Euromoney 30th anniversary: Paul Volcker interview – A creaky system


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Paul Volcker, chairman of the US Federal Reserve Board from 1979 to 1987, chairman of Wolfensohn & Co from 1988 to 1996, now 71, looks back over 30 years at a world banking system which "lurched from one crisis to another" from the late 1970s to the early 1990s, and a global financial system which is "still pretty creaky". He fears for small, vulnerable countries, which are like rowboats in an ocean of volatility. He talked to David Shirreff.

Euromoney 30th anniversary: Heroes and villains

What were the turning points?

It was a big turning point when the dollar moved off gold (1971), then the oil crisis (1973), then the US attack on inflation (in the early 1980s), which became a worldwide obsession. The oil crisis was probably inevitable. But it was affected by uncertainty about currency values. There was the second oil crisis at the end of the 1970s, then the US led the world in an attack on worldwide inflation.

Didn't the battle on inflation precipitate the 1982 debt crisis? High interest rates aggravated the debt crisis and may have precipitated it at that time, but it would have happened sooner or later. These countries had overborrowed.

Who were the heroes of that particular hour? Who would you add to Paul Volcker, Jacques de Larosière [IMF chairman] and Bill Rhodes [Citibank's chief debt negotiator]? Fritz Leutwiler [president] at the BIS and Gordon Richardson [Bank of England governor] had an instinctive understanding of the problem.

What about Walter Wriston [Citibank chairman]?
Wriston helped by assigning Bill Rhodes to the problem. In the case of one country I urged him to put Rhodes back in when he assigned the negotiations to somebody else. Lou Preston [chairman of JP Morgan] played a constructive role, so did John McGillicuddy [chairman of Manufacturers Hanover].
Did you encourage Citibank's $3 billion provisioning in May 1987?
Citibank didn't do it with my encouragement. It was an idiosyncratic move which had the natural effect of depressing the prices of those loans. It was the first time a bank had said: "These loans are no good." We were happy to see the banks doing more reserving, but it was a kind of ambiguous situation. This big move changed the tenor of the assets. Maybe John Reed [Citibank chairman from 1984] was trying to distinguish himself from his predecessor Walter Wriston. Between 1982 and 1987 the banks were very vulnerable. By 1987 they weren't so vulnerable.
But by the end of the 1980s, Citi, Chase and Chemical were on their knees again.
Yes [laughs], particularly Citi. They'd got themselves in trouble on real-estate lending.
People talk about systemic risk, but has the system ever been close to breakdown?
We've seen systemic risk, we haven't seen a systemic breakdown. There is systemic risk when you have conditions that threaten contagion. Nineteen eighty two was certainly a systemic crisis in the sense that the large banks had so much of their capital committed to loans in Latin America. You could argue that the [1997/98] Asian crisis was systemic, but a much lesser one, because the banks were not as exposed. There were tensions in the [US] domestic market because of Long-Term Capital Management [LTCM]. The things were related, in that LTCM was hit by spread risk. It was the combination of these two effects which made it more serious.
Was the LTCM rescue a satisfactory outcome?
I was surprised about the LTCM solution, since there was another option on the table [from Warren Buffett]. But I can't judge because I wasn't there.
What would have happened if they'd let LTCM go down, as they did Barings on the Monday morning?
Barings didn't present the same systemic risk. The LTCM crisis came in already disturbed circumstances.
There was a fear LTCM's positions might have affected many markets...
There's no doubt they had very large positions. But LTCM had no presumption of protection at all. It was highly secretive, and flaunted its secrecy. Moreover, it seems there was another offer on the table.
What about villains during the last 30 years?
Michael Milken, although some people think he was a great hero.
How would you classify Henry Kravis?
In the 1980s there was a group of people who drove the financial world into more and more leverage. I don't want to demonize anyone. But the banking industry has lurched from one crisis to another from the late 1970s to the early 1990s.
You mean the last few years have been more stable?
Asia was not strictly a commercial banking crisis. Commercial banks are less important than they were. Now more people can get involved. Behind a lot of this lies technology. You can do things outside the regulatory system. Banks used to have a much more secure place in finance. Today the banks are in better shape. I can't say the system is more stable, it seems a little creaky.