Stocks, Peso Keep Falling as Investors Shun Mexico : Economy: Crisis threatens to spread to troubled banking system, sends jitters through Latin America.

Investors fled Mexico on Tuesday as the stock market plunged further and the peso lost more ground, mocking the government’s rescue efforts and sending shock waves throughout Latin America.

The country’s 22-day-old currency crisis threatened to spread to its already troubled banking system and to undermine the national solvency. President Ernesto Zedillo, a Yale-educated economist, was apparently unable to stop it.

“Mexico is losing,” lamented one stock trader, smoking nervously on the steps of the capital’s trading floor, where shoving matches broke out as warning bells signaled that the close of trading was near.

Only after the intervention of Mexico’s development bank, Nafinsa, did the market bottom out and recover slightly. But it still closed below 2,000, at 1,972.33, down 131.72 points, or 6.26%. Nafinsa bought up “a lot” of stocks late in the day, a bank official said.

The peso lost 30 centavos, reaching 5.75 to the dollar compared to 5.45 Monday, after the government failed a litmus test of confidence: Investors bought only $63.7 million of the $400 million in dollar-backed government bonds, or tesobonos , that were offered at 20% yield.

“People just want to take their money out of Mexico and put it somewhere else,” said Brian Barish, an analyst at Lazard Freres in New York. “People are afraid of currency controls or other measures, and even at a 20% yield they do not have the confidence to step in front of that kind of risk.”

With $684 million more in tesobonos scheduled to mature Thursday, the failure of Tuesday’s sale constituted a run on Mexico. “Mexico used to have just a currency crisis. Now they have a full-blown solvency crisis,” Barish said.

Mexico’s stock-market jitters were duplicated Tuesday in Brazil, Argentina, Chile and Peru. And as uncertainty spread throughout Latin America--where many countries have undertaken difficult free-market reforms dependent on foreign investment, as Mexico did--the threat to Mexico and the rest of the region attracted high-level concern in Washington.

“It is enormously important that we work with Mexico and help them work themselves through this current difficulty, not only to help Mexico, but to make sure that (it) does not spill over and interfere with the realization of the very substantial potentials in Latin America,” Treasury Secretary-nominee Robert E. Rubin told a Senate confirmation hearing.

As early as next week, Mexican officials expect to try to lure tesobono investors with bonds backed by U.S. government debt. Funds for that option are expected to come from the $9-billion credit line the U.S. government has already announced.

Nearly $20 billion has already fled the country in less than a year, first because of worries about political instability and then, more dramatically, because of the peso devaluation announced Dec. 20. Since then, the peso has lost about 40% of its value against the dollar.

The Mexican government has tried to regain investor confidence with an economic-emergency plan that includes an $18-billion line of credit with international lenders. Top government officials are in foreign capitals this week pitching their plan. But none of the government’s actions are working.

In particular, investors worried that Mexico’s banks--already saddled with large bad-loan portfolios from aggressive lending in recent years--could find themselves adding an overwhelming number of clients to the default list as the economic crisis continues.

One U.S government banking official who asked not to be named said that one “well-known Mexican bank” is reporting “severe liquidity problems.” He said U.S. banking regulators were dispatched this week to assess the overall condition of Mexico’s banks.

But the fast pace of events and the minimal reporting requirements of Mexico’s banks made it difficult to gauge the severity of the problems facing the nation’s banking industry.

The steep increase in interest rates and disappearance of dollar investors creates enormous pressure on the banks. They have to pay depositors much higher rates for money than they can hope to collect from borrowers.

The skyrocketing rates mean that consumer credit could all but disappear in Mexico, analysts warned, which could raise intense political problems for Zedillo.

The effects of the crisis spread to Mexico’s auto industry Tuesday as Volkswagen announced a weeklong halt to production at its huge Puebla plant because Mexicans have all but stopped buying cars.

Meanwhile, some analysts appealed for calm and insisted that the Zedillo government is doing the right things.

“It is psychosis,” said a perspiring trader for Banorte Brokerage, who asked that his name not be used. “The people’s actions are psychological. They do not believe in anything anymore.”

Darling reported from Mexico City and Kraul from San Diego. Times researcher Susan Drummet in Mexico City also contributed to this story.

* RELATED STORIES: D1, D3

More on the Peso

Reprints of a Times article explaining how the floating peso affects investors are available from Times on Demand. Call 808-8463 and press *8630. Select option 1. Order Item No. 2819. $3, including fax or mail delivery.

Details on Times electronic services, B4