Order Code RL30272
CRS Report for Congress
Received through the CRS Web
Global Financial Turmoil, the IMF, and the
New Financial Architecture
Updated April 14, 2000
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress

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ABSTRACT
This report focuses on the global financial turmoil in 1997-2000 that spread from
Thailand, through Southeast Asia, up the coast to South Korea, and eventually battered
Russia, and hit Brazil and the policy issues it has raised. It briefly reviews the problem and
examines a number of the major policy responses taken or being considered. The policy
options under consideration include economic and regulatory policy, new financial
architecture, and International Monetary Fund reforms. Other CRS products on this topic
include: CRS Report RL30467. IMF and World Bank Activities in Russia and Asia: Some
Conflicting Perspectives; CRS Report RL30467, the Asian Financial Crisis and U.S.
Foreign Policy Interests; CRS Report RL30394, Russian Capital Flight, Economic Reforms,
and U.S. Interests: an Analysis; CRS Report 98-987, and Brazil’s Economic Reform and the
Global Financial Crisis. This report will be updated as circumstances warrant.

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Global Financial Turmoil, the IMF, and the New Financial
Architecture
Summary
How does a financial problem in Thailand — of seemingly minor dimensions —
trigger financial turmoil of global consequences, destroy billions of dollars in wealth,
throw 20 million people into poverty, become a major factor in the fate of certain
political leaders, and eventually threaten the health of the robust U.S. and European
economies?
Trade and capital flows along with global price competition constitute the major
links that tie the United States to the economies of the world. Underlying these links
are markets for currency, capital, securities, goods, and services. Behind these links
are markets and a communications and financial infrastructure that allows news to
travel and transactions to occur at faster and faster speeds. Currency crises tend to
flow along international trade paths. They first are regional, although they also spread
to countries with macroeconomic conditions similar to the countries in crisis because
of the actions of speculators and investors. A new factor has been the activity of
hedge funds that are able to accumulate huge leveraged (borrowed) positions that can
threaten world financial stability if those positions are reversed too quickly.
Congressional interest in this issue is related to: (1) the effects of the global
economic turmoil on the U.S. economy, (2) the operations of the International
Monetary Fund, and (3) proposals to create a “new financial architecture.”
In seeking a new world financial architecture, policymakers are trying to improve
the international monetary and financial system, to reduce the risk that systemic crisis
will recur, and to ensure that, when isolated country crises do happen, there are early
warnings, effective policy tools, adequate resources, and broad support to help
nations withstand difficult external conditions. These policy discussions are still
ongoing. Meanwhile, some countries, such as Malaysia, have taken measures to
protect themselves from volatile, short-term capital flows.
Several studies have examined the role of the IMF and other international
financial institutions in the financial crisis. The IMF, itself, also has been reviewing
its policies and operations in light of severe criticism from various quarters. It has
begun to take more preventative measures, such as it did with a loan package for
Brazil in December 1998. The 105th Congress also conditioned the funds it
appropriated to increase the IMF’s quota and borrowing authority upon certain
reforms by the IMF.
The 106th Congress is considering legislation dealing with hedge funds, the sale
of gold and other operations of the IMF, and IMF reform.

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Contents
Contagion of Financial Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Volatility in Currency Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
IMF Support Packages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Securities Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Speculation and Leverage in Financial Instruments . . . . . . . . . . . . . . . . . . 11
Hedge Funds and Speculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Outlook for Countries in Turmoil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
U.S. Links to the Global Turmoil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Effects on U.S. Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Policy Proposals and the New Financial Architecture . . . . . . . . . . . . . . . . . . . . 18
International Financial Institution Advisory Commission . . . . . . . . . . . . . 18
G7 and Other Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
IMF And World Bank Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
List of Figures
Figure 1. Exchange Values of the Brazilian Real, Indonesian Rupiah, Japanese Yen,
South Korean Won, Thai Baht, and Russian Ruble, July 1997-March 2000
5
Figure 2. Stock Market Indices in the United States, Japan, Indonesia, South Korea,
and Hong Kong, July 1997-January 1999 . . . . . . . . . . . . . . . . . . . . . . . . . 11
Figure 3. Growth in Real Gross Domestic Product for Thailand, Indonesia, South
Korea, Brazil, and Russia, 1996 to 2001 (forecast) . . . . . . . . . . . . . . . . . . 14
Figure 4. U.S. Economic Growth Rate, 1991-2001 (forecast) . . . . . . . . . . . . . 17

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Global Financial Turmoil, the IMF, and New
Financial Architecture
The global financial turmoil that began in July 1997 as a potential default on
loans by financial companies in Thailand rapidly spread to neighboring countries in
Asia — engulfing Indonesia, Malaysia, and the Philippines — and compelling South
Korea to join Thailand and Indonesia in asking the International Monetary Fund
(IMF) to coordinate a package of emergency loans to help them repay short-term
foreign debts. For the first year of the crisis, most economic experts seemed confident
that the “Asian flu” could be confined primarily to countries in east and southeast
Asia. Countries in Eastern Europe and Latin America did allow the values of their
currencies to depreciate and interest rates to rise, but the scope of the problem
seemed to fall within manageable proportions. During the summer of 1998, however,
economic turmoil in Russia caused the ruble to fall in value, capital to flow into
foreign currencies, and a government default on its foreign debt. Even though this
was caused as much by problems internal to Russia as by international factors, the
Russian crisis triggered a drop in equity markets world wide and caused huge losses
for banks and securities companies. Brazil’s currency also came under pressure, and
the IMF had to coordinate a loan package from private banks in order to stop the
contagion.
In September 1998, the U.S. Federal Reserve facilitated a $3.625 billion rescue
of Long Term Capital Management (LTCM) and its hedge fund by a consortium of
banks and investment houses. This triggered new doubts among investors about the
value of their holdings of equities. A rush out of equities into U.S. government bonds
and other more stable investments caused further declines in stock markets worldwide
despite an easing of interest rates by the U.S. Federal Reserve.
At the International Monetary Fund’s annual meetings in October 1998, the
threat of global recession loomed over the world. As 1999 progressed, however,
world stock markets recovered significantly and surprisingly strong economic growth
reports came out of South Korea, Japan, and other countries that had been in
recession. Equity markets also continued to recover or grow strongly, albeit with
considerable volatility. By early 2000, economic observers were declaring the global
financial crisis to be over, although serious financial imbalances and economic
problems remained in many countries. As the threat of global recession receded, calls
became stronger for reforms in the IMF and the international financial system.
The world economic outlook for 2000 is for rising world growth including in the
United States, although there are some concerns about the robust American economy.
The global slowdown in 1998 that arose from the Asian financial crisis turned out to
be the mildest of four downturns in the last three decades. In essence, the strong U.S.
economy with its liberal import and capital markets had carried the rest of the world
through the financial crisis. In 2000, the major threat to world prosperity turns out

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CRS-2
to be rising energy prices, a volatile U.S. stock market, and a possible downturn in
the U.S. economy.1
Congressional interest in this issue is related to: (1) oversight and regulation of
U.S. financial institutions, (2) effects of global economic turmoil on the U.S. economy,
(2) operations and financing of the International Monetary Fund and World Bank, and
(4) proposals to create a “new financial architecture” for the international monetary
and financial system. In the 106th Congress, bills have been introduced to reform the
IMF and limit its ability to make loans for long-term, structural adjustment (H.R. 3750,
Saxton, and H.R.1203, Saxton) or to abolish it altogether (H.R.1147, Paul). The
foreign aid authorization bill also contains provisions dealing with IMF gold
authorization and IMF (and World Bank) reforms.
In March 2000, the International Financial Institution Advisory Commission
released a report recommending that IMF lending be restricted to short-term liquidity
loans and that the IMF end longer-term lending for other purposes.2
This report first examines the sources of the global financial instability and the
mechanisms by which the economic problems are transmitted from one country to
another. It then reviews some major proposals to revamp the international financial
system. This report addresses economic aspects of the problem. Other information
and analysis are available in CRS Report RL30467. IMF and World Bank Activities
in Russia and Asia: Some Conflicting Perspectives; CRS Report RL30467 and The
Asian Financial Crisis and U.S. Foreign Policy Interests; CRS Report 98-987.
Specific information on the IMF’s quota increase is in CRS Report 98-56, The
International Monetary Fund’s (IMF) Proposed Quota Increase: Issues for Congress
and CRS Issue Brief 97038, The International Monetary Fund’s “New Arrangements
to Borrow” (NAB.). Previous versions of this report with more detail on certain issues
are: CRS Report RL30012, Global Financial Turmoil: Contagion, Effects, and Policy
Responses and CRS Report 98-434 and The Asian (Global?) Financial Crisis, the
IMF, and Japan: Economic Issues. Information on Russia is found in CRS Report
RL30394, Russian Capital Flight, Economic Reforms, and U.S. Interests: an Analysis
and CRS Report 98-578, The Russian Financial Crisis: An Analysis of Trends,
Causes, and Implications. Information on Brazil is in CRS Report 98-987, Brazil’s
Economic Reform and the Global Financial Crisis. This report will be updated as
circumstances warrant.
Contagion of Financial Crises
How does a financial problem in Thailand — of seemingly minor dimensions —
set off global consequences, destroy billions of dollars in wealth, throw 20 million
people into poverty, and become a major factor in the fate of certain political leaders?
The global economic turmoil can be traced to many factors. First were foreign
exchange rates in Asia tied to the appreciating U.S. dollar and too inflexible to adjust
1Behravesh, Nariman. The Global Economy: A Multi-Speed, Multi-Risk World. In World
Market Economic Outlook, Fourth Quarter, 1999. Standard & Poor’s DRI.
2

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CRS-3
to changing trade and capital flows. Second were bankers and corporations in Asia
who borrowed short-term on international markets to finance long-term investments
– some of dubious value – in booming local economies. Third were emerging markets
without developed financial infrastructure and with insufficient regulation and market
discipline in which the allocation of capital and resources was influenced excessively
by personal connections and politics (cronyism). Fourth were highly confident
businesses that overbuilt manufacturing capacity and office buildings in Asia and began
to default on bank loans. Fifth were real estate and stock market bubbles by which
excess liquidity was poured into land and corporate equities creating a euphoria as
prices rose but also generating huge losses as prices fell.
These five factors were magnified by one theme: globalization. Financial markets
today are international in scope, global in nature, and connected by high-speed data
systems. They are more linked, volatile, leveraged, and larger than at any time in
modern history. This globalization implies that the economies of the world have
become more interconnected not only through trade in goods and services but through
flows of investment capital, speculative financial activities, and bank loans. These
extensive linkages have combined with rapid communications to make currency and
stock markets more volatile and easily influenced by events and economic conditions
in other countries. Financial investments also have become more leveraged with
borrowed funds. When markets suddenly turn, these highly leveraged positions can
generate enormous losses (or gains).
The magnitude of the flows of capital among countries also has become huge and
unprecedented. A study by the Bank for International Settlements indicates that the
volume of foreign exchange transactions in 43 markets has exploded to an estimated
$1.5 trillion per day (after making corrections for double counting) — or about 60
times as great as world trade in goods and services.3 Private capital flows have grown
to the extent that many countries no longer can maintain adequate foreign exchange
reserves to handle sudden outflows or keep such outflows from pushing down
exchange rates.
This world of increased global contagion generates two major policy questions:
what can the United States do to insulate its economy from drastic gyrations in world
financial and economic markets and what changes might be implemented in the world
financial system and International Monetary Fund to bring more stability into the
system? In order to understand where actions can be taken, we first examine some
sources of volatility in currency markets.
An unanticipated consequence of the global economic slowdown in 1998-99 has
been the resurgence of cohesion among the oil exporting nations (OPEC). As the
Asian financial crisis depressed demand for petroleum, prices dropped to $12 per barrel
in 1998 before they began to recover to $17.50 per in 1999. The low prices caused
huge reductions in oil revenues for the oil exporting nations and galvanized them into
cooperating on reducing supply. The oil exporting nations constricted supply by about
6.7% in 1999. This, combined with a relatively cold winter, a booming economy in the
3Bank for International Settlements. Central Bank Survey of Foreign Exchange and
Derivatives Market Activity 1998. May 1999. P. 1-4.

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CRS-4
United States, and faster than anticipated economic recovery in Asia caused the price
of crude petroleum to shoot up to more than $30 per barrel (for West Texas
intermediate crude) in early 2000.4 During the coldest part of the winter of 1999-
2000, home heating oil in New England jumped to more than $2 per gallon and the
price of gasoline in 2000 is expected to settle at about $1.50 per gallon.
In the 106th Congress, H.R.4102 (Saxton) would direct the Secretary of the
Treasury to instruct the United States Executive Director at the IMF to oppose any
new loans to a country that is acting to restrict oil production to the detriment of the
United States economy, except in emergency circumstances.
Volatility in Currency Markets
Currency markets play a large role in both capital and trade flows. Most
international transactions require converting currency from that of one country to that
of another using an exchange rate. Until the early 1970s, most nations maintained
foreign currency regimes in which their exchange rate was fixed with respect to
another currency or to gold. Since March 1973, most major currencies have been
allowed to float according to demand and supply with occasional intervention by
monetary authorities. Experts on exchange rate systems generally recommend that
currencies either be allowed to float freely or be fixed with respect to the dollar, Euro,
or other major currency. If a government opts for a fixed rate, however, it must
maintain the rate by intervening into exchange markets or by altering domestic fiscal
and monetary policies. In order to alter demand and supply for its currency, the
government may buy or sell foreign exchange as well as raise or lower interest rates
to adjust international capital flows to and from their economies.
A pegged exchange rate that is neither fixed nor floating is usually not
recommended because such a regime tends to attract speculators who seek to benefit
from a revaluation. Adjustment under a pegged rate occurs in large steps rather than
as a continuous process. This opens opportunities to speculate on future currency
devaluations while taking market positions to both induce such actions and to benefit
from them. A fixed rate, however, also can attract speculators. During the Asian
financial crisis, Thailand was not able to maintain its fixed exchange rate in the face
of massive capital outflows. Hong Kong and China, however, were able to do so.
The values of national currencies are quoted in terms of U.S. dollars, Euros, or
special drawing rights of the International Monetary Fund. A change in one exchange
rate affects the rate at which all other currencies trade with respect to that currency but
may or may not affect cross exchange rates. For example, a depreciation in the Thai
baht with respect to the U.S. dollar changes the baht-dollar exchange rate but may not
affect the cross rate at which U.S. dollars are exchanged for euros or yen.
Figure 1 shows the value of the Thai baht, Indonesian rupiah, South Korean won,
Japanese yen, Brazilian real, and Russian ruble relative to the U.S. dollar. The cur-
rency depreciation that began in Thailand in July 1997 rapidly spread across southeast
Asia and affected other currencies as well. Some (such as the Hong Kong dollar and
Chinese renminbi) proved quite resilient to this “Asian flu,” but other currencies
4Standard & Poor’s DRI. Oil Market Outlook, Long-term Focus. January 2000.

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CRS-5
likewise fell. The dramatic fall in the value of the ruble did not occur until August
1998. By March 2000, the South Korean won and Thai Baht had recovered to about
80% and the Brazilian real to about 60% of its pre-crisis value. The Indonesian rupiah
was at about 32% and the Russian ruble at about 20% of their 1997 values, while the
Japanese yen had appreciated to a level higher than its pre-crisis level.
Figure 1. Exchange Values of the Brazilian Real, Indonesian Rupiah, Japanese
Yen, South Korean Won, Thai Baht, and Russian Ruble
July 1997-March 2000
120
Japanese Yen
100
Thai Baht
80
60
S. Korean
Brazilian Real
40
Won
20
Indonesian
Russian
Rupiah
Ruble
1997
1998
1999
2000
0
3
7
1
5
9
3
7
2
23
15
26
18
13
24
16
28
20
24
26
18
29
10
22
15
Jul 2
Nov 5
Jun 3
Jul 15
Oct 7
May 5
Jul 28
Sep 8
Dec 1
Aug 13
Sep 24
Dec 17
Jan 28
Mar 11
Apr 22
Aug 26
Nov 18
Dec 30
Feb 10
Mar 24
Jun 16
Oct 20
Jan 12
Feb 23
Source: Data from PACIFIC Exchange Rate Service
What is the mechanism by which weakness in one currency drives down the
values of other currencies? In order to understand the process, one must recognize
that trade flows no longer dominate foreign exchange markets. In times past, foreign
exchange was bought primarily for use in foreign trade transactions — for the
international buying and selling of goods and services. Now non-trade transactions
dominate foreign exchange markets. Capital flows completely overshadow trade flows
in value and effect on exchange rates. Foreign currencies are bought by investors
seeking higher rates of return, by wealth-holders seeking safety from political or
economic instability, by multinational corporations building manufacturing or
distribution facilities abroad, by speculators betting on movements in exchange rates,
and by others for a variety of reasons. Trade flows remain important, but they are only
one factor in determining foreign exchange values.

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CRS-6
Because currencies play such a variety of roles in the world financial system, their
value fluctuates as underlying financial conditions, macroeconomic variables, investor
expectations, and actions of central monetary authorities change. Like stock markets,
there is no sure method of predicting short-term movements in exchange rates. Many
economists have concluded that, while underlying financial and macroeconomic
conditions — such as interest rates, trade deficits, and economic growth rates —
influence exchange rates over the long run, in the short run, fluctuations are more
random and unpredictable in nature.5
Even though trade flows do not determine currency movements, they play a large
role in determining the path through which currency crises spread. Over the past three
currency crises — the European crisis in 1992, the Mexican Peso crisis in 1994, and
Asia financial crisis in 1997 — the best predictor of the path of contagion has been
along trade lines. Currency crises have tended to be regional — among those countries
that trade the most with each other or trade with similar markets.6 The major reason
that currency crises spread along trade lines is that once a country devalues its
currency, its neighbors suffer a competitive disadvantage in export markets and in
selling to that country.
For example, once Thailand allowed the value of its currency to fall, Malaysia, the
Philippines, and Indonesia — neighboring countries that compete in similar export
markets — suddenly found their exports significantly more expensive than those of
Thailand. Not did this affect their balance of trade, but speculators and other buyers
of foreign exchange placed financial bets that those other countries would have to
allow their currencies to depreciate also. This unleashed tremendous downward
pressures on exchange rates in these countries. In the Asian financial crisis, the lines
of transmission led from Thailand to Malaysia, the Philippines, and Indonesia, then
later to Hong Kong and South Korea. After that, the problem became more global as
it spread to Eastern Europe, Russia and Brazil.
Since underlying macroeconomic conditions affect the long-run exchange rate of
a country, speculators and investors may target certain currencies for devaluation if
their countries exhibit macroeconomic and financial features similar to the country that
has devalued its currency. For example, since Thailand’s main problems were its weak
banks, a rising current account deficit, and an accumulation of short-term foreign
currency loans, countries with similar macroeconomic and financial conditions were
targeted by speculators. This is one of the reasons that countries with scanty trade ties
with a country in crisis also can find themselves subject to currency speculation or
capital flight by their own citizens seeking a safe haven to store their wealth. In 1997,
for example, as Hong Kong’s currency came under attack, speculators also descended
upon Estonia’s currency. Like Hong Kong, Estonia also has a currency board. In
South Korea’s case, its currency came under attack because it too had a weak banking
5Frankel, Jeffrey A. and Andrew K. Rose. Empirical Research on Nominal Exchange Rates.
In Handbook of International Economics, Vol. III, Edited by G. Grossman and K. Rogoff.
Amsterdam, Elsevier, 1995. Pp. 1690-91.
6How Do Currency Crises Spread? Federal Reserve Bank of San Francisco Economic
Letter, August 28, 1998. On the Internet at <http://www.frbsf.org/econrsrch/wklyltr98/
el9825.html>.

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CRS-7
system, an accumulation of short-term international loans, and other economic
conditions that resembled those of the countries of Southeast Asia.
IMF Support Packages
During the global financial turmoil in 1997-1998, the IMF arranged support
packages initially for Thailand, Indonesia, and South Korea and augmented a credit to
the Philippines to support its exchange rate and other economic policies. Later, the
IMF extended support to Brazil and Russia. The five support packages are
summarized in Table 1. The total amounts of the packages are approximate because
the IMF lends funds denominated in special drawing rights (SDRs), and because
pledged amounts may change as circumstances change. The initial support package
for Thailand was $17.2 billion, for Indonesia about $43 billion, and for South Korea
$57 billion. The United States pledged $3 billion for Indonesia and $5 billion for South
Korea from its Exchange Stabilization Fund (ESF) as a standby credit that may be
tapped in an emergency. The U.S. Treasury lends money from the ESF at appropriate
interest rates and with what it considers to be proper safeguards to limit the risk to
American taxpayers.
Table 1. Financial Support Packages
(Amounts in U.S.$Billion)
Thailand
Indonesia
S. Korea
Russia
Brazil
Date Initially
Aug. 20,
Nov. 5,
Dec. 4,
July 20,
Dec. 2,
Approved
1997
1997
1997
1998
1998
Total Initially
$17.2
$43.0
$57.0
$22.6
$41.5
Pledged
IMF
$3.9
$18.6
$21.0
$11.6*
$14.7
World Bank
$1.5
$4.5
$10.0
$2.3
$4.5
Development
$1.2
$3.5
$4.0
$4.5
Bank
(ADB)
(ADB)
(ADB)
(IDB)
Bilateral
$10.6
$24.0
$22.0
$1.0
14.5
IMF
$3.4
$10.1
$19.5
$5.4*
$11.1
Disbursements
Note: ADB = Asian Development Bank. IDB = Inter-American Development Bank.
Actual amounts disbursed by the IMF’s are in SDR’s. Development bank figures are for
structural adjustment and exclude funds for customary projects.
*The IMF cancelled the 1998 program after disbursing $4.8 billion. In July 1999, it
announced a new program worth $4.5 billion to be paid in tranches of about $640 million
each. The first was distributed immediately, but the others have been delayed.
Source: IMF, World Bank, ADB, IDB. IMF disbursements are as of Dec. 31, 1999.
The support packages are initiated by a request to the IMF from the country
experiencing financial difficulty. This request then requires an assessment by IMF
officials of the conditions in the requesting nation. If a support package is approved,

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CRS-8
the IMF usually begins with an initial loan of hard currency to the borrowing nation.
Subsequent amounts are made available (usually quarterly) only if certain performance
targets are met and program reviews are completed. The support packages were
designed to restore investor confidence — both international and domestic — in the
economies of the recipient nations. The packages constituted a three-pronged
approach to the problems: (1) immediate efforts to restore liquidity in currency
markets, (2) structural reforms aimed at strengthening financial sectors, and (3)
governance issues underlying the crisis which included improving the efficiency of
markets, breaking the “crony capitalism” links between business and government in
several of the distressed countries, liberalizing capital markets, and providing for more
transparency (in disclosing data on external reserves and liabilities). Russia faced many
particular problems that the other market-oriented economies did not.
The IMF assessments and the policies the borrowing country intends to
implement which are reported in letters of intent are now being made public (with
permission of the borrowing country) and posted on the IMF’s Internet site.7 The IMF
has faced severe criticism that the monetary and fiscal policies it required of the Asian
countries as a condition of support were too severe and were instrumental in plunging
their economies into recession.8 However, as recessions did develop, the IMF eased
its requirements and allowed more expansionary fiscal and monetary policies by the
troubled countries.
In addition to IMF support, recipient countries have tapped funds pledged by the
World Bank, the Asian Development Bank or, in the case of Brazil, the Inter-American
Development Bank, and by certain industrialized nations. The World Bank, in
particular, has played a key role in attenuating the negative effects of the financial
crises on the poorer people who are less able to shield themselves from the recessions.
In 1998, the World Bank created a Special Financial Operations Unit (SFO) to help the
Bank respond to financial sector crises. Working closely with the country
departments, the SFO's mandate is to provide immediate support to governments to
help them stabilize their financial systems, followed by support for structural reforms
and resolution of nonviable financial institutions.9
In 1997, the World Bank pledged $1.5 billion in support of Thailand and, as of
June 30, 1999, had approved loans of $1.3 billion. For Indonesia, the World Bank
initially pledged in October 1997 a sum of $4.5 billion to be disbursed over a three-
year period. In July 1998, this was raised to $5.5 billion. By the end of 1997, the
Bank had loaned $619 million to Indonesia, much of which was for traditional
economic development projects. By June 1999, the loan total had risen to $2.74
billion, although much of the lending was for traditional projects not necessarily
occasioned by the financial crisis. For South Korea, in December 1997, the Bank
committed up to $10 billion for financial support. In December 1997, the Bank
approved a $3 billion loan for Korean financial reconstruction and in 1998 a total of
7On Internet at: <http://www.imf.org/external>.
8See, for example, Sachs, Jeffrey. Fixing the IMF Remedy. Banker, v. 148. February 1998.
Pp. 16-18.
9The World Bank. The Special Financial Operations Unit. 1998. On Internet at <
http://www1. worldbank.org/finance/html/sfo.html>.

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CRS-9
$4 billion in loans for structural adjustment and $48 million for financial and corporate
restructuring. 10
Japan has a special interest in the Asian financial crisis since it occurred within its
region and not only affected its close trading partners and competitors but also
threatened bank loans and investments by Japanese companies in the region. Japan has
been providing financial assistance under what it terms the Miyazawa Initiative (named
after their Finance Minister). It includes $30 billion in loans to Thailand, Malaysia, the
Philippines, Indonesia, and South Korea. This was augmented in 1999 with a
commitment by Japan to assist Asian nations to mobilize another 2 trillion yen (about
$17 billion) in domestic and foreign private-sector funds for Asia.11
Japan, in conjunction with the United States, World Bank, and Asian
Development Bank, has announced an Asian Growth and Recovery Plan which has a
target of raising $5 billion in bilateral and multilateral support. The purpose of the
initiative is to accelerate the pace of corporate and bank restructuring in the region,
mobilize new private sector financing, and promote restoration of economic growth.12
As a result of the Group of Seven Industrialized Nations (G-7) meeting on
February 21, 1997, the U.S. Export-Import Bank has coordinated support among 18
export credit agencies from 11 countries to provide trade financing support to Asia.
At the time, the U.S. Export-Import Bank stated that it could commit up to $3 billion
in additional short-term financing in the support of American products sold to South
Korea, Thailand, and Indonesia. In January 1997, the Bank also decided to expand the
short-term insurance capacity for commercial banks in South Korea.13 In July 1998,
the U.S. Ex-Im Bank established a $2 billion medium-term loan facility for South
Korea and, for example, in June 1999 financed $796 million for Korean purchases of
U.S. aircraft.14
The funds borrowed by the recipient country from the IMF usually go into the
central bank’s foreign exchange reserves. These reserves are used to supply foreign
exchange to buyers, both domestic and international. They normally are not loaned
directly to private companies, although those companies can purchase the foreign
exchange on the open market. The foreign exchange borrowed from the IMF often is
used to repay short-term obligations denominated in foreign currencies. A common
criticism of the IMF is that its funds end up being used to repay bank loans. Foreign
10The World Bank.Group. World Bank Financial Support to East Asia Since July 1997.
Factsheet. On Internet at <
11Japan. Ministry of Finance. Resource Mobilization for Asia: The Second Stage of the New
Miyazawa Initiative. May 15, 1999. On Internet at <http://www.mof.go.jp>.
12Japan. Ministry of Finance. Asian Growth and Recovery Initiative. On Internet at
<http://www.mof.go.jp>.
13U.S. Export-Import Bank. Ex-Im Bank Working in Support of 18 Country Export Credit
Agency Trade Finance Initiative to Stabilize Asian Markets. Press Release. Februry 23,
1998. On Internet at <http://www.exim.gov>.
14U.S. Export-Import Bank. Ex-Im Bank Finances $796 Million for Korean Aircraft
Purchase. Press Release. June 25, 1999. On Internet at <http://www.exim.gov>.

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CRS-10
banks, therefore, tend to recover more of their assets than investors in equities or other
liquid assets in time of financial crisis.
Funds from Export-Import banks are used to finance imports or exports and tend
to be self-serving for the lending country. They generally are used to help finance the
lending country’s own exports.
Funds from the World Bank and regional development banks usually provided for
specific projects. During the financial crisis, however, they were provided to countries
for general purposes such as strengthening the borrowing country’s financial sector
and structural adjustment. In this case, they tended to go into the same central bank
foreign exchange accounts as the funds from the IMF. In the cases in which the funds
went for specific projects, the funds might have been used to pay specific companies
involved in the project.
Securities Markets
Fluctuations in currency markets also affect stock and securities markets. The
process is two-fold. First, when a currency depreciates it also reduces the value of any
asset denominated in that currency such as stocks and bonds. If investors (both foreign
and domestic) in national equity markets anticipate a currency depreciation, they may
sell their stocks and convert the proceeds into a foreign currency before the
depreciation or before the currency depreciates further. Second, when a country is
facing a rapidly declining currency, the country’s monetary authorities may raise
interest rates (to stem capital flight) and adopt restrictive fiscal policies (to raise
savings and reassure investors) which may slow economic growth, reduce corporate
profits, and raise the return on bonds or money market accounts relative to stocks.
Both higher interest rates and lower profits tend to reduce equity values. As funds are
moved from a troubled economy to a safer haven (such as the United States or
Europe), equity values or bond prices may well be bid up in those safe-haven countries.
During the Asian financial crisis, values on equity markets fluctuated almost as
much as currency values. Figure 2, shows indices of stock market values on
exchanges in the United States, Japan, South Korea, Hong Kong, and Russia over the
period of the worst of the financial crisis – from its onset in July 1997 to June 1999.
The similar behavior of the Asian markets as well as both the positive and negative
effects on the U.S. stock market as measured by the Dow-Jones index is apparent.
The market that has recovered the least is the Russian.
Speculation and Leverage in Financial Instruments
In assigning blame for the Asian currency crisis, some have pointed the finger at
speculators — even though speculators certainly were not to blame for the underlying
economic conditions that contributed to the perceived overvaluation of the currencies
in the first place. Speculators, often managers of large international investment funds,
generate gains by taking advantage of perceived weaknesses in exchange rates. They
place financial bets on depreciation (or appreciation) based on their perceptions of
underlying forces of demand and supply. They also combine currency speculation with
financial maneuvering in derivatives, stocks, securities, and money markets. For
smaller emerging markets, these financial actions may trigger currency crises and may

---

CRS-11
be paralleled by similar maneuvering by other investors and businesses engaged in
currency transactions.
Figure 2. Stock Market Indices in the United States, Japan, Indonesia,
South Korea, and Hong Kong, July 1997-January 1999
Russian
140
U.S. Dow Jones
Default
120
Japan
100
Tokyo
80
60
40
Hong Kong
Hang Seng
South Korea
Russia
20
Seoul
Trading System
1997
1998
1999
0
7
5
2
9
6
4
1
18
15
12
10
30
27
27
24
22
19
17
14
11
29
26
26
23
21
17
Jul 4
Jul 3
Aug 1
May 8
Jun 5
Jul 31
Apr 9
May 7
Jun 4
Aug 29
Sep 26
Oct 24
Nov 21
Dec 19
Jan 16
Feb 13
Mar 13
Apr 10
Aug 28
Sep 25
Oct 23
Nov 20
Dec 18
Jan 15
Feb 12
Mar 12
Source: Trendlines, Seoul Composite, Tokyo Nikkei 225, Hong Kong Hang Seng,
Russia Trading System & Dow Jones Industrial Indices
The mechanics of currency speculation are complicated. Essentially the process
involves currency buyers and sellers generating profits from fluctuations in exchange
rates by using spot markets (markets for current delivery of foreign exchange), forward
or futures markets (markets for future delivery), currency swaps, loans, and other
financial maneuvers. The key to this process is that when speculators expect a
depreciation in a local currency, they begin short sales (without the currency in hand)
of forward or future contracts to deliver that currency at a future date in the hope that
they will be able to buy the currency at a lower price before they have to deliver it.
They also can speculate in stock market futures by amassing holdings of a currency to
dump on the market in order to elicit a response from monetary authorities who often
will raise interest rates in order to maintain the exchange rate. The higher interest
rates, in turn, cause equity values to fall.
Once a currency begins to show signs of weakening, astute investors and
speculators who profit from volatility in exchange markets take actions to minimize
losses and maximize gains. The ensuing flight from the local currency pushes its value
down even further until it often overshoots what would be considered an equilibrium
rate. Recovery may be slow.

---

CRS-12
Hedge Funds and Speculation
A recent force in stock and securities markets has been the rise of hedge funds.
These funds normally engage only large investors (including banks) and are highly
leveraged. Perhaps the best known of these is the fund managed by Long Term Capital
Management (LTCM) of Greenwich, Connecticut. This company worked by spotting
unusual differences between the prices of financial instruments with well-established
historical relationships — government bonds, fixed-income derivatives, equities, and
equity derivatives. The fund would purchase securities with borrowed money and take
large financial positions in world securities and derivative product markets. LTCM
reportedly had borrowed $125 billion on its capital of $4.7 billion (as of December 31,
1997) and had derivatives exposure of $1.2 trillion.15 The fund would place large
financial bets in such a way that if interest rates and prices converged to their usual
patterns, the fund would gain profits. These positions carried a large probability of
making a small profit but a small probability of incurring a huge loss. Since the fund’s
profit margins were small, it worked with enormous sums of investment capital and
attempted to reduce risk by diversifying across many interest-rate products, markets,
and geographical locations. Most of its activities were in U.S., European, and
Japanese markets.
LTCM’s computer models and convergence trades enabled the fund to generate
huge profits for a time. Its total returns after fees were 45% in 1995, 41% in 1996,
and 17% in 1997, but the computer models did not anticipate the Russian default on
its government bonds on August 17, 1998, and the subsequent turmoil in global
financial markets. In August alone, LTCM reportedly lost about $2 billion and
possibly more than that during the first three weeks of September.16 By September 23,
LTCM’s equity position stood at $600 million but it was supporting balance sheet
positions in excess of $100 billion. The hedge fund’s losses on its highly leveraged
positions had wiped out 90% of its equity.
The threat to the international financial system of a collapse by LTCM and a
forced dumping of its illiquid securities on markets at prices well below their face value
was large and threatened to further widen spreads and trigger a massive sell off of
securities in markets that were already strained and jittery. On September 23, 1998,
the U.S. Federal Reserve Bank of New York coordinated a private bailout of LTCM
in which fourteen banks and investment companies agreed to inject $3.625 billion into
the fund. The rescue of LTCM was a type of out-of-court bankruptcy reorganization
in which its major creditors have become its new owners. The bailout did stabilize
international financial markets, but critics of the action argue that because LTCM was
not subject to the Federal Reserve’s supervisory and regulatory jurisdiction, it was not
appropriate for the Fed to risk its reputation and goodwill by intervening. The action
also may have created a moral hazard for institutions not ordinarily regulated or
supervised by the central bank or who are highly leveraged. Such institutions might
be more inclined to make risky investments if they think the Federal Reserve or other
15Day, Kathleen. Top Regulator Was Aware of Fund’s Debt. Washington Post, November
18, 1998. P. C11.
16Mayer, Martin. Bailing Out The Billion-Bettors. Los Angeles Times, October 5, 1998. On
Internet at <http://www.latimes.com/cgi-bin>.

---

CRS-13
central bank will help in their rescue.17 In July 1999, the bankers who oversee the
LTCM decided that the financial institutions that rescued the institution will get back
$1 billion of the $3.625 billion injected into the fund while original investors will
receive all the $300 million they had left in the fund.18
In the 106th Congress, several bills have been introduced to bring more
transparency and discipline into hedge fund activities. These include H.R. 2924
(Baker) which would require unregulated hedge funds to submit regular reports to the
Board of Governors of the Federal Reserve System and H.R.3483 (Markey) and S.
1968 (Dorgan) which would amend the Federal securities laws to enhance oversight
over certain derivatives dealers and hedge funds.
In a separate action, the Hong Kong Monetary Authority also intervened to affect
market speculation. In August 1998, the Hong Kong Monetary Authority spent about
$15 billion buying stocks on the Hong Kong market in order to prop up the Hang Seng
index (of stock market values) and deter speculators. The Hong Kong government
purchased about 7.3% of the 33 companies that make up the Hang Seng index and
used the equivalent of $2,500 for every person in Hong Kong for the operation.
Eventually, those stocks are to be sold.19 This market intervention was quite a
departure for a government that prided itself in its free-market approach to its
economy, but it illustrates one method of thwarting speculation.
Malaysia has pursued a different approach to speculation and short-term capital
flows. It has taken measures to prohibit trading in its currency, the ringgit, and in its
stock market by foreign parties. As of September 1, 1998, Malaysia made the ringgit
acceptable as a currency only in Malaysia. After a short grace period, re-entry of
offshore ringgit was prohibited. The currency became no longer accessible to currency
dealers and can be traded for foreign exchange only in Malaysia. All stock trading not
conducted on the Kuala Lumpur Stock Exchange is no longer recognized (particularly
that previously done in Singapore).20
Analysts view the Malaysian currency controls as quite drastic, but acknowledge
that the measures have allowed the country to re-peg its currency to the U.S. dollar
17International Monetary Fund. World Economic Outlook and International Capital
Markets, Interim Assessment. December 1998. P. 136. On Internet at <http://www.imf.org/
external/pubs/ft/weo/weo1298/index.htm>. Eleven of the 14 financial institutions took equity
stakes of $100 to $300 million in LTCM.
18Pacelle, Mitchell. Long-Term Capital to Return Money to Bailout Group. The Wall Street
Journal, July 7, 1999. P. A4.
19Hong Kong. Fair Shares. The Economist, October 31, 1998. On Internet at <http://
www.economist.com/archive>.
20The major changes in Malaysia’s exchange control rules were: (1) approval is required for
ringgit funds transferred between or withdrawn from external accounts; (2) all purchases and
sales of ringgit financial assets can be transacted only through authorized depositary
institutions; (3) all settlements of exports and imports must be made in foreign currency, and
(4) limits are placed on the amount of ringgits carried by resident and non-resident travelers.
Malaysia Ministry of Finance. Economic Report 1998/99. December 1998. P. 4 of
Overview. On Internet at <http://www.treasury.gov.my/er9899/er9899.htm>.

---

CRS-14
and have brought stability back into the value of the ringgit. Whether these policies
will hurt the ability of Malaysia to attract the foreign capital and industry important to
its long-term economic growth is an open question.
Outlook for Countries in Turmoil
As shown in Figure 3, for the five countries that received IMF support packages,
South Korea seems to be recovering the most quickly. After dropping 5.8% in 1998,
growth in Korean real gross domestic product rebounded to 10% in 1999 and is
expected to continue to grow at about 7% in 2000. A strong fiscal boost (a fiscal
deficit of 4% of GDP in 1999) plus strong consumer spending and rising exports are
helping the economy. The economy is now operating at pre-crisis levels. Private sector
reform, particularly of the chaebol, or industrial conglomerates, is progressing only
haltingly and improving economic conditions are decreasing the urgency of the task.
Figure 3. Growth in Real Gross Domestic Product for Thailand, Indonesia,
South Korea, Brazil, and Russia, 1996 to 2001 (forecast)
Actual
Forecast
10
Brazil
S. Korea
5
0
-5
Russia
-10
Thailand
Indonesia
-15
1996
97
98
99
2000
2001
Source: Standard & Poor's DRI

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CRS-15
The Thai economy also is recovering. Output shrunk by 10.4% in 1998, with
investment down by 36% and private consumption down by 13%. In 1999, the
economy began to recover and grew by 5% – helped by a large government stimulus
package. In 2000, the economy is expected to expand by 6%. The Thai trade balance
remains positive, and foreign exchange reserves have risen.
Indonesia still faces difficult economic times. In 1998, real GDP dropped by
13.2% and grew by a paltry 0.1% in 1999 and is expected to grow by about 3.5% in
2000. In 1998, investment fell by 46%. New investment also was discouraged by riots
and the destruction of buildings and equipment. The value of the Indonesian currency
remains at about a third of its pre-crisis level, although a certain normalcy has returned
to most parts of the country. Food prices have decelerated as production of basic
commodities has resumed. Still, rising poverty and joblessness abound. Parliamentary
elections in 1999 brought a legitimately elected government led by President
Abdurrahman Wahid and a relatively smooth transfer of power in October 1999. In
the Aceh province, however, secessionist demands are yet to be resolved.
On February 4, 2000, the IMF approved a three-year, $5 billion Extended Fund
Facility to support Indonesia’s economic and structural program. The World Bank,
Asian Development Bank, and nations (particularly Japan) also pledged up to $4.7
billion in additional support for Indonesia in fiscal year 2000.21
The Brazilian economy is recovering from a sharp slowdown in which economic
growth dropped to 0.2% in 1998 and 0.7% in 1999 following the devaluation of the
currency from an average of 1.17 reals per dollar in 1998 to 1.81 reals per dollar in
1999. For 2000, growth is projected to rise to about 2.6%. A major concern is the
huge fiscal deficit of about 11% of gross domestic product and a growing trade
deficit.22
Russia dropped back into recession in 1998 with negative growth of 5% (similar
to the negative growth through most of the 1990s) but has been recovering in 1999
with the economy expanding by about 3%. Between 1992 and 1999, the Russian
economy had contracted by more than 30%. Inflation remains a problem, although it
declined from 84% in 1998 to 36% in 1999. Interest rates remain at about 45%.
Russia’s trade balance continues to improve (about $30 billion in 1999), although this
stems mainly from a drop in imports rather than an expansion of exports. In July 1999,
Russia and the IMF agreed to a $4.5 billion standby credit, although the funds
primarily were just shifted from one IMF account to another. With the election of a
new Russian President in March 2000, the hope is for the country to turn its attention
toward resolving economic problems and the situation in Chechnyu..23
21International Monetary Fund. IMF Approves US$5 billion Extended Arrangement for
Indonesia. Press Release No. 00/4, February 4, 2000.
22Standard & Poor’s DRI. World Markets Report, Brazil. January 2000.
23Standard & Poor’s DRI. World Markets Report, Russia. October 1999

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CRS-16
U.S. Links to the Global Turmoil
Trade and capital flows along with global price competition constitute the major
links that tie the United States to the economies of the world. Underlying these links
are markets for currency, capital, securities, goods, and services. Behind these links
are markets and a communications and financial infrastructure that allows news to
travel and transactions to occur at faster and faster speeds.
Global financial turmoil affects the United States economy through the trade
deficit, interest rates, stock values, and commodity prices. These variables affect U.S.
economic growth, rates of unemployment, and the health of various industries, which,
in turn, may seek assistance from Washington or protection from import competition.
Three industries have been particularly affected by the financial turmoil. The first
is the steel industry. In 1997, Southeast Asia was the world’s largest steel import
market with 75 million tons imported (as compared with 30 million tons imported into
the United States). The Asian financial crisis along with severe recessions in the
countries of the region (except for China) caused steel import demand to fall, and more
production from Asian steel mills to be diverted to other markets (including those in
the United States). Asian mills have more than 300 million tons in steel making
capacity (counting the capacity in Japan and South Korea). Also, European producers
who previously exported to Asia, diverted some of their product to the United States.
Between August 1997 and August 1998, steel imports into the United States increased
almost 80%. U.S. production suffered, and total employment in the industry dropped
by about 10,000 workers. This brought anti-dumping petitions from the U.S. steel
industry with respect to imports of hot rolled steel from Japan, Brazil, and Russia. On
April 29, 1999, the Department of Commerce found that Japan was dumping
hot-rolled steel in the United States and assigned duties ranging from 17.86% to
67.14%. In February 2000, The White House decided to impose import curbs on wire
rods and line pipes.24
The second industry particularly hurt by the financial turmoil is U.S. agriculture.
Falling exports, lower U.S. prices, and a drop in farm income were among the reasons
the Secretary of Agriculture has announced several food aid measures to boost U.S.
agricultural exports. In 2000, the U.S. agricultural trade surplus is forecasted to drop
to around $11 billion, the lowest level since 1986. Behind the continued low export
levels are the slow economic recovery in East and Southeast Asia, the strength of the
dollar, and increased competition in world corn, wheat, and soybean markets.25
The third industry is crude petroleum, particularly those U.S. companies involved
in extraction and in servicing the oil drilling industry. The drop in crude oil prices
caused primarily by the recession in Asia placed oil producers in a profit squeeze. The
subsequent revival of the OPEC cartel and the hike in crude oil prices in 2000 have
24U.S. Grants Minimal Relief on Wire Rod; More on Line Pipe in 201 Cases. Inside U.S.
Trade. February 18, 2000.
25See: CRS Issue Brief 98006, Agricultural Export and Food Aid Programs, by Charles
Hanrahan.

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CRS-17
offset some of the losses, but for some companies, the recovery has been too late. The
high prices, in turn, have hurt the users of petroleum products (particularly gasoline,
diesel fuel, and home heating oil) who had benefitted from depressed prices in 1998-
99.
Effects on U.S. Economic Growth
The U.S. economy in late 1998 shook off the effects of the slump in Asian and
other foreign economies. A rising trade deficit was largely offset by capital inflows
seeking safety and a
more accommodating
Figure 4. U.S. Economic Growth Rate
Federal Reserve which
1991-2001 (forecast)
lowered interest rates
three times during the
Actual
Forecast
5
worst of the global
4.4
4.1
4.1
turmoil. U.S. econ-
3.9
4
omic growth in real
3.5
3.4
g r o s s d o m e s t i c
2.9
3
2.7
product reached 4.1%
2.3
2.3
in 1998, up slightly
2
from 1997 and the
3.4% in 1996. In
1
1999, the economy
remained strong with a
0
4.1% growth rate and
is expected to log a
similar high rate in
-1
-1
2000.26 (See Figure
4.)
-2
91
92
93
94
95
96
97
98
99
0
1
S t a n d a r d &
P o o r ’ s D R I , a n
Sources: Standard & Poor's DRI, U.S. Dept. of Commerce
econometric fore-
casting service, explains that the U.S. economy continues in its record-breaking
expansion – even as higher interest rates and oil prices threaten
to stop the expansion. International trade remains the major imbalance in the economy
as the merchandise deficit continues to set new records. Imports are rising faster than
exports, but foreigners seem willing to invest in U.S. assets to fund the current account
deficit.27
Policy Proposals and the New Financial Architecture
The commonly accepted vision for international capital markets is that they should
operate at least as well as the better domestic capital markets. While volatility and
26Standard & Poor’s DRI. The U.S. Economy, 3/2000. P. 10.
27Standard and Poor’s DRI. The U.S. Economy, 2000/3. P. 6.

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CRS-18
contagion cannot be eliminated, at a minimum, the frequency and intensity of market
financial crises and the extent of contagion should be reduced.
The policy proposals that have arisen take three broad tracks. The first is
economic and regulatory policy — both by the United States and by other nations to
reform their domestic economies. The second is what is being termed a new financial
architecture, and the third is in the activities of the International Monetary Fund. The
reforms seek to accomplish certain goals. They include: (1) promoting the more
orderly working of the international monetary and financial system, (2) minimizing the
risk that systemic crisis will recur, and (3) ensuring that, when isolated crises do
happen, there are early warning mechanisms, effective policy tools, adequate resources,
and broad support to help countries withstand difficult external pressures and
conditions.
International Financial Institution Advisory Commission
On March 8, 2000, the congressionally mandated International Financial
Institution Advisory Commission submitted its report to the Congress and U.S.
Treasury.28 The Commission considered the future roles of seven international
financial institutions: the International Monetary Fund, the World Bank, three regional
development banks, the World Trade Organization, and the Bank for International
Settlements. With respect to the IMF, the Commission made the following
recommendations:
! The IMF should be restructured as a smaller institution with three major
purposes: (1) to serve as a quasi lender of last resort (standby lender to prevent
panics) to emerging economies, but its lending operations should be limited to
the provision of liquidity (short-term funds) at penalty interest rates (above the
borrower’s recent market rates) to solvent member governments when financial
markets close; (2) to collect and publish financial and economic data from
member countries and disseminate those data in a timely and uniform manner;
and (3) to provide advice (but not impose conditions) relating to economic
policy as part of regular consultations with member countries.
! The IMF should be precluded from making other than short-term loans to
member countries, particularly long-term loans in exchange for compliance with
conditions set by the IMF.
! The IMF’s Poverty and Growth facility should be closed and its long-term
assistance to foster development and encourage sound economic policies be the
responsibility of a reconstructed World Bank and regional development banks.
The Commission listed four “pre-conditions” for a country to quality for IMF
assistance: (1) a competitive banking system that allows a greater presence for foreign
28International Financial Institution Advisory Commission. Report of the International
Financial Institution Advisory Commission. Allan H. Meltzer, Chairman. March 8, 2000.
The members of the commission included Allan H. Meltzer, C. Fred Bergsten, Charles W.
Calomiris, Tom Campbell, Edwin J. Feulner, W. Lee Hoskins, Richard L. Huber, Manuel H.
Johnson, Jerome I. Levinson, Jeffrey D. Sachs, and Esteban Edward Torres.

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CRS-19
financial institutions; (2) the regular publication of information regarding that nation’s
outstanding debts and liabilities; (3) commercial banks that are adequately capitalized,
and (4) proper fiscal policy. The Commission suggested that these rules be phased in
over a five-year period and that they be suspended if necessary for global stability in
the event of a major crisis.
Several members of the Commission dissented from the recommendations of the
report. The dissent with respect to the IMF centered on the constraints placed on the
IMF in combating financial turmoil and on who would qualify for assistance. The four
dissenters, for example, argued that the suggested pre-conditions for crisis loans would
ignore the macroeconomic policy stance of the country in turmoil, because the IMF
would not be authorized to negotiate policy reform. In short, the IMF might end up
supporting countries with runaway budget deficits and profligate monetary policies.
The pre-qualifying conditions also might preclude support for countries that are critical
for global financial stability.29 Other objections by commission members were that it
did not address worker rights or sustainable development issues and that it might
undercut the fight against global poverty.
In a response to the report, House Majority Leader Dick Armey stated that the
report would help reverse years of IMF mission creep and that it will form the
bipartisan basis for legislative action in 2000.30 In a Senate Banking Committee
hearing, Senator Phil Gramm stated that his inclination was to study the report and to
use the legislation for debt relief for certain highly indebted poor countries to
implement necessary reforms of the IMF and World Bank.31
As for the Clinton Administration, in a March 2000 hearing of the House Banking
Committee, Treasury Secretary Summers stated that the ongoing reform of the global
financial architecture had produced some important achievements, including, more
recently, the creation of the G20 (Group of Twenty nations) which is to be a
permanent informal mechanism for dialogue on key economic and financial issues
among industrial and emerging market economies. In addition, the IMF has changed
the terms of the exceptional financial support that the international community
provides by creating a Supplementary Reserve Facility and has been working to reduce
problems of moral hazard by charging premium interest rates. The IMF also has
provided increased incentives for countries to pursue sound policies before financial
crisis strikes. The IMF also has found new ways to involve the private sector in the
resolution of crises - most notably in the cases of Korea and Brazil. The
Administration also claim that there has been a sea change in transparency and
accountability at the IMF and World Bank, a new emphasis in program content with
substantial changes in the scope and nature of the conditionality for IMF (and World
Bank) support that places greater emphasis on the importance of market opening and
liberalization of trade, focuses more on the development of the institutions and policies
29C. Fred Bergsten, Richard Huber, Jerome Levinson, and Esteban Edward Torres.
Dissenting Statement (to the International Financial Institution Advisory Commission report).
c. March 6, 2000.
30Office of the House Majority Leader. Press Release. March 8, 2000.
31Senate Banking Committee. Gramm Plans Legislation to Implement Reforms of
International Monetary Fund, World Bank. Opening Statement. March 9, 2000.

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CRS-20
that will allow markets to operate, takes better account of the impact on the poor of
economic adjustments; increases national ownership and participation in reforms, and
incorporates environment, social and labor issues into program design, as
appropriate.32
G7 and Other Recommendations
Other studies in the aftermath of the global financial crisis have made similar
recommendations. In June 1999, the finance ministers of the G7 (Group of Seven
Industrial Nations) recommended reforms in six priority areas:
! strengthening and reforming the international financial institutions and
arrangements;
! enhancing transparency and best practices;
! strengthening financial regulation in industrialized countries;
! strengthening macroeconomic policies and financial systems in emerging
markets;
! improving crisis prevention and management, and involving the private sector,
and
! promoting social policies to protect the poor and most vulnerable.33
In February 1999, the G7 established the Financial Stability Forum which has
endorsed a broad range of concrete policy actions to address concerns related to highly
leveraged institutions, volatile capital flows, and offshore financial centers. The Forum
aims to promote international financial stability through enhanced information
exchange and co-operation in financial supervision and surveillance. It comprises
national authorities responsible for financial stability in significant international financial
centers, international financial institutions, international supervisory and regulatory
bodies, and central bank expert groupings. The Forum is chaired by Andrew Crockett,
General Manager of the Bank for International Settlements. For hedge funds and other
highly leveraged institutions (HLI), the Forum recommended strengthened risk
management practices, enhanced regulatory oversight of HLI credit providers,
enhanced public disclosure, guidelines on good practices for foreign exchange trading,
and building a firmer market infrastructure.34
A separate study by the Council on Foreign Relations chaired by Carla Hills and
Peter Peterson makes recommendations aimed at altering the behavior of
emerging-market borrowers and their private creditors in ways that would reduce
vulnerabilities in the exchange rate systems of emerging economies; inducing private
creditors to accept their fair share of the costs of crisis resolution; reforming the IMF's
32Summers, Lawrence H. Testimony before the House Banking Committee. March 23, 2000.
33G7 Finance Ministers. Strengthening the International Financial Architecture, Report of
the G7 Finance Ministers to the Köln Economic Summit, Cologne, June 18-20, 1999.
34Financial Stability Forum (Basle, Switzerland). Financial Stability Forum Endorses Policy
Actions Aimed at Reducing Global Financial Vulnerabilities. Press release No. 7/2000E,
March 26, 1999.

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CRS-21
lending policies; and refocusing the mandates of the IMF and the World Bank on
leaner agendas.35
IMF And World Bank Actions
The IMF, itself, along with the World Bank and member governments have been
addressing the problems in the international financial system. The IMF has outlined
the reform proposals as summarized briefly below.36
I. Inadequate Financial Data, Standards, and Surveillance
.
Problem: In the countries that experienced financial crises, banks, lending
companies, and other financial institutions had incurred extensive short-term debts in
foreign currency while lending long-term for arguably uneconomic purposes in
domestic currencies. True risks were not disclosed, and reliable data often were not
available.
1. Transparency in IMF and Country Operations
Problem: Insufficient information was available to the public to protect their
investments and lessen the risks involved when investing or conducting business in the
countries that experienced financial crises, even though some of this information had
been gathered by the IMF. Insufficient information was available on IMF analyses and
operations.
Objective of Proposals: Help foster better decision-making and economic
performance by further improving transparency in the policies and practices of
countries and international institutions without compromising the candor of the
dialogue with members that has characterized the IMF’s role as a confidential policy
advisor.
Proposals:
A. Make available more information on IMF surveillance of member
countries and analyses of policy issues.
– The IMF agreed in March 1999 that it should continue to actively
encourage the release of Public Information Notices following Article
IV consultations. (About 80% of them have been released.)
– In April 1999, an eighteen-month pilot project for the voluntary public
release of Article IV staff reports was established with 45 countries
agreeing to participate.
– On June 3, 1999, the IMF decided to release statements of the
Chairman of its Executive Board summarizing the board’s views
following discussions of a member's use of Fund resources. At the same
35Council on Foreign Relations. Safeguarding Prosperity in a Global Financial System: The
Future International Financial Architecture. 1999.
36Proposals are summarized in: International Monetary Fund. Report of the Managing
Director to the Interim Committee on the Progress in Strengthening the Architecture of the
International Financial System. September 24, 2000.

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time, the IMF established a presumption that the relevant Letters of
Intent, Memoranda of Economic and Financial Policies, and Policy
Framework Papers, if any, would be published (with country
permission) in use of Fund resources cases (to September 1999, 26 out
of 31 had been published).
– Key IMF documents are being released including various policy
papers and related summaries, external evaluations of the IMF's
surveillance and economic research activities, the staff's statements on
the findings of these studies, and summaries of the Executive Board
discussions.
B. In July 1999, an independent, external evaluation of IMF surveillance
recommended that with respect to scope, the IMF concentrate on its
traditional areas of surveillance while giving increased attention to the
international and regional aspects of surveillance and more explicit
attention to vulnerability issues including enhanced analysis of the
capital account, the financial sector, and the treatment of contagion.
With respect to organization and governance, the report made several
proposals with a view to (i) making the Executive Board's oversight
more focused; (ii) enhancing ownership of the surveillance process by
the Board; and (iii) ensuring that consultations cover the most important
issues. The IMF noted that over the past two years, it had already
focused more on several of the issues raised in the report. This included
greater attention to financial sector vulnerabilities, capital account issues
and sustainable exchange rate regimes, debt and reserve management
practices, as well as developing early warning systems to signal potential
problems.
2. International Standards
Problem: Financial data available to investors and policymakers on economic and
business activities in the countries in turmoil often has not been based on
internationally accepted standards. Newly industrialized countries often lack good
practice standards for economic and financial activities and social safety nets to cope
with severe recessions..
Objective of Proposals: Foster the development, dissemination, and adoption of
internationally accepted standards or codes of good practice for economic, financial,
and business activities and governmental monetary and fiscal policies.
Proposals:
A. Strengthen the IMF’s Special Data Dissemination Standard.
—By March 2000 all SDDS subscribers are required to conform to the
IMF’s comprehensive template for disseminating data on international
reserves and related liabilities.
B. Implement the “Code of Good Practices on Fiscal Transparency —
Declaration of Principles” that was adopted by the IMF’s Interim
Committee. A Code of Good Practices on Transparency in Monetary

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and Financial policies was approved by the IMF’s Executive Board and
awaits approval by the Interim Committee.
C. Improve the quality of banking supervision internationally.
— Address the gaps in existing standards on banking supervision.
D. Complete work in other standard-setting bodies on developing standards
relevant for the functioning of financial systems, including accounting
and auditing, bankruptcy, corporate governance, insurance regulations,
payment and settlement systems, and securities market regulation.
E. Strengthen social policies as an essential complement to the reform of
the international financial system.
— Assist countries in establishing social safety nets.
— World Bank to develop principles of good practice in social policy.
3. Surveillance and Enforcement of International Standards
Problem: Monitoring and regulation of banks and other financial institutions are
done by national governmental organizations according to national regulations. Even
though many financial institutions had been operating within allowable national
standards, those standards did not rise to the level of international standards. The
extent to which national regulatory authorities enforced international standards also
was not clear.
Objective of Proposals: To induce countries to adopt international financial
standards and monitor the extent to which countries observe them.
Proposals:
A. Better integrate the use of international standards in IMF surveillance.
– IMF has completed two rounds of experimental assessments on the
observance of standards and codes by member nations.
– IMF’s Executive Board has announced that it would give greater
attention to financial sector vulnerabilities, capital account issues, and
sustainable exchange rate regimes.
– Improve members’ systems for monitoring of short-term external
debt.
B. Improve financial market supervision by national authorities to include
reducing “crony capitalism” lending based more on political or other
connections rather than on market discipline.
– Basle Committee on Banking Supervision (BCBS) is reviewing gaps
bank regulation (sponsored by the Bank for International Settlements)
and has proposed a New Capital Adequacy Framework to replace the
1988 Basle Accord.
– National authorities are reviewing their ongoing procedures to
enhance oversight of financial sectors, particularly with respect to highly
leveraged institutions and offshore operations.

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II. Strengthening Financial Systems.
Problem: The international financial system has been evolving and becoming
more integrated, while countries are becoming less able to cope with shocks to their
exchange rate regimes. Weaknesses in one country’s exchange rate may be transferred
to other countries, particularly by sudden outflows of short-term capital or by currency
speculation.
Objective of the Proposals: Reduce the risk of sudden weakness in exchange
rate systems — caused especially by rapid outflows of capital or currency speculation
— and the risk that a financial crisis in one country will be transmitted to other
countries.
Proposals:
A. Assess measures related to exchange rate arrangements to improve the
functioning of the international financial system.
– In the course of IMF consultations, provide increasing attention to
analysis of financial sector vulnerabilities. IMF to prepare Financial
Sector Stability Assessments based on IMF-World Bank Financial
Sector Assessment Program launched in April 1999.
– Countries move toward either more flexible or purely fixed exchange
rate regimes, although the IMF has concluded that no single exchange
rate regime is appropriate for all countries or in all circumstances.
Exchange rate flexibility needs to be accompanied by a credible
monetary policy.
– Adoption of the U.S. dollar as the domestic currency in certain
countries (e.g. Argentina) and whether the Federal Reserve discount
window or U.S. bank supervision should be extended to such countries.
B. Have the IMF provide contingent resources
– In April 1999, the IMF approved contingent credit lines and in early
1999 reviewed and decided to maintain the Supplemental Reserve
Facility.
C. Increase resources available for the IMF to provide to countries in crisis.
— Already effective are the increase the Fund’s quotas and the bringing
into force the New Arrangements to Borrow.
— In September 1999, the IMF decided to sell up to 14 million ounces
of gold on the basis of market prices to some central banks of member
countries who, in turn, would use the gold to make loan repayments.
These transactions would allow the IMF to replace the gold in their
reserves (at a value of SDR 35 per ounce) and use the balance from the
sale at market prices for its Special Disbursement Account for
investments benefitting the Heavily Indebted Poor Countries (HIPC)
countries. By keeping the gold transactions out of the market, the price
of gold is not affected. The IMF’s first gold sale occurred on December
14, 1999, in which slightly more than 7 million ounces of gold were sold
to Brazil and accepted it back for payment of an obligation due the same
day. Of the proceeds, the IMF invested about $1.6 billion with the Bank
for International Settlements to generate income for the HIPC initiative.

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The second sale on December 17 was of 655,000 ounces of gold to
Mexico which created about $152 million which likewise was invested.37
III. Capital Account Issues.
Problem: Sudden and large capital outflows contribute to the severity and
contagion of financial crises.
Objective of Proposals: To reduce the volatility of capital flows.
A. Consider the role of capital controls.
— Most IMF directors have concluded that the reimposition of controls
on capital outflows was not generally an effective policy instrument in
a financial crisis, although some pointed out that such controls could
play an important role. Directors also agreed that there is no single
approach to securing the benefits of international capital flows while
limiting its risks. The IMF Directors also concluded that capital
controls cannot substitute for sound macroeconomic policies.
— Consider measures to raise the cost of short-term cross-border
capital flows (such as the taxes on short-term capital inflows [the so-
called Tobin tax] imposed by Chile).
D. Consider how to achieve orderly capital market liberalization.
— National authorities to pursue orderly integration and liberalization,
building on the need for strengthened financial systems and prudential
regulation.
III. Involving the Private Sector in Forestalling and Resolving Crises.
Problem: The sheer magnitude of private capital flows into and out of countries
in crisis, along with the moral hazard that international financial support packages by
the IMF merely encourage risky private sector lending, mean that the private sector
needs to be involved in any solution.
Objective of Proposals: To better involve the private sector in crisis prevention
and crisis resolution, in order to limit moral hazard, strengthen market discipline, and
help bring about orderly adjustment processes when crises do occur, while still
maintaining international financial flows.
Proposals:
A. In trying to involve the private sector to help finance adjustment
programs, the IMF has relied on its catalytic role to mobilize private
financing. In recent cases with Ecuador, Pakistan, Romania, and the
Ukraine, the IMF has encouraged these countries to approach their
creditors for additional financing and to use market-friendly approaches
that avoid defaults and disorderly creditor-debtor relations.
37International Monetary Fund. Press Release No. 99/48. Newsbriefs No. 99/84 and 99/86.

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B. Encourage countries to consider changes in the terms of foreign
sovereign bond contracts to speed the negotiation process in times of
difficulties.
— The G-22 has consulted with the private sector on model clauses.
C. Allow the IMF to lend to support government-issue debt in arrears held
by private bondholders to support adjustment measures during debt
negotiations.
— The IMF’s Executive Board has agreed in principle to extend its
1989 policy on lending into arrears on a case-by-case basis.
D. Allow the IMF to lend to support non-governmental debt in arrears,
arising from the imposition of exchange controls, to support adjustment
measures during debt negotiations.
E. Provide for the imposition of stays on creditor litigation to facilitate
orderly non-governmental debt renegotiation.
— Further consideration required.
F. Strengthen national insolvency codes and the operation of insolvency
regimes.
U.S. Economic and Regulatory Policy
In terms of economic and regulatory policy in response to the global economic
turmoil, the United States can pursue monetary, fiscal, regulatory, and trade policies.
Monetary policy is primarily in the hands of the Federal Reserve. While Congress
plays an important oversight role, actual monetary policy changes are carried out by
the Fed in accord with its own assessments. Since mid-1999, as inflation has picked
up and labor markets have remained tight, the Fed has raised interest rates several
times to ease labor and price pressures and to provide alternative investments to the
high-rising U.S. stock market. If, however, the economy slows sharply or drops into
recession, there will be pressures both on the Fed to reduce U.S. interest rates and on
Congress and the White House to pursue a stimulative fiscal policy — tax cuts and/or
additional spending.
As for U.S. exchange rate policy, one question is whether the United States,
Europe, and Japan should intervene more regularly to stabilize currencies. In June
1998, the United States and Japan did intervene to prop up the yen,38 but such action
has been the exception rather than the rule.
As for regulatory changes, in the wake of the bailout of Long Term Capital
Management (LTCM), several questions have been raised about financial market
transparency, internal risk management and control procedures of large financial
institutions, and the adequacy of prudential supervision and systematic financial market
surveillance. The key issue is how large leveraged positions, such as those held by
38Sanger, David E. U.S. Intervenes in Currency Markets to Support the Yen. The New York
Times, June 18, 1998.

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LTCM, could be built up across a sizable number of financial institutions to the point
where systemic risk was raised to dangerous levels.
In response to this issue, the White House organized the President’s Working
Group on Financial Markets. Some of the world’s largest financial institutions also
have agreed to try to set their own industry-wide standards in derivatives markets. By
setting their own voluntary guidelines, the financial industry reportedly hopes to both
prevent recurrences of the problems that have arisen and to keep stricter regulations
from being imposed by regulatory authorities. In April 1999, the President’s Working
Group recommended the following measures:39
! to make public more frequent and meaningful information on hedge funds;
! public companies, including financial institutions, to publicly disclose additional
information about their material financial exposures to significantly leveraged
institutions, including hedge funds;
! financial institutions to enhance their practices for counterparty risk
management;
! regulators to encourage improvements in the risk-management systems of
regulated entities, and
! regulators to promote the development of more risk-sensitive but prudent
approaches to capital adequacy.
The Hedge Fund Disclosure Act, H.R. 2924 (Baker), incorporates the core of
these recommendations. It would require hedge funds with over $3 billion in capital
to file quarterly reports which would be made public. The Working Group also noted
that regulators need expanded risk assessment authority for the unregulated affiliates
of broker-dealers and futures commission merchants. It also recommended that the
U.S. Congress enact the provisions with respect to financial contract netting (In the
106th Congress, see H.R. 833 [Gekas], H.R. 1161 [Leach], S. 625 [Grassley]) and that
U.S. regulators consider stronger incentives to encourage offshore financial centers to
comply with international standards.40
As for international trade policy, pressures are building in two areas. The first is
in the growing size of the U.S. trade deficit. In 1999, the merchandise trade deficit
reached a record $347.1 billion, while the current account also came in at a record
$338.9 billion, up from $220.6 billion in 1998. While these deficits currently are being
matched by inflows of capital into the relatively safe U.S. market, the trade imbalance
reflects growing pressures on U.S. industries that export to the troubled economies or
compete with imports. The United States continues to encourage Japan to resolve its
bad loan problem and to lift its economy out of recession in order that it might lead,
39The President’s Working Group on Financial Markets (Department of the Treasury, Board
of Governors of the Federal Reserve System, Securities and Exchange Commission,
Commodity Futures Trading Commission). Hedge Funds, Leverage, and the Lessons of
Long-Term Capital Management. April 1999. On Internet at <http://www.ustreas.gov/
press/releases/archive.htm#june>.
40For a general description of hedge funds, see CRS Report 94-511 E and CRS Report
RS20394, The Hedge Fund Disclosure Act: Analysis of H.R. 2924, by Mark Jickling.

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rather than retard, economic recovery in Asia and take in more exports from Asian
nations. For 1999, Japan again reported recessionary economic conditions.

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