The framework described in the previous chapter presents the bare bones of the genesis, buildup, and downward spiral of a generalized financial crisis as it occurs in an emerging market economy. To really understand the specifics of why financial globalization can go so wrong and what policies are needed to make it work, we need to examine specific crises in more detail. We will look at the villains, and sometimes the heroes, in these episodes.
The case studies in this chapter and the two that follow illustrate many key themes of this book. First, financial crises are primarily homegrown and can result from inadequate prudential regulation and supervision, perversion of the financial globalization process by powerful business interests, irresponsible fiscal policy, or any combination of these factors. Second, a peggedexchange-rate regime and liability dollarization (in which debt is denominated in foreign currency) are a deadly combination that leaves emerging market countries highly vulnerable to financial crises. Third, because strategies that work well in advanced countries often do not translate to emerging market countries, “one size fits all” policies can be dangerous. Fourth, government officials often delay the inevitable and sweep difficult problems under the rug shortly before financial crises begin, making the crises much worse. Fifth, crises become far worse if the response to them is slow and confidence is not restored quickly.
In this chapter we look at the Mexican crisis of 1994–95, which Michel Camdessus, then the managing director of the IMF, described as the “first financial crisis of the twenty-first century, meaning the first major financial crisis to