Indonesia and South Korea, 1997
What became known as "the Asian flu,” a financial crisis spread around the region over the course of the fall and winter of 1997, infecting Indonesia and then South Korea. Both countries watched as tens ofbillions of dollars quickly flowed out of their economies, placing intense pressure on their currencies and raising the prospect they might default on their external debts. Late that year, both countries had agreed to substantial aid packages from the IMF. Invoking the EFM, the Fund responded swiftly and with immense resources: $8 billion for Indonesia in November 1997; $15 billion for Korea in December. The Korean package was, in fact, the largest single commitment the Fund had ever made. It was almost 20 times larger than Korea’s quota. In terms of speed, the program was approved just one day after Korea’s letter was submitted to the board.
With the expiration of the D’Amato amendment in September 1997, Treasury was again free to make commitments to foreign governments without congressional constraints. It did just that, pledging $3 billion for Indonesia and $5 billion for Korea in early December. In the case of Indonesia, the funds were to be used only if IMF financing was inadequate. The money promised to Korea would only be released "to fill any gaps in [Korea’s] financing needs between the release of IMF installments.” Treasury’s initial commitment to Korea was "at the low end of expectations” and paled in comparison to its bailout of Mexico two years prior. Shortly after the initial tepid commitment to Korea, markets were not responding as hoped and it appeared the initial response had failed. Once again, a Korean default seemed imminent. Recognizing that the major commercial banks held the majority of Korea’s short-term debt, the United States, in consultation with the IMF and G-7, attempted to revive the "concerted lending” strategy. This time, the Federal Reserve took the lead. Edwin Truman—the director of the Fed’s Division of International Finance—spearheaded the effort. As described in one account of the crisis, Truman, "better than any other senior U.S. policymaker, appreciated the art of twisting bankers’ arms to save countries from financial crises.” The plan was put into action in late December 1997. The FRBNY president, William McDonough, called executives from the six largest US banks to the New York Fed and applied pressure, informing them,
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 . . . . 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 Fed urged its European counterparts to apply similar pressure on their banks. On Christmas Eve 1997, a group of major US banks agreed to negotiate with Korea to reschedule the government’s debts. British banks soon followed suit. Even with the concerted lending plan in action, Treasury felt the financing package was too small. Rubin authorized the ESF to make yet another $1.7 billion credit available to Seoul just days before the New Year. This was part of a broader, multilateral rescue package coordinated by the G-7, designed to be announced alongside a second $9.5 billion IMF commitment. In total, Korea now had access to a massive $55 billion line of credit. Yet, unlike Mexico, bilateral credits pledged outside the Fund (including ESF resources) were only to be used as a "second line of defense” if IMF financing proved insufficient. At the time, however, this seemed a distinct possibility. Ultimately, neither Korea nor Indonesia drew on the pledged ESF resources.
On one hand, the decision to limit the US commitment to a "second line of defense” can justifiably be viewed as a weak response when compared to the Mexican rescue. The temporal proximity to the congressional backlash to that massive 1995 bailout likely tempered the Clinton administration’s response. Indeed, even after the relatively tepid commitments to Indonesia and Korea were made public, many of the usual suspects in Congress once again placed the ESF in their crosshairs. For example, during the crisis, the IMF was seeking to increase member quotas as its resources were under considerable strain. Charging that the White House had once again acted to bail out big Wall Street banks, some Republicans in Congress were threatening to tie new IMF appropriations to the reimposition of constraints on the ESF. In short, larger, up-front credits to Indonesia or Korea may have resulted in even more forceful limits on ESF credits and complicated the administration’s ability to get Congress to approve an increase in the United States’ IMF quota. Viewed in this political context, the decision to act as an ILLR alongside the IMF in these cases indicates the administration believed American interests were
IMF Liquidity Ratio, 1982-1999
sufficiently threatened by the Asian crisis to demand action. This, despite the fact that these actions might result in new constraints on the ESF.
Why did the United States choose to pledge ESF resources on behalf of Korea and Indonesia? First, like the Mexican case, the United States tapped the ESF as a way to supplement an IMF credit—to augment the overall size of the financing package and convince a heterogeneous group of investors that there was sufficient liquidity to backstop the crisis. Even though the size of IMF’s commitment to Indonesia and Korea was unprecedented, Lipton noted that Treasury believed it was still not large enough (especially after the failure of the initial Korean loan). What was needed was "overwhelming financial force,” which led to the second line of defense concept and its ultimate multilateralization. Steinberg echoed this, noting the administration wanted to send a message that "the full faith and credit of the [United States] is behind this and there is no point in running on Korea ... . It’s all about what you can do to crush the Bears; to crush the short-sellers.”87 On its own, there was no way the IMF could have pledged $55 billion. It had already promised loans in many multiples of borrowers’ quotas, and the potential for pushback from the executive board if additional funds were requested would grow.
More important, the Fund’s increasingly large rescue packages were placing severe pressure on the institution’s resources. Figure 6.4 depicts the IMF’s liquidity ratio from 1982 through 1999. This represents the liquidity position ofthe Fund and is calculated by dividing the institution’s net uncommitted usable resources by its liquid liabilities. A lower liquidity ratio indicates that the Fund’s resources were under growing strain at that time. The figure also reports the IMF’s net uncommitted usable resources (in SDRs, which are special drawing rights) from 1990 through 1999. Although the IMF was relatively flush with resources during the first half of the 1990s, the cumulative effect of fighting the Mexican and Asian crises was substantial. Indeed, in 1997 and 1998, the IMF’s liquidity ratio was lower than it had been during the initial years of the 1980s debt crisis. The possibility that the world economy’s primary financial fire brigade might run out of water contributed to Treasury’s decision to supplement the Fund’s ILLR actions. According to Steinberg, "There was concern [within the administration] about IMF resources.” He added, "If you look at any one crisis, Korea was one that could significantly impair [the Fund’s] financial resources. So there was some question as to how many fires the IMF could put out.”
If IMF resource insufficiency provided the need for unilateral ILLR actions, US economic and geopolitical interests provided the motivation. By December 1997, the contagion effects of the crisis, which had escaped the administration earlier that year, had crystallized. On their own, the crises in Korea and Indonesia did not represent a systemic threat to the US financial system. Indeed, systemically important US banks held only about 6 percent of total foreign claims in these two countries. Combined, these claims represented about 12.7 percent of their total capital. Thus, a full-scale default on their obligations was not sufficient to bring down a major US bank. However, uncertainty about how far the crisis could spread without a strong response from the United States and IMF was high.
At the Fed, which from the outset ofthe Asian crisis was deeply involved in crafting the US response, top brass worried about the possibility of the crisis spreading across the Atlantic to Latin America. At an FOMC meeting in November 1997, prior to Korea’s troubles, the group discussed the worst-case scenario (which it had shared with the White House via its Greenbook forecast). Specifically, it noted that if the "storm clouds” over Korea "darkened further ... the spread of contagion to Latin America may intensify.” At the following month’s meeting, Vice Chairman McDonough presciently warned that "the next country we have to worry about is Brazil.” Steinberg notes in meetings on the crisis, "There was a lot of worry about Brazil and other emerging markets ... . Every day you have a meeting asking, 'Who’s next?’ ” He then added that there was also "a lot of focus on Mexico.” In a conversation about the crisis with British Prime Minister Tony Blair, President Clinton remarked, "If Brazil goes south we are all going to suck eggs big time.” If the response to Korea was not sufficiently large to prevent contagion across the Atlantic, economies where US financial interests were far more at risk could be the next to fall. More than 10 percent of systemically important US banks’ foreign claims were concentrated in Brazil and Mexico. More worrisome, these combined claims represented 21.5 percent of their total capital. Add in US investments in stocks and bonds in these two Latin American economies and the US financial system was exposed to a tune of $167 billion, as presented in Figure 6.5. Thus, US ILLR actions during the Asian crisis were part of a strategy that aimed to contain the crisis and prevent it from spreading to systemically important markets that would have posed a clear and present danger to the stability of the US financial system.
Finally, geopolitical factors also weighed heavily in the US decision to act. South Korea’s strategic importance to the United States was evidenced by the 37,000 US troops stationed there to deter a North Korean attack. Indeed, existing accounts of the administration’s debates over whether or not to come to Korea’s aid reveal that some of the strongest supporters of the bailout were at the Department of State, the Department of Defense, and the NSC. Indeed, Steinberg pointed out that although these groups
US Financial System Exposure in Five Emerging Markets, 1997 had advocated for a package for Thailand, the effort was relatively weak, and what won out was Treasury’s assertions that Thailand was not sys- temically important enough for a unilateral rescue and fears about additional restrictions on the ESF. However, by the time the crisis had spread to Korea, Steinberg indicated that the diplomats at State and the NSC had gained the upper hand within the administration. As he put it,
We [at the NSC and State] didn’t push hard enough in Thailand . . . . By the time we got to Korea, now we’re on top. Because now Indonesia has gone, and now you have a treaty ally . . . at that time the Secretary of State [Madeline Albright] says, “We’re going to do something.”98
-  See IMF (2003, p. 113) and Copelovitch (2010, p. 273) for a more detailed discussionof the "second line of defense.”
-  Stevenson 1997a.
-  Stevenson 1997b.
-  Blustein 2001, p. 188.
-  Ibid., p. 196.
-  Copelovitch 2010, p. 273.
-  G-7 1997; Stevenson 1997b.
-  Besides IMF credits, an additional $10 billion came from the World Bank, $4 billion from the Asian Development Bank, $6.7 billion from the United States, $10 billionfrom Japan, as well as smaller contributions from Australia, the United Kingdom, Canada,France, and Germany (Pollack 1997).
-  Stevenson 1998.
-  Lipton 2014.
-  "Net uncommitted usable resources” accounts for the IMF’s total resources minusnonusable resources (i.e., gold, funds committed to borrowers). In short, this measures theresources available to meet new loan requests by IMF members. The IMF’s total liquid liabilities largely reflects credit extended by the IMF. That is, the more members borrow fromthe IMF, all else equal, its liquid liabilities should increase. It may seem odd that the IMF’sliquidity ratio can exceed 100 percent. However, when the IMF’s net uncommitted usableresources are greater than its liquid liabilities, this can occur.
-  Liquidity ratio and net uncommitted usable resources data are taken from relevantIMF annual reports. Annual reports did not regularly report uncommitted resources dataprior to 1990.
-  Steinberg 2014.
-  Rubin summed up Treasury’s motivation for contributing to the multilateral rescue ina speech at Georgetown University in January 2001, stating, "These countries face the risk ofdefault . . . which could readily result in deep and prolonged distress in these countries, possible contagion effects for emerging and developing countries around the world, and potentially serious impacts on the industrialized countries, including our own” (Rubin 1998).
-  FOMC 1997a, p. 19.
-  Ibid.
-  Steinberg 2014.
-  National Security Council and Records Management Office 2016, p. 209.
-  Pempel 1999.
-  Steinberg was one of the most vocal bailout proponents within the administration aswas his boss, Sandy Berger, who worried about the kind of "mischief” North Korea mightattempt if the South Korean economy collapsed (Blustein 2001, p. 138). In his memoir,President Clinton acknowledges the role geopolitics played in the decision as well. Indeed,Clinton admits that Defense and NSC both lobbied for a US contribution to the Thailandbailout because that country was the United States’ "oldest ally in Southeast Asia.” Treasury,however, did not support putting US funds into the Thai package and their position held(Clinton 2004, p. 807).