The Chastening

by Paul Blustein

  The general view on the staff was that “this is the Asian model, and it won’t change,” said Karin Lissakers, the U.S. executive director of the IMF. “But it was so clear, at least to the United States, that the real problems with Korea were structural and that the financial system was the point of vulnerability.”

  Lipton’s presence in Seoul added another element of theater to the negotiations—and provided a symbol to the Koreans of how the United States was influencing the IMF behind the scenes. Lipton checked into the Hilton and, mistaken for an IMF staffer, escaped notice by the press at first, even though he was meeting often with Neiss and had to walk past reporters thronged in the hall near the elevator on the nineteenth floor where the IMF mission was staying. But after a day or so of anonymity, he opened his door to find a photographer lying in wait. He closed the door, waited for a while, and the photographer fell asleep. But when Lipton started to leave, the photographer Jumped up and followed him, taking pictures. Soon Lipton’s visage would be featured in anti-IMF and anti-U.S. cartoons in the Korean media. After being “outed,” he changed rooms at the Hilton and registered under a false name.

  In accord with his mandate from Rubin, Lipton was pressing both the IMF and the Koreans to strike as far-reaching an accord as possible. When Korean officials informed him shortly after his arrival that they had practically completed a pact with Neiss, Lipton told them they could announce anything they wanted, but until it was actually agreed with the IMF, it wouldn’t have the backing of the United States. Toward the end of the negotiations, he had a dramatic 4 A.M. encounter with Chung Duk Koo, a top Finance Ministry official, who emerged from a meeting with Neiss to tell Lipton that Seoul had granted every concession it could possibly make. Lipton was unmoved, reminding Chung that he had met the previous morning with Finance Minister Lim and discussed the elements Washington believed were necessary to turn the economy around and needed in an IMF program. “I told the minister this morning, and I mean it, what we want in terms of change in your economy,” Lipton told Chung.

  Much of Lipton’s effort was concentrated in obtaining firm, specific Korean commitments to speed up liberalization of the country’s financial system. He also wanted a much tighter monetary policy. IMF staffers thought many of his proposals were sensible, but they bridled at others that they felt were focused more on serving U.S. interests than Korea’s, in particular a demand for Seoul to allow greater business opportunities for foreign brokerage firms. Some on the mission team fumed that they couldn’t get to see Neiss because when he wasn’t locked in negotiations with the Koreans, he was spending so much time with Lipton. But Neiss himself, ever the diplomat, showed no irritation whatsoever with Lipton’s intervention, and Lipton, for his part, had only kind words for Neiss. “I would meet with Hubert at, say, 2 A.M. or 4:30 A.M.,” he recalled. “When I went to sleep, he would be in a meeting; when I got up a couple of hours later, he would still be in a meeting. The amazing thing was his equanimity.”

  Not that Neiss was impervious to the pressure. On the last night of the negotiations—Tuesday, December 2—he disappeared from the hotel in the wee hours of the morning, to the consternation of Tseng, who like Neiss had not slept since Sunday. “I was getting very worried,” said Tseng, who finally tracked Neiss down and found that he had gone for a midnight Jog. “He said he had Just gone out on Namsam Mountain [a small mountain near the Hilton]. He said he went up to the top and saw Seoul and all the lights. He said he Just needed to clear his head.”

  At 6 A.M. on Wednesday, December 3, Neiss—who had finally collapsed, fully dressed, for a couple of hours in his bed—was Jolted awake by the sound of a phone ringing. It was Chung Duk Koo, from the Finance Ministry, who was downstairs waiting to go with him to the airport. Neiss hurriedly brushed his teeth; there was no time to shower or shave. Arriving that morning in Seoul to complete the negotiations was his boss, Michel Camdessus. In contrast with Camdessus’s previous visit, all of Korea would be aware of his presence this time.

  The IMF’s managing director and his wife, Brigitte, did not look pleased as they stepped off the plane at Kimpo Airport in the early morning of December 3. The weather was frigid, and reporters were mobbing them so aggressively that Mrs. Camdessus became apprehensive. To ease the tension, Oh Jong Nam, a Korean Finance Ministry official who had been sent to welcome them officially, tried a Joke: “Since it is so cold, I invited many reporters to warm the air, so don’t be scared.”

  Camdessus’s mood did not improve when Oh handed him the ministry’s proposed schedule for the day. The managing director’s arrival in a country at the end of negotiations usually means that the talks are essentially finished, the Letter of Intent has been readied for signing, and the champagne has been chilled for toasting. That, in fact, is what Korean officials were devoutly hoping for this visit; they tried to arrange a virtually content-free day filled mostly with press conferences, signing ceremonies, a courtesy call with President Kim, and a luncheon with the ambassadors to Korea from the G-7 countries, capped by a send-off for Camdessus to Tokyo, where he was scheduled to arrive that evening. The Koreans had been embarrassed a couple of times during the negotiations when they told the press they had reached agreement with Neiss, only to be forced to admit later that further bargaining was required. (Both sides professed to be furious over the mix-ups. IMF officials accused the Koreans of trying to bulldoze them into an agreement, and the Koreans accused the IMF of constantly raising new issues at the behest of the United States.) On the afternoon before Camdessus’s arrival, Finance Minister Lim Chang Yuel suggested that he foresaw no further major obstacles. “The talks are virtually completed,” he told reporters.

  But they weren’t. “I am here to negotiate,” Camdessus said stiffly after glancing at the schedule handed to him. In fact, he did so much negotiating that day that he had to postpone his flight to Tokyo and send his wife to represent him at the ambassadors’ luncheon. By all accounts, he got the Korean program “strengthened” considerably during his one-day whirlwind visit, extracting substantial further concessions from the Korean side.

  It is not clear how tough Camdessus had originally planned to be. Several days before his arrival, while Neiss was still negotiating with the Koreans, Camdessus had participated in a conference call with a group of senior IMF officials in Washington who argued that the Fund should be insisting on stronger conditions. Informed during the call that the Americans were particularly dissatisfied, Camdessus retorted dismissively, “They’re always unhappy.” That comment left his listeners uncertain about whether he genuinely intended to disregard the U.S. concerns or was simply engaging in a show of bravado for his staff.

  The Treasury was evidently worried that Camdessus would acquiesce to a quick signing of a Letter of Intent based on the concessions the Koreans had already offered. To head off that eventuality, Rubin phoned the IMF chief shortly after Camdessus’s arrival in Seoul. What Rubin said, and how far he went in pressuring Camdessus, nobody will reveal. But this much is certain: Rubin delivered an extraordinarily blunt, unequivocal warning that the United States would not countenance what it regarded as a weak program. There was a chance, of course, that the Koreans would eavesdrop electronically on the call—but as far as the Treasury was concerned, such snooping would be a plus, not a minus, since it would help Seoul understand that Camdessus was under tremendous pressure to take a hard line.

  The final negotiations on December 3 took place in Lim’s Finance Ministry office instead of at the Hilton, because of the media frenzy at the hotel. One major dispute was over the short-term interest rates set by the central bank. To attract foreign investors, Camdessus said, those rates should be doubled from 12.5 percent to the legal limit of 25 percent—well above the 15 to 20 percent figure that the Koreans and the Neiss mission had been negotiating. Lim and his lieutenants voiced deep concern about the impact on Korea’s highly indebted corporations, and argued that in Korea, higher rates wouldn’t help much in luring capital from overseas because o
f the limited opportunities for foreigners to invest in the economy in the first place. But Camdessus stood firm, diplomatically presenting the case for higher rates as a way for the country to win back the confidence of the markets by restoring the credibility of the central bank. The Koreans finally backed down, recalled Lee Kyung Shik, the central bank governor, because the country’s supply of usable reserves at that point was down to about $6 billion.

  Finally, around 6:30 P.M., the two sides shook hands on a deal that would provide Seoul with a package of loans and backup credits totaling more than $55 billion. (The sum would rise as high as $60 billion in the next few days as the number of countries offering bilateral lines of credit increased.) The $21 billion IMF portion was the most the Fund had ever lent to a single country, and it was more than six times the amount Korea would normally be allowed to borrow. The Koreans had agreed to a slew of measures aimed at opening their economy to greater foreign involvement, increasing competition in the financial sector, and weakening the ability of the chaebol to pile on debt from compliant banks. Foreigners would be allowed to establish bank subsidiaries and brokerage houses in the Korean market by mid-1998, as the Americans had demanded. The ceiling on aggregate foreign ownership of publicly traded companies would be raised by year-end from 26 percent to 50 percent, and the ceiling on individual foreign ownership from 7 percent to 50 percent. The nation’s opaque accounting practices would be brought much closer to international standards, with corporations required to submit consolidated balance sheets and profit and loss statements, part of an effort to discourage the complex webs of loans and crossguarantees the chaebol had established among their subsidiaries. Large financial institutions would be required to submit to audits by internationally recognized firms. The Koreans also backed down on the issue of closing merchant banks, announcing that nine insolvent institutions would be suspended from operating and given thirty days to draft plans for rehabilitating themselves or face closure.

  As Camdessus and Lim emerged to face the cameras, Camdessus’s buoyant confidence contrasted with Lim’s sorrowful appearance. “I am pleased to announce that the Korean authorities and an IMF team concluded discussions in Seoul today on a strong economic program that provides for a decisive and welcome response to the country’s present financial difficulties,” the IMF chief declared. Lim, meanwhile, said that he had “come here to beg the forgiveness of the Korean people.... These pains and burdens are the cost our economy has inevitably to pay to revive and to recover our lowered credibility in the world financial society.” In Washington, a Treasury official briefing reporters on the terms of the bailout crowed that the program “will bring about substantial changes in the Korean financial sector, which in turn have the potential to open up the Korean economy and move it toward one that is much more dependent on the operation of market forces.”

  The High Command was doing its best to turn the situation into a finale from “The Perils of Pauline,” the silent movie adventures that typically ended with the tethered heroine plucked from the path of an onrushing train. The message to the outside world was, Breathe easy. The IMF and the rest of the High Command would provide the money needed to avert a potentially catastrophic default, and Seoul would be forced to change its crisis-prone system. Korea would be saved.

  But Pauline was still firmly lashed to the railroad tracks.

  6

  THE NAYSAYERS

  Bob Rubin’s concern about the IMF’s credibility was well founded. The Fund’s skill at resuscitating ailing economies was coming under severe question following the disappointing results in Thailand and Indonesia. The chorus of voices criticizing its approach to the crisis was growing louder.

  The IMF, of course, was hardly unaccustomed to criticism. But for the most part, Fund officials had successfully rebuffed their critics and easily surmounted the political challenges they posed. To those on the left who complained about the austerity incorporated into IMF programs, the Fund replied that there is no reasonable alternative to making countries live within their means. To those on the right who accused the IMF of interfering in markets and propping up inefficient governments, the Fund countered that cash-strapped countries deserve to be helped through a painful adjustment period if they are willing to change their ways.

  But as the Asian crisis spread, discord arose from within the economic mainstream, from people who shared the Fund’s ideology of free markets, free trade, globalization, and the need for an official safety net. Some criticism was even coming from within the Bretton Woods institutions and top officials of the G-7. Among the dissidents were four of particular prominence who were raising significant issues that would weigh heavily on how the IMF conducted its affairs.

  Sitting on a panel at a conference in summer 1997, Harvard Professor Jeffrey Sachs received a note from fellow panelist Larry Summers, the Treasury’s deputy secretary. The note asked for Sachs’s views on how the IMF ought to handle the budding crisis in Asia. “I wrote back, ‘Stay home!’” Sachs recalled. “And Larry wrote back saying, ‘No, really.’ And I wrote back, ‘Really!’”

  The episode was vintage Sachs, who reveled in his role as gadflyin-chief to the IMF. The Fund had endured slings and arrows from many distinguished academics over the years, but the brash, boyishfaced Sachs stood above them all in his capacity for making veins bulge and teeth grind. The owlish Martin Feldstein, Sachs’s Harvard colleague, might chastise the Fund using scholarly terminology in the pages of Foreign Affairs, but Sachs pulled no punches in his opeds. Shortly after the first IMF rescue for Korea was announced, he wrote in the Financial Times: It defies logic to believe that the small group of 1,000 economists on 19th Street in Washington should dictate the economic conditions of life to 75 developing countries with around 1.4 billion people.... Since perhaps half of the IMF’s time is devoted to these countries—with the rest tied up in surveillance of advanced countries, management, research and other tasks—about 500 staff cover the 75 countries. That is an average of about seven economists per country.

  One might suspect that seven staffers would not be enough to get a very sophisticated view of what is happening. That suspicion would be right. The IMF threw together a Draconian program for Korea in Just a few days, without deep knowledge of the country’s financial system and without any subtlety as to how to approach the problems.

  Such screeds were derided by indignant members of the Fund’s External Relations Department as exercises in self-promotion, and indeed, Sachs’ ego often did loom large. “Mr. Sachs is not shy about his academic accomplishments,” a New York Times profile observed in 1989. “His curriculum vitae runs some 13 pages and contains such tidbits as the fact that he graduated third in his Harvard class of 1,650 students. He took pains in an interview to note that he is a member of Harvard’s elite Society of Fellows.”

  Sachs first made his name not as a critic but as an adviser helping acutely distressed developing countries achieve economic turnarounds. His stock-in-trade was an approach that came to be known as “shock therapy,” which involved radically market-oriented reforms and—as the name implies—an initial period of dislocation and Joblessness as a precursor to recovery. His first case was Bolivia, which was racked by an inflation rate that by 1985 had reached somewhere between 24,000 percent and 60,000 percent, depending on how it was counted, on an annual basis. Sachs, who was thirtyone at the time, was one of Harvard’s youngest tenured professors (along with his friend, Larry Summers), and he was fascinated by the problem of hyperinflation. At a university presentation by a group of visiting Bolivians, he insisted there was a plausible way to stabilize the economy, and they invited him to come to La Paz and try. He accepted, and helped reform-oriented officials in the government devise a plan that included drastic spending cuts, the closure of money-losing state enterprises, the liberalization of prices and restraints on wages. Some initial results were excruciating—unemployment rose to 22 percent by 1988, and incomes, already miserably low, dropped to about $573 per person. But i
nflation shrank to 10 percent the year after the plan took effect, and the economy began eking out some growth after years of stagnation.

  Sachs’s next case was Poland, where inflation was running at about 50 percent a month in the late 1980s and the economy was sinking fast amid the collapse of communism. The leaders of the Solidarity labor movement, who were about to take power in 1989 and desperately wanted to bring their country into the Western mainstream, enlisted Sachs’s advisory firm. Together with his colleague David Lipton, Sachs drafted a program that envisioned a breathtakingly ambitious break from Poland’s socialist past, and promised Poles in speeches and television appearances that the plan would eventually bring growth and stable prices. The “big bang” came on January 1, 1990, when the government freed almost all prices to rise to market levels, slashed subsidies for lumbering state enterprises, and reined in wages and the money supply. As in Bolivia, inflation and unemployment soared at first, and workers’ purchasing power shrank. But within a couple of years, as industrial efficiency improved and new enterprises sprouted, Poland became a star performer among Eastern Europe’s newly capitalist economies.

  As these stories suggest, Sachs was no foe of the free market and was not reluctant to prescribe temporarily painful adjustments for the countries he counseled. But as his reputation grew, he clashed often with the IMF, which he viewed as insular, rigid, and resistant to considering novel approaches. And upon seeing the onset of the Asian crisis, Sachs went into overdrive, arguing passionately in academic papers and op-ed articles that the Fund was fundamentally misdiagnosing the problem by putting so much of the blame on the Asian economies’ internal weaknesses.