By DAVID LUHNOW
MONTERREY, Mexico—A surge of violence by drug gangs in this industrial hub is leading to an exodus of wealthy Mexicans as well as scores of U.S. and foreign expatriates, dealing a blow to what has long been one of Latin America’s richest and safest cities.

The security situation is so alarming in Monterrey, known as the “Sultan of the North” for its industrial power, that the mayor has sent his family to live in Dallas, according to people familiar with the matter. The mayor’s office didn’t respond to requests for comment.

In the past two weeks, U.S. farm equipment maker Caterpillar Inc. ordered executives with children to leave the city, following a similar move by the U.S. State Department for American diplomats here. Other U.S. firms are allowing employees to leave voluntarily.

“Based on recent guidance from the State Department, Caterpillar has informed expat employees in some regions of Mexico (including Monterrey) that they and their families should repatriate as soon as possible,” Jim Dugan, Caterpillar’s chief spokesman, said in an email to The Wall Street Journal. The move affects about 40 employees, he said.

Monterrey is caught in a war between two powerful and bloodthirsty drug cartels, the Gulf Cartel from neighboring Tamaulipas state, and the Zetas, a splinter group that used to provide its security muscle. The two groups fell into open war at the start of this year, Mexican officials and analysts say.

Monterrey sits just 135 miles from the U.S. and is used as a staging ground to smuggle drugs north.

The battle has shocked the city, which historically had murder rates lower than the U.S. average. More than 274 people have been executed in gangland hits so far this year, according to local officials.

Residents don’t only face the threat of getting caught in the crossfire: Gangs are also carrying out a wave of kidnappings—most of which go unreported because of fear of police involvement—and extorting local businesses, demanding protection money.

Crime in Monterrey has helped push Mexico up the agenda of U.S. President Barack Obama, U.S. officials say. This week, administration officials said they will look for stepped-up military cooperation to help Mexico fight what some U.S. officials called a growing “narco-insurgency” threat, suggesting Mexico had lost control of parts of the country.

In Monterrey, cars with Zeta gunmen patrol the city streets at night. Residents describe an informal 10 p.m. curfew, a time when many taxi drivers call it quits for the day.

Some Mexican businessmen say the panic about Monterrey is overdone. “This place used to be like Switzerland, so it’s the change that bothers people,” said one businessman.

But the fears are taking a toll. One young Mexican executive at cement giant Cemex SAB, which has headquarters in Monterrey, said he can count at least 20 different families from his circle of friends who have left—nearly all of them for nearby Texas. “It’s a rush for the exits,” he said.

So many people are leaving that the city’s leading businessman, Cemex Chief Executive Lorenzo Zambrano, recently used his Twitter account to urge his fellow regios, as people from Monterrey are called, to stop the exodus.

“Whoever leaves Monterrey is a coward. We have to fight for what we believe. We have to reclaim our great city!” he wrote.

The decline of Monterrey presents one of the biggest challenges for President Felipe Calderón in the three and a half years since he took power and declared war on powerful drug cartels. The city of 3.7 million, surrounded by dramatic mountains, is Mexico’s third biggest after Mexico City and Guadalajara, accounts for 10% of the country’s annual economic output, and is a symbol of modernity for the rest of the nation.

“Mexico can’t afford to lose Monterrey,” says Raul Benitez, a security expert at the National Autonomous University of Mexico, the country’s biggest university.

Officials in Nuevo León state, where Monterrey is located, say they are going all-out to fight organized crime, improving coordination with the army, rooting out corruption in local police forces and launching programs to improve social conditions in poor neighborhoods.

“We are not going to hand the keys to the city over to these groups,” says Javier Treviño, the deputy governor of Nuevo León.

Last year, Monterrey still had a relatively low murder rate of 6.5 deaths per 100,000 residents, well below Mexico’s average, and comparable to New York City. This year has brought one grim event after another. In March, two doctoral students at the Monterrey Institute of Technology and Higher Education, Mexico’s most prestigious university, were killed in a gun battle between soldiers and cartel gunmen.

A month later, hooded men raided a Holiday Inn in the downtown area and seized several guests, who remain missing and are presumed dead. In late August, a mayor from a Monterrey suburb was kidnapped and executed by a presumed drug gang.

But the event that spooked residents here the most took place on Aug. 20, when two bodyguards from a leading Monterrey company were killed by cartel gunmen near the entrance to the prestigious American School Foundation, where most American expats and many Mexican elite send their children to school.

The shooting took place just as school was letting out, prompting frightened children to take cover in the cafeteria.

Danielle Helfrich had just picked up her 12-year-old daughter Ema and was driving on the street in front of the school when a dark-colored sport-utility vehicle suddenly came to a halt in front of them. Men carrying automatic rifles poured out and began shooting at another SUV on the right. Mrs. Helfrich tried to back out, but was blocked by traffic.

“We were stuck. I pushed my daughter down in the car. All I could hear were gunshots and her screaming,” says Mrs. Helfrich. “It was terrifying.”

At least one bullet shattered the windshield of her Honda CRV. After several minutes, the shooting stopped. Mrs. Helfrich drove home and packed their bags. She and her daughter left Monterrey the following morning, and now live in Texas.

Days later, the U.S. consulate said it would order out any underage family members of U.S. diplomats in Monterrey, putting the city on a par with rules for U.S. outposts in places such as Sudan, Yemen, and Beirut.

U.S. officials say the city’s ill-equipped local and state police forces are no match for the cartels. They also say the city’s police have been broadly corrupted. “We felt we had no choice,” says one U.S. official.

Mr. Treviño, the state deputy governor, doesn’t dispute that there is corruption in the state’s 51 different local police forces. The state is pushing Mexico’s Congress to pass a proposed bill to eliminate Mexico’s municipal police forces and replace them with 32 state forces, one for each state.

Some Mexicans and Americans in Monterrey aren’t waiting around for things to improve. “The wealthy Mexicans have been leaving for a few months now, but the exodus of Americans is just getting underway,” says Rafael Moreno, owner of Moreno Moving Co., which has seen a surge in demand for its services. “It’s really sad to see.”

In recent months, the violence has moved into Monterrey’s most exclusive neighborhoods. One spooked American resident said he recently witnessed a drive-by shooting. Another said he decided to leave Monterrey after four decapitated bodies were found along the route where he regularly went biking.

Even longtime American residents of Monterrey are moving. “I know what the last reel of this movie looks like, and I’m not sticking around to watch it,” said a prominent American businessman who has lived here for 20 years. He said he is moving to Mexico City within a few months and plans to leave Mexico altogether shortly after.

The businessman said he is pessimistic about Mexico’s ability to create honest police and a functioning judicial system in order to weaken the cartels.

“We are going to find out what Colombia would have looked like without Uribe and without the U.S.,” he said, referring to former Colombian President Alvaro Uribe, widely credited with bringing stability to the Andean country.

Printed in The Wall Street Journal, page A1

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