The Chastening

by Paul Blustein

  While on the plane to New York, Kim Ki Hwan had decided on a name for the plan he wanted to pitch to the Treasury—“IMF Plus.” Since he was intending to ask the Treasury a big favor, he thought he should offer something in exchange—namely, additional and faster reforms of the Korean economic system than had been pledged in the December 3 IMF program. The question was, would DJ endorse such a policy? During his campaign, the president-elect had backed off from his initial denunciations of the IMF program and had pledged to support the reforms. But to assert that DJ would go even further down the reform path—especially given the likely pain for his working-class constituency—was a claim Kim Ki Hwan was not prepared to make on his own.

  When I learned the next president would be DJ [Kim said], I thought, “I have to get his endorsement.” So as soon as I arrived in Washington, I made several calls to Seoul. I contacted an influential legislator in DJ’s party, and he in turn got in touch with DJ’s secretary. The reply came from the secretary. He said, “Oh, Ambassador Kim, we are all behind you, and we wish you all success for your mission.” That call came Just a couple of hours before I left my hotel to go to the Treasury.

  Actually, the way it happened was this: I had been waiting for the call in my room. But you cannot deny yourself a call from nature. When I came back, there was a voice mail saying the president-elect assures me you have our full support. So I felt I could tell the Treasury I speak for both governments—incoming and outgoing.

  To prepare for the meeting with Summers, Kim had met Lee Kyung Shik of the Bank of Korea on December 16 and had obtained a table showing how much hard currency the central bank had left and how many days would pass before default was likely. But by his arrival in Washington on the nineteenth, he worried that the figures might already be outdated. So he called Lee, asking for a more upto-date version. Concerned about security, Lee replied that he would have someone in his Washington office deliver the data by hand. “When the guy gave me that data, his hand was shaking,” Kim said. “He said, ‘The situation is truly bad, and I hope you succeed.’ The table showed that if nothing were done, our foreign exchange reserves as of December 31 would be minus $600 million to $800 million.”

  At the meeting with Summers, Kim explained how precarious Seoul’s reserve situation was, and he made two requests. First, he asked the deputy secretary to use his influence so that the IMF would speed up its disbursements of rescue loans to Seoul. Second, he asked for the U.S. government to persuade American banks and other international banks to roll over their loans to Korean banks. “On the first request, Mr. Summers indicated he was quite willing,” Kim said. “But on the second question, he played a little poker face on me. He said, ‘You know our system. Our government cannot tell banks what to do.’ I said, ‘Well, if you cannot tell your banks, would you please tell the Japanese to tell their banks.’ That is something he said he would consider.”

  Toward the end of the meeting, Summers asked where Kim would be that evening, and Kim replied he would be at his hotel. Hopeful that favorable word would be forthcoming, Kim waited for a call, but having heard nothing by 9:30 P.M., he rang Summers’s office and was told the deputy secretary was in a meeting. About fifteen minutes later, however, Tim Geithner phoned back with what sounded like promising news: The Treasury was dispatching David Lipton to Seoul, on a plane leaving Washington the following day at 1 P.M.

  The meeting with Kim Ki Hwan, according to Summers, was “very consequential.” The promise that Korea’s new president would seize the mantle of reform provided the basis the Treasury needed for one last attempt at forging a new rescue. On the morning of Saturday, December 20, Summers and the other top Treasury policymakers held a marathon conference call with Rubin, who—in a characteristic manifestation of sangfroid—had flown off for a fishing vacation in the British Virgin Islands.

  Although a final decision would take a couple more days, the Treasury was at long last coming around to the view held by Mussa, the Germans, Ted Truman, Camdessus, and Fischer, who had been quietly lobbying the G-7 after weighing the options in the Plan B memo. The conclusion was simply inescapable: Korea would default without an initiative to bail in the banks. Even Greenspan finally agreed, despite his distaste for government-imposed solutions, that the potential consequences of default were simply too great to risk.

  But now the question was whether the banks would go along or whether they would react by pulling loans all over the world, engendering an even bigger crisis. John Reed, chairman of Citicorp, told Summers that the scheme had a fifty-fifty chance of success.

  Furthermore, there was almost no time left, as Kim Ki Hwan’s data from the Bank of Korea suggested. The Christmas holidays were Just around the corner, and once commercial bank CEO’s left town for the ski slopes or beach resorts, the chances of persuading them to act collectively were almost nil. A substantial amount of Korea’s short-term debt was coming due the last week of the year, and if the bankers holding those claims insisted on immediate repayment instead of rolling them over, Seoul would be forced into default. Help for Pauline was on the way, but she was still on the railroad tracks, and the onrushing locomotive was fast approaching.

  That was the urgent message from another power center in the U.S. government, the Federal Reserve Bank of New York, which is by far the most important of the twelve regional banks in the Federal Reserve System. The New York Fed supervises most of the largest banks in the country, and it also serves as the central bank’s watchdog for financial markets and handles the day-to-day dealings in the money markets through which the Fed controls interest rates.

  The New York Fed’s president, William McDonough, was the second most powerful Fed official after Greenspan, and unlike Greenspan, the sixty-three-year-old McDonough was itching to use the moral suasion his office commanded to convince the banks that it was in their collective interest to avert default. Over the weekend of December 20-21, in calls to Washington, he argued for convening a meeting of bankers as quickly as possible before the holidays. “I said, I’ve got to have the meeting on Monday, because otherwise there won’t be anyone to talk to,” McDonough recalled.

  With his silver hair and square Jaw, McDonough exuded the polished charm one would expect in a high-ranking central banker, though he had been raised far from the lap of luxury. The son of Irish immigrants who moved to the west side of Chicago, he lost his mother at age ten, and his father, who sold insurance, died the following year. He went to Holy Cross College in Massachusetts on a U.S. Navy ROTC scholarship, majoring in economics. Then came five years in the Navy, during which he continued his economics training with a master’s degree from Georgetown University, and six years in the State Department. He Joined First Chicago National Bank in 1967, where he spent more than two decades and rose to the rank of vice chairman. With this background as a top commercial bank executive, he felt he understood how the minds of bankers worked and how to persuade them of what was in their self-interest.

  At McDonough’s behest, top executives from six of America’s largest banks—Citibank, J. P. Morgan & Co., Chase Manhattan, Bank of America, Bankers Trust, and Bank of New York—filed into the stately offices on the New York Fed’s tenth floor on Monday morning, December 22. The meeting was to make sure the top banks would be prepared to move fast to start the process toward a collective agreement aimed at stopping the hemorrhaging from Korea. Policymakers in Washington were still debating what sort of approach to take with the banks. Some favored a strong-arm stance to ensure that the banks rolled over their loans; others argued that tough words would only backfire. The approach favored by McDonough and Terrence Checki, a New York Fed executive vice president responsible for international issues, was to avoid giving the bankers the feeling they were being locked in a room and handcuffed; rather, the idea was akin to inviting them into the room and suggesting they try on the handcuffs to see how they feel. “You’ve got to put them in a position where doing ‘the right thing’ is demonstrably in their interests and that of their
shareholders,” McDonough said. “You don’t want to make a guy stand up at his annual meeting and say, ‘We did this for the good of mankind.’ You want him to feel that he’ll be able to stand up and say, ‘We did it because otherwise we would have had a loss, and we believe Korea’s debt is fully collectible.’”

  At the meeting, McDonough confined himself to explaining his personal view, which was that if the banks refused to roll over their loans and stretch out their claims, the IMF and the High Command would have to refuse to take any further steps aimed at preventing a Korean default. His words to the bankers went roughly as follows: This is not an official position of the U.S. government. But let me tell you what my view is, and what I’m advising my colleagues in Washington, which is, it is unconscionable for taxpayers’ money, whether from the IMF or bilateral funds, to be used to repay private-sector creditors. So my advice to my colleagues in Washington is, there should be no additional public-sector money for Korea unless you guys reschedule the debt. That’s my position. It doesn’t mean it will be followed, because it is not yet U.S. policy. But I wanted you to know that, because the flow of funds is such that we’re talking about a Korean default next week if this matter is not resolved.

  The bankers asked a number of questions and expressed several reactions, according to people who were present. But one of the most striking, and widely voiced, was this: Why had it taken so long for a meeting such as this to be called?

  Upon hearing that David Lipton was returning to Seoul, Ambassador Kim Ki Hwan didn’t waste any time. He knew Lipton would be seeking the commitment of president-elect Kim Dae Jung to a host of reform policies, and he feared that if Lipton heard a lot of equivocating, American support for the “IMF-Plus” plan might be lost. The Korean envoy wanted to make sure that DJ was well-briefed on what to say, because after all, the president-elect didn’t even know what IMF-Plus was. “I felt I had to beat Mr. Lipton back to Seoul,” Kim said with a sly smile. So early Saturday morning, December 20, Kim left Washington to catch an earlier flight back to Seoul from New York, which enabled him to land in the South Korean capital Sunday afternoon. Lipton’s flight would not arrive until 6:30 Monday morning.

  Back in Seoul, Kim Ki Hwan reported immediately to Finance Minister Lim, who agreed that it was “inevitable” for Korea to accept further reforms, and said that DJ should hear directly what had happened at the meeting with Summers. An appointment was arranged for Kim Ki Hwan to meet DJ at the president-elect’s home early Monday morning, around the same time as Lipton’s plane was scheduled to land. In fact, as Kim walked into DJ’s house, he passed a number of aides who were watching a TV screen showing a live broadcast of a bedraggled Lipton arriving at Kimpo Airport, wearing Jeans and a blue-and-red sports shirt. “When I made my report to the president-elect,” Kim Ki Hwan recalled, “I said, ‘Mr. President-elect, I am sure the U.S. embassy will call you shortly, asking for an appointment with Mr. Lipton.’ And I said, ‘You’ve got to do IMF-Plus.’ I didn’t exactly say it was a promise I had made to the U.S. Treasury. The president-elect asked me, ‘What does that involve?’ I said, ‘Well, [Finance Minister] Lim should report to you.’ But I gave him four or five examples of what my conception was.”

  Fortunately for Kim Ki Hwan, who had never met DJ before, there were some powerful advisers within the president-elect’s camp who favored breaking the power of the chaebol. Indeed, DJ’s main economic adviser, You Long Kuen, a provincial governor and former Rutgers economics professor, had been trying since the election to convince the Treasury and IMF that the populist DJ would prove far more willing than the existing government to endorse those kinds of reforms. He soon got the chance to show he was right.

  Lipton’s meeting with DJ took place at the headquarters of the president-elect’s political party, the National Congress for New Politics, an unassuming eighteen-story office building that was draped with a banner declaring, “Thank you. I’m going to revive the economy. I will work hard. Kim Dae Jung, President-elect.”

  A key question about DJ, as far as the U.S. Treasury was concerned, was whether the aging crusader for democracy was willing to accept the dislocations—including Job losses—that would inevitably accompany the closure of weak banks and uncompetitive chaebol units. Korea had a law against layoffs, and some of the unions that had provided DJ’s strongest support were already demonstrating against a proposed easing of the law. But the Treasury hoped that DJ, as a leader with a history of championing labor rights, would be ideally situated politically to persuade workers of the need for sacrifice.

  Lipton didn’t demand that DJ accede to layoffs, although he came close, suggesting that Korean unions could save their Jobs only by accepting much lower pay. He told the president-elect that he felt the subject of labor was “key to Korea’s situation,” and that if the unions wanted to have a high level of employment, they would have to “exercise wage flexibility.” Citing his own experience in Poland, Lipton reminded DJ that in that country, too, a Jailed dissident leader with ties to labor, Lech Walesa, had come to power in the midst of a financial crisis and saw that short-term pain would lead to long-run gains. “I said that while unemployment rose in Poland, there were a lot of Jobs created, and unemployment is now below the European average,” Lipton recalled.

  Kim Dae Jung replied that his first priority was to make needed adjustments in the Korean economy, and that everyone—including labor, business, and government—would have to share in that adjustment. Job security, he said, must come second. Watching a news account of the encounter on television, Kim Ki Hwan sighed with relief. “As far as I could tell,” he said, “it was all music to Mr. Lipton’s ears.”

  It was the timing, not the content, of the G-7 deputies’ conference call that Jürgen Stark found so objectionable. With less than twenty-four hours remaining before Christmas, Stark, the German state secretary for finance, “did not appreciate” being stuck in his office on the phone until well after midnight, another official recalled, especially since he thought the conversation should have taken place weeks earlier.

  On Monday, December 22, out of the blue, Larry Summers had delivered an important message to his fellow deputies: The New York Fed was approaching large U.S. banks about rolling over their loans to Korea, and the United States was now urging its G-7 partners to do the same, in what would be a massive bailing in of Korea’s creditors. This sort of “private-sector involvement” was, of course, exactly what the Germans had been advocating. So although a couple of the deputies voiced qualms, Stark said the idea was fine with him, as long as all banks involved were treated equally. But he warned that he couldn’t be sure he could implement it, because some of Germany’s top bankers might not be reachable. Christmas is a holy time of year in any Christian country, but that is especially true in Germany, where families traditionally retreat to their homes starting Christmas Eve to decorate the tree—often with candles, which requires considerable time and care—and don’t expect to be disturbed until after the twenty-sixth. The point, Stark said, was that the plan shouldn’t have waited until the last minute.

  During the conference call on December 23, the deputies and Stan Fischer hammered out the details of a statement that would be released on Christmas Eve, stating that the Fund, Korea, and a number of advanced industrialized countries had reached agreement on a new plan: The IMF would speed disbursement of $2 billion to Seoul on December 30, well ahead of schedule, and the World Bank and the Asian Development Bank would disburse $3 billion and $2 billion, respectively. Moreover, the countries contributing to the second line of defense—including the United States—would “support” a disbursement of $8 billion from the second line (though in the end, the second line would never be tapped). In return, Korea would accelerate many of its promised reforms and undertake new ones, under the terms of a revised Letter of Intent, which Hubert Neiss was already negotiating in Seoul.

  But the statement contained a new catch: The aid for Korea was being provided “in the context of a significa
nt voluntary increase in rollovers or extensions of the maturities of existing claims by international bank creditors on Korean financial institutions.” In other words, Just as McDonough had admonished, the Fund would help Korea avoid default only if the banks played their part by agreeing to a standstill—calling a halt to their withdrawals of money—and accepting a payback of their loans over a longer period of time.

  As Stark had feared, organizing the standstill over Christmas proved a monumental and nerve-racking challenge. To get in touch with Martin Kohlhaussen, chairman of Commerzbank and a leader of the Association of German Bankers, German Finance Ministry officials had to go through Chancellor Helmut Kohl’s office, where an officer in charge—in the German equivalent of the White House Situation Room—tracked down a private phone number for Kohlhaussen’s vacation home in the Bavarian Alps. In France, Stark’s counterpart, Jean Lemierre, had little trouble getting the banks’ top executives to agree to the standstill, given the French tradition of government intervention, but rounding them up wasn’t easy. Upon being reached at home, one CEO told Lemierre, “Look here, I’m opening oysters [a traditional Christmas Eve treat in France]; I’m not going to talk about Korea,” to which Lemierre replied: “Look here, you are going to talk about Korea.”