worst blunders, The

Global Finance, Feb 1999 by Hill, Christine, Lanchner, David

The IMF can be faulted for much. But the misstep with the worst repercussions was its policy in Indonesia.

An ironic tragedy is that many of the pratfalls of 1998 came from governments and companies stumbling toward free market capitalism. An exception was Hongkong's defense of its currency that looked suspiciously like stumbling toward nationalization of the city-state's biggest companies.

Many bloopers had a domino effect: Russia's fall exposed inept risk management practices of banks and Long-Term Capital Management. The theft of Russia's bailout money emphasized the onwise policies of the International Monetary Fund.The IMF has its supporters, but Global Finance is not among them. We lay the blame for Indonesia's continued despair at the feet of the IMF whose cure, we argue, is worse than the disease.

Corporate missteps were also abundant, but we picked on one for the audacity of its author: Al Dunlap, the self-proclaimed king of corporate downsizing, came crashing to earth as Sunbeam lost its luster.

1 The IMF's Indonesia Policy The International Monetary Fund can be faulted for much last year, including letting itself be swindled by the Russians and assembling a $41.5 billion support package to help Brazil protect its overvalued currency. But the misstep with the worst repercussions was the IMF's policy in Indonesia.

The problem is that the IF addressed Asia with the same formula it devised for high-inflation, deficitspending Latin America in the 1980s. For Indonesia, the IMF came up with a $37 billion rescue package in late 1997 but wouldn't disburse it until Jakarta complied with IMF requirements, such as shutting 16 banks, which worsened capital flight. By early 1998 the economy was in free fall; analysts reckoned that 95% of exchange-listed companies were technically bankrupt.

The IMF quashed the deficitspending budget President Suharto devised to help the economy. Not understanding that Indonesia's crony monopolies ensured that food and other necessities reached remote corners of the archipelago, the IMF demanded that monopolies be dismantled, prices of basic commodities be increased, and interest rates put back up near 100%.As violence broke out, thousands of Chinese businessmen and their families fled. More than 500 people died in riots and fires last May, and Suharto stepped down.

The economy is believed to have shrunk 15% in 1998. The United Nations reckons that half of Indonesia's 180 million people can't afford the food to meet minimal daily calorie requirements. For all their sins, Suharto and his cronies fed their people.

2 Russia's Debt Default

Last August 17, Sergei Kirvenko's Russian reform government suddenly devalued the ruble and defaulted on some of the country's debt. That touched off a worldwide panic that widened lending spreads, leading to a temporary credit crunch for many companies, damaging many bank balance sheets, and pushing many investors to the brink of collapse.

Events leading to the crisis are murky. By one theory, the government's inability to meet debt payments came after the central bank released dollars from an IMF loan to Russian bankers to support the ruble and Russia's treasury bill marketonly to see the dollars disappear. Another rumor was that gas monopoly Gazprom flexed its muscles to intimidate the government, and events got out of hand.

Whatever the intrigues, the basic problem was too cosy an alliance between the government and a coterie of robber barons led by Boris Berezovsky. To keep the Communists out of power, the banker-oligarchs and oilmen provided financing for Boris Yeltsin's 1996 reelection. But instead of restructuring Russian industry and paying taxes, they speculated in treasury bills (transferring some $66 billion overseas), blocked tax and other reforms, and virtually stole companies in rigged privatizations. When Kiryenko finally tried to declare some of the banks insolvent, he found himself out of office.

Russia's choice has been between Communists and robber barons. It needs something better.

3 LTCM's Implosion

The near-implosion of LongTerm Capital Management had ramifications far beyond the embarrassment of the 14 banks that participated in September's $3.6 billion bailout. At best, a fire sale of more than $100 billion worth of securities to meet the Connecticut hedge fund's margin calls would have caused a global markets meltdown. At worst, it might have sparked a worldwide depression.

LTCM, founded in 1993 by bondtrader John Meriwether, a former Salomon vice chairman, boasted two Nobelists, a former Federal Reserve vice chairman, and 25 PhDs. Clients such as Merrill Lynch, Goldman Sachs, Credit Suisse First Boston, and Union Bank of Switzerland remained woefully ignorant about the contents of LTCM's investment portfolio.

Assets more than doubled between 1994 and 1998, but the fund was increasingly betting on takeover stocks, currencies, and illi uid instruments such as Danish mortgage bonds, far from the fixed income markets that it was meant to concentrate on. And LTCM increased leverage to an astonishing 50 to 1, telling clients the ratio was 20 to 1.