SAIS Europe MAIA Thesis Abstract:
Financial Labyrinths: How Latin America Can Escape a History of Crises

Latin America's history from independence onwards is a story of external capital dependence, and financial crises. A moment of quiet was reached during the post-war years thanks to the controls built into the Bretton-Woods system. After the system's collapse, Latin America has suffered a string of financial crises that have generally been attributed to the same structural weaknesses on its fundamentals. But not all crises are the same, albeit some similar dynamics and outcomes.

Starting with the 1980s crisis, each crisis in Latin America has differed from its predecessors, and has left behind a specific set of lessons. A common thread, however, can be found on the constant dependence from foreign capital to fuel investment and development. A feature that leaves Latin America on the hands of the financial system's hegemonic players, and their will to keep—or not—the stability required.

Now, the analysis of financial crises in Latin America is relevant for, at least, three reasons: (1) Latin America's crises-filled history provides the perfect, yet unwilling, laboratory for financial crises study; (2) the financial sector is connected with the real economy; in Latin America, that means development. Plus, a crisis has costlier effects than the average recession; and (3) Latin America's dependence on external foreign capital, historically the US yet increasingly from a diversified portfolio, makes the region particularly prone to volatility.

To analyze the crisis-prone history, four cases are considered: the 1982 Debt Crisis, the 1994 Tequila Crisis, the 1997 Asian Crisis spread to Latin America, and the 2008-9 Global Financial Crisis. In each of these case studies the research analyzes the causes of the crises; the lessons each crisis left; what can be done to internalize those lessons; and finally, what is the political architecture needed to do so. The result highlights two relevant aspects: first, the diversity of the crises, that is, not all financial crises are the same. Second, a common thread can be drawn from these historical examples in the role played by the financial hegemonic player and its stabilizing effect, or lack thereof.

The solution of the four crises will then provide a framework of lessons that can be translated into few institutional fixes and/or political agreements that could lead to the financial emancipation of the region, i.e., a more resilient market. This framework of lessons will address: (1) moral hazard, through political agreements that look to avoid overspending/overborrowing when markets are too willing to lend. (2) Original sin, by mutualizing risk among countries through a financial asset supported by a pool of currencies. (3) Sudden-stops, through temporary and flexible capital controls; and self-fulfilling crisis, through self-insurance as long as the hegemonic lender of last resort's capacity remains contingent. And finally (4) contagion and pegged currencies, through the development of a regional domestic market. All four of these solutions aim to respond to the challenges of a more volatile, casino-like financial system in the post Bretton Woods world.