Treasury Secretary Paul H. O'Neill came to office 20 months ago intent on transforming the face of international finance. He would just say no to big International Monetary Fund bailouts of deadbeat nations. Instead, the former Alcoa Inc. boss hoped to usher in an era in which both countries and creditors shared responsibility for their mistakes, just like in the corporate world, where dud debts are sorted out in bankruptcy courts. To advocates of IMF reform, Treasury's new attitude looked promising. After meltdowns in Asia, Latin America, and Russia, pretty much everyone agreed something was seriously wrong with the global financial system. And as the top IMF shareholder, the U.S. had the clout to push change. Unlike his Clintonite predecessor, Robert E. Rubin, O'Neill was no creature of Wall Street, so he might be less sympathetic to the inevitable pleas from big banks and investors that had pumped money into ill-managed countries. O'Neill also could turn to a Congress led by feisty Republicans armed with the 2000 Meltzer Commission report that called for an overhaul of the IMF. How well is O'Neill doing? Four words: Turkey, Argentina, Uruguay, Brazil. Despite its tough talk, the U.S. has backed big IMF-led rescues in each nation, including a record $30 billion package in August to calm panic in deeply indebted Brazil. Political reality and fears of a wider fallout from a market crash have taken precedence over principle. ``We have to deal with the world the way it is,'' O'Neill concedes, ``not the way we'd like for it to be and the way we're trying to remake it.'' Nor have Treasury and the IMF made much headway in selling Wall Street on a grand vision for reforming global finance. Industry groups representing bankers, bond traders, and brokerage firms generally endorse one Treasury-backed idea: that emerging-market bond and loan contracts should have ``collective-action clauses'' specifying the procedures for sorting out debt claims once a country is declared insolvent. But so far, few countries and U.S. issuers include such terms in new debt. And it's unclear how they will be written into trillions of dollars of outstanding emerging-market obligations, many of which don't mature for years. The bid for a more far-reaching reform that would set up an international bankruptcy system of sorts for nations faces steeper obstacles. IMF First Deputy Managing Director Anne O. Krueger, a Bush Administration nominee, has secured the Fund's support for such a concept and hopes to win strong backing from the world's finance ministers Sept. 27-29 at the annual IMF and World Bank meetings in Washington. ``The expectation and hope is that they will ask us to move forward with all due speed,'' says Krueger. But major banks and investment groups oppose the scheme as overly complex and a threat to creditor rights. What's more, industry lobbyists who have tracked statements by U.S. officials say they are confused over how committed Treasury really is and where it stands on many details, despite O'Neill's repeated support. To many global finance experts, the mixed signals suggest the Treasury hasn't gotten its act together. ``They have lost their way,'' says Morris Goldstein of the Institute for International Economics. ``There have been big packages galore and lots of proposals. But when push comes to shove, they're not prepared to follow through.'' Former IMF chief economist Michael Mussa agrees. Emerging-market policy at the Treasury, the IMF, and the Group of Seven nations is ``erratic and incomprehensible,'' he says. ``It is just a mess.'' It's certainly a far cry from the Treasury of the 1990s. Think what you want of the Clinton Administration's handling of crises in Mexico, Thailand, South Korea, Indonesia, and Russia. But Rubin and his deputy, Lawrence H. Summers, exuded confidence and knew how to talk to Wall Street. IMF policy, meanwhile, was directed by then-First Deputy Managing Director Stanley Fischer, who listened politely to dissenters but acted decisively. By contrast, ``this is an Administration that gets pulled two ways,'' says BCP Securities Inc. research director Walter Molano. ``They have very ideologically motivated views on the IMF, but the pragmatic issues of reality come in.'' IMF critic Alan Meltzer, an economist at Carnegie Mellon University, is sympathetic to O'Neill. When a bailout decision arises, ``you get one adviser like me saying, `Don't do it!''' he notes. ``But you have 99 of your advisers saying you must do this or you run the risk of depression. So you don't take the risk.'' Of course, nobody believes that a blueprint for a new global financial system can be drawn overnight. And while proposals for making debt-workouts more orderly have circulated for decades, O'Neill deserves credit for making reform a top priority of the IMF and G7. By constantly bailing out creditors and countries, critics argue, the IMF has made matters only worse by encouraging bad and risky practices. But this is a particularly bad time for Treasury and the IMF to be less than surefooted. Five years after the Asian crisis, the climate for emerging markets remains fragile. Private capital flows to developing nations have plunged from $335 billion in 1996 to a projected $123 billion this year, according to Washington's Institute of International Finance. In Latin America, the IIF estimates, banks and bond holders will pull out $3 billion more than they put in this year. This doesn't include Argentina, the continent's sinkhole. ``The situation is quite gloomy,'' says Caio K. Koch-Weser, a senior official in Germany's Finance Ministry. Meanwhile, the cost of capital for governments and corporations in developing nations--provided they can get foreign financing at all--remains high. Rates for sovereign loans in J.P. Morgan Chase & Co.'s 33-nation Emerging Markets Bond Index are more than eight percentage points higher than 30-year U.S. Treasury bonds. Spreads have risen by about one-third since February and are twice as high as in 1997. Not that all emerging markets are shut out of capital markets. South Korea, Mexico, El Salvador, Poland, and other nations with relatively sound financial systems all have been able to tap international bond markets at reasonable rates. But the average spread for Latin America is more than 1,000 basis points, and the contagion from Brazil and Argentina has clobbered neighbors such as Uruguay, which has a record of good financial management. Political concerns make it hard for the Bush Administration to be consistent. After criticizing Clinton for helping Russia on national security grounds, the Bushies did the same thing by backing two bailouts in two years for strategic ally Turkey. Reversing course again, the Administration backed a $10 billion bailout for Argentina last year that failed to avert a default. In July, as disaster loomed in Brazil, O'Neill caused an uproar by implying that IMF aid to Latin America could end up in Swiss banks. Weeks later, the IMF granted a record $30 billion package. The sense that Washington is making up policy case by case adds to market anxiety, analysts argue. ``Creditors don't know how they will be treated,'' says Goldstein. And O'Neill's railing against bailouts means creditors must guess under what conditions the IMF will help in an emergency. So they tend to stampede at the first hint of trouble. ``If the markets knew there was a lender of last resort, that would remove uncertainty,'' says Edmar L. Bacha, senior advisor to Brazil's Banco BBA-Creditanstalt. With clear rules for debt workouts, the Treasury and the IMF argue, it would be easier to avert crashes that wipe out creditors and inflict deep economic damage. Back in the 1980s--when developing nations owed most of their debt to banks--the IMF, the U.S., and a few influential bankers usually were able to hammer out deals to restructure debts with governments behind closed doors. But the process became a free-for-all in the 1990s when creditors included thousands of portfolio managers, pension systems, and hedge funds. The idea of collective-action clauses and a system similar to Chapter 11 gathered steam after the Asian crisis. ``Now we are no longer discussing whether reform is necessary but how you reform the legal framework,'' says IMF assistant legal director Sean Hagan. Many proposals are being floated, but the two-stage process pushed by the IMF and the Treasury works roughly like this: First, it wants all bond and loan contracts to include collective-action clauses. Among other things, the clauses would allow for key creditors to negotiate new payment terms with the debtor government. The deal would need the approval of, say, 85% of creditors, based on their holdings. All of the creditors would have to adhere to the terms, with payments frozen for a fixed period. The idea, say reformers, is to ``bail in'' creditors so that they have a vested interest in resolving a crisis. In addition, the IMF calls for changing international laws to set up a new legal process for restructuring debts. During a crisis, all of a country's loans and bonds would be consolidated. A committee of key creditors would bargain with the government to roll over debts. Meanwhile, the IMF and debtor nation would forge a long-term rescue program that would put the country's economy on sounder footing and allow creditors to get repaid. Many of the creditors would take haircuts, but presumably investor losses--and economic damage--would be less than if the country defaults. But the hurdles to setting up such a system are many. To implement the debt-restructuring process worldwide, all existing bond and loan contracts would have to be rewritten--or new paper with such provisions would have to be issued. That essentially would change the rules in midstream for investors and lenders. What's more, the IMF will have to amend its bylaws, a long and laborious process that would require member countries to change their statutes. Also, a new institution would likely be needed with power to mediate disputes. That could undercut national sovereignty. Some workout experts think the concept is overdue. Attorney Richard A. Gitlin, who has handled messy corporate insolvencies in Indonesia, says having a formal bankruptcy process for countries would pressure creditors and governments to reach a solution to avert default. ``If there were accepted ground rules, there's no question that problems in emerging markets would be less severe,'' he says. ``Last year, it was O.K. to be in intellectual-discussion mode. But the world is crying out for something that works today.'' Opponents call such a system unnecessary. ``We want nothing to do with an international-bankruptcy framework,'' says Sabine Miltner, policy director of the IIF , whose 320 members include the world's biggest banks. ``The Big Bang cure is way out of proportion to the problem.'' Miltner notes that actual defaults are rare--the vast majority of developing nations pay debts on time. The best solution, the IIF argues, is for the IMF and creditors to do a better job heading off crises by holding frank talks with countries headed for trouble. Another concern is that overhauling the rules of global finance now will add to the uncertainty. With Iraq, U.S. corporate scandals, and a fragile global economy, ``the markets already are nervous enough,'' says PIMCO Emerging Markets Bond Fund manager Mohamed El-Erian. ``This is not the time to talk about changes to the system.'' The Treasury, IMF, and G7 also must fight deep-seated suspicions that they play favorites. Washington has seemed eager to use the IMF to help nations that serve geopolitical aims, such as Turkey, Colombia, and Pakistan. But the U.S. has seemed tougher on nations that are less strategic, such as Argentina. ``They want public bailouts for Turkey, but private-sector bail-ins for Argentina,'' says BCP's Molano. That charge may be unfair. But recouping money certainly is a concern for the IMF. Mussa estimates roughly $50 billion of the IMF's $150 billion in usable, hard-currency reserves is tied up in three countries that don't appear to be in shape to repay without fresh infusions: Indonesia, Argentina, and Turkey. ``That is unprecedented in the history of the fund,'' says Mussa. ``If the same thing that happened in Argentina occurs in Brazil, they could have big problems.'' Krueger says such fears are overblown. To allay creditors' concerns, IMF officials promise they are willing to give the private sector a leadership role in operating a bankruptcy system. Krueger says the IMF also hopes to cajole developing nations to put a collective-action process in place. But Washington would have to provide forceful leadership. O'Neill has certainly gotten a good debate going. Now, he needs to develop the finesse to sell his vision.
By Pete Engardio in New York, with Rich Miller in Washington, David Fairlamb in Frankfurt, and Jonathan Wheatley in São Paulo