It was a scene that has become all too familiar in President Kim Young Sam's South Korea. Prosecutors trooped out of company headquarters in Seoul, carting box after box of documents, all part of the search for evidence of corruption. Grim-faced employees looked on, wondering what they would do next. Hanbo, a steel and construction conglomerate, had gone bankrupt. This time it was the largest corporate collapse in South Korean history.

Korea has had scandal before, but no bankruptcy has exposed the weakness of the system with greater clarity or shown how far short of the mark President Kim's attempts at reform have fallen. And none has underscored more forcefully the need for greater accountability in a financial system crippled with bad loans. Hanbo's fall leaves in its wake nearly $6 billion in debt at the flagship company, a gaggle of embarrassed bankers, an uncertain future for the 23,000 employees of the country's 14th-largest conglomerate, and a simmering political controversy, complete with allegations of corruption and cronyism. The Korea stock index fell 3% on the news, a blow to a market that slid 26% in 1996. And the central bank has injected $7.1 billion into the financial system so other cash-strapped companies would not crash.

POLITICAL CLOUT. Hanbo's fall highlights the weaknesses in the country's banks, which pay more attention to their borrowers' political connections than to their ability to repay. International bank rating agencies put three of Hanbo's creditor banks on watch for a possible downgrade. Korea First Bank, the prime creditor, said bad loans resulting from Hanbo's collapse total $180 million, or 14% of its equity.

Opposition political parties have been quick to seize on the issue of the banks' exposure, arguing that such large loans wouldn't have been funneled into Hanbo without government backing. The implication is that someone in government was being paid off. "President Kim must take responsibility for what promises to be the largest financial scandal in history," says opposition leader Kim Dae Jung. The opposition charges that the president's son, Kim Hyun Chul, is involved, an allegation the president heatedly disputes. The Blue House, seat of the presidency, has mounted an investigation, denying that anyone from Kim's family or inner circle is complicit.

Whatever happened, it's obvious that despite President Kim's promises to overhaul the system, government control of finance remains a prime lever of power. Given the chronic shortage of funding and the high levels of debt at Korean companies, the system inevitably breeds corruption. And whether he paid bribes to win loans or not, Hanbo founder Chung Tae Soo--a former ruling party fund-raiser who served time in prison after a 1991 corruption scandal--knew how to make the most of his connections. Hanbo officials could not be reached for comment.

The Hanbo troubles leave Kim's flagging reform efforts in tatters. He has suffered through a trying month, after nationwide strikes broke out following the passage of controversial labor and national security laws on Dec. 26. With presidential elections scheduled for December, and Kim limited to a single five-year term, his power is slipping quickly. "After the labor unrest and Hanbo, Kim will have nothing left to show for his presidency." says Park Ki Young, research director at the Citizens' Coalition for Economic Justice.

The wonder isn't that Hanbo collapsed, but that it survived so long. The flagship Hanbo Steel & General Construction Co. lost $105 million on sales of $389 million in the first half of 1996. By the time it crumbled, the company's $5.8 billion debt dwarfed its equity of just $260 million. Most of the money it borrowed was spent on a yet uncompleted steel minimill whose cost of construction had more than doubled, to an estimated $6.7 billion. The mill had little chance of turning a profit, given Korea's overbuilt steel industry.

Yet the banks kept pouring money into Hanbo, seduced by Chung's political pull to believe that he couldn't fail and would succeed in rivaling Pohang Iron & Steel Co. as one of the country's top steel makers. "Bank managers are still in the habit of taking orders and feeling that their future depends on meeting a request from someone influential," says a government financial adviser.

Even as it struggled to build the steel mill, the company kept overreaching, amassing a stable of 22 companies. It bought a bankrupt construction firm, a pharmaceutical company, and stakes in a Venezuelan iron ore venture and a Russian natural gas exploration project.

Although Hanbo was known for its aggressive style, in many ways it was a typical Korean conglomerate or chaebol. Founder Chung Tae Soo exercised total control, along with his son, Chung Bo Keun, who as chairman of the group publicly apologized for the bankruptcy. Hanbo had its first brush with notoriety in 1991 when the elder Chung went to jail, charged with using his connections to get agricultural land rezoned for residential development, a recipe for windfall profits. Chung was again convicted in a recent round of corruption cases, stemming from $17 million in bribes he gave former President Roh Tae Woo.

CORRUPTION PROBES. There's no concrete evidence of wrongdoing to date, but if the scandal continues, it could cost the ruling party control of the presidency in December's election. At the very least, it could mean that Kim Young Sam will be unable to choose his successor. And Kim could be vulnerable to the same sorts of corruption probes after he leaves office that his predecessors have endured. "It's very, very serious politically and personally," says a prominent Seoul academic. Both of Kim's immediate predecessors, Roh Tae Woo and Chun Doo Hwan, are currently serving lengthy jail sentences.

The biggest issue is whether the uproar will prompt a sweeping change. Other chaebol have expanded feverishly around the globe, borrowing billions and frantically using profits from healthy operations to prop up money-losing ventures. The sputtering economy could expose more of them to trouble, which would weaken the banks even further. "I'm wondering how many more times we have to go through these kinds of irregularities before our banking system is overhauled," says the academic.

It's a question many people in Seoul are asking. Kim Young Sam's new blue-ribbon commission on financial reform held its first meeting in mid-January. Unlike other such panels, this one for the first time doesn't include government officials, who tend to oppose sweeping changes. "The Hanbo failure brings urgency to restructuring the industry," says Kleinwort Benson Securities Ltd. research analyst Brian Hunsaker. But given the dashed hopes of previous reforms and the difficulty of pushing through meaningful change in an election year, reformers still have the deck stacked against them.

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