The Rubin Rescue

By Michael Duffy/Washington

It tells us something about the new world order when the global battles America is fighting are less about the balance of power than about the balance sheet. We gauge our vital interests not by which boundaries we will defend but by which currencies. And the meetings that matter most don't always take place in the soundproof White House Situation Room; some are held in a private dining room at the Jefferson Hotel.

That's where Treasury Secretary Robert Rubin met on Dec. 18 with Federal Reserve Chairman Alan Greenspan and their top aides to craft a new approach to the Korean credit crisis, which they had long underestimated, at least in public. The three-hour dinner was a turning point in a months-long U.S. journey from backroom player to more visible leader in a global effort to solve the financial crunch. For months, Rubin & Co. had played down the crisis and balked at committing U.S. taxpayer dollars to a bailout that would help South Korea and the big financial institutions around the world that held its debts. But seven days before Christmas, the U.S. changed course, offering immediate aid for the first time, pressing banks to roll over their loans and urging a new Korean leader to seize the moment and change the way his country does business. Finally, on a quiet Christmas Eve, while most Americans were happily distracted, the latest plan was announced. Treasury officials insist the timing was a coincidence.

South Korea's crisis is far from over. And the U.S., as it feels its way as the lone superpower, finds that the tools it needs to lead are not aircraft carriers and armored divisions but emergency stabilization funds and better accounting practices. Inside the Clinton Administration, the man working these delicate new levers is Treasury Secretary Rubin. For the past 50 years, private banks like J.P. Morgan had led the way, picking over the wreckage of a remote foreign collapse. In a newer world, where "remote" economies no longer exist and where many more players make many more investments in many more nations, the game has been reversed. Only one government, whose currency is king, can lead. The House of Morgan has given way to the House of Rubin.

Though the Treasury Secretary is supposed to manage the American economy, Bob Rubin has discovered that a big part of the job comes down to managing the economies of nations overseas. After taking a shellacking from Congress in 1995 for successfully bailing out Mexico with $20 billion in taxpayer-backed loans, Rubin was hardly eager to get out front in the Asian economic crunch. As the liquidity crisis swept across Southeast Asia last summer, Rubin and other U.S. officials urged the International Monetary Fund to take the lead. Washington did not regard the Thai or Malaysian economy as vital to American interests, and in a year that had seen far too many fund-raising stories about Jakarta's Mochtar Riady and the Lippo Group, the Administration could hardly take the lead for anything Indonesian. Despite prosperity at home, the nation--and Congress in particular--was in no mood to be generous. In November, Congress killed $3.5 billion in new borrowing authority for the IMF as part of an unrelated dispute over foreign family-planning funds.

But when the Asian contagion reached the Korean peninsula in September, Rubin could no longer soft-pedal the problem. South Korea is the world's 11th largest economy, America's fifth biggest trading partner, and home base for 37,000 U.S. troops who guard the border with a hostile, if starving, North Korea. Nearly every nation, from the U.S. to Slovenia, had a piece of Korea's foreign debt, and none held more than Japanese banks, which, by the standards of U.S. bank examiners, are themselves in varying states of insolvency. It didn't take much imagination to see how the dominoes might fall. A default in Korea would almost certainly trigger a massive banking crisis in Japan. U.S. banks would get swept into the mess not just because of their loan exposure to Asia but also as a result of the trillions of dollars in interest-rate and currency swaps, hedging contracts and other derivative deals that link American financial institutions to the region. For strategic as well as political reasons, Rubin & Co. believed, the Asian flu had to be contained before it spread to other markets, including Japan.

That task was made harder by the fact that Korea's economy is one of the world's most inbred. The vast majority of the nation's wealth is held by a dozen or so gigantic interlocking conglomerates called chaebols. The huge firms employ most of the adult working population and own most of the banks, which during a decade of superheated growth lent far too much money back to their parent companies for risky investments all over the world. As those projects faltered, so did the banks. And as overseas lenders tried to recoup their investments, Korea's currency and foreign reserves began to deflate.

Washington was slow to grasp the problem. Clinton had allowed his embassy in Seoul (as well as in Tokyo) to go without an ambassador for a year. Not that the Koreans were helping. For months, they had refused to admit their problems or even provide credible accounting of their assets and liabilities. By November the embattled government of Kim Young Sam was refusing to explain to U.S. officials just how much money was left in its foreign-currency reserve. Along with negotiators from the IMF, Deputy Treasury Secretary Lawrence Summers pushed Seoul to clarify its reserve positions. "If you don't want to tell me, that's fine," Summers advised his counterpart. "But you have to tell somebody." On Thanksgiving, Clinton told Kim Young Sam by telephone that radical surgery was needed to attract foreign investors. But the White House kept the call secret for weeks, lest it spook the markets further.

Shortly thereafter, on Dec. 3, the IMF announced a $57 billion package of loans. In return, South Korea agreed to open its financial markets, lower trade barriers and revise its banking structure--moves demanded by Rubin and transmitted to the IMF. Mindful of the likely congressional reaction, the U.S. offered only to provide a small amount in loans--but not unless necessary. American officials played down the crisis. Clinton called the Asian markets a "glitch." Still, the markets kept glitching. After a brief rise, South Korea's stock market plunged again. By mid-December more than $1 billion a day was flowing out of Korea.

Though it had been scheduled earlier, the Dec. 18 dinner was the turning point for U.S. policymakers. Japanese markets had dipped nearly 6% overnight, and the Dow Jones industrial average had dropped more than 100 points. Fears were spreading that an Asian recession would shrink earnings of American companies and halt the U.S. economy's remarkable and long-running growth. Just that morning, South Korea's foreign-exchange reserves had fallen to less than $10 billion. Default was about 10 days away.

Within a few hours, IMF president Michel Camdessus in a letter asked the U.S. to be ready to pony up additional funds. By evening, as the latest news from Seoul and Tokyo hit the Jefferson dining room in a blizzard of cell-phone calls, there was a growing sense around the table that the U.S. must, as one put it later, "intensify the effort." That meant sending to Seoul $2 billion in direct American loans that had been offered just a few weeks earlier as "a second line of defense."

U.S. officials had one reason to be optimistic. That same day, in a defeat for the ruling party, longtime South Korean dissident Kim Dae Jung was elected President. Rubin and his guests stayed in contact with the White House through the dinner to coordinate the exact wording of President Clinton's congratulatory phone call that night to newly elected President Kim. Clinton told Kim that he had a brief window of opportunity with no room for false steps. Just to be sure, one participant in the dinner, Treasury official David Lipton, was dispatched to Seoul two days later to measure Kim's intentions and help negotiate a deal. "To allow the situation to spiral out of control," Summers said later, "wouldn't be responsible."

Treasury and IMF officials worked through the next day to finish the aid package. The IMF would lend Seoul $2 billion, while the U.S., Japan, Germany and other nations kicked in an additional $8 billion in loans. In exchange, the Koreans would pass new laws opening their financial markets to foreigners, close insolvent banks and supervise others. As the deal came together, Treasury officials discussed the impact of a bailout on the Korean and American labor unions, fearing some of Labor's backers in the Democratic Party would balk at bailing out either Wall Street or the protectionist Korean workers. But the officials decided that it would be in the best interests of both Korean and American workers to avoid default. Congressional leaders were briefed on the plan on Dec. 23.

The next move was to send a clear signal of determination around the globe. In a conference call on the morning of Dec. 21, Summers had asked the six other deputy finance ministers of the G-7 nations to make sure their largest commercial banks gave a hand by delaying Korea's loan repayments. Three days later in Manhattan, New York Federal Reserve Bank Chairman William McDonough met with six large banks to urge them to roll over loans to Seoul. McDonough also asked the bankers to delay the "margin calls" on currency swaps and derivative deals, which might help unravel the deal. The bankers didn't have much choice: it was go along or go without. Similar meetings took place in Frankfurt, London, Paris and Tokyo. The holiday complicated matters: as Christmas approached, Rubin and Summers spent some time tracking down the nation's "masters of the universe" at various ski resorts and Caribbean watering holes to reinforce the message.

Whether the South Koreans can keep their part of the bargain is unclear. The legislature in Seoul rushed through a host of reforms last week but balked at a bill that would have made it easier to implement layoffs and restructuring at the large chaebols. No wonder: last January, when the parliament tried to pass a similar measure, Korean workers staged a general strike that paralyzed the country for more than three weeks.

"We are absolutely against any measures that unilaterally force Koreans to make the biggest sacrifice here," says Kim Young Dae, general secretary of the Korean Confederation of Trade Unions, the country's second largest and most militant labor union. "The people in charge of the chaebols are responsible for this crisis, so why should we pay for their mistakes?" The union has threatened to repeat the strike if the government allows companies to fire workers at will.

For now, U.S. officials have no choice but to pin their hopes on Kim, the 73-year- old dissident turned President. In an exclusive interview with TIME last week, Kim promised to "resolve Korea's crisis and restore our international credibility and competitiveness. We have needed these reforms for quite some time. But because of collusion between politics and business, nothing happened."

Kim has promised to spread the burden of reform. Last week his government asked citizens to donate gold jewelry to ease the currency crisis and said it would put two failing banks up for sale to foreigners. Almost immediately there were reports that Chase Manhattan and Citicorp had expressed an interest in taking positions in the firms, though the banks refused to comment. Kim told TIME that "if layoff of workers is necessary, then that is what we will do." And he has warned the chaebols that if they don't reform, he will do it for them. "It is sure to be a year on the brink of catastrophe or rejuvenation," he said in his New Year's message. "The pain of overcoming our difficulties must be borne by all."

Whether that kind of attitude prevails in the U.S. is another question, and the House of Rubin will be watching closely in coming weeks. Some lawmakers will surely attack the new aid package after the holiday recess. Populist Democrats will object to any bailout of Wall Street speculators, and conservative Republicans will see little to praise in a taxpayer subsidy for a foreign government. The White House will defend its actions, noting that Korea is strategically more important than other Asian nations.

What is also true is that the investments and prosperity Rubin is trying to protect belong not just to the banks but also to those same little old taxpayers all over the nation.

--Reported by Bernard Baumohl/New York, Frank Gibney Jr. and Stella Kim/Seoul and Karen Tumulty, Bruce van Voorst and Adam Zagorin/Washington

With reporting by Bernard Baumohl/ New York, Frank Gibney Jr. and Stella Kim/Seoul and Karen Tumulty, Bruce van Voorst and Adam Zagorin/Washington