by Robert Rubin
Larry and David Lipton had been deeply involved in trying to help Russia since 1993. Their hopes for an economic transformation had waxed and waned with the coming and going of reform-minded politicians within Boris Yeltsin’s government. As Russia’s economic situation deteriorated in the spring of 1998, such optimism as remained was closely tied to the figure of Anatoly Chubais, a deputy prime minister who had handled a series of major privatizations. Chubais, who spoke not only good English but the more arcane jargon of Western finance officials, visited Washington in May 1998 to push for a large new IMF support package. Larry and David felt that Chubais was an honest figure fighting to do the right thing in a corrupt environment. My only real sense from meeting him was that he was a shrewd operator with a considerable degree of Russian pride.
My view of Russia was considerably more pessimistic than David and Larry’s—and the President’s. Bill Clinton spoke to his friend Boris Yeltsin regularly and was very focused on trying to be helpful to Russia in whatever way possible. I fully recognized the importance of helping Russia but also felt that the country had poor economic policies and enormous problems. I didn’t know a great deal about the subject, but my view had been colored by a few experiences I’d had before joining the government. In 1992, I had traveled to Moscow with Judy. The impression I formed on that trip was of pervasive corruption and economic disarray. I remembered some of the stories related by my friend Robert Strauss, who was then serving as the American ambassador. One in particular stuck in my mind, about a high Russian official who had been demanding enormous payments from American businessmen to allow routine transactions to go forward. Bob had solved the problem in a quiet meeting where he threatened public disclosure of this extortion.
I supported the $23 billion program for Russia that was announced by the IMF in July on strict probabilistic grounds. Larry and David agreed with me that the odds were against the program being successful, but the risks to the United States from destabilization in Russia seemed so enormous—from both economic and security standpoints—that going ahead made sense despite the relatively limited chance of success. I also accepted a point that Strobe Talbott, the State Department’s chief Russia specialist, often made about the danger of further alienating the Russian public. Even if the chances of success were remote, just trying to be helpful to Russia’s government could be valuable in this way. Supporting the reformers was also important, because failure to do so could strengthen the hand of reactionary political forces and endanger the prospects for change in Russia, a particular concern given its nuclear stockpile. (The issue wasn’t so much whether the arsenal would be used but whether Russia would sell nuclear materials to Iran and other nations and whether Russian nuclear scientists would sell their expertise to countries hostile to the United States.) At that point, Boris Yeltsin was desperate for assistance, and all the emphasis within the Clinton administration was on trying to find a way to respond affirmatively. A small chance of success was worth a high risk of failure. And as usual with IMF programs, the money would not be disbursed all at once, leaving the option of withholding later drawings if policies went off track.
Something less than $5 billion of the total IMF loan was disbursed at the outset. But within a very short time, it became apparent that releasing additional money would be highly unlikely to confer an additional chance of success. The clearest sign was the Russian Duma’s refusal, later in July, to support Yeltsin and Chubais on the issue of tax collection and other reform measures that were conditions of the IMF loans. Even though Yeltsin overrode the Duma unilaterally, I didn’t think more money would raise the odds of Russia getting on the right track without a broader commitment from the Russian government.
At that point, both continuing the flow of IMF money and not continuing it had potentially very damaging effects, and those effects had to be weighed against each other. If Russia’s economic deterioration led to the wrong people coming into power in Russia and blame was put on the IMF, the decision to cut off aid might later appear disastrously wrong. On the other hand, sending more money in the face of the Duma’s defiance, in addition to almost surely being futile in terms of promoting recovery, would have undermined the credibility of the IMF in its efforts to apply conditionality elsewhere in the world and created an immense moral-hazard problem with respect to creditors. Investors were buying Russian bonds at tremendous yields in the expectation of being bailed out. Providing more money to Russia without imposing appropriate conditions could do serious harm by giving foreign investors and domestic oligarchs just enough breathing space to get their money out before a collapse. All of this raised the moral-hazard problem we’d been dealing with to a new dimension. An additional dimension of the debate was whether to also put up money from the Exchange Stabilization Fund. My own judgment was that, weighing these competing considerations, the better choice was to discontinue the IMF program and do nothing with the ESF.
One problem in this episode was that the people in the geopolitical sphere tended not to relate fully to the issues in the economic sphere, and vice versa. Even after the Duma vote, members of the Clinton foreign policy team were still very focused on trying to find a way to help Russia. Sandy Berger called a meeting in the White House Situation Room to persuade Treasury to agree to more support. Many people were on his side of the issue, including Secretary of Defense Bill Cohen, Madeleine Albright, and General Henry “Hugh” Shelton, chairman of the Joint Chiefs of Staff. They all argued for doing everything we could to help the Russian people and avoid the national security nightmare that could ensue if Russia disintegrated. After these officials made their comments, they turned to me and asked what I thought.
I said that in one sense they were right. We all wanted to support the forces of reform in Russia and avoid further alienation of the Russian people. But I also thought that the Duma’s unwillingness to act meant that the odds of more money helping were close to nil, especially given the immense role of organized crime and corruption in the Russian economy. Then I turned to Steve Sestanovich, a Russia expert at the State Department who was sitting in back of me, and asked him if he disagreed. He said that some parts of Russia were more corrupt than others—which seemed to be a reluctant assent.
I also argued that providing money under these conditions would create an immense moral-hazard problem. I had lived in the markets, and I could feel people taking advantage of the situation. I knew that if I were running a trading operation, I’d be trying to make sure my firm profited from it. During all my time at Treasury, I was very conscious of market sensitivity and avoided discussing Treasury matters with friends in New York, many of whom still worked in the financial markets. Even by asking a question, a Secretary of the Treasury can indicate what’s on his mind. But Treasury and Fed officials do need to understand what market participants are thinking, which requires listening carefully to what people are saying as well as monitoring what the markets are doing. In the midst of the Russia debate, a friend of mine on Wall Street told me that investors were assuming the United States wouldn’t allow a Russian default. At the same time, David Lipton mentioned that earlier in the year he had heard investors refer to people buying Russian government bonds at 80 percent yields as a “moral-hazard play.”
On the whole, the foreign policy and economic teams worked together well on Russia as on other issues. But at this meeting, there was a lot of pressure on us to proceed with less conditionality. I recognized the validity of the argument about the need to appear helpful even if additional support was exceedingly unlikely to do any good. But I believed very strongly that the risks on the other side were greater—so strongly that I felt that if they wanted to get another Treasury Secretary who would use the ESF, or who would try to force the IMF to act, that was fine with me.
But declining to provide more liquidity didn’t mean giving up on encouraging Russia to take the steps that would allow the IMF to disburse more money. The IMF was in Russia, working very hard to persuade the Russians to implement
the needed measures, and had warned the government in late July that if it did not act it would likely face the prospect of being forced into a default and devaluation as it ran out of reserves. On August 10, David Lipton flew to Moscow to try to give us at Treasury a direct sense of what was happening on the ground. He also conveyed to Russian officials the message that their country faced very dire consequences by not confronting the rapidly deteriorating situation, and that there would be no further disbursement of IMF funds unless its conditions were met. Russia’s reserves were falling faster than most politicians knew, and the “burn” rate could accelerate dramatically if the government failed to take the necessary steps to reform and IMF talks failed. But David’s sense was that no one in the government seemed to understand how precarious the situation was or to be too concerned about the loss of reserves. Many in the government simply opposed reforms without having any idea how dangerous the failure to take action could be.
On August 17, Russia announced that it was devaluing the ruble and defaulting on its foreign-held debt. The default triggered immediate consequences, not just for the Russian people but for financial markets around the globe, which became increasingly volatile. The moral-hazard problem that had preoccupied us, of course, diminished. A lot of investors paid a high price for their faulty assumptions about our willingness to provide support without Russia’s meeting the appropriate conditions.
Several days after the default, I left for a vacation in a place that used to be Russia—Alaska, where I aspired to catch some fish. There I was, fly casting for silver salmon at a lodge a short plane ride away from Anchorage, with a Secret Service agent standing a few feet away. Silver salmon are much smaller than Atlantic salmon—they weigh eight or twelve pounds—but they’re strong. You wade into the river or fish from the bank, wearing polarized lenses to reduce glare so you can spot the salmon under the water and cast to the fish you see.
Right at noon on my first day of fishing, the Secret Service agent, an enormous man named Kevin Gimblett, told me that Betty Currie, the President’s secretary, was on the cell phone for me. He relayed the message that the President wanted to talk to me about Russia in an hour. Clinton, who was on vacation on Martha’s Vineyard, was terribly concerned about the situation, and I’d been briefing him regularly. I assumed the President wanted to discuss the latest bad news, which was that the default had led to a suspension of ruble-dollar transactions and a run on the Russian banks.
“Kevin, I’ll bet you that at five to one I get a fish on the line,” I said. And sure enough, at 12:55, I hooked a big silver salmon. While I was wrestling with it, Kevin’s phone rang.
So I said to Kevin, “Just tell the President that I’m someplace else and you’ll have to go get me.”
“I can’t do that Mr. Secretary,” Kevin said. “I’m a Secret Service agent.” He had a point—it wouldn’t look so great if he said he’d lost track of me someplace where I could be eaten by bears.
So I said, “Okay, just ask Betty if I can call the President back in a few minutes.” And he did. I finished catching my fish, released it, and phoned the President to talk about Russia again.
RUSSIA’S DEFAULT USHERED in a period of grave danger for the global economy—and for the second time in less than a year (the first was when South Korea had stood on the brink of default), I was very worried about the threat to our own economy and financial markets. So was President Clinton. He had been deeply engaged in the Asian crisis from its beginnings in 1997, holding private discussions with leaders from the region as well as the heads of the other major economies. For some months, he’d been content for Treasury to take the lead on our public response.
But as the situation worsened in 1998, the President felt more and more strongly that he should speak out. In times of crisis, he said, leaders should be engaged with the public. Larry and I disagreed with this idea. We worried that we did not have a strong enough policy message for the President to communicate and that a presidential speech without concrete measures could be counterproductive for confidence. Clinton countered that engagement itself, even in the absence of definitive answers, could engender confidence—by showing a thoughtful understanding of the issues and providing a sensible discussion of possible approaches. As the crisis wore on, other world leaders began to take a similar view. They wanted to hold a joint meeting to emphasize their commitment to resolving the crisis. We all agreed that financial market disruptions tended to feed on themselves and that providing reassurance before the turmoil spread further was important, but the question was how and when to do so. The President felt strongly about his view and brought it up several times. Initially, he acceded—though reluctantly and somewhat irritably—to our suggestion to wait.
To the American public, the most visible spillover effect from Russia was a period of worrying instability and decline in the stock market. One day in late August, the Dow dropped 357 points, and by early September, the index was down nearly 20 percent from its summer peak. Our concerns went beyond what was happening in the stock market. The U.S. economy had stayed remarkably strong throughout the crisis, but we were unsure how long that could last. On September 4, Alan Greenspan captured our fears in a speech in Berkeley, California, when he warned that the United States could not remain an “oasis of prosperity” if the rest of the global economy continued to weaken. Financial markets, attuned to every nuance in the Fed chairman’s carefully chosen words, understood the signal: short-term interest rates in the United States might be heading down.
The Fed had last moved the federal funds rate—which is the overnight lending rate between banks and the key rate the Fed directly controls—in March 1997, tightening it a notch to fight inflation against the backdrop of a strong economy. In the eighteen months since, the official interest rates had been on hold and the market rates for government and corporate borrowing had broadly followed the Fed’s lead. But developments in the bond markets now became extremely troubling. Bond traders like to talk about the “spread” between the yield on Treasury bonds, which are considered as close as you can come to absolutely safe investments, and the yields of various other bonds, from high-grade corporate debt to lower-grade, higher-yielding “junk” bonds and emerging-market debt. When the spread between Treasuries and other bonds widens, investors are demanding more of a “risk premium,” i.e., a higher return for investments that aren’t as secure. In the fall of 1998, investors were fleeing from risk. This was now affecting not just emerging-market debt but countries and companies around the world, including in the United States. As a result, companies had to pay more to borrow from the capital markets. At the beginning of the year, lower-grade corporate debt had been yielding only around 2.75 percent more than Treasury bonds with similar maturities. Now, eight months later, the spread over Treasuries was 6 percent.
If it lasted, this increase in the cost of longer-term credit would dampen the economy and undermine investment and jobs just as surely as a deliberate tightening by the Fed of the short-term interest rates it controlled. Moreover, credit wasn’t just becoming more expensive. It was also getting harder and harder to obtain as both creditors and investors became less willing to take risks. Fed and Treasury officials focused on how to relieve these strains before a severe credit crunch took hold.
The easing signal from Greenspan helped somewhat. But a cut in U.S. interest rates alone seemed unlikely to quell the sense of a world in crisis. Now Larry and I agreed with President Clinton: we should try to elicit as powerful a statement as possible from the world community, and the President himself should deliver a message to the American people. Views had been crystallizing around steps to bolster the international response to the crisis. With the IMF quota increase still languishing in Congress, these included a new mechanism to speed provision of money from a group of individual countries, if needed, alongside that from the IMF. In the tight-knit circle of central bankers, the Fed was trying to convince colleagues in other countries of the need for an infusion of liquidity,
with lower interest rates across the industrialized world. I remember Alan Greenspan saying, first privately, then publicly, that in watching markets for fifty years, he had never seen a set of circumstances like this.
At first, we had considerable difficulty convincing some of our major partners in Japan and Europe of the need to act. On the eve of his Berkeley speech, Alan Greenspan and I flew to the West Coast to meet the Japanese finance minister, Kiichi Miyazawa, whom Alan had known for many years, and Japan’s central bank governor. We were troubled at how little Japan was doing to address its deepening malaise; one major bank had collapsed, and the situation seemed very fragile. Miyazawa, a very sensible man with a keen appreciation of Japan’s problems, nevertheless seemed to view the meeting more as a negotiation about how we would refer publicly to Japan’s economy than as a substantive exchange between the two major economic powers about a situation that was extremely threatening to both.
In Europe, officials had been focusing on preparation for the run-up to European monetary union and for the introduction of a new currency, the euro, to replace the national currencies of the union’s member countries. Many also had qualms about the IMF’s big financing packages and the effects of moral hazard on financial markets. It took days of intense discussions and negotiations to convince them that global recession was now a bigger threat than inflation or the moral hazard from IMF lending. Finally we were able to reach agreement on a carefully worded joint communiqué by the G-7 central bank governors and finance ministers. At the last minute, one central bank governor got cold feet and tried to back off the statement, but Alan Greenspan talked him into coming back on board. The communiqué said that the “balance of risks has shifted” on monetary policy, away from solely fighting inflation and toward the need to promote growth. Those five words—probably anodyne-sounding to most people—were a big deal in the global financial world and had a significant impact. Every war has its weapons, and when you’re dealing with volatile financial markets and jittery investors, the subtleties of a carefully crafted communiqué—signed by the top financial authorities in the world’s seven largest industrialized nations—can make a crucial difference.