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'Taking advantage of the Russian situation'
By Robert Rubin
Published: November 10 2003 20:16 | Last Updated: November 10 2003 20:16


On the same day in August 1998 that Russia became the first of the crisis countries to default on its foreign debt, President Bill Clinton testified before a grand jury and made a televised speech apologising to the nation about Monica Lewinsky. On September 10, he convened a meeting of the cabinet in the White House residence to apologise for misleading us.


I wasn't planning to say anything. But I thought that the whole issue, though certainly serious, had been disproportionately covered by the news media, with the result that other issues, including the momentous events in Indonesia and Russia, hadn't got enough attention.

After a while, I raised my hand."You know, Mr President, there's no question you screwed up. But we all make mistakes, even big ones. In my opinion, the bigger issue is the disproportion of the media coverage and the hypocrisy of some of your critics."

I truly admired the way Clinton had dealt with the crisis - even though the crisis was of his own making. He was remarkably focused and intent, doing his work while the storm raged around him. Talking to the president about Russia, you wouldn't have known he had anything else to worry about.

Our concerns about Russia had been intensifying during the spring of 1998. By August, we had been fighting to contain what was called the Asian crisis for more than a year. But no sooner did one country's problems seem to be under control than pressures would erupt somewhere else. From its beginnings in Thailand, when massive capital outflows led to the baht's devaluation and financial collapse, a kind of financial contagion had spread violently and inexorably across emerging markets. We soon learnt that an effective response required both strong policy reforms and money from the international community to give those policies time to work.

The growing turmoil in Russia reflected elements of most of the previous crises. The rouble exchange rate was linked to the dollar's. The government had a significant budget shortfall, financed by issuing short-term bonds known as GKOs.

Attracted by the promise of high yields and a boom mentality, foreign investors had bought these bonds aggressively. Though the post-Soviet economy clearly had enormous problems, investors had assumed that the International Monetary Fund would step in during any emergency. Russia was, as the saying went in the markets,"too nuclear to fail".

But as the psychology that had tripled the price level of the Russian stock market in a single year shifted, Russia found itself in terrible difficulty. Yields on Russia's debt rocketed, hitting 60 per cent in May 1998. It became doubtful whether Russia could continue to roll over the GKOs, which were coming due at the rate of $1bn a week, or meet the payments on other Russian bonds. Yet the country's political system seemed paralysed.

For us, Russia raised a new version of a by now familiar problem: what to do about a country that isn't prepared to participate adequately in its own rescue. And what if that country happens to be an unstable, former superpower, with thousands of nuclear warheads still pointed at you?

Larry Summers, my deputy, and David Lipton, undersecretary at the Treasury, had been deeply involved in trying to help Russia since 1993. My view of Russia was considerably more pessimistic than David's and Larry's and the president's. Clinton spoke regularly to his friend Boris Yeltsin, the Russian president, and was very focused on trying to be helpful to Russia. I fully recognised the importance of helping Russia but also felt that the country had poor economic policies and enormous problems.

I supported the $23bn IMF programme that was announced in July on strictly probabilistic grounds. Larry and David agreed with me that the odds were against the programme's being successful, but the risks to the US from destabilisation in Russia seemed so enormous from both an economic and a security standpoint that going ahead made sense. 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.

Something less than $5bn of the total IMF loans 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. At that point, both continuing the flow of IMF money and not continuing it had potentially very damaging effects. An additional question was whether to put money from the Exchange Stabilisation Fund [a pot of money the US Treasury used for currency intervention] as well.

[Here was the dilemma.] If Russia's economic deterioration led to the wrong people coming to power 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 [to enact IMF conditions for reform], 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. I had lived in the markets. 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.

Providing more money to Russia without imposing appropriate conditions could also do serious harm by giving foreign investors and domestic oligarchs just enough breathing space to get their money out before a collapse.

Sandy Berger, the national security adviser, had called a meeting in the White House situation room to persuade the Treasury to agree to more support. Many people were on his side of the issue, including William Cohen, secretary of defence, Madeleine Albright, secretary of state, and Henry"Hugh" Shelton, chairman of the Joint Chiefs of Staff.



People can forget the lessons of a painful experience very quickly and that can lead to poor decisions. An illustration is what happened in 1999 when South Korea was first able to borrow again in private markets. This was a massive step forward for the country. Borrowing privately at a reasonable rate of interest would create confidence in South Korea's post-crisis economy, underscore the credibility of the policy direction the country was pursuing under Kim Dae-jung, and promote growth. Read

On the whole, the Clinton 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 recognised 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 Exchange Stabilisation Fund or who would try to force the IMF to act, that was fine with me.

On August 17, Russia announced that it was devaluing the rouble 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 of course diminished. A lot of investors paid a high price for their faulty assumptions about our willingness to provide support without Russia meeting the appropriate conditions.

To the American public, the most visible spillover effect from Russia was a worrying instability and a 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 per cent from its summer peak. Our concerns went beyond what was happening in the stock market. The US economy had stayed remarkably strong throughout the crisis. But we were unsure how long that could last. On September 4, Alan Greenspan, chairman of the Federal Reserve, captured our fears in a speech in Berkeley, California, when he warned that the US could not remain an"oasis of prosperity" if the global economy continued to weaken.

On Wall Street, the default triggered a chain of events that threatened the solvency of Long-Term Capital Management, a huge hedge fund. Many feared that its failure could significantly exacerbate the stresses on the US markets.

[One weekend in September] I was at home in New York when I received a telephone call from Gary Gensler, then assistant secretary for financial markets and a former partner at Goldman Sachs. Gary said that LTCM, which had made enormous profits trading on the basis of mathematical models, was on the verge of collapse. He wanted to go out to the firm's headquarters in Connecticut with an official from the Federal Reserve Bank of New York to investigate. I told him to go ahead.

Gary called again on Sunday evening, September 20, to tell me what he had learnt. LTCM had taken vast positions financed by billions of dollars in loans from major financial institutions - positions that would work out only if the financial markets calmed down and spreads reverted to more normal relationships. LTCM was facing massive losses, and its imminent bankruptcy portended uncertain effects on the financial markets.

My first reaction was to say to Gary:"I don't understand how someone like John Meriwether - who was thought of as such a sophisticated and experienced guy when he worked at Salomon Brothers - could get into this kind of trouble."

Before founding LTCM, Meriwether had run a massive trading operation at Salomon and had done very well over a long period. He had some of the top minds in finance working with him at LTCM, including Nobel Prize winners Robert Merton and Myron Scholes. I was amazed that they had done what it seemed they had, betting the ranch on the basis of mathematical models.

Models can be a useful way of looking at markets and can provide useful input into making decisions. But ultimately traders have to make judgments, because reality is always far messier and more complicated than models can capture. I gather that many of LTCM's positions would have worked out in time. But LTCM was essentially betting that a return to normal would come without some prior highly aberrational move.

The problem with LTCM was not just that one company had a bad set of positions. Traders at other firms had similar kinds of positions, because they all used similar models and similar historical data. When positions began to move against them, they all wanted out at the same time, exacerbating the movement. And since all the major players already had these positions, there were no buyers.

No one wanted to rescue LTCM's partners or investors. But there was a concern that liquidating such large positions could lead to a general unravelling of the markets. With the hedge fund's creditors - Chase, Citigroup, Goldman Sachs, Bear Stearns, Morgan Stanley, Merrill Lynch and many others - all selling into the same decline, the entire system could freeze up, with a spillover into the real economy as confidence was damaged and businesses and consumers found credit less available and more expensive.

The ideal solution would have been for LTCM's creditors to agree to extend their loans on terms that might be somewhat harmful to each of them but less harmful than a default. But doing anything to promote this agreement raised tricky problems. The Fed regulates financial institutions and would not want to be seen as coercing the lenders to act. Yet without some outside pressure, LTCM's creditors would almost surely not come together in their own self-interest.

Bill McDonough, president of the New York Fed, convened the heads of the big investment and commercial banks at the Fed's New York headquarters. He walked a fine line, calling in the chief executives but then leaving the room so they could work out the details on their own. After a lot of jockeying, 14 institutions agreed to provide a total of nearly $4bn in additional credit to LTCM, with strict terms attached. This capital infusion gave the hedge fund breathing room to liquidate its positions in an orderly fashion. Although I did not share the view that a collapse of LTCM was likely to lead to systemic disruptions, I thought the concerns and Bill's actions were sensible and appropriate, given the market and economic duress at the time.

Looking back, I feel even more strongly that our approach to combating the crisis made sense. [International co-operation, led by the US] helped reverse the financial turmoil in countries that took appropriate actions. These efforts led to great improvements in economic fundamentals and growth prospects in developing countries, and helped avoid a more severe global crisis that could have greatly affected the industrial countries.

During the Asian crisis, critics argued that a categorical position of one kind or another would have worked better than our pragmatic approach to restoring confidence and addressing policy problems. But these conceptual views didn't take account of all the complexities of responding to a real crisis. Dealing with crises was messy because the reality was messy. At one point, aiding Russia made sense. At a later stage, it didn't.

Perhaps the best testimonial to the market-based approach - as opposed to trying to solve these problems through additional regulation, capital market controls and trade restrictions - comes from decisions taken by emerging market governments themselves, including some with an electoral mandate from the disadvantaged in their societies.

Both Kim Dae-jung of South Korea and, more recently, President Luis Inácio Lula da Silva in Brazil, had come to power on populist platforms. Both chose to embrace global integration and policy regimes designed to engender market confidence as part of their mandates to reduce poverty and raise living standards.

At the same time, the entire Asia experience left me with the view that future financial crises are almost surely inevitable and could be even more severe. The markets are getting bigger, information is moving faster, flows are larger and trade and capital markets have continued to integrate. So it's imperative to focus on how best to minimise the frequency and severity of such crises and how best to respond if and when they do occur.

The global economic crisis also left me deeply concerned about the politics of globalisation. For many people, the Asia crisis highlighted the potential hazards and shortcomings of globalisation for the first time. By the time I left Washington in 1999, I could see that maintaining support for market-based policies and trade liberalisation - necessary in my view to promote growth - was becoming a far greater political problem around the world.

Some time later, sitting at my breakfast table in New York, I read some comments in the paper by Paul O'Neill, President George W. Bush's newly appointed Treasury secretary. He was highly critical of the way we had handled the Asian crisis. He called me the"chief of the fire department" and said our theory of interconnected markets was a passing fashion that needed to be retired, like the"hula hoop". O'Neill's view was that the new administration could avoid the moral-hazard problem simply by letting poorly managed emerging market economies fail.

I liked Paul. I didn't even mind him calling me the chief of the fire department. But as I read the story, I said to myself:"They say they won't intervene, but they will."

And they did. When Turkey erupted in early 2001, the Bush administration got involved because of the country's strategic importance. When Argentina got into trouble that same year, the administration supported another large IMF programme before refusing to do so again at the end of 2001. The following year, it provided direct US money to Uruguay and supported a very large IMF programme for Brazil.

Whether the administration was philosophically in favour of support programmes, or against them, it was bound to end up doing them, because US self-interest was so much involved, geopolitically and economically. A lot of people begin their analysis with a priori constructs. But the orderly view from the armchair is not the perspective you have when you're facing the messy reality of a global financial crisis.

From In An Uncertain World, by Robert E. Rubin and Jacob Weisberg. Copyright 2003 Robert E. Rubin and Jacob Weisberg. Published by arrangement with Random House Publishing Group

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S Korea's 25 basis points



People can forget the lessons of a painful experience very quickly and that can lead to poor decisions. An illustration is what happened in 1999 when South Korea was first able to borrow again in private markets. This was a massive step forward for the country. Borrowing privately at a reasonable rate of interest would create confidence in South Korea's post-crisis economy, underscore the credibility of the policy direction the country was pursuing under Kim Dae-jung, and promote growth.

A new Korean finance minister was stopping in Washington on his way to New York to sign a new loan agreement. But ahead of his visit, our people told me that the minister wasn't going to go ahead with the loan after all because their investment bankers told him it was going to cost 25 basis points more than he had expected.

"You've got to be kidding," I said. Here was a country that a year earlier had been on the verge of default that could have had vast, even calamitous consequences. And now the government wasn't going to raise money when it could because of 25 basis points? The chance for South Korea to re-establish itself with global financial markets through this bond issue was worth vastly more than 25 basis points.

The finance minister came in with his interpreters, and they all sat down at the table in my conference room. We started talking, and I said:"I understand you're going to raise this money and there's a little problem because you think it's 25 basis points too high. What difference is 25 basis points, or 100 basis points, when re-establishing yourself is so important?"

The finance minister said:"well, 25 basis points is 25 basis points. We shouldn't have to pay so much." I told him I'd been around markets a long time and my advice was to take the money while they could get it - circumstances change very quickly in markets. If the issue went well, South Korea could borrow more and probably would see some rate improvement. Pulling out now could raise doubts again in investors' minds.

But our debate continued, and after a while I began to lose my patience a bit."You know something?" I said,"I don't really care what you do. It's your country, not mine."

Everyone looked at me as if I had taken leave of my senses. And perhaps I had, momentarily. South Korea's government had done a remarkable job responding to the crisis. But I was reacting to the spectacle of intelligent people behaving short-sightedly. I'd seen the same kind of behaviour at Goldman Sachs. Someone who has got into trouble is offered a brief opportunity to escape - and often their response is to forget the mess of a few days