How Jacques de Larosière and Paul Volcker contained the 1982–89 global debt crisis
The most serious global financial crisis in post–World War II history, up to that point, flared up over the summer of 1982. Mexico found it was unable to service its external debts and turned to the United States and the International Monetary Fund (IMF) for help.
The leaders of the IMF and the Federal Reserve acted to prevent the collapse of Mexico’s finances from precipitating a potentially catastrophic global financial crisis: Jacques de Larosière, then managing director of the IMF, who celebrated his 90th birthday on November 12, 2019, and then Fed chair Paul A. Volcker, who died a month later at 92. Together they worked tirelessly to contain the crisis by devising new tools and approaches. Had they not acted decisively, the crisis would have caused a global recession on the scale of the 2008–09 recession.
The global debt crisis had been building since the mid-1970s as countries financed their external deficits via loans syndicated by the major international banks. In 1982, the combined external debt of the 17 countries most seriously affected by the crisis was $392 billion, of which $291 billion was owed to foreign banks. Claims of US banks on these countries well exceeded their capitalization. The exposures of British, French, German, Swiss, and Japanese banks were only slightly smaller. Mexico led the league in the size of its bank debt, and its 1981 current account deficit was 6.2 percent of its GDP.
Following the devaluation of the peso in March 1982, Mexican officials regularly visited Washington to meet with de Larosière and staff, US Treasury officials, and Volcker and myself. Everyone hoped that Mexico could stumble along until December 1982, when a new president of Mexico, Miguel de la Madrid, would take office. It was not to be. In mid-August, Mexico ran out of foreign exchange. US officials led by the Treasury cobbled together enough financing to enable Mexico to continue to make interest and principal payments to its banks for a few days. Volcker reached out to other G-10 central bankers to implement a novel collective bridge loan to provide Mexico with additional immediate financing that would be repaid out of an IMF program. The US Treasury and Federal Reserve financed half the bridge.
Subsequently, in November 1982, de Larosière announced that the financing package in support of the IMF program should include not only the banks’ agreement to the rescheduling of 1982 principal arrears and principal payments coming due in 1983 but also their proportionate participation in a new $5 billion loan to Mexico. Crucially, later that day, Volcker stated that the “credits should not be subject to supervisory criticism.” This extraordinary, controversial, but essential supervisory forbearance enabled US banks to participate without reserving against their old and new exposures.
Before the IMF program for Mexico was off the drawing board, Argentina followed Mexico into external financial crisis. It received a collective bridge loan, with US Treasury participation, to prefinance its IMF program.
Volcker and de Larosière, seeing that the crisis would spread, decided that the approach used in the Mexican and Argentine cases should be formalized and generalized. The Volcker Plan sketched out how it would apply not only to Mexico, Argentina, and Brazil but also to the Philippines and (former) Yugoslavia, countries of importance to Japan and Europe. Volcker received the necessary endorsement from the US Treasury and the White House.
Unfortunately, the countries that qualified in 1983 were not able to tap financial markets sufficiently to meet 1984 principal payments. Those debts were also rescheduled. But these annual negotiations were time-consuming and failed to recognize uneven debt profiles in the out years. The de Larosière-Volcker response was to encourage the banks to negotiate multi-year restructuring agreements linked to enhanced IMF surveillance of the borrowers’ policies.
Almost all the major South American countries and several in other regions ended up with variations of the basic approach applied on a case-by-case basis. However, many continued to struggle. The 1980s have been described correctly as a lost decade for much of Latin America and other countries in the developing world, though some countries did better than others. But in 1982–83 global debt crisis was at least contained. Final resolution, in which Volcker and the Federal Reserve were less involved, required two more major chapters: one in 1985 led by Treasury Secretary James Baker and the other in 1989 led by Treasury Secretary Nicholas Brady.
Author’s Note: In the 1980s, I was director of the Division of International Finance of the Board of Governors of the Federal Reserve System. I participated in and was a close observer of most of what I have described. I thank several of my current and former colleagues for their comments on an earlier draft.