Americans — at least those born after the Great Depression — aren’t very accustomed to dealing with financial panics. The same can’t be said for their southern neighbor, whose emerging economy suffered calamitous shocks as recently as the 1990s.
“We’re always in a mess,” joked Pedro Aspe, who served as Mexico’s Secretary of Finance from 1988 to 1994, during a recent Wharton Leadership Lecture. Consequently, “we are really good at judging messes. In the last 25 years of my life, I have had experience with six or seven crises, some of them of my own making. I have learned some things.” Today, he said, “it’s the Americans who are in a mess,” and the resulting recession, he predicted, “will be longer and more complicated” than first envisioned.
An economist with a PhD from the Massachusetts Institute of Technology and membership on the board of directors of McGraw-Hill, publisher of Standard & Poors, Aspe spoke at length about the global economic situation before briefly discussing one of his other business ventures, a fast-growing, low-cost Mexican airline.
Apartment Hunting in Miami
According to Aspe, the current economic turmoil can be traced to two liberalizations: One that transformed the mortgage market and another that did the same for the investment banking system. In the U.S. housing market, “Everybody was saying, ‘Oh my God, they have a boom in real estate.’ But … it wasn’t a permanent boom.” Eventually the housing market would collapse.
Aspe had first-hand experience with the U.S. real estate market in 2005, during a weekend in Miami with his wife and three of her friends. On Saturday morning, “one of the ladies said to me, ‘You know a little bit about finance.’ And I said, ‘Well, I’m supposed to.’ And she said, ‘Why don’t you come with me because I’m supposed to buy an apartment.’”
Aspe tried to explain that his field of expertise involved “nothing useful,” but he agreed to go with the four women to meet the broker. As Aspe tells it, the broker said: “What I want is to sell at least two apartments to the four of you. So I am ready to tell you that the down payment is not 30%. It is 2%.” Did they have that much? No. The broker asked how much they did have. “One of women said, ‘$5,000.’ And the broker said, ‘Sold.’” It amounted to 2% down. The woman got out a credit card, the broker swiped it and the apartment was hers, according to Aspe.
They returned to the hotel where Aspe remembers thinking, “The Americans are really crazy. They are selling an apartment for 2% down payment on the premise that prices are going to increase 15% per annum.” Back home, he followed the apartment’s progress. During the first three years, the place appreciated rapidly, as advertised. And then, in about the time it took to swipe the credit card, the situation changed. “What’s the problem in the U.S. if you buy a house with only 2% down?” Aspe asked. “If the price of the house goes down more than 2%, what do you do? You return your apartment. And that’s exactly what is happening.”
As it happened, established banks were acting just as recklessly. Turning to the liberalization in the banking industry — which included the very people who fronted the money for all those 2% apartments — Aspe displayed a chart showing the degree to which firms like Deutsche Bank, UBS and Bear Stearns had become highly leveraged. He then turned to what he described as a massively flawed response on the part of his former counterparts in the U.S. financial bureaucracy once these establishments started teetering. “What do public servants of the treasury ministry in Kazakhstan, Guatemala, Germany, the U.S., Russia and Mexico have in common? The only thing we know is that banks can fail, but you never, never, ever file for bankruptcy…. Why? Because there is something called interbank lending.”
Banks’ willingness to lend to one another is the key to a financial system’s confidence — a confidence that is undone when a big bank goes belly-up and no one comes to the rescue, Aspe said. “The U.S. Treasury Secretary decided to innovate,” he deadpanned, by letting Lehman file for bankruptcy. The LIBOR (London Interbank Offered Rate — an interest rate at which banks can borrow funds from other banks in the London interbank market) shot up and the crisis was on. “By the way, that was really creative. They globalized the problem from the U.S. to everyone and across sectors…. It opened up the whole enchilada.” Subsequent government tinkering, including slashing interest rates, failed to bring down 30-year mortgage rates, Aspe said.
Your Home and Your 401(k)
Looking forward to other would-be solutions, the assumption was that Washington would run a public deficit of between 4% and 5%, according to Aspe. But a new administration, with plans for a middle-class tax cut and talk of major infrastructure investment to stimulate the economy, could dramatically raise that figure. “So you are going to have a debt problem,” he said. And while he agrees with not hiking taxes in a recession, “there is a cost. And it’s going to be very interesting what the IMF tells the U.S. I imagine they are not going to say much.” Further complicating the American outlook: a strengthening dollar, which makes exports more costly, a global recession that spans Europe and Japan, and deceleration in the Indian and Chinese economies.
During past downturns, Aspe noted, the government has primed the pump and then relied on consumer spending to pull the country out of recession. But this situation, he said, is different because real estate is central. For average U.S. consumers, net worth comes down to two things: the value of their home and the value of their 401(k). Both have been clobbered. “When you have a negative wealth effect two years in a row, do you think the average consumer is going to switch cars?” The Detroit carmakers, he said, downgraded their projections from 17 million annual sales to 12 million this year, and predict 10 million cars a year going forward. “I don’t think the consumer, this time, can help the U.S. economy out. The consumer is overburdened with debt…. It will have to be corporate investment plus the infrastructure program that President [Elect] Obama has promised.” Both types of spending, of course, are much smaller percentages of a total economy than the consumer variety.
Asked whether he believed certain strong Latin American economies, like Peru’s or Panama’s, might be immune from the downturn, Aspe said he believed no one was immune in a global economy. His own Mexico will take a massive hit because the seven major sources of foreign income — from oil to auto parts to remittances from workers in the U.S. — are all in trouble. But the same goes for Brazil, far less connected to North America’s ups and downs. “The Brazilians say, ‘We are different. We don’t export so much to the U.S. We export more to Europe.’ Well, bad luck! Europe entered into a recession before the U.S.”
But Aspe did not forecast any major philosophical assault on the modern market economy. Rather, he said, attention would be paid to what sort of regulatory techniques governments will use now that the crisis had exposed the current system’s potholes. As an example, he cited Chile, where two different deregulatory efforts had been launched. The first was a colossal failure. The second has helped make the country Latin America’s most advanced. “It’s not about Marxist versus market economies,” Aspe said. “It’s about good deregulation versus bad deregulation.”
The same goes for bailouts. Aspe predicted it would be hard for Washington, after twice rescuing AIG, to say ‘no’ to the national icons that are the Detroit automakers. But, he said, there was a right way and a wrong way to help. “I would fire all those managers. They are really bad. When we buy a Toyota or a Honda and not a Chevy, we are not crazy…. If [the government provided funds] just as a handout, are things going to be improving?”
Aspe concluded his talk by offering some “tales from the south,” about his career in and out of government. These days, one big component of that career is Volaris, the 20-plane low-cost carrier that is taking on Mexico’s two mammoth legacy carriers and has just joined with America’s Southwest Airlines and Canada’s WestJet to ferry passengers all around North America. “It is tough to compete with the big guys, but it is fun,” he said. Among the line’s innovations: Labor contracts that reward workers for quick loading and unloading of airplanes — and penalize them for slow service, too. The contract calls for Volaris to load and unload planes in 27 minutes.
A CEO of the Mexico City boutique investment bank Protego Asesores Financieros and co-chairman of boutique investment bank Evercore Partners, Aspe also urged his audience of business students to view positively their departure from the ivory tower and their entrance into a recessionary economy. “I think it’s a wonderful thing to go back in the middle of a troubled year because the investments you can make are really, really interesting,” he said. “For private equity, this is really the moment.”
Aspe also predicted that despite the campaign-season rhetoric, Washington would not back away from free trade with Mexico and beyond. He was in government when Bill Clinton was elected in 1992 after a campaign that featured similarly mixed messages about trade. Aspe’s side was distinctly worried before their first sit-down with Clinton administration negotiators hammering out the NAFTA accords. “I was scared to death,” he said. As it turned out, the man on the opposite side of the table was Lloyd Bentsen, Clinton’s first Treasury Secretary and one of Aspe’s old fishing and hunting buddies. The negotiations turned out to be easily managed. The U.S., he said, “has been extremely clever in using free trade as a means to expand and to grow its economy.”