Savers Need a Savior in Mexico

The Puerto Vallarta People’s Credit Union opened its first branches in western Mexico in 1995 and soon exploded in popularity, thanks to interest rates of 45% a year--more than double the rates available from Mexican banks.

Such inexplicably good fortune couldn’t last, and didn’t. About $160 million worth of deposits from 58,000 credit union members are at best frozen--and at worst have vanished.

Since February, the credit union’s flamboyant founder has been jailed, and its 49 branches in Jalisco state have stayed shut. Members such as Luz Maria Rodriguez worry when, or even if, they will ever see their money again.

The 72-year-old widow stood stone-faced among a dozen other bewildered depositors outside her locked-up storefront branch one recent day. “I had a house, but I had nothing to eat,” she recalled, “so I sold my house for 300,000 pesos (about $33,000) and I deposited it all here and lived off the interest. Now I am asking friends for loans so I can eat.”

In a nation that is spending nearly $90 billion to rescue its mainstream banking system, a second financial crisis is quietly unfolding, this one ravaging the poor and working class.

Unscrupulous or incompetent operators appear to be pillaging parts of a community credit system that for decades was a healthy and vital source of savings and loans for those whom the banks shunned. The Mexican government has seemed unwilling to intervene, adopting a hands-off approach that some critics fear puts the entire network of informal credit at risk.

The Puerto Vallarta credit union fiasco is the latest of three major scandals to strike Mexico’s vast and mostly unregulated informal financial sector since the early 1990s. Well over 100,000 savers now face financial setbacks, if not ruin, from those cases alone. They range from schoolchildren to retirees. Members say dozens of their fellow depositors have committed suicide.

Although depositors in Mexico’s formal banking sector are insured against losses, the unsuspecting savers seeking higher interest rates and lower fees in the informal credit sector are unprotected--left at the mercies of fraud and ineptitude.

To be sure, informal credit in Mexico and other developing regions from Asia to South Africa has played a mostly honorable and successful role in providing savings and loan channels for poorer people, whose paltry savings don’t excite major banks.

Money for the Masses

Encouraged by parish clerics since the early 1800s, cooperative credit unions help people pay for homes, schooling and other basic needs, and they finance micro-businesses that create much-needed jobs more cheaply and efficiently than any public-sector program.

The traditional savings associations are built on trust, embracing small groups of people who usually know each other, and for whom peer pressure is a powerful motivator to meet obligations.

But as the credit unions have multiplied and grown in sophistication in Mexico--with seeming government encouragement--cases of malfeasance also have grown.

In this latest case, the alleged villain is the credit union’s high-profile founder, Jose Ocampo Verdugo, jailed Feb. 28, pending trial on charges that he used the credit union to launder money for the Amezcua brothers, better known as the “Speed Kings” for their alleged North American methamphetamine empire.

JOV, as he is known by his initials, also amassed his own empire of at least 70 properties and assets, including six planes and a five-star hotel, allegedly using the credit union’s funds to finance his personal businesses.

Incredibly, the same Ocampo Verdugo was accused in 1993 of a similar scandal in the Gulf Coast state of Tamaulipas, involving his Dos Laredos Credit Union. He fled, was caught, tried and acquitted. Yet despite that history, he was allowed to set up a similar operation on Mexico’s west coast two years later.

Ocampo Verdugo, 53, proclaims his innocence in both cases, maintaining that jealousy of his success is driving his accusers.

“I devoted myself to an activity that would allow poor people to obtain better profits and access to loans,” Ocampo Verdugo said in a public letter from jail in March. He told a newspaper, “It is a lie that I launder money, that I am a drug trafficker, that I do business outside the law.”

Case Could Involve Many More Co-ops

But federal prosecutors say they are worried, because Ocampo Verdugo controls hundreds of other credit unions in 28 of Mexico’s 31 states, with as many as 1 million members. So far, only the Puerto Vallarta-based chain has been accused of wrongdoing.

“This is the oldest fraud in the world--to pay high interest from fresh deposits,” said Felipe de Jesus Preciado, a congressman from the center-right National Action Party, who is pushing a bill to tighten controls on informal credit institutions.

“The government has a huge responsibility in this by promoting savings and letting these organizations advertise without any controls,” Preciado added. “This is a perfect incubation dish for great frauds against innocent people.”

In Baja California, Sonora and other northern states, for instance, the 67 branches of Northwest Savings & Loan credit union, known as El Arbolito (the Little Tree), were shut down in February 1999 because of alleged fraud, freezing the accounts of more than 40,000 people. That messy case is still unresolved, despite repeated meetings and angry demonstrations in several states.

Felipe Marino Aragon, a lawyer representing savers in Sonora state, said, “Under the supposed goal of promoting savings, the state made all primary school students save in the Arbolito, and one child would collect savings from other children. Then every Monday, a credit union employee went to the school and collected the money.”

The Arbolito was declared bankrupt in July, and several directors were arrested. Creditors are still fighting to get at least some of their money back.

“At least 24 depositors have died by suicide or from stress brought on by this situation,” said Peter Offermann, a Canadian retiree in the Sonora town of Los Alamos. “Many others, myself included, have been put into dire financial jeopardy.”

Offermann said he had about $800,000 tied up in the Arbolito and was probably the biggest depositor. In all, the savings society is believed to have had about $180 million in deposits when it was closed.

Victims on Both Sides of the Border

Along with children and retired foreigners, Mexicans who work in the United States and send money home to their families have also been victimized. The local credit unions often were convenient places to send such funds.

Now, finally, some state and federal officials are resolving to impose mandatory supervision and regulation on a sector that manages the savings of at least 2 million Mexicans.

The landscape is murky in part because it is so complex. The informal institutions are broadly known as “cajas populares,” or “people’s strongboxes,” which take in term deposits of one to six months. Early withdrawals are penalized harshly.

Among these are 14 larger institutions called savings and loan societies, which are nominally supervised by the National Banking and Equities Commission--but uninsured. The Arbolito was among these supposedly regulated institutions, until it was shut down for fraud.

But far more credit unions operate as co-ops, and these--like the Puerto Vallarta operation--are expressly unsupervised as well as uninsured. These are estimated to number from 180 to 350 nationally, some with dozens of branches.

A 1994 law was intended to require self-regulation of these institutions. Six years later, the required federal regulations have never been issued by the Finance Ministry. The ministry and the cooperative association trade blame for the delay. During this wrangling, the newspaper Reforma estimates, 200,000 savers have been affected by bankruptcies and other liquidity problems in the unregulated savings societies.

“I believe there has been carelessness by the authorities, and there has been abuse and trickery in calling businesses credit unions when they are not really credit unions,” said Lorenzo Santos, a finance professor at the University of Guadalajara.

“It is critical that the government regulate the alternative finance sector. Just as there has been excessive protection in the formal financial sector, in the informal sector there has been too little oversight.”

Alejandro Vargas, vice president of the federal banking commission, acknowledged in an interview: “It would seem that the legal framework was not ideal, and it will have to be modernized.”

Legislation now before Congress would harmonize the confusing array of existing savings organizations and subject them to the same rules. It would also require all credit unions to maintain minimum capital reserves, and to agree to supervision and disclosure rules. And the law would create a fund, paid for jointly by the cooperatives and the government, to cover members’ savings in case of bankruptcies.

Returns Proved Irresistible

For those whose money already is frozen, though, it may be too late. And the years lost in addressing the problem have certainly raised the costs for many people.

Fred Arpino, a retired barber from New Jersey who lives in Guadalajara, said ruefully, “Last month I put in $10,000 more. I shouldn’t have done it, but you get greedy. I was getting 47% annual interest on a three-month deposit.”

In cracking down on fraud, regulators are also eager to avoid scaring away depositors from the good credit unions. Jorge Camarena, director general of revenues for the Jalisco state government, said it’s easy to tell the difference.

“When they pay 50% to 100% above market rates, or loan to friends at below market interest rates, these are danger signs,” Camarena said.

The cautious, traditional credit unions, meanwhile, “have been extremely beneficial in the last few years,” he added. “They have become almost the only source of regular and trustworthy finance for poor and working-class people to obtain a house or other fixed asset.”

“We are trying to support these co-ops, and help people understand the difference so we avoid any panic.”

Santos, the finance professor, said a basic problem is that Mexicans “lack a financial culture. The people complain that banks are paying lower interest rates, but they don’t realize that this is a good sign because it means inflation is coming down.”

Inflation peaked at 52% in 1995 in the worst economic crisis since World War II, but fell to 18% in 1998 and 12% last year.

Santos added, however, that Mexican banks traditionally have had Latin America’s biggest spread between deposit and lending rates. Add to that high banking fees, and it’s no wonder poorer people look elsewhere for a better return.

Reasons Hector Morfin, a retired accountant and member of the Puerto Vallarta credit union:

“If the bank pays 10% or 15% and inflation is 30% or more, we lost 20%. How can you live that way?”