Part 1 of 2: Lessons from crisis management

Ross H. McLeod, Indonesia Project, Australian National University, Canberra

The Indonesian Bank Reconstruction Agency (IBRA) is in the process of being wound up. IBRA was established in 1998, with the objective of minimizing the government's losses from the collapse of the banking system that had begun in 1997.

The government faced the prospect of financial disaster -- first, because the central bank had loaned huge sums to troubled banks without adequate security, and second, because the government later chose to guarantee all deposits within the failing banking system.

IBRA acquired a large and diverse portfolio of assets, the divestment of which was hoped to enable the government to redeem a large proportion of about Rp 650 trillion (US$75 billion)in bonds it issued in order to finance the cost of meeting this guarantee.

During the six years of its existence, IBRA was able to make cash payments amounting to around Rp 115 trillion to the government from the sale of various assets, while the market value of its remaining assets is estimated at Rp 15 trillion. We can conclude that the government has ended up losing something in the order of Rp 520 trillion, or say $60 billion, from its "investment" in the banking system. This is a huge amount, equivalent to over 40 percent of the output of the entire economy in 1999.

What does it mean to say that $60 billion has been "lost"? Where did all that money go? That is the question raised by Olivier Fricaut in the newly published special issue of the Bulletin of Indonesian Economic Studies. The key insight of Frecaut's paper is this: If I borrow $100 from you and then fail to repay, the end result is exactly the same as if I had stolen $100 from you.

Your loss is my gain. When the debt is written off, your assets and my liabilities have fallen by exactly the same amount. And if the government then decides to take over your loss, the effect is as if I had stolen this amount directly from the general public. But there is no loss to the economy.

For the most part, the losses incurred by the banks, and transferred via the government to the general public, were not losses to the economy as a whole, but rather, transfers of wealth between entities within the economy.

I suspect that this is why, when one moves around Jakarta now, one cannot help being struck by the superficial appearance of pre-crisis normality -- even prosperity -- with fancy shopping malls abuzz with activity, sales of luxury cars at high levels, a new boom in the construction of luxury apartment buildings, and so on, at the same time that the level of output of the economy as a whole still languishes at levels similar to those achieved before the crisis began.

During the Soeharto era it was frequently claimed that "the rich were getting richer and the poor were getting poorer", but the people who parroted this clichi ignored the empirical evidence. During three decades of Soeharto's rule the process of steady economic growth delivered significant material benefits to the vast majority of the population; no serious researcher in this field believes otherwise.

But the effect of the government's approach to handling the banking crisis has indeed been to make the rich richer at the expense of the poor. This single financial disaster took the existing wealth pie and changed everybody's shares, making the rich richer and the poor poorer at one stroke.

An important question that arises from this episode is: Is there any way that this enormous transfer of wealth can be at least partially reversed?

In a properly functioning economic and legal system, failure to repay debts results in the transfer of assets owned by the borrower to the lender; only if there are no more such assets to transfer will the lender be out of pocket.

But to my knowledge, no conglomerate owner whose companies defaulted on loans from the state or private banks has lost all his assets through this process. The courts have simply proved too corrupt to enforce loan contracts -- almost inevitably taking the side of wealthy defaulters, as IBRA found to its cost.

Moreover, the government has chosen to furnish release and discharge statements to many of the conglomerate owners who have benefited from these wealth transfers, even though it appears that none of them has handed over assets with a genuine market value anywhere close to the value of their liabilities; rather, having been "cooperative" seems to have been the key here. Further court action is ruled out by these statements.

It is well to remember the example of the late Al Capone, America's famous crime boss, who was eventually convicted for tax evasion, not murder or theft. If Indonesia's company income tax were properly administered, then -- in line with Frecaut's insight -- any de jure or de facto forgiveness of debt should be reflected as windfall income of the borrower, and subject to tax, so the taxation directorate of the Ministry of Finance should be able to collect a good deal of additional tax from the firms that were able to get away with non-repayment of their debts to the banking system.

This would certainly be the case for all those conglomerate owners that have been given a statement of release and discharge. It would also be the case for those who have successfully resisted debt recovery proceedings in the courts.

A second question that arises with the departure of IBRA from the scene is: Have we learned enough that we are confident either that there will never be another banking system collapse or, if there is, that it can be handled in such a way that it does not result in a huge transfer of wealth at the expense of the general public? I will return to this question in the second part of this series tomorrow.