FRONTLINE

#1719

"The Crash"

Air date: June 29, 1999

Written and Produced by Sherry Jones

NARRATOR: The U.S. stock market is the richest it has ever been, and investors are exuberant- irrationally so, some have claimed. The euphoria seems to have erased the memory of a terrifying time only 10 months ago.

TELEVISION REPORTER: Black Monday on Wall Street. The Dow drops more than-

NARRATOR: On August 31st, 1998, the Dow Jones Industrials plunged. Trillions of dollars in paper profits evaporated. Small investors watched more than $500 billion of their savings disappear.

TELEVISION REPORTER: Investors who are depending upon their stock savings to pay for imminent retirement should think about cashing out.

NARRATOR: The United States was the just the latest to be hit by a financial panic that roared through the global economy. It was a crisis that ravaged countries and wrecked lives from Thailand to Russia. Today almost half the world's economies remain mired in recession, and that fact has at least some insiders worried.

ROBERT JOHNSON, Soros Fund Management (1992-95): Our stock market's at an all-time high. It's a little bit like fiddling while Rome burns because the world is struggling all around us.

NARRATOR: While Wall Street rides high, a worldwide debate has erupted over what went wrong and why.

JEFFREY SACHS, Dir., Harvard Institute for Intl. Development: We're going to have to face up to some realities that we're not fully facing up to right now.

NARRATOR: Tonight on FRONTLINE: Is the worst over? Or is the global economy, including the United States, heading for another crash?

In the United States, the stock market was already on a roll when the cold war ended. After nearly a century of ideological conflict, the American idea, free-market capitalism, had won. Market economics would mean new wealth, paying jobs and richer lives for hundreds of millions of people worldwide. That was the promise. Wall Street and the Fortune 500 companies saw their mission as spreading the American gospel to the newly open global marketplace.

Pres. BILL CLINTON: Look what's happened in America in the last 11 years. The stock market- and I have nothing against the stock market, but the stock market tripled while wages went down.

NARRATOR: Despite the campaign rhetoric aimed at traditional Democratic voters, Bill Clinton did, in fact, woo Wall Street and its money, money traditionally given to Republicans. By election day, 1992, banks, brokerages and insurance companies had contributed $1.7 million to support his candidacy.

And he would turn to the money men to guide his new presidency into the new global economy. He would tap Robert Rubin, an investment banker whose firm had been the campaign's largest business contributor, as his senior economic adviser. "Complicated deals, endless details, big money," one new appointee said. "That's the future of foreign policy."

JEFFREY GARTEN, Undersecretary of Commerce (1993-95): When I entered the Clinton administration, there was a growing sense that what mattered most in the world was increasingly centered on economic issues.

NARRATOR: Now dean of the Yale School of Management, Jeffrey Garten was an investment banker before he was named undersecretary of commerce for international trade.

JEFFREY GARTEN: For 50 years, the U.S. fought the cold war on certain principles, and one of them was we wanted to see capitalism and democracy spread, and we- most Americans make a link between the two. You have economic freedom that leads to political freedom and vice versa.

DAVID ROTHKOPF, Dep. Commerce Undersecretary (1994-95): In the first days of the Clinton administration, we were in a period of growth and boom in the world, and there was a real sense that the opportunities for the United States to take advantage and to lead in this period of globalization were enormous.

NARRATOR: Countries would be pushed to free up trade, sell off state-owned enterprises and open their financial markets to foreign capital. It was called the "Washington consensus." It was, in fact, Washington's prescription for the world.

DAVID ROTHKOPF: We saw it in our interest, as it was, to liberalize markets, to get these countries to plug in better, to get capital to flow in. It's in the interest of these markets for capital to flow in, and to make that a condition for entry into these clubs that these countries wanted to join is a sensible, responsible thing.

JEFFREY GARTEN: The constituency for pushing hard was very strong. And it's all of corporate America. I never ran into a company that said, you know, "You're going too fast."

NARRATOR: Voices urging caution were drowned out. "Developing countries" became "emerging markets." And removing barriers to the free flow of capital became the price of admission into the global trading system, the club of industrialized nations.

JEFFREY GARTEN: The principal actors became American companies and the Wall Street firms. One, they had more knowledge than anyone else. They were out there. And secondly, they became, in a sense, the surrogates for American influence and power. So we were heavily influenced by their views.

DAVID ROTHKOPF: And I think that there was also a degree of hyping that I and others were guilty of, where we would say, "Here are these emerging markets. Let's go in, and let's take advantage of it." And what we were saying was, "Look, we have common interest with these people, common commercial and economic interests, as well as common social interests. And let's try to define the relationships in terms of those common interests." That was the right thing to do.

NARRATOR: The "emerging markets" would be opened up to the full blast of global competition, and millions of Americans became unknowing investors in a laboratory experiment in globalization.

WILLIAM GREIDER, Author, "One World, Ready or Not": "Emerging market" is just Wall Street buzz talk. That's all it is.

NARRATOR: Washington-based journalist and author William Greider has spent 20 years studying the impact of economics on society. In his 1997 book, "One World, Ready or Not," he warned that U.S. insistence on the unfettered flow of capital would prove to be dangerous.

WILLIAM GREIDER: The U.S. government in numerous situations played hardball and said, "Hey, if you want to stay in the club, you better liberalize your banking system along the terms that we say. You better remove your capital controls so that we can go in and out on our terms, not your terms. Basically, you've got to give up your sovereign governing powers to this global system and trust the global system to lift you out of poverty."

NARRATOR: In the early 1990s, the first hot, new emerging market would be the country closest to home, Mexico.

JORGE CASTANEDA, Author, "The Mexican Shock": The Americans wanted all of Latin America to totally open up their borders to trade with the United States and were presenting this in terms of "It's in your best interest to do this. You should open up your borders because trade liberalization is good for you. It's the right thing to do. Not because I want you to do it, but because it's the right thing to do."

NARRATOR: Jorge Castaneda is a professor of political science at the National University of Mexico. His book, "The Mexican Shock," probes the economic relationship between the U.S. and Mexico.

JORGE CASTANEDA: The Latin Americans were being told "This is the tide of history. You have to go along with it."

NARRATOR: Mexico embraced Washington's consensus. It tore down trade barriers and opened up its financial markets. Foreign investment in its stock market climbed more than 400 percent. And Mexico boomed.

WILLIAM GREIDER: The real fuel for that boom was a very simple reality in global finance. We had at that moment in the early '90s lower - relatively low - interest rates in the United States because the Fed was still trying to help some banks get out of their troubles - our banks - and also get the economy going again. So if you borrowed money in New York at 3 percent and took it to Mexico and invested it in stocks or bonds or even directly in companies, you could expect a return of at least 8, 10 percent, and maybe 20 or 30 percent if you hit the right bells. So of course, people did that.

When did the boom begin to break up? In 1994, when the Federal Reserve started raising U.S. interest rates. And as the 3 percent rate became 4 percent, then 5 percent, then higher, that profitable gap for investors simply disappeared.

JORGE CASTANEDA: In the middle of 1994 investors, particularly American ones, started getting nervous and started telling the Mexicans, "Look, we're leaving." And the Mexicans say, "Hey, wait. Don't go away. You don't like our pesos? Fine. I'll transform your investment in pesos into dollars, and I'll pay you 12, 13, 15, 16, 17 percent on your dollar investment." This was a great deal, but the danger was, of course, Mexico didn't have the dollars to pay those investors back if they all wanted their money at some point. Well, it's pretty simple what happens. Collapse.

NARRATOR: In December, 1994, the Mexican government was running out of the dollars needed to pay off its mounting debt. If the peso collapsed, no one would get all his money out. Global investors panicked and began to flee. There was panic in Washington, too. One top official warned that the unraveling of Mexico's finances could lead to a "true global catastrophe."

JORGE CASTANEDA: Why were they so upset in Washington? Well, essentially because there were all these American investors, both institutional and sort of mom-and-pop investors, who had money in these Mexican bonds, these $30 billion of dollar-denominated Mexican financial instruments, which were not going to be paid. This was your pension fund, and all of a sudden your life savings were on the brink of collapsing.

MIKE McCURRY, White House Spokesman: [White House briefing] The president has had a meeting this evening with the secretary of the treasury and with the chairman of the Federal Reserve. And the text of the statement is: "We agree to do what is necessary to restore the financial confidence in Mexico."

NARRATOR: In the White House press room, Robert Rubin, the newly-confirmed secretary of the treasury, along with Federal Reserve chairman Alan Greenspan, would attempt to explain what was going on.

MIKE McCURRY: Let me go to people who will be well-equipped to answer your questions. And the attribution will be "U.S. officials."

REPORTER: But they're already here, Mike. Isn't that a little ridiculous to put it off camera when these senior officials are standing right here?

MIKE McCURRY: No, it's not.

NARRATOR: Even though every reporter in the room knew who was doing the talking, this briefing would be "off the record."

REPORTER: Who are you guys?

ROBERT RUBIN, Secretary of the Treasury: We are the "some other people" who've been called in to brief.

NARRATOR: The "senior administration officials" were worried that revealing their own fears publicly would further frighten the markets.

ROBERT RUBIN: Chairman Greenspan and I, as we've talked about this for the last couple of days, have both reflected that we've been around financial markets for awhile, and neither of us have seen anything quite like this.

NARRATOR: Mexico needed money to staunch the hemorrhaging peso. Washington wanted to assure Mexico's foreign creditors that they would be repaid.

ROBERT RUBIN: And we will do what is necessary to prevent this problem from happening.

REPORTER: Is this a blank check, in effect?

ALAN GREENSPAN, Federal Reserve Chairman: It's not a blank check. It is an issue of confidence in the financial markets.

NARRATOR: The Clinton administration would engineer an internationally-financed $50 billion loan. The loan would be dispensed largely through the International Monetary Fund - or IMF - which serves as a kind of credit union for countries in crisis. The single largest share of its funding comes from the United States.

GEORGE SOROS, Chairman, Soros Fund Management: The IMF, under the leadership of the Treasury, came in with a very large rescue package, which allowed Mexico to service its debt.

NARRATOR: Billionaire investor George Soros says that the Mexican rescue, which bailed people like him out of some high-risk ventures in the Mexican market, helped ignite a global crisis.

GEORGE SOROS: So the people who had invested in Mexico came out scot-free, and that gave rise to what is considered the "moral hazard"- that it's safe to invest even in an unsound economy because if things go wrong, the IMF and the Treasury is going to bail you out.

JORGE CASTANEDA, Author, "The Mexican Shock": When people invest, they know that the reason they're getting 3, 4, 5, 8, 10 points above Treasury bills in the United States is because it's riskier, but they don't really face up to what that means. What it means is you might not get your money back. That's what it really means. The logic of that investment is that you're getting more because you might not get anything. And you decide you want to take that risk. That relationship or that dilemma has been skewed or nullified by these bailouts. Everyone thinks that whatever happens, there are some countries that the U.S. will not allow to sink. And so you can invest in those countries risk-free.

NARRATOR: One of the risks that every investor confronts is whether the dollars he converts into a foreign currency, be it the Mexican peso or the Russian ruble, will hold their value. The worth of a country's currency, its money, is crucial to every global transaction and to every country's prosperity. So the global financial system, through its treasury secretaries, finance ministers and central bankers, constantly argues about the value of currencies.

WILLIAM GREIDER, Author, "One World, Ready or Not": The instability of currencies fluctuating dramatically, whether it's yen/dollar or dollar/deutschmark or the ringgit or the baht or the ruble is- makes what I call the poker game in the sky. And almost nobody sees it clearly, and very few people even know that it's going on. And it's played among governments, and almost all of it is done in private. [www.pbs.org: Read the full interview]

NARRATOR: The combat of currencies, their continually changing value, is one of the reasons global speculators like George Soros or Tiger Management or so-called "hedge funds" can make billions of dollars with one smart bet.

TRADER: He's talking about changing rates, guys. He says he's prepared to change rates.

WILLIAM GREIDER: The George Soroses and the hedge funds and big banks make a regular, profitable practice of looking at that poker game and saying, "I think they've got it wrong. They can't keep that relationship that's developed between the baht and the dollar or between the yen and the deutschmark or whatever, so I'm going to play off that imbalance that they're stuck with and wait for them to collapse," or wait for them to quit the game and let the currency fall or whichever.

NARRATOR: Robert Johnson is a former top portfolio manager for Soros Fund Management, a private fund whose minimum required ante is a quarter of a million dollars.

ROBERT JOHNSON, Soros Fund Management (1992-95): You're looking at electronic screens. When I watch my children playing Nintendo or Sega or Pokemon or whatever the current game is, it's analogous. There's an electronic screen. At some level, the video game is like a virtual reality. You're playing with this game with your imagination. In essence, you're not out in the field experiencing the changes in employment and agricultural harvests or things like that, you're looking at a distillation of all the indicators about that process over an electronic screen. You're removed from the actual economy, while trying to interpret the economy through electronic means.

NARRATOR: In today's hot-wired financial markets, modern technology means traders can move money anywhere in the world at lightning speed, more than $1.5 trillion every day.

ROBERT JOHNSON: You spend almost all your time, even some of your dreaming time, thinking of things that could hurt you and how you would react. "How am I going to react if this happens?" or alternatively, "What can I imagine that could happen that could hurt me that I haven't thought of yet?" When I sit at the pool on Saturdays with my kids, sometimes they think I'm not there because in my mind I'm off playing these scenarios through in my mind. And it's all about trying to stay a couple of steps ahead and anticipate what's coming up.

NARRATOR: A speculator makes money by betting on how a currency will move. If his bet is that it will fall, that play is called "shorting."

ROBERT JOHNSON: When you put on a play is when you feel like you know something that the world doesn't.

INTERVIEWER: If you're right, then you make a lot of money. That's the theory.

ROBERT JOHNSON: Yeah, yeah. But it's interesting. It isn't about truth because you can be wrong. As long as the world changes their opinion to feel that what you perceive is true, even if you're all wrong, you still make money. So it's about the migration of their perceptions more than it is about the underlying truth.

JORGE CASTANEDA: Countries commit to an exchange rate in order to guarantee returns on investments in the domestic currency to foreign investors or to domestic investors. That guarantee is only worth how much money you have in the bank. And it's only worth the confidence, the trust, you can instill in investors and speculators that you will have enough wherewithal to sustain your currency. If they decide you can't, you've had it, because they will end up getting you.

ROBERT JOHNSON: And the speculators call the bluff of the finance minister who's saying this is a fixed exchange rate for all time. It's the pressure that the speculators put on which says, "The markets don't think you can sustain it. Show us. Inflict pain upon the economy. Raise interest rates. Defend the currency that you say is so vital." That can go on so far, but a central bank might have $20, $50, $80 billion in the market that's daily volume is $600, $700 billion. And if everybody becomes focused on the same thing, $50 billion can disappear in an afternoon.

NARRATOR: The inside moves of the global poker game are often put in play by decisions made in Washington. In April, 1995, the U.S. Treasury would orchestrate an agreement - virtually unnoticed at the time - that would help ignite the Asian financial crisis. The finance ministers from the world's seven richest countries, the global game's high rollers, would try to re-start the long-ailing Japanese economy by ratifying the U.S. proposal to try to increase the value of the dollar against the yen.

WILLIAM GREIDER: Those countries in Asia, for instance, or some in Latin America that decided, "Well, we can't play in that big poker game in the sky, so we'll just attach our currency to the dollar. And whether it goes up or down in relative value to others, we will promise investors that we're going to stick with the dollar." And that's basically a guarantee to U.S. investors "If you send our capital to our country, you won't be burned by a sudden change in currencies."

NARRATOR: The Asian tigers, caught up in their own giddy growth, paid little attention at first to the move by the G-7 high rollers.

WILLIAM GREIDER: The problem is that as the dollar appreciates, those countries' currencies have to ride with it, too.

NARRATOR: The dollar began to rise. As it did, the Asian currencies pegged to the dollar rose in value, too. And that meant the countries' exports became more expensive in the global market. Sales began to fall and deficits began to grow.

WILLIAM GREIDER: In early 1997, investors like George Soros and the hedge funds, who have a sharp eye for instabilities building in the system, focus on Thailand and begin betting that Thailand is going to have to devalue its currency because it's borrowing too much money. And so they start betting that there's going to be a currency devaluation, at least, if not collapse. Of course, the fact that the big money starts betting against the currency often has the effect of fulfilling the prediction.

ROBERT JOHNSON: There is a very rational process going on in the financial markets. It goes kind of like this. "I know I'm not that smart, but I know Soros is. So I'll watch what he's doing, and I'll go along for the ride."

WILLIAM GREIDER: Soros is shrewd and powerful, but he can't move the system by himself. His power is amplified because all of these major banks - the ones in Wall Street, the ones in London, Frankfurt, even in Tokyo - are putting chips down on his bet.

NARRATOR: As the betting escalated, the Thai currency - the baht - literally came under attack, and the Thai government was forced to buy more and more baht with the dollars it kept in reserve, essentially paying off the speculators who wanted to cash out.

ROBERT JOHNSON, Soros Fund Management (1992-95): Each and every one of those transactions is pulling money out of Thailand and bringing it back to the United States, putting downward pressure on the Thai baht.

WILLIAM GREIDER: And the Thai government has to then spend more of its reserves to prop the currency up, and eventually it reaches a point of exhaustion, and then you get a crisis of collapse. And that was the trigger for all of the events that followed. But it wasn't Thailand's fault. It simply happened to be in the crosshairs first.

NARRATOR: As the assault on the baht intensified, the government turned to the International Monetary Fund for help.

JEFFREY SACHS, Dir., Harvard Institute for Intl. Development: What was the name of the game for good doctoring at that point? It was to calm the nerves and prevent panic.

NARRATOR: Jeffrey Sachs is a Harvard economist who has become a leading critic of the policies pushed by the U.S. Treasury and the IMF. He calls the IMF "the typhoid Mary of emerging markets."

JEFFREY SACHS: The IMF came in, as is their wont. And I think the U.S. rhetorically added to this. And the IMF took one look around Thailand and said, "This place is much worse than anybody thinks. We're going to clean it up. Fifty-eight finance companies, we want you to close right now." All of a sudden, people started to look around, said, "I don't know what's going to happen in Thailand in 1998. But I know in the second half of 1997, there's not enough to pay us all off, and I want to be the first one out."

WILLIAM GREIDER, Author, "One World, Ready or Not": What happens when a currency like Thailand's cracks is that everybody who didn't see it coming suddenly turns white with fear and runs for the door. I mean that almost literally. Their first impulse is to get out. Because they're all trying to do that at once, that drives the currency or the stock market or whatever down even further, more dramatically, and very quickly, in matters of hours or days.

NARRATOR: On July 2, 1997, the government in Bangkok lost its battle against the speculators and ran out of cash. Within weeks, currencies tumbled, capital fled, and governments began to tremble throughout the region, first Malaysia, then on to Indonesia, and by the end of the year, South Korea. As in every financial panic since the 17th century, one investor said, greed had turned to fear.

JEFFREY GARTEN, Undersecretary of Commerce (1993-95): The one problem that I said would not happen would be a generalized financial crash. Of course, I was dead wrong, but I think I may have reflected what most of us were thinking, and that is, yeah, there could be a lot of problems, but they would be confined to individual countries or they would be problems of corruption or maybe a revolution somewhere, but nothing like what happened when the problem in Thailand started to spread. It took everybody by surprise.

Pres. BILL CLINTON: I think this is a time for confidence in the future of Asia and confidence in the future of our relationship with them. We have a few little glitches in the road here, and we're working through them.

NARRATOR: The president tried to reassure the markets himself. But faced with a raging panic they had not foreseen and a jittery U.S. stock market, he and Treasury Secretary Rubin would dispatch the International Monetary Fund to lend the money to prop up the rapidly falling currencies.

To secure the emergency IMF credit, the Asian governments had to agree to the economic remedies favored by Washington and Wall Street, including cutting budgets and dramatically raising interest rates paid to foreign investors.

JEFFREY GARTEN: They certainly came in there and demanded a level of immediate austerity which threw these countries into a tailspin. And I believe personally - now, a lot of people disagree with me - that they asked these countries to do too much at one time. It wasn't just to get their monetary policy and their trade policy in order or their fiscal policy in order, but they immediately started to ask for wholesale restructuring of the economies themselves. And while all of that had to be done, if you do it all at once, the social cost, the cost in terms of unemployment and the sheer human misery that is created, I think it was too much.

NARRATOR: Sky-high interest rates might slow down the outflow of dollars, but they also crush domestic economies and turn once secure jobs into rubble. The jobless rate in Thailand would increase by 50 percent, and much of its budding middle class was thrown back into poverty.

In South Korea, a country where being out of work is considered a stigma, nearly 10,000 people a day were losing their jobs. Tens of thousands took to the streets in protest. In Indonesia, the freefall of the rupiah set off waves of panic buying. When the government signed a final pact with the IMF, riots erupted. Within a year, 80 million Indonesians were once again poor.

DAVID ROTHKOPF, Dep. Commerce Undersecretary (1994-95): The voices of the markets, like the IMF, have become the villains of the markets. And if you go to Korea right now and you talk to them about the bad year they've just gone through, they refer to it as the IMF time.

STANLEY FISCHER, International Monetary Fund: This has been a terrible crisis for all the countries concerned, but it is surprising that the depth of the social distress that it has created is less then the critics have asserted throughout.

NARRATOR: Stanley Fischer is the number-two official at the International Monetary Fund, the man who most often lays out the terms countries must accept in return for IMF assistance. He has become the lightning rod for critics of the U.S.-driven policies.

STANLEY FISCHER: I don't want to minimize the social crisis that has been created, but it is not of a scale that has been suggested by those who have been so vociferously critical of these programs.

WILLIAM GREIDER: Nobody walks away utterly innocent. You can say in Korea's case, "Well, they borrowed too much money." Yeah, of course. But I think what gets left out of that discussion is who lent them too much money? And there the culpability is international. It wasn't just the U.S. It was Japan. It was Europe, some others.

And for every failed debtor who was operating on half baked-illusions, there's a banker who was operating on the same half-baked illusions. Only the way this world works, the U.S. government, the Federal Reserve, the IMF and others step forward and say, "Well, we have to help this banker get over his pain and suffering."

You're literally punishing innocent bystanders who didn't borrow the money, who didn't make the deals, in order to make global capitalists whole so that they will keep on being global capitalists.

NARRATOR: In early 1998, the administration continued to insist that the causes of the Asian crisis - and the solutions - were to be found in the countries themselves.

ROBERT RUBIN: The IMF program did include difficult measures, but implementing difficult measures is always necessary in restoring financial stability.

NARRATOR: And Exhibit One in their own defense was that the policies were working. The markets seemed calm.

ROBERT RUBIN: Moreover, the contagion risks that threatened in the early stages of the crisis have so far been largely contained, and economic instability has not spread to other developing countries in other parts of the world.

NARRATOR: But despite the assurances from Washington, the crisis would continue its destructive rumble through the world's economies. When the cold war ended, the United States decided to offer its vanquished adversary little aid but lots of advice. And Western advisers believed the introduction of even imperfect stock and bond markets in Russia would ensure that things would change.

Foreign investors piled in. But their focus was on the fledgling financial markets instead of direct investment into the real economy, which continued to collapse. By 1995, the Russian government faced massive corruption and yawning gaps in its budget.

JEFFREY SACHS, Dir., Harvard Institute for Intl. Development: The Russian government, without other sources of revenue, without any real aid from abroad, facing tremendous political pressures-

NARRATOR: From 1991 until 1994, Harvard's Jeffrey Sachs was an adviser to the Russian government.

JEFFREY SACHS: -they went on a borrowing spree, with a lot of it money borrowed from abroad on a very short-term, highly speculative basis.

NARRATOR: With the approval of the U.S. Treasury and the IMF, the masters of Russia's finances created a channel to raise easy cash selling government treasury bonds, with terms from one month to one year. They were known as GKOs. Moscow was now trying to finance all of Russia with borrowed money that had to be rolled over - re-borrowed - every 30 days.

JEFFREY SACHS: Anybody that got the money in and then was smart enough to take it out and go on vacation made, say, a 50 percent return in dollars. This was the greatest game in town. What happens, though, with a lot of these guys - mostly it's guys, and that's just the truth - is that they get addicted to the easy money. They think they're all super-geniuses, masters of the universe. And they're going to lend, and when they get the money out, they put it back in one more time. "That greater fool is going to come, or the IMF is going to come, and get us out." It's what economists call, in essence, a Ponzi scheme.

NARRATOR: When GKO yields soared into triple digits, investors should have been wary. But Russia, the markets believed, was too big and too nuclear to be allowed to fail.

STANLEY FISCHER: If there was one country in the world where investors could have thought that somehow the G-7, the industrialized world, whatever, would not allow the country to collapse economically, it was Russia. And well before the Russian crisis, it was recognized - I said it a few times, I'm sure many others did - that if there was one case of "moral hazard" it was Russia because it was not an unreasonable supposition that given the importance of Russia, when the crisis came, a way would be found of preventing it.

NARRATOR: But the shock waves from Asia's financial meltdown would crash into the heart of Russia's real economy, oil. Asian countries had been major oil importers. Their collapse meant they could no longer afford to buy as much. The world price for oil plummeted, and so did Russia's export earnings. And the government's addiction to short-term debt was transformed into a ticking time bomb.

JEFFREY SACHS: You had oil prices collapsing. You had an overvalued currency, in the sense that exporters weren't profitable, so that was another factor. And you had Washington saying, "Everything's fine. Just raise those interest rates. Just raise those interest rates and keep paying the foreign investors because that's what establishes confidence, after all. And if need be, we'll give you the money to do it."

NARRATOR: As Mexico had done four years earlier, Russia would offer higher and higher interest rates to anyone who would buy their 30-day GKOs. But rolling over the short-term debt steadily drained the government's dollar reserves until those reserves were well below what was needed every month to pay off foreign investors and Russia's fattest banks, who were playing the game, too.

STANLEY FISCHER: We could see what was happening, but we were still hoping that the underlying source of their problem - which is the fiscal situation and which remains the fiscal situation, namely, these very large budget deficits requiring them to borrow - could be fixed.

JEFFREY SACHS: I think in all of these cases, it is fair to say, that both the governments in question and Washington play a mutual role. "All right, just one more drink." "Okay. Great. Let's go to the bar." "One more." "Great." "One more. Just one more."

And they encourage each other. So it's not simply Washington forcing anyone to do it. The governments have a lot of responsibility on their own end. In Russia, by the way, though, they haven't a clue. They've never gone through this kind of process. And they relied so heavily on the IMF that I put the responsibility so much more heavily on the side of Washington in that case.

NARRATOR: And Washington insisted that the problems would be solved if Russia would just raise more money in taxes. Hooded tax police began surprise raids, mostly for the television cameras. But the GKO debt continued to compound.

STANLEY FISCHER, International Monetary Fund: The debt was somewhere around $15 to $20 billion. Now, that's not small by the standards of what you and I get paid, but relative to the scale of the Russian economy, or relative to the tax effort that they should have made or could have made, those are not massive amounts. And if the roll-over had not been $15 billion, but $5 billion, and they could have collected $10 billion more in taxes, the problem could have been solved.

NARRATOR: But it wasn't. So in July, despite IMF resistance, the U.S. Treasury pushed through an emergency IMF loan. The initial $4.8 billion installment propped up the ruble just long enough to let the corrupt banks and a few foreign investors get their money out of the country.

GEORGE SOROS, Chairman, Soros Fund Management: The IMF plan assumed that the maturing treasury bills will be rolled over, or can be rolled over, even if the interest rate is atrociously high. At some interest rate, there will be some buyers. But what they've left out of the account is that the holders of the GKOs were banks that borrowed dollars to buy the GKOS, couldn't repay the dollars. And foreign banks were not willing to lend them any more money. So what started out as a hole of $7 billion within a week or two became a hole of $15 billion.

NARRATOR: On Thursday, August 13th, Russia's stock index fell more than 10 percent in its first 40 minutes of business. Trading was shut down. GKO yields soared above 200 percent. In the Russian White House, one top official muttered, "It's over."

STANLEY FISCHER: They said, "If we devalue, everybody is going to lose confidence, and they're going to pull their money out. And then we'll not be able to service the debt. But if we try to, in a consensual way, meet with our creditors and refinance this debt or restructure this debt, all the people who are not involved in that debt will see that they're going to be the next ones, and they're going to pull out. And then we'll have to devalue." So they realized that they were caught, at that point. It was when the investors decided it was over that it was over.

NARRATOR: Four days later, on August 17th, Russia devalued the ruble and defaulted on $40 billion in GKO debt. Russia's banks, who were among the biggest speculators, tanked. And the Russian people who had trusted their savings to the promise of the market were shut out.

TELEVISION REPORTER: The ruble is a monetary pile of rubble this evening. It is plummeting, and Russia's central bank is refusing-

NARRATOR: Russia's meltdown finally brought the global crisis home. Some of America's biggest bankers and Wall Street investors, including George Soros, lost money, and on a gargantuan scale. On "Black Monday," August 31st, the Dow Jones Industrial nosedived, wiping out the entire year's gains. And bettors in the global poker game, who had been caught flat-footed once again, began selling Brazil to cover their losses in Russia. The crisis would claim yet another victim.

GEORGE SOROS: The crisis affected a great number of countries, some of which followed very different kinds of policies. There is, however, a unifying theme, and that is the role of capital flows. And the capital flows themselves can be destabilizing. And that- I mean, it's sort of an innate feature of markets. I think it's very good to have capital flows, but I think you also have to recognize that they are, they can be, destabilizing. [www.pbs.org: Read the full interview]

JEFFREY GARTEN, Undersecretary of Commerce (1993-95): Maybe we pushed too hard, too fast without understanding or without taking the time to realize that we have a lot of underpinnings in our economy that took 100 years to build, 200 years, and many of these countries didn't. And so they were going through the motions without the right kind of regulatory systems.

DAVID ROTHKOPF, Dep. Commerce Undersecretary (1994-95): This crisis was not a crisis of fundamentals. This was a crisis of confidence. In many of these places, things in a different mindset in the marketplace could have gone on okay. But what happens in a crisis of confidence is that when there is a misstep in one place, the markets start having to look for capital to cover margins and stuff like that from elsewhere.

And the places that they look are where they think maybe there's going to be a problem in the future, and a lot of that's based on the confidence that has been engendered by the government's policies there. So the Brazilians had this very unusual experience of watching Boris Yeltsin go to bed drunk and having them wake up in the morning with a hangover.

NARRATOR: With the herd stampeding out of Brazil, the U.S. Treasury would once again cobble together a rescue package, this time as a firewall to try to prevent the panic before it spread. As in Mexico, Asia and Russia, the money was not foreign aid financed by U.S. taxpayers but a $42 billion loan.

JEFFREY SACHS, Dir., Harvard Institute for Intl. Development: Who ends up bearing that burden? Of course, it's the Brazilian people, in the end, because we lend them the money so that we can make the 50 percent interest rates _ I won't say "We," let me say Wall Street, just to be absolutely clear - so they can make the 50 percent speculative interest rates. When the currency collapses, the Brazilian people have to pay back the loans that the IMF has so generously bestowed upon them, and which the Brazilian government has used in a wasted effort to "defend" - quote, unquote - a currency that should not have been defended in the first place.

NARRATOR: Two months later, with its treasury another $42 billion in debt and its economy on the brink of recession, Brazil was forced to devalue the real. Once again, the people had lost, and the markets had won.

Today, almost two years after the global crisis detonated, 40 percent of the world remains mired in recession. Across Asia, the families of a million children who had enrolled in school could not afford for them to return. Almost half of Russia is poorer than ever before. But in Washington, the financial crisis has been declared mostly over.

STANLEY FISCHER: I don't deny, nor can anyone, that this crisis has brought substantial misery. But it is turning around, and we shouldn't deny that, either.

JEFFREY SACHS: The IMF says, "Well, it's all coming out all right in the end. You see, the Korean won is stable. The Thai baht is stable. Our policies worked." What they do is they shift the attention away from the real facts and from the real world that people live in. Sure, the currency is stable, but at what cost? An economic collapse? A massive social crisis? Isn't that what they're trying to prevent? [www.pbs.org: More on the IMF and its critics]

GEORGE SOROS: There have been tremendous economic dislocations, tremendous human suffering as a result of what happened in financial markets, affecting what is now called innocent bystanders, millions of people who are not entrepreneurs, who hadn't made any decisions, who didn't borrow foreign currency, a lot of them rather poor people who have actually benefited over the years, seen an improvement in their standard of living, and suddenly a collapse. But it has, if anything, actually benefited our economy because we have had the benefit of cheaper imports.

NARRATOR: On March 29, 1999, the Dow Jones topped the mythical 10,000 mark, and continued its surge from there.

GEORGE SOROS: So it's very hard right now to convince people that there is something really wrong because they don't feel it themselves.

NARRATOR: The crash of 1998 seems today like ancient history, but throughout history stock market bubbles have always burst.

JEFFREY GARTEN: I interviewed 20 top executives on Wall Street and in Washington, and they disagree on a lot of things, but the one thing they all agree on is that we're going to have another crisis, that it's baked into the cake.

GEORGE SOROS: We now have global markets, but we don't have an appropriate international mechanism for regulating the global financial markets. It's carrying the belief in markets to an extreme which is, I think, today very, very dangerous.

NARRATOR: Much of the world now regards major financial reform as a matter of global urgency- at the least, some rules that would slow down the manic movement of the short-term capital that can smash a country's economy in an instant.

Pres. BILL CLINTON: [address to IMF] When nations half a world apart face the same crisis at the same time, it is time for decisive action. In the end, we must fashion arrangements that serve the global economy as our domestic economies are served, enabling capital to flow freely without the crushing burdens the boom-bust cycle brings. And we don't have a moment to waste.

NARRATOR: But Wall Street remains firmly opposed to any controls on capital flows. So while the president's words may suggest action, the official U.S. position remains the same: to defend Washington's consensus against the storm.

ROBERT RUBIN: I think all of us agree that we need to figure out how to try to reduce what you might want to call the excesses in flows of capital, but that doesn't-

INTERVIEWER: Has the U.S. ruled out considering capital flow controls, basically, as an option?

ROBERT RUBIN: We do not believe that capital controls are a sensible approach or an approach that's consistent with long-term economic- promoting long-term economic growth in the global economy.

WILLIAM GREIDER, Author, "One World, Ready or Not": The world system, led by the United States, has pursued what is really a utopian idea, the idea that self-regulating markets, cut free from any moderating controls and regulations, will always correct themselves. And that's a very alluring idea put out by the classical, neo-classical economists.

History has demonstrated repeatedly over 300 or 400 years of capitalism that it's wrong, that that's not what happens, that unregulated markets, their idea of equilibrium may be to swing wildly back and forth at extremes. And sooner or later, they'll get caught in a period of wishful thinking or over-investment, use whatever term you like. And that illusion, bubble, collapses and you've got ruin. General ruin.

DAVID ROTHKOPF, Dep. Commerce Undersecretary (1994-95): One of the things that strikes me as an absurdity in this conversation is when you have hedge funds and other players in the global markets saying, "We'll be self-regulating."

You know, these guys would never think of walking out of their plush office down into the street and getting into a self-regulating taxi cab, and they certainly wouldn't, you know, use the toothpaste of a self-regulating drug manufacturer, you know? So why is it that they think that somehow they are going to be so public-spirited that they should be allowed to do this? The answer is they can't be. Markets can't be self-regulating.

JEFFREY GARTEN, Undersecretary of Commerce (1993-95): I think we could do more. I think that we could take a little more responsibility in terms of trying to shape the rules of the world economy.

JORGE CASTANEDA, Author, "The Mexican Shock": That leadership doesn't exist because American ideology gets in the way. Americans don't believe in regulations, so how are they going to build a consensus for regulation? They would be the first ones to be against that consensus. And this is a real problem because you can't do anything without the United States. But the way things are, you can't do anything with the United States.

ANNOUNCER: For more of this report, turn to FRONTLINE's Web site. There's a reporter's inside story on Russia's meltdown in the summer of '98, a primer on experts' ideas for fixing the global financial system, more of the in-depth interviews with top financial analysts and much more at www.pbs.org.

Coming in August: Critics have called FRONTLINE's The Farmer's Wife "the television event of the decade."

JUANITA BUSCHKOETTER: When we first moved onto this farm, we were really optimistic.

ANNOUNCER: "The characters lodged in your mind and heart." "One of the most rewarding viewing experiences of your life."

DARREL BUSCHKOETTER: It just makes you tougher.

ANNOUNCER: "This film gets at a truth about human relationships that will resonate through every household that tunes into The Farmer's Wife." An encore presentation coming in late August to FRONTLINE.

For videocassette information about tonight's program, please call this toll-free number: 1-800-328-PBS-ONE.

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