESF and foreign exchange market intervention generally. Most conservative economists see foreign exchange intervention as an act of futility (at best) and as gross political manipulation of markets (at worst). The legal challenge raised by the Schultz case has the potential to deprive the Treasury of the very financial facility that it has used to prop up the dollar since the early 1960s, and make loans to Mexico and scores of other authoritarian countries over the past decade or more.

Plaintiffs in the Second Circuit lawsuit originally sought an injunction to stop the bailout, prevent further loans to Mexico and. most important, obtain a judgment finding that the federal statute which authorizes the (ESF) is "illegal and unconstitutional." With the Mexico loan terminated, the plaintiffs now are focusing on the second objective and hope to prevail by rendering the Gold Reserve Act moot.

Walker Todd, the Cleveland-based attorney for the plaintiffs, says that a finding in their favor would shut down the ESF and "force the Treasury to come to Congress hat-in-hand for an appropriation for future bailouts." Todd, a former official of the Federal Reserve System and an outspoken critic of the Treasury's use of the ESF for periodic bailouts and foreign exchange intervention, is confident that his clients will at least get a fair hearing. But other close observers of the case believe that the Treasury will work some political machination to deprive the plaintiffs their day in court.

It is no small irony that a group of patriotic American business people and academics, represented by a former official of the Federal Reserve System, has been able to mount a more effective legal challenge to the Mexico bailout than was presented by the entire U.S. Congress following the Mexico meltdown. If the plaintiffs in Schultz are able to prevail, however, an odious era of official market manipulation and foreign intrigue will be at an end. Next time the U.S. Treasury wants to bailout a foundering client state, whoever occupies the White House will be forced to go before Congress and ask for the necessary billions of dollars openly, in the full light of day, a welcome change from the under-the-table manner in which the rescue of profligate Mexico was achieved in 1995.

Christopher Whalen is a financial analyst who writes from New York. He founded The Mexico Report in 1992 and served as editor of that fortnightly newsletter until the end of 1996.

R.C. Whalen

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