Grasping Reality on TypePad, by Brad DeLong

Browsing through the newly online Brookings Papers on Economic Activity reminds me of the days when the then-junior senator from New York, Alfonse D'Amato, accused me of withholding from Congress a report on the Mexican economy by Rudi Dornbusch and Alejandro Werner that the Brookings Institution had printed up in a print run of 7,000--and when the Washington Post printed D'Amato's charge without demurer...

Hoisted from the Archives: January 21, 1998:

Last week I came across an old Washington Post clipping from March 2, 1995. The story was by Clay Chandler. The headline was: "TREASURY AIDES' MEMOS WARNED OF PESO PLUNGE... ADMINISTRATION DIDN'T HEED SIGNALS." It brought back memories, for I worked at the Treasury, and the not-very-senior aide in the headline--one of them, at least--was me.

According to the story, I had warned eight months before the crisis that Mexico was in trouble. I had advised senior officials to "pay careful attention" to M.I.T. Professor Rudiger Dornbusch's predictions of trouble . The story quoted my "bottom line: peso overvalued..." In the passive voice and subjunctive mood, the reporter--Clay Chandler--concluded that my memo (and two others) "bolster[ed] ... [the] charge that {Clinton administration] officials missed warnings of trouble" and lent support to "critics of... handling of the Mexican crisis": staff warnings had been ignored.

But the story was false.

I had not warned anyone in April 1994 that Mexico was in trouble. No one needed to tell anyone to pay close attention to Rudiger Dornbusch, who has been one of the most insightful analysts of international currencies for a quarter of a century. What the article reported as my bottom line was in fact Dornbusch's assessment. And in April 1994 I dismissed it. I called it possible but unlikely: the Mexican government had only recently intervened to keep the peso from rising. The market was pushing the peso up, not down.

I wish that I had forecast the collapse. But every half-competent economist and financial reporter knows such collapses, whether in Mexico or in East Asia, can't be reliably forecast. They depend on a sudden psychological conversion of the community of investors: consensus that investments were profitable and attractive turns, suddenly, into consensus that investments are dogs.

The best that economists can do is note situations in which such a crisis is possible. But as I (wrongly) read the situation in April 1994, the Mexican peso did not look like a bubble about to burst. Even Dornbusch--out on the (then) extreme of economists' positions--thought the worst-case outcome for the next year was a small devaluation (along the lines of Britain's devaluation of 1992), not the large collapse and a subsequent severe depression (alleviated only by the peso support package).

So why write a story full of half-truths spun into whole lies? That's not a terribly interesting question. This is not your mother's Washington Post--indeed, it never was. In Washington not-very-good reporters bossed by not-very-good editors print a lot of one-sided stories. They find the story--gift-wrapped, with a ribbon and a bow--on their front step. They print it because they want to go home early, or because they want someone to owe them a favor.

What is interesting is: who boxed and wrapped the story? The answer is as clear as if muddy prints led from the pond where the victim drowned to the suspect's front door: Alfonse D'Amato.

The lead refers to "sources familiar with the documents" that detail Treasury staff thinking about Mexico in 1994. The story discusses Senator Alfonse D'Amato (R-N.Y.) and his request for "all records... on Mexican currency policies and any assistance... provided Mexico." In Washington-speak, this juxtaposition says that "sources familiar with the documents" are Senator D'Amato's staff at the Banking Committee, and that they selectively leaked the documents.

In Washington-speak, the story tells us that it is a plant by Senator D'Amato to support his claims that the Treasury Department lied and covered-up, and so Congress should stop the loans form the U.S. and the IMF to Mexico. (Never mind that the claims were ludicrous: the story could have--but didn't--point out that the April 1994 "information" D'Amato said the Treasury "withheld" from Congress was Rudi Dornbusch and Alejandro Werner's article that had in fact been published in the spring 1994 edition of Brookings Papers on Economic Activity.)

And when I realized that it was D'Amato who was the prime mover, I was amazed.

There were arguments against supporting the peso. I think they are weak, and that when such arguments dominated economic discourse they brought us the Great Depression. That they were wrong in this case is conclusively shown by the fact that everyone gained from the peso support package (although Mexican workers gained far less than had the U.S. put up more money and loaned it to Mexico for a longer term).

But these arguments, boiled down, amount to the claim that New York City is too large and too well-off a place: the world financial industry should be smaller, less money should be flowing through New York, and much of the financial-sector employment in New York should simply not exist. So I was astonished to see Alfonse D'Amato making them.

I was amazed because I had never before seen a Senator try his very best--using every political trick in the book, and some that added new (to me at least) pages to the book--to shrink the major industry that employs his constituents.

And now it looks like he is about to do it again. A strange alliance of the left and the right against the center is forming to try to keep the International Monetary Fund from gaining additional resources to manage possible future financial crises. Hearings will be held. I think the case for topping-off the IMF's funding is very strong, and is especially strong for anyone who lives in New York City. And what does the junior Senator from New York say? Publicly, he is on the fence--but worrying about "taxpayer dollars... put at risk" through IMF expansion.

Here, from the Post's electronic archives, is a later version of the story, missing the direct and out-of-context quote from my memo "bottom line: peso overvalued" that told me what Clay Chandler was looking at when he wrote his article:

Treasury Aides' Memos Warned of Peso Plunge; Critics Say Administration Didn't Heed Signals [FINAL Edition]
The Washington Post (pre-1997 Fulltext) - Washington, D.C.
Author: Clay Chandler
Date: Mar 2, 1995
Start Page: C.11
Section: FINANCIAL
Text Word Count: 745

Treasury Undersecretary Lawrence H. Summers, the Clinton administration's senior official for international finance, was warned of potential economic problems in Mexico in at least three separate memos during the eight months before the peso's collapse, according to sources familiar with the documents.

Congressional critics of the administration's unprecedented $20 billion bailout of the Mexican economy say they want to know whether Treasury Department officials missed warning signs of impending trouble in the months leading up to the peso's spectacular collapse, and what advice they may have given Mexican officials.

Two of the memos from Summers's subordinates -- one written in April and the other in September -- recommended he pay careful attention to papers written by Rudiger Dornbusch, a Massachusetts Institute of Technology economist widely respected for his expertise on developing Latin American economies.

Dornbusch, whom Summers has known since Summers's days as a Harvard University graduate student, had been warning since the beginning of 1994 that the peso was overvalued by at least 20 percent and that failure to devalue the currency quickly could result in a painful peso collapse later.

A third memo, passed from staff to Summers through Deputy Assistant Treasury Secretary Timothy F. Geithner in late November, warned that the Mexican economy had seriously deteriorated and recommended the Treasury Department begin "contingency planning" in anticipation of a possible financial slump in the Latin nation.

These documents, whose authenticity was not disputed by Treasury Department officials, could bolster critics of the administration's handling of the Mexican crisis who charge that officials missed warnings of trouble.

Treasury Department spokesman Howard Schloss said the memos buttressed the administration's argument that officials were on top of events.

"These leaked documents, one of which may be classified, confirm what we have been saying all along," he said. "Senior officials at the highest levels of the Treasury Department were alert to potential financial problems in Mexico throughout 1994." Schloss said the officials "monitored the Mexican economic situation closely and communicated appropriately with their Mexican counterparts."

Yesterday was the deadline set by Senate Banking Committee Chairman Alfonse M. D'Amato (R-N.Y.), who plans hearings on the administration's handling of the Mexican bailout, for Treasury Secretary Robert E. Rubin to turn over all records from Jan. 1, 1994, to the present on Mexican currency policies and any assistance the Treasury Department provided Mexico.

A Treasury official said that while 260 pages of material had been turned over to the committee by yesterday, all the requested documents would not be forwarded by D'Amato's deadline. Documents also have been sent to the House Banking Committee.

"We're getting the runaround," D'Amato said last night. "This is absolute and total nonsense . . . I know darn well that the administration received information that should have alerted any prudent person that there were problems with the Mexican economy and then ignored it and withheld it from the Congress."

D'Amato made similar requests of Secretary of State Warren Christopher and Federal Reserve Chairman Alan Greenspan.

Yesterday, the House voted 407 to 21 to ask the administration to turn over within 14 days a long list of documents concerning the Mexican rescue.

The September memo also included assessments of the Mexican economy's prospects by Fed officials and by Wall Street economists and analysts. The Wall Street experts, contacted by Treasury officials and not named in the document, offered predictions about Mexico that ranged from bullish to bearish, the sources said.

How much Mexican officials understood about the stability of their nation's economy also remains unclear. In recent days, senior aides to Mexican President Ernesto Zedillo have leaked accounts of an October confrontation between Zedillo and then-Mexican President Carlos Salinas de Gortari.

According to the accounts, Zedillo, who was elected in August but was not sworn in until December, repeatedly urged Salinas to devalue the peso before leaving office. But Salinas, concerned about his political legacy and mindful of his bid to head the new World Trade Organization, rejected the plea.

Also yesterday, House Republican leaders dismissed a colleague's suggestion of a conflict between Rubin's handling of the Mexican financial crisis and his previous role as co-chairman of Goldman Sachs & Co., a major underwriter of Mexican stocks and bonds.

"I don't have any evidence to that effect," House Speaker Newt Gingrich (R-Ga.) told reporters at his daily briefing. Rep. Spencer Bachus (R-Ala.), chairman of the House Banking subcommittee on oversight and investigations, has said he would hold hearings on that question.