Part 1 of 2: Lessons from crisis management

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.