The Chastening Read online

  Korean government officials had taken the humiliating step of seeking IMF assistance only after considerable anguish and debate. They were enormously proud of having guided their nation from the ruins of war in the 1950s to the status of an export powerhouse that boasted the eleventh-largest gross domestic product in the world. But the country’s financial position was becoming increasingly precarious. The Herd’s actions were depleting the Bank of Korea’s reserves of hard currency—the U.S. dollar and the handful of other maJor currencies that are essential for nearly all transactions across international borders. Foreign banks were calling in short-term loans to Korean banks, and foreign investors were dumping the Korean won for dollars as they unloaded their holdings of Korean stocks and bonds. If this drain continued, the central bank’s reserves would run so low that the bank would be unable to provide dollars to people who needed them. The ultimate nightmare was default, meaning that the government, the nation’s banks, and virtually all the maJor corporate names in Korea Inc., such as Hyundai, Daewoo, and Samsung, would not be able to obtain enough dollars to make payments due to foreign creditors and suppliers.

  Neiss’s mission was to negotiate a plan that would calm the markets and banish the nightmare. The IMF, as well as top U.S. government officials who exercised major influence over the Fund, feared that a default by Korea could cause the country to suffer a prolonged, crippling cutoff of loans and investments from abroad; further, as the creditworthiness of neighboring countries came into question, they might follow Korea into default, sending the entire Asian region into a decade of stagnation and depression like the one that afflicted Latin America during most of the 1980s. Conceivably, the nerves of investors and lenders the world over would be so shattered that the financial conflagration would leap across the Pacific, lay waste to the U.S. economy, and engender global recession.

  So when he arrived at the Bank of Korea that cool November day, Neiss thought he understood how dire the circumstances were—until he started examining the figures furnished by the central bank’s international staff. To his horror, Neiss realized that Korea was far closer to default than anyone in the IMF had understood. The readily available reserves of dollars were so paltry that the country was almost certain to run out within days—perhaps as soon as a week.

  Only a couple of weeks before, in conversations with IMF officials, the Koreans had put their reserves at $24 billion, which was low for an economy Korea’s size but did not pose an emergency. Now Bank of Korea staffers were citing figures suggesting that “usable” reserves were about $9 billion and declining at a rate of roughly $1 billion a day. This was mainly because foreign banks, which had previously made short-term dollar loans to Korean banks and routinely extended them month after month, were suddenly demanding repayment as the loans came due. The situation was even worse because the bulk of the central bank’s reserves couldn’t be used in a crisis like this. The funds had been deposited in the overseas branches of Korean commercial banks, which had been using the money to pay obligations; withdrawing the funds would make it impossible for the banks themselves to avoid default, and that in turn would bring down the nation’s entire financial system.

  Seated at a small conference table across from Bank of Korea officials, IMF staffers heard increasingly bad news as they pressed for details about the country’s international indebtedness. A couple of months earlier, an IMF mission conducting a routine annual review of the economy had been told that the short-term debts owed by Korean firms to foreigners totaled around $70 billion. Now it seemed clear that the previous mission had failed to ask sufficiently probing questions: The debts of Korean firms’ overseas operations hadn’t been included in the previous estimate; with those debts included, the figure was closer to $120 billion. Worse, Bank of Korea officials acknowledged that much of the debt would fall due in the next few weeks—so the need for dollars was particularly acute.

  The more the IMF team queried the Koreans, the more desperate the situation looked. Neiss recalled that two things went through his mind: One, what to do? And two, how to inform IMF management quickly? Despite his relatively senior position, Neiss had no authority to cut a deal with Seoul on his own.

  Back in Washington, the long Thanksgiving weekend was Just starting, and the IMF, which prides itself on its rapid-response capacity in financial emergencies, was almost comically unprepared for the impending bankruptcy of a maJor economy. The managing director, Michel Camdessus, was in his native France. Stanley Fischer, the first deputy managing director, was attending a seminar in Egypt. Jack Boorman, the director of the Fund’s Policy Development and Review Department and the man generally viewed as the Fund’s third most powerful official, was at his vacation home in Rehoboth Beach, Delaware, where twenty-four guests were about to arrive for turkey dinner.

  Neiss handwrote a fax to IMF headquarters explaining the depth of the problem he faced and listing a couple of options for dealing with it. First, a wealthy country such as Japan could extend a short-term emergency loan to Korea (though he knew the Koreans had already tried unsuccessfully to get such a loan). Second, Korean banks could obtain emergency permission to pay their foreign obligations with bonds instead of cash (though that would constitute a virtual default as far as many foreign creditors were concerned).

  Another option would be to throw together an IMF rescue program before Korea ran out of reserves—an undertaking that Neiss described as “barely feasible” and “not credible.” After all, one purpose of the rescue was to stem the market panic by showing banks and investors that plenty of dollars would be available for those who needed them, and this would require marshaling a loan package for the Korean government of unprecedented size, larger even than the $50 billion Mexico had received in 1995. Another purpose was to draw up plans for a thorough overhaul of Korea’s economic policies to show the markets that the country was eliminating its most glaring weaknesses. A few days did not seem sufficient for devising a full economic program of this magnitude.

  Yet this was the option Neiss was ordered to pursue, following a series of meetings and conference calls involving top officials of the U.S. Treasury, Federal Reserve, State Department, and National Security Council and their counterparts in other governments belonging to the Group of Seven maJor industrial countries (the G-7). Proceeding with that option was an incredible ordeal, both mentally and physically, for almost everyone involved.

  Starting on Friday, November 28, Neiss began conducting nearly around-the-clock negotiations in the Seoul Hilton with officials of Korea’s Ministry of Finance and Economy concerning the bailout’s conditions—that is, the painful economic changes and reforms that Seoul would have to pledge in exchange for an international loan. For three full days and nights, Neiss got no sleep; Wanda Tseng, a Chinese-born economist who was cochief of the IMF mission, went even longer without so much as a catnap—four days and nights. For nutritional sustenance, IMF team members resorted mainly to snacking on chicken wings and other hors d’oeuvres served on the hotel’s executive floor. Taking the time to dine in a restaurant, or even to eat a proper meal ordered from room service, seemed out of the question given the mountain of work required to cobble together an IMF program that stood a chance of calming the markets before Korea’s reserves ran completely dry.

  Other distractions and inconveniences abounded—not to mention the fact that the Korean negotiators were strenuously resisting many of the reforms sought by the IMF. Most of the talks were held in the Kuk Hwa banquet rooms, located in the hotel’s lower level a mere thirty paces from the entrance to Pharaoh’s, a hotel disco with ancient Egyptian decor, which continued to operate and emanate a thumping beat. The main entrance to the negotiating room was quickly surrounded by hordes of Korean reporters and TV crews. Determined to avoid potentially market-rattling encounters with the media, IMF staffers had to take a circuitous route to a back entrance that involved going up and down flights of fire stairs and through the Hilton’s vast kitchen. When they weren’t talking direc
tly with the Koreans, they were contacting their superiors and colleagues, by phone, fax, and e-mail, to discuss the complex details of the negotiations. They also had to contend with David Lipton, the U.S. Treasury undersecretary for international affairs, who had flown to Seoul and checked into the Hilton to convey the views of the U.S. government, a visible manifestation of the influence the United States wields over IMF policy.

  Alas, all these heroic exertions were to produce an embarrassing flop.

  On Wednesday, December 3, an agreement between the two sides was triumphantly announced by Michel Camdessus, who had flown to Seoul on the final day of talks to use his stature as managing director to close the deal. Under the accord, the Korean government would receive loans totaling $55 billion, more than any country had ever before received, including a record $21 billion from the IMF backed with additional loans and pledges of credit from the World Bank, the United States, Japan, and other countries. The program involved a staggeringly wide array of promises by Seoul: The budget would be cut; interest rates would be raised; ailing financial institutions would be closed for the first time in modern Korean history; government-directed bank loans for the nation’s powerful conglomerates would be eliminated; foreign investors would be allowed greater freedom to buy stocks and bonds; and the economy would be liberalized in a host of other ways.

  Camdessus pledged that the plan would be submitted within forty-eight hours to an emergency meeting of the IMF Executive Board, which represents the member countries. Following board approval, the IMF would immediately disburse $5.6 billion, and another disbursement would follow two weeks later—all of which, in accord with IMF custom, would be deposited in the nation’s central bank. The “far-reaching” reforms that Korea had promised would enable the nation’s economy to recover, Camdessus predicted, adding, “I am confident this program will also contribute to the needed return of stability and growth in the region.”

  But his optimism proved misplaced. The Electronic Herd showed little sign of being impressed by the Fund’s rescue efforts, and within days, Korea was in even worse financial straits than before. During the week of December 8, trading in the Korean won was suspended every day because it had fallen against the dollar by the 10 percent limit set by the government—on some days, this occurred within three minutes after the start of trading. Foreign banks in New York, Tokyo, London, Frankfurt, and other financial capitals continued to cancel credit lines and demand immediate repayment on loans they had once routinely extended and reextended to Korean banks. The chaos in Korea sent markets tumbling anew in the United States, Europe, and Asia.

  Shell-shocked members of the IMF mission in Seoul began an exercise they called the “drain watch.” This involved sending a staffer or two to the Bank of Korea at around 9 P.M. until well after midnight, when markets were open in the United States and Europe, to monitor how the central bank was being forced to relinquish precious reserves to meet the demands of foreign banks for repayment on their loans. The long faces of the drain-watchers at breakfast the next day often betrayed the bad news that another $1 billion or so had been withdrawn from the country overnight in this manner.

  By the week of Christmas, almost all of the $9 billion the IMF had disbursed had gone to pay off foreign banks that were calling in their loans to Korean borrowers. The Korean won was nearly 40 percent below its level at the time the IMF rescue was unveiled. And Seoul once again stood at the brink of default.

  The failure of the IMF’s rescue of Korea in early December 1997 was one of the scariest moments in the series of crises that rocked the world economy in the late 1990s. But it was far from the only such moment. Time and again, panics in financial markets proved impervious to the ministrations of the people responsible for global economic policymaking. IMF bailouts fell flat in one crisis-stricken country after another, with the announcements of enormous international loan packages followed by crashes in currencies and severe economic setbacks that the rescues were supposed to avert.

  In August 1997 in Thailand, for example, the nation’s currency, the baht, which had already fallen substantially in value, plunged further almost immediately after the approval of an IMF-led rescue totaling $17 billion. In Indonesia, a $33 billion package of loans marshaled by the IMF at the end of October 1997 generated only a brief rally in the Indonesian rupiah, which soon thereafter resumed its decline in currency markets. A “strengthened program” unveiled in January 1998 fizzled even more spectacularly, with the value of the rupiah shrinking to a sliver of its former level.

  Likewise, Russia received a $22 billion IMF-led package in July 1998, followed about a month later by the announcement that Moscow was devaluing the ruble and effectively defaulting on its Treasury bills—a development that sent U.S. financial markets into a terrifying tailspin. In January 1999, the same script was followed in Brazil, where nine weeks after agreeing to a $41 billion IMF program, officials found themselves forced to abandon the fixed-rate policy for the Brazilian real, which promptly sank 40 percent against the dollar.

  This book offers a retrospective of key events in the crisis and how they were handled by the global economy’s “High Command,” which includes not only the IMF but also powerful officials at the U.S. Treasury, the U.S. Federal Reserve, and other economic agencies among the G-7, who oversee IMF operations and steer international economic policy. (To some extent, the IMF’s sister institution, the World Bank, is part of the High Command as well, though the bank took a distinctly subordinate role during the crisis.) I use the term “High Command” advisedly, and with a pinch of irony, for the tale recounted in this book suggests that this group’s ability to safeguard the global economy from crises is neither high nor commanding.

  The events of 1997-1999 cast disquieting doubt on the IMF’s capacity to maintain financial stability at a time when titanic sums of money are traversing borders, continents, and oceans. The IMF is an institution designed to help countries correct problems in their economic fundamentals, and that was a manageable task when the flows of private capital moving around the world were much smaller than they are now. But the late 1990s brought crises of confidence in markets whose size, speed, and propensity for large-scale disruptions have vastly outstripped the Fund’s resources and ability to keep up. The IMF’s efforts to contain the crises were analogous to a team of well-trained orthopedic surgeons trying to cure a ward of patients experiencing emotional breakdowns, and the Fund has emerged from the experience with its credibility damaged. Thorough scrutiny of these developments lays bare how distressingly volatile the global economy has become in the new era of massive international capital flows. Unless steps are taken to make the system safer, future crises could be much more disastrous.

  The IMF was itself at the vanguard of the movement that liberalized the flow of capital around the world in the 1990s, taking globalization to new heights. International trade in many goods—shoes, chemicals, microchips—was already substantially free. So was investment in overseas factories by multinational manufacturers. A new goal for the globalizers at the IMF—and their backers in maJor governments including the United States and Great Britain—was the elimination of national barriers to foreign funds, which was expected to help create a more efficient world economy, raising living standards in rich and poor countries alike. A further Justification was that developing countries would reap enormous benefits by establishing modern stock and bond markets to finance their industries instead of relying heavily on traditional (and often corrupt) banking systems. The advocates of globalized capital were by no means unconcerned about the dangers of international crises, and they hedged their recommendations by urging countries to develop proper legal institutions and improve supervision of their banks before allowing the Electronic Herd to invest large amounts of money in their markets. But money poured into fast-growing emerging markets nonetheless, much of it “hot,” meaning it could be sold or withdrawn quickly, often at the stroke of a computer key, by portfolio managers or commercial bankers or curr
ency traders sitting in offices thousands of miles away.

  The precipitous drop in the Mexican peso in late 1994 and early 1995 provided a Jarring example of the potential for volatility that lurked within the system. But the Mexican crisis caused little contagion, and it ended triumphantly for the Clinton administration and the IMF in January 1997, when a recovering Mexico repaid—in advance—the $12 billion it had borrowed from the U.S. Treasury. If anything, the Mexican case gave the High Command an overblown sense of its power to manage such situations. Only after the much more widespread gyrations and perturbations of the late 1990s did the system’s lack of governability begin to hit home.

  The popular perception of the High Command was illustrated by an article published in Time in early 1999, titled “The Committee to Save the World.” The magazine’s cover displayed a photo of Robert Rubin, the secretary of the treasury, his deputy (and eventual successor) Lawrence Summers, and Alan Greenspan, chairman of the Federal Reserve Board, posing amid the marbled splendor of the Treasury with arms folded and faces cheerfully composed. As the photo and accompanying article suggested, these three men, working hand in glove with the IMF, were exercising extraordinary influence over the strategy for containing the crisis.

  The soothing notion that the world was being “saved” by brilliant policymakers was understandable, for the crisis did have a more or less happy ending. In a couple of countries in particular, the IMF posted notable successes as well as failures. Following the Fund’s abortive attempt to bail out Korea in early December 1997, a second rescue a few weeks later used a different approach to restore confidence in that country’s financial system, averting what might have been a far wider crisis. A second IMF program for Brazil in March 1999 also worked, and even the earlier bailout, while failing in its avowed goal of preventing a Brazilian devaluation, at least staved off a collapse in the country’s currency until global markets had recovered from other devastating shocks.