The history of debt relief: from de Larosiere to Rhodes, Mulford to Ortiz, and Herrhausen to Gurria, the struggle for debt solutions goes on.

Author:Engelen, Klaus C.

In 1986, then-Senator Bill Bradley called for third-world debt relief at a meeting in Zurich. That was highly controversial. But the debt conversion and reduction move led, a few years later, to the success of debt relief in the form of the Brady Plan. Issuing "Brady Bonds" helped former problem debtors in Latin America regain access to capital markets.

Ever since Greece's left-wing Syriza party under its radical leader, Alexis Tsipras, won a big election victory on January 25, 2015, and took extremist right-wing coalition partners, European leaders have been facing the eurozone's first anti-austerity government and its calls for massive external debt relief.

The Greek economy is still in an alarming state. GDP has shrunk by 25 percent since the start of the crisis in the spring of 2010. The unemployment rate is 25 percent, and youth unemployment hovers around 50 percent. External debt at about 175 percent of gross national product is not sustainable. Rescue loans from the European Union, the European Central Bank, and the International Monetary Fund have reached about 240 billion [euro].

When the new Greek government calls for debt relief, the battle lines are drawn. Speaking for the largest creditor country, German Chancellor Angela Merkel takes the position: "I do not envision fresh debt cancellation. There has already been voluntary debt forgiveness by private creditors; banks have already slashed billions from Greece's debt."

It might be useful to look back at how earlier debt crises were tackled so that problem debtors were put in a position to regain market access, and how this compares with the way European leaders in the spring of 2010 rose to the challenge of countering an insolvency of Greece and contagion threats on international bond markets to other eurozone member states. For the euro area, the question of what to do with the debt overhang of some member countries remains critical.

How politicians, bankers, and international officials have dealt with earlier debt crises and contagion risks through debt restructuring and debt conversions brings flashbacks to some who have been reporting on debt crises around the world for decades. Due to these firsthand and still-vivid experiences, many who went through these turbulent times in financial markets and who observed the financial firefighters at close range will have difficulty in understanding some of the "political lending" decisions of European leaders when hell broke loose. With Greece, European policymakers embarked on a rescue without requiring the financial sector to absorb part of the burden right from the beginning.


Beginning in August 1982, when Mexico's Finance Minister Jesus Silva Herzog Flores declared that Mexico would no longer be able to service its debt, the international financial system was threatened by globally spreading "systemic risks." It was a huge shock for banks exposed to insolvent sovereign debtors such as Mexico, Brazil, and Argentina through syndicated loans on their books. The large U.S. banks in particular had sometimes lent more to Latin American sovereign debtors than their capital buffers could cover. By 1982, the nine largest U.S. money-center banks held Latin American debt amounting to 176 percent of their capital; their total lesser-developed country debt was nearly 290 percent of capital. Looming were the financial, social, economic, and political upheavals in the debtor countries that were cut off from having access to international capital markets.

As the Institute of Latin American Studies calculated in its paper Debt Crisis in Latin America, in the wave of recycling petro dollars through ever-larger syndicated bank loans in the years 1975 to 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent. External debt increased from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's GDP. Debt service (interest payments and repayments of principal) grew even faster, reaching $66 billion in 1982, up from $12 billion in 1975. The debt crisis turned out to be the worst in Latin American history. According to some estimates, real wages in the ten years after 1980 in urban areas dropped between 20 percent and 40 percent.

"In 1982, falling international oil prices, rising world interest rates, and massive capital outflows pushed external creditors to refuse to roll over Mexico's short-term debt, leading to subsequent suspension of Mexico's interest payment," notes Guillermo Ortiz Martinez, former Mexican finance minister and central bank governor.

Latin American economies, like peripheral Europe in the 2000s, let government expenditures run well ahead of revenues. Governments were able to finance large deficits with external debt which reached levels similar those of Greece, Ireland, Spain, and Portugal before the current crisis. While private and public spending was rising, productivity was not. Once excess liquidity dried up and interest rates rose, the unsustainability of Latin America's debt became evident."

In the summer of 1982, the role of crisis manager fell to Jacques de Larosiere, then managing director of the International Monetary Fund. Paul Volcker, thenchairman of the Federal Reserve Board, helped to organize a bridge loan for Mexico, part of which was extended by the Bank for International Settlements.

In November 1982, de Larosiere summoned the members of the Advisory Committee for Mexico, headed by William R. Rhodes, a top Citicorp banker, to the New York Federal Reserve to give them the shocking IMF numbers on the financing requirements and told them what the banks would have to do.


As Bill Rhodes recounted in his 2011 book, Banker to the World, there was no question at the time that the banks had to be part of the rescue from the beginning--and his committee had to organize their rescue dollars.

De Larosiere told the bankers that in the coming year, Mexico would need $10 billion to cover interest payments due on public sector debt alone. The IMF could only provide at the maximum $1.3 billion per year. Mexico faced a current account deficit of $4.5 billion, as well as the repayment on short-term loans arranged at the start of the crisis in August from the Bank for International Settlements. In addition, Mexico's official reserves would require $1.5 billion. Other countries providing bilateral aid could be expected to fund $2 billion.

But that left a hole of $5 billion these commercial banks would have to come up with, de Larosiere said, providing new loans for Mexico in that amount while also agreeing to restructure the loans that were coming due. They had to do their fair share to help Mexico's recovery.

De Larosiere then asked the banks "to commit in writing to $5 billion in 'new money' for 1983, a rollover of short-term loans, and a long-term debt rescheduling." He warned that eventually a similar support arrangement would be needed. De Larosiere left the meeting telling the bankers, "I am going to go ahead with the IMF loans. But I have to be able to say that the banks will be able to put in this new money."

Representing Citibank, the bank with the largest exposure in Latin America, Rhodes was left with the Herculean task of getting banks in all parts of the world committed to increasing their exposure to Mexico by 7 percent. It took until March 15. 1983, when 526 creditor banks had signed on to raise the committed $5 billion as promised to the IMF.

As it turned out, Rhodes, a long-term senior vice chairman of Citi, who started his banking career in 1957, has been in the maelstrom of global financial crisis for the last five decades as the world's top financial firefighter through debt negotiation agreements for Argentina, Brazil, Mexico, Peru, Uruguay, and Jamaica. Later, in the Asian crisis of 1997-1998, when the Republic of South Korea experienced liquidity problems, he chaired the international bank group that negotiated the extension of the short-term debt of South Korea's banking system.

Referring to those turbulent years, former Federal Reserve Chairman Paul Volcker recalled that "as country after country began to melt down during the Latin American debt crisis, Rhodes was the man who regulators and politicians turned to repeatedly to bring the agreements [with debtor countries and banks] home."

On the Latin American debt front, Mexico's Angel Gurria also comes to mind. For decades he was Rhodes' sparring partner on the Mexican...

To continue reading