In an Uncertain World

by Robert Rubin

  Late in the evening, I was still on the phone with the President and Sandy Berger. After speaking to South Korean President Kim Young Sam to strongly urge reform, Clinton, who was at Camp David, was waiting to be connected to the Japanese Prime Minister. President Clinton was supposed to urge Hashimoto to address Japan’s problems and to discuss the South Korean problem more generally. But Hashimoto was on an airplane and couldn’t be reached right away. As we waited and waited, some wondered if the Prime Minister didn’t want to take this call. While we were standing by, Clinton was doing the New York Times crossword puzzle, which he reputedly could dispatch in a matter of minutes. He asked me about a clue—a three-letter word starting with some letter or other. I had no idea, so I asked my son Jamie.

  “Who’s so stupid that they don’t know that?” Jamie retorted in a voice that could be heard at the other end of the phone.

  “The President of the United States,” I said.

  IMF Managing Director Michel Camdessus had already gone to South Korea once to begin negotiations. That trip had been made in secret to prevent spreading additional alarm. Now Camdessus was headed back to South Korea officially to negotiate the terms of an IMF program. Facing the prospect of a huge U.S. commitment to South Korea, we decided to send David Lipton to Seoul right away. We wanted to get an independent assessment of the situation as well as to reinforce the importance of strong reform measures.

  Our view was increasingly that nothing short of a major reform program in South Korea would bring back market confidence. And more than in Mexico, the necessary policy changes needed to go beyond macroeconomic issues such as interest rates and exchange rates to encompass a range of structural issues that went to the heart of the South Korean economic system. One troubling practice was “directed lending,” whereby government officials could tell banks to whom to extend credit. That kind of arrangement was the lifeblood of what was being called “crony capitalism.” Korea also limited foreign investment and competition. The result of all this was that banks that had little discipline and that favored businesses were protected from failure and had virtually no financial constraints. South Korea would have to tackle fundamental issues for the economy to recover. But in negotiations with the IMF staff and direct discussions with David, officials of the Ministry of Finance and Economy offered inadequate proposals on key structural issues.

  Our discussions within Treasury—about what South Korea needed to do to stop the crisis—continued almost around the clock. For many of these meetings, we relied on the Treasury telephone operators to connect us from disparate spots on the globe. During an intense phase of this discussion, I was in Chile at a meeting of Latin American finance ministers, David was in Seoul, in a completely different time zone, and Larry and others were in Washington. I remember placing a call from Chile to Michel Camdessus, who was under heavy pressure in Seoul to reach an agreement. The South Koreans kept announcing that they were about to sign a deal, perhaps trying to force the IMF’s hand. We hoped that the South Korean intelligence service would be listening in, so my discussion with Michel—about the extreme importance of a strong program—was meant for the South Koreans as well.

  As we continued to hold out, the South Koreans began to take the IMF conditions more seriously. They agreed that interest rates would be set at levels sufficient to restore a willingness to hold won-denominated assets. Directed lending would be abolished. Failed financial institutions would be closed or else restructured and sold. And South Korea’s financial sector would open to competition, including from foreign companies. With these concessions in hand, Camdessus announced a $55 billion assistance package on December 3. This was the largest support program the IMF had ever assembled, although smaller relative to the size of the South Korean economy than the Mexican program had been.

  Signing a deal didn’t make us think South Korea’s problems were solved—far from it. The big question was whether the commitments the government had made on paper would be implemented in practice and whether the markets would respond. The immediate reaction of the financial markets was positive, giving us initial cause for optimism. The South Korean won moved up a bit, and the South Korean stock market rose a good deal. But after two good days, the situation began to darken again. Beginning on Monday, December 8, the won plunged 10 percent a day for four days in a row—as much as it was allowed to move under the existing currency regime. That decline triggered a further downward spiral in other world markets, especially those in Asia.

  What went wrong? One problem was that South Korea did not really want to let interest rates rise to the levels necessary to induce investors and creditors to stay. The government faced a kind of Catch-22: higher interest rates threatened to hurt the over-indebted chaebols and weaken the South Korean banks still further. But companies and banks would also be damaged if the won fell more against the dollar, pushing up the won value of their dollar debts. And that was likely to happen if interest rates were kept too low.

  As the situation deteriorated, foreign banks became more desperate to pull out their money. None of them wanted to be the last ones in when there were no reserves left to pay them. We kept daily tabs on what we called “the drain,” or the rate of hard currency outflows from South Korea. We now knew that the South Korean central bank was depositing its hard-currency reserves in South Korean banks. These banks promptly used the dollars to repay foreign bank loans, so the central bank could not feasibly get the dollars back. In early December, even after drawing $5.5 billion from the IMF, South Korea’s foreign currency reserves were down to around $9 billion, with a “drain rate” of $1 billion a day.

  We also had a problem, as with Thailand, of belated disclosure. The revelation that South Korea’s buffer of reserves was almost gone spooked the markets. Rumors began flying about the size of South Korea’s foreign debt. One estimate put the total foreign debt coming due in the next year at $116 billion. That meant that even the huge IMF program couldn’t save South Korea if confidence didn’t return. Around that time, Barton Biggs, a well-respected Wall Street analyst, estimated that South Korea could run out of reserves by the end of the month.

  An additional problem was that the South Korean elections were rapidly approaching. With the country’s political leadership in flux, the markets were skeptical that the government would be able to take ownership of the IMF program. Although the IMF had gotten the three leading candidates for the South Korean presidency to sign on, none of them evinced much enthusiasm for the reform measures that President Kim Young Sam had agreed to. The front-runner in the campaign was Kim Dae-jung, a heroic former dissident and eventual winner of the Nobel Peace Prize, who had spent time on death row under the military dictatorship that fell in 1987. Kim was a trade-union populist who, despite an election manifesto that in some respects echoed the IMF program, said in one interview that if elected, he wanted to renegotiate the terms of South Korea’s deal with the IMF.

  On December 18, the day of the election, top Treasury and Federal Reserve officials met to address what we all viewed as the threat of an imminent collapse of the South Korean economy. Of the many, many discussions we had about the deepening financial storm in Asia, the dinner we had that night at the Jefferson Hotel stands out in my mind as a critical moment. During the evening, there were several calls from the White House to work on the wording of the message President Clinton would deliver in a congratulatory call to the apparently victorious Kim Dae-jung that night. The basic point we wanted Clinton to convey was that President Kim had a real opportunity to change the way his country did business—and that the consequences of not doing so could be very bleak indeed.

  Over dinner, we all discussed the situation. Our first attempt at an intervention—the biggest package ever negotiated by the IMF, backed up with additional support from the United States and other nations—hadn’t restored the confidence of foreign investors in the South Korean economy. South Korea was significantly larger than Thailand and Indonesia put together. If the South Ko
rean government or banking sector failed to make its scheduled loan payments, contagion could spread quickly through other emerging markets in Asia, Eastern Europe, and Latin America. We were very focused on the risk to the global financial system and the possible consequences for the industrial countries, including the United States. Some people at the table tried to convey their sense of this with a somewhat hyperbolic reference to a “1930s scenario.”

  Most of the discussion that night was about our remaining options, none of which was very promising. One alternative was to “let South Korea go” and somehow try to build a firebreak around it by supporting other countries. But no one thought this was likely to work. So we focused much of our effort on other ways to shore up confidence: accelerating the disbursement of IMF funds and putting together a stronger international aid package—with more upfront money from the United States and Europe—as backing for stronger reforms in South Korea. Larry Summers said that the IMF money should be disbursed aggressively to avoid a “Vietnam” situation—that is, a gradual escalation that didn’t work. Because the problem was confidence, he felt that we needed, as we had in Mexico, something more akin to the famous Colin Powell Doctrine—a massive show of financial force.

  But even the more robust support package we were considering seemed insufficient to restore confidence by itself. Dinner ended with a better understanding of various unpromising options, but without any clear decision about which way to go. At the end of the evening, Tim Geithner’s pager transmitted the news that concern about the effects of Kim Dae-jung’s election victory was driving the won down further. Markets had opened in Seoul, where it was already morning.

  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 chaebols 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 wa
s 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.