Last Bow for the Inflation Tamer

By Stephen Koepp

He is the most revered economic leader of his era, and yet at times he stirred fire storms of public protest. He had profound impact on a $4.3 trillion economy but lived in a tiny $500-a-month apartment furnished with castoffs. He ran his agency in a notably serene and straightforward style, and still his mystique grew so potent that his every move sent global financial markets into spasmodic guessing games about what he was thinking. He towered physically above his colleagues, yet instead of lording over them and issuing orders in his basso profundo voice, he preferred to lean back in his big chair and quietly listen to other people's ideas.

There has been no shortage of irony and drama in Paul Volcker's eight-year tenure as Federal Reserve chairman. During that time, the U.S. went through one of its deepest economic slumps since the Great Depression, as well as its second longest peacetime boom in modern times. Volcker shares in the blame -- and credit -- for both those cycles, but one major accomplishment was virtually all his own. He was the valiant tamer of U.S. inflation, the tightfisted money manager who stopped one of the worst price spirals in this century and made it bearable once again for Americans to go to supermarkets and shopping malls. But that was not the only reason moneymen around the world slept more restfully knowing Volcker was in charge. He was a crisis manager extraordinaire, a five-star monetary marshal who helped save the financial system from panic when it was threatened by Mexico's debt crisis in 1982 and Continental Illinois bank's near collapse in 1984.

By most accounts, Volcker ranks as the best-known chairman in the Fed's history. His bald pate and halo of cigar smoke became a familiar sight on magazine covers and TV screens, while his name frequently cropped up in everyday household discussions of mortgage rates and car loans. Overseas, his willingness to involve his agency in other countries' economic concerns earned the U.S. large amounts of economic goodwill. Even bankers like former Citicorp Chairman Walter Wriston, who tangled with Volcker on many issues, admired the Fed chief's willingness to do the dirty work of wringing inflation out of the system. Says Wriston: "It took guts to lock the wheels of the world, and I do not know of any other way it could have been done."

The need for Volcker's brand of inflation fighting arose during the aftermath of two oil shocks, which had sent prices zooming out of control by 1979. G. William Miller, who had served only 17 months as Fed chief, was proving ineffective against the growing crisis. Suddenly one day in July, while Treasury Under Secretary Anthony Solomon was cooling off in his backyard pool, he got an urgent phone call from President Jimmy Carter, who wanted suggestions for a new Fed boss. "Paul Volcker," Solomon replied with little hesitation. "Who's that?" Carter asked, not recognizing the name of the head of the Fed's New York branch.

Volcker's obscurity did not last long. Less than two months after he took the post, foreign fears about U.S. inflation sent the dollar into a dive. No group felt the strain more than the elite delegation of U.S. economic policymakers -- Volcker among them -- who went to Belgrade, Yugoslavia, in early October 1979 to try to restore the calm at a conference of international moneymen. As the unrest mounted, the U.S. delegates became "scared half to death," recalls one of them. When Volcker arrived late for a dinner at the U.S. ambassador's residence, he found the dejected Americans just picking at their veal and peas, too preoccupied for conversation. "This is a mess," mumbled the chairman as he sat down. "Going to do something."

Indeed he did. The next morning Volcker jetted back to Washington to launch a shock treatment for inflation. On Oct. 6 he took the highly unusual step of calling a Saturday-night press conference, and there he announced a plan that would shake the world's economy: the Fed would put a choke hold on the U.S. money supply until prices stabilized, and interest rates would be allowed to go as high as necessary to do the job. The plan impressed international moneymen and stopped the dollar's tailspin, but the domestic result was painful. The prime rate kept racing upward, hitting a record 21.5% in December 1980. As the high cost of money began to spoil sales of homes, cars and appliances, the economy went into a deep slide. Unemployment headed toward a peak of 10.7% as millions of workers were laid off.

At that point, Volcker began getting nominations for Public Enemy No. 1. As symbols of their suffering, idle home-builders sent him pieces of two-by- four lumber, and auto dealers mailed him keys from unsold cars. The cover of an issue of the Tennessee Professional Builder, a construction-trade publication, consisted of a WANTED poster of Volcker and his Fed colleagues, - accusing them of "premeditated and cold-blooded murder of millions of small businesses." At one point, a gunman reportedly upset over the prime rate was arrested outside the Fed's boardroom. Howard Baker, then majority leader of the Senate, declared that the Federal Reserve "should get its boot off the neck of the economy."

Volcker and the Fed did not ease the pressure until the summer of 1982, when inflation had been throttled. But in the meantime the hardship of high interest rates had created dangerous fissures in the financial system and hastened the arrival of the Third World debt crisis. The first eruption came in August 1982, when Mexico announced it would be unable to meet payments on its foreign debts, which totaled $80 billion. Mexican officials, seeking emergency assistance, went to Volcker for help after they had been rebuffed by Treasury Secretary Donald Regan, who was philosophically opposed to Government intervention in the problem.

Volcker, huddling with moneymen from around the world, helped persuade commercial banks, the White House and international lending agencies to give Mexico a multibillion-dollar package of new loans and easier terms. That rescue plan served as a model for successive developing-country bailouts, thus lessening the threat of major defaults and financial calamity.

After the bailout of Mexico, the next major challenge for Volcker came in the summer of 1984, when Continental Illinois, once the seventh largest bank in the U.S., suffered a relentless run on its deposits after word got out about its immense pile of bad loans. To stave off a crisis, Volcker helped assemble a package of $4.5 billion in fresh commercial-bank loans for Continental. "This is a very historic thing," remarked a New York City banker. "This is the first time the Fed has been party to any kind of statement that 'nobody is going to lose.' " While the Federal Deposit Insurance Company had to take over and reorganize the bank, Volcker's eagerness to get involved in the rescue was a confidence-building signal to the public that major U.S. banks would not be allowed to founder.

When inflation-free economic growth returned to the U.S., Volcker's image underwent a transformation. The central banker became a folk hero of sorts. Citizens started approaching Volcker on the street and thanking him for what he had done. Volcker was sitting in a coffee shop during an outing in Montana when a local rancher in a Stetson and faded jeans suddenly recognized him and ( ambled up. It looked as if the cowboy might be aiming to pick a fight over monetary policy, but instead he pulled out a $10 bill and asked Volcker to autograph it.

Volcker's toughest customers in the past year or so have been the Reagan appointees on the Federal Reserve Board. In February 1986 Volcker came up on the losing side when his colleagues voted 4 to 3 to cut the discount rate that the Fed charges on loans to member banks. The chairman likes debate, but was furious to lose a vote and considered quitting. "The second floor ((where Volcker has his office)) was rocking a bit," says a former assistant. Following the episode, the official who resigned was not Volcker but his rival, Vice Chairman Preston Martin.

Volcker's eventual decision to leave must have been at least partly motivated by the financial sacrifices he and his wife Barbara have made during his tenure. When Volcker originally took the post, he accepted a pay cut from $110,000 to $60,000. His salary has since increased to $89,500, but that is still less than many of today's M.B.A.s earn by their late 20s. The Volckers struggled at times to support both a one-bedroom Washington residence for the Fed chairman and the family's larger Manhattan apartment. At one point Volcker's wife, who suffers from diabetes and arthritis, took a job as a bookkeeper to help pay the bills. Volcker's son James now works for a bank in New York City, and his daughter Janice, who lives in Virginia, is a nurse. In a recent interview in the Washingtonian magazine, Volcker admitted, "It ain't quite fair to leave a family sitting out there ((when)) you obviously have the possibility of assuring a little more comfort than I have done so far." One sign that Volcker was ready to make major changes in his life-style came March 18: he gave up his trademark 28 cents Antonio y Cleopatra cigars because both his wife and a close friend had stopped smoking.

Volcker no doubt has dozens of job offers. He could easily earn $1 million a year at a Wall Street investment house, or perhaps much more if he started his own consulting firm. But some think he may resist the big money and go into academia instead, possibly teaching at Harvard or Princeton while picking up hefty consulting fees on the side. If he does join a university, his classes should be popular on campus. This is one professor who will have plenty of true-life adventures to illustrate on the chalkboard.

With reporting by Jay Branegan/Washington and Frederick Ungeheuer/New York