In an Uncertain World (35 page)

In this case, not choosing immediately turned out for the best. Over the next few days, Treasury and Federal Reserve officials turned attention to another idea that we hadn't thought wise or feasible when it was first floated in the IMF a few weeks earlier. The proposal was a voluntary version of what's known as a “standstill,” whereby banks would agree to roll over their loans, extending their due dates and converting short-term obligations to longer-term ones. I don't think the banks would have considered doing this earlier because they hadn't yet realized how dire the situation was. But now was the eleventh hour, and the banks were staring default in the face. Still, they would not act on their own; we would need to provide a catalyst. The plan had two other elements: a stronger reform package on the part of South Korea and accelerated money from the IMF and creditor governments, including the United States.

As well as being more likely to work, this three-pronged plan could also reduce the moral-hazard problem by involving private creditors in the resolution of the crisis. The banks were reluctant to roll over South Korea's loans and would not have chosen to take the continued exposure on their own. Under this plan, they shared the continuing risk of nonpayment with one another and to some extent with the multilateral institutions. I never liked calling our rescue efforts “bailouts”—rescuing investors was an unavoidable side effect of restoring stability—but you could reasonably describe this approach as a private-sector “bail-in.” My view of the extent to which creditors and investors had lost their sense of the risks involved in emerging markets was borne out when we began to explore the idea. We asked the commercial and investment banks how much exposure they had to South Korea by way of financial derivatives, apart from their direct loans. Most had a very imprecise idea, and some took a full week to find out.

Among the risks of the plan was the considerable difficulty of successful execution. Every bank had an interest in being a free rider, in not participating while others did. But if a preponderance of the major financial institutions didn't agree to participate on equal terms, the deal would fall apart. We had little practical leverage to induce their cooperation. We could only try to affect the outcome by making phone calls, asking bank CEOs to do what was in their collective self-interest, and, in the case of some reluctant parties, suggesting that the world might know who was responsible for failure and its consequences, should they occur.

Meanwhile, David Lipton was on his way back to Seoul again, in part to try to gauge Kim Dae-jung's commitment to reform. Some people at the State Department at first objected to the President-elect of South Korea meeting with a Treasury Department official before a more ceremonial visit from someone at State. But the new ambassador to South Korea, Stephen Bosworth, overruled the objection, saying the situation was so pressing that we couldn't stand on ceremony. Bosworth, a distinguished former ambassador to the Philippines who had previously also worked at the State Department's Economic Desk, was not only very sensible and effective but also an example of the kind of diplomat we're going to need more of in the future—one who combines foreign policy expertise and skill with a good understanding of economic issues. Bosworth said that Lipton should see Kim Dae-jung as soon as possible, and Lipton's first stop in Seoul was the union headquarters that had served as the former labor leader's campaign office.

I left that day for Virgin Gorda in the British Virgin Islands on a family vacation that we'd taken annually for fifteen years. As usual, I had hired Garfield Faulkner, a local guide, to take me fly fishing for bonefish off the neighboring sleepy island of Anegada—where arriving pilots used to have to be on the lookout for cattle blocking the airstrip. You fish from a boat or wade in the ocean flats and try to spot the silvery bonefish, which never stop moving in the clear water. The fish are fast, finicky, and immensely powerful. One weighing only a few pounds will run out several hundred feet of fishing line in an instant. But this time I had to cancel Garfield while I spent the day talking on the phone with Alan and Larry in Washington and David in Seoul.

As I stared longingly at the water, David reported back that his meeting with Kim Dae-jung had been highly encouraging. Kim, despite having been elected on a populist platform, told him that the South Koreans would never be able to deal with their problems if they kept blaming them on America and the IMF. The new President also said the burden would have to be shared three ways: the government would have to be reorganized to take power away from the Ministry of Finance. The
chaebol
s would have to restructure. But, perhaps most important given his background, Kim told David that unions would have to accept layoffs and wage reductions if South Korean companies were to become profitable again. Only then would investment and growth recover. At the end of the meeting, David described Kim as becoming more philosophical. “For thirty years, they arrested me, drove me into exile, and tried to kill me,” he said. “Now I come back and get elected President, just in time to face the collapse of my country.”

That Kim was committing himself to reform meant we were going to move ahead with the bail-in proposal. South Korea owed money to banks in Japan, Germany, and many other countries, as well as the United States. To be successful, we needed our G-7 partners and other key countries on board. Many of them had favored trying some form of bail-in, but we also needed their support for the stepped-up financing from the IMF as well as their individual contributions. I flew back to Washington as Larry juggled phone calls with the top management of the IMF and his G-7 colleagues in Japan, Europe, and Canada while briefing the White House and the foreign policy team on our progress.

We must have set some kind of record that holiday for disturbing the slumber of finance ministers and central bankers all over the world. But the calls we made paid off. With twelve other countries on board, we released a statement on Christmas Eve saying that the IMF would speed up the disbursement of funds in the context of voluntary rollovers that we would seek from banks throughout the developed world. The statement listed all the countries willing to put bilateral funds on the table, provided the private banks and the South Koreans did their part.

A massive, synchronized international effort to encourage the banks to act together was also put into effect by the Federal Reserve, acting primarily through the Federal Reserve Bank of New York and the Treasury Department. Compounding the intrinsic difficulty of the situation was that the bankers we needed to convene had all dispersed for their Christmas vacations. I made calls to U.S. banks and investment banks from the conference table in Larry's office. William McDonough, the president of the New York Fed, made calls to his international counterparts, who made similar calls to banks in Europe and Japan.

These calls required great tact. I had to be persuasive about the banks' collective self-interest—and even on a few occasions suggest that a poor citizen would probably become known in the event of failure—without overstepping an uncertain line. And for Bill McDonough, the balance was even more difficult. The Federal Reserve is the nation's chief financial regulator and could apply pressure just by convening a meeting. If such pressure went beyond a strong sense of “moral suasion,” that could be an improper use of the Fed's regulatory position and could also prove counterproductive by scaring the banks further. As a former commercial banker himself, Bill knew how to frame the issue. When the heads of the leading U.S. banks came together at his office, he suggested that they act collectively, not for the sake of South Korea but in their self-interest and that of their shareholders. Otherwise, the vast South Korean debt they held could become uncollectible. Some bankers grumbled, but nearly everyone agreed to participate. Critical to the effort was Bill Rhodes, a banker who was central in the world of international finance and whose “golden Rolodex” and tireless cajoling had brought renown in global financial circles during the 1980s debt crisis. Meetings like ours took place in financial capitals around the world. In London, where there are probably more foreign banks than anywhere else, Bank of England governor Eddie George summoned key bankers back from vacation to a meeting on Boxing Day, when The City, London's financial district, was usually shuttered for the holidays.

In combination with President Kim's public commitment to economic and financial sector reform and the international community's financial support, our coordinated effort showed signs of having the desired effect. South Korea's currency and stock markets soon stabilized, although they did not rise appreciably for some time. Contagion seemed to abate and our fears about the global financial system eased for the moment. In the end, the banks did not suffer from their participation. They were paid back in full and ended up receiving a higher rate of interest in the interim. And in the end we did not disburse any U.S. funds. Treasury's discussions on the loan agreement with South Korea—initially quite heated—petered out after a few months. The money turned out not to be needed.

That wasn't the end of the South Korean stage of the crisis. At several points in 1998, there were dicey moments when we feared that the plan wasn't working, or when political developments elsewhere threatened to plunge the country back into economic gloom. But basically, the South Korean economy was on the mend. And what had mattered most wasn't anything the IMF or U.S. Treasury had done but South Korea's own response. President Kim Dae-jung and his colleagues, the heroes of the South Korean recovery in my view, showed how sound, courageous political leaders can make a great difference—in fact, the key difference—in overcoming economic duress.

CHAPTER NINE

A Crisis Considered

WHEN THE ASIAN FINANCIAL crisis swept through a country, it often changed not just the economy but the political landscape as well. By early 1998, new governments were in place in Thailand and South Korea, and their commitment to economic reform was essential to calming financial markets. But in Indonesia, the prospect of political change only threatened to make financial difficulties worse. For me, Indonesia's escalating crisis highlighted how difficult overcoming financial turmoil can be when political, economic, and foreign policy concerns are interwoven.

Indonesia, the fourth most populous nation in the world, was a key strategic U.S. ally in Southeast Asia. It had been under military rule for more than thirty years, dominated by one man, seventy-six-year-old President Suharto (who, like many Indonesians, has no other name). Suharto's autocratic regime had delivered both stability and a dramatic rise in living standards to what had been a largely rural and very poor country when he took control in 1965. A mix of economic openness and tight political control had allowed the economy to develop rapidly. Domestic and foreign-owned businesses flourished, while ethnic tensions were kept at bay. Ethnic Chinese entrepreneurs, who had suffered persecution in the past, prospered in relative safety, while Indonesians mainly of Javanese descent controlled the military and the powerful state sector. Foreign investment was encouraged, foreign banks poured money into Indonesian companies, and jobs were plentiful.

But as financial turmoil moved across the region, the pervasive corruption and crony capitalism that helped to shore up Suharto's support came under closer scrutiny. Political and family connections were all-important in business. Indonesia's legal system was corrupt and slow-moving. Public money was siphoned from the budget for projects that enriched family and friends. Officially sanctioned monopolies in plywood, cars, and cloves—used in cigarettes and a mainstay of Indonesia's economy—channeled money into corrupt hands. Foreign investors and creditors who were now fleeing the country called for fundamental reform to put the economy on a sounder footing. But the reforms they wanted risked undermining a regime already under pressure from the spreading economic chaos.

Unlike Thailand and South Korea, Indonesia had no early prospect of a democratic shift of power. As Suharto's government wrestled with the worsening economy, the danger that the society could explode into violence made the task of recovery vastly more difficult. The confidence of domestic businessmen and savers, many of whom were ethnic Chinese, was closely bound up with Suharto's survival. They—and we—were afraid of a replay of the civil unrest that had marked the previous change in power in 1965, when half a million people, including many Chinese, had been murdered. Domestic capital was now also flooding out of the country, from local entrepreneurs who feared a change in the regime that had served their economic and political interests.

This made reestablishing market confidence particularly difficult, because reforms that would reassure foreign investors might alarm domestic investors. Certain Indonesian officials themselves had identified a wide array of reforms to combat corruption, from restructuring banks to curbing key monopolies and opening up the government's books to scrutiny. Foreign confidence now hinged to a significant degree on these reforms being implemented. But such reforms could further weaken Suharto and thereby worsen domestic capital flight.

There was no easy way to deal with the inherent political and economic conflicts, and the handling of the Indonesian situation sparked widespread criticism of Treasury and of the IMF, including from Capitol Hill. We at Treasury and officials at the Fund may well have underestimated how damaging certain reforms would be to Suharto and how destabilizing the growing threat of his departure was in itself. But these issues were on investors' and creditors' minds and couldn't be ignored. Whether triggered by foreign or local money leaving the country, the escalating crisis threatened an economic unraveling that could quickly spiral as investors became frightened.

An initial IMF program for Indonesia in the fall of 1997 underscored this problem. In that episode, Suharto's government had failed to follow through on commitments that hit at entrenched interests close to the President. Though the government closed some debt-ridden banks, doing so only helped to create a run on the others left open—including banks that were also insolvent but politically connected, and that were, in some cases, owned by Suharto's friends and family. Many people believed that the IMF should have foreseen this. To show how complicated crisis response is, many criticized the IMF for pressing for bank closures at all (at least without putting into place full deposit insurance to reassure depositors at those banks left open), while others thought that the IMF should have insisted on closing more banks. One case in particular was highly publicized and became a symbol of the concerns about whether Suharto would ever truly reform. A bank owned by Suharto's son Bambang was closed but reopened three weeks later under a different name. News reports described workers pulling up to Bambang's skyscraper in downtown Jakarta, pulling down a blue Bank Andromeda sign in the lobby, and putting up a blue Bank Alfa sign in its place.

At the same time, rather than keeping monetary policy tight, Indonesia's central bank supplied whatever loans were needed to prop up those banks facing massive withdrawals. The rupiah plunged and inflation soared. We had significant evidence by now that adhering to a tight monetary policy, even if this meant sharply higher interest rates, was an essential element in stopping a financial market panic. But that would mean cutting off government credit to failing banks and companies, many of which had close ties to Suharto.

As it became clear in early 1998 that the first IMF program had failed and the crisis was deepening, we at Treasury felt keenly the need to understand Indonesia's political situation better. In addition to internal discussions with the foreign policy experts in the administration, we reached out to others. Larry and I both knew Henry Kissinger, and he paid a quiet visit to us at Treasury. In addition, Paul Wolfowitz, former U.S. ambassador to Indonesia and later number two at the Pentagon in the second Bush administration, also came to Treasury for a lengthy discussion. And Larry and I both spoke to Lee Kuan Yew, the strongman who had built Singapore. Lee is deeply knowledgeable about geopolitical and cultural matters and had done much thinking about Southeast Asia from a realpolitik point of view. Although he had earlier been supportive of Suharto, he had become doubtful that Suharto would take needed steps on the economy. As a consequence, Lee was highly pessimistic about Indonesia's future. He worried that ethnic conflict and political unrest generated by Indonesia's sinking economy could have a spillover effect, leading to clashes between ethnic Chinese and non-Chinese elsewhere in the region.

We made a series of attempts to get through to Suharto about the need to take ownership of reform, including a phone call from President Clinton on January 8. The response from Suharto, who felt that he had run his economy successfully for a quarter century, was not promising. When Clinton encouraged him to continue dealing with the IMF, Suharto blamed foreign “speculators” for driving down his country's currency. When Clinton pressed Suharto on corruption and mentioned specifically the reopening of his son's bank, the Indonesian leader buried him in legal technicalities. This mighty autocrat said he had no power in the matter—it was all up to the courts.

Our next move was to send Larry to Jakarta to meet with Suharto in person. The two of them sat down in the presidential palace for an hourlong session, but Larry, who was seldom reticent, hardly got a word in. As he described it to me, he got only one turn at bat, while Suharto played nine innings. Next to arrive in Jakarta was Michel Camdessus, who succeeded in securing Suharto's signature on a second, strengthened IMF program on January 15, 1998. There's a notorious photograph of Camdessus standing with his arms folded, looking over Suharto's shoulder as Suharto signs the document, an image that seemed to many critics to typify the heavy hand of IMF conditionality.

Ironically, we saw in the coming days how much countries themselves determine their own fate and how little the IMF or anyone else can do in the absence of a genuine commitment to reform. Suharto had agreed to stringent conditions on a broad array of issues—from the government clove monopoly to aircraft manufacturing. He also promised to keep tight control of monetary policy. I was skeptical about whether this program would work any better than the first. Suharto hadn't done anything to suggest that his basic attitude toward reform had changed. But the situation was sufficiently worrisome that even an uncertain IMF program—designed, as was usual, so that the government wouldn't be able to draw down much of the money if Suharto didn't follow through on reforms—seemed better than none.

This program was hugely controversial. Some outside critics thought the West was simply taking the opportunity to force our own free-market policy preferences on Indonesia via IMF conditionality, and ignoring the government's views about what would be best. Others argued that in focusing on confidence in this way, the IMF and we at Treasury were following the whims of the financial markets—which might be irrelevant or even counterproductive—rather than focusing on fundamental problems. If the markets wanted Indonesians to wear blue shirts, would blue shirts become essential to the restoration of confidence?

My view was that by and large the markets tend to shine a spotlight on real economic problems, although they may exaggerate the importance of those problems at times (as well as ignoring them at other times). In a situation like Indonesia's, foreign investors and creditors might become preoccupied with a symbol, such as the ending of a specific monopoly or the removal of a single corrupt official. But those symbols weren't just blue shirts; in most cases they related to significant underlying issues: monopolies, corruption, mismanagement, and weak financial systems.

In Indonesia, many of the changes that the IMF pushed were outside its usual realm of expertise on exchange rates, interest rates, and government finances. And in hindsight, many people involved agree that there were too many conditions spread across too many different areas. Expecting the government to fix so many problems at once just wasn't realistic and probably blurred focus on the most urgent ones. The most controversial structural measures, however, were not dreamed up by the IMF, the U.S. Treasury, or other outsiders. The IMF had often been criticized for following a “cookie cutter” approach that ignored the distinctive features of different countries. In this case, the Fund's policy conditions were informed by the views of a number of Indonesian officials, such as the respected economist Widjoyo Nitisastro, whom Suharto had put in charge of negotiations, as well as by the World Bank.

But as happened with the first program, financial markets seemed to have no faith that Suharto would do what he said. At the same time, spreading violence and fears of a political breakdown worsened capital flight. Many merchants closed their businesses and factories and fled. The rupiah dropped from 7,300/dollar the day before the announcement to 15,450 on January 23. Indonesia stood on the brink of hyperinflation.

Rather than implement reforms, Suharto continued to look for another way out. One idea he turned to was a “currency board,” a mechanism to stop the fall of the Indonesian rupiah by tying it to the U.S. dollar and putting Indonesia's monetary policy on autopilot. But this kind of regime is difficult to maintain even for countries with the economic requisites: ample foreign currency reserves, a real commitment to sound monetary and fiscal policies, and a strong banking system, which is needed because the central bank would no longer be able to provide finance to prop up ailing banks. We feared that trying to fix the exchange rate in this way might merely be an opportunity for Suharto's cronies to get their money out of the country before the arrangement collapsed and the rupiah fell still further.

Eventually, the IMF persuaded Suharto to drop the idea. But that got us no closer to solving the problem, which was how to structure something Suharto would credibly agree to that would also reassure international markets and persuade Indonesians to keep their money at home. In wrestling with these issues, Treasury worked closely with other countries that had a huge stake in the region, such as Australia, Japan, and Germany, which had particularly close ties to Indonesia.

The immense difficulty of dealing with Suharto—who reportedly promised his cabinet that he would fight a “guerrilla war” against his own economic program—was brought home to us in February, when he formally nominated B. J. Habibie as Vice President. A loyal crony with little independent standing, Habibie now looked like the obvious successor should the President leave. Some saw the move as a way to show critics that Suharto's ouster would only make things worse. Jim Steinberg of the NSC said in one of our meetings that perhaps we should be reaching out to the reform forces in Indonesia, so that if Suharto did fall, they wouldn't feel we'd been their opponents. The argument on the other side was that doing so could hurt our relations and effectiveness with Suharto and might destabilize the situation even further if it became known.

I remember sitting in Erskine Bowles's office one day in early February and saying, “We've got to find some way to get our message across to this guy.” We needed someone Suharto would take seriously. Out of that discussion, we decided to ask Walter Mondale to go to Indonesia. The question of what Mondale would say to Suharto showed yet again the difficulty of balancing financial market and other concerns. Our view at Treasury was that Mondale should be as direct as possible with Suharto and tell him his government didn't have much of a future if it didn't become serious about economic reform. The State Department worried about the danger of appearing to withdraw our support from a crucial ally. Suharto was seen as the only glue holding a fragile country together; Indonesia falling again into chaos or civil war was a real danger. The foreign policy team also felt that we risked turning Suharto hostile to the United States by insisting he meet strong conditions. This is the kind of complexity that arises in dealing with the wide range of issues relating to crisis response. Persuading countries to adopt good policies and improve governance is a vast challenge in itself. But when doing so touches foreign policy and national security goals, that difficulty greatly increases.