Tuesday, 13 May 2014

The Russian Economy Part 2 : Loans-for-Shares and the Creation of the Russian Oilgarchy

The Russian economy of the late 1980's and early 1990's was in the beginning of a freefall that would take nearly three decades to recover from.  The lack of innovation, demoralized workforce and poor levels of foreign investment left them well behind the West.  The U.S.S.R. was breaking up and many of the newly freed countries sought alliances with the West and the adoption of its economic philosophies.

Meanwhile, back at the ranch Moscow had large bills and little ability to right the ship under the existing system.  In a way they were back in 1917, trying to figure out a way to quickly jump start a moribund economy and a dejected citizenry.

The Russian Economy

Mikhail Gorbachev was gone, replaced by Boris Yeltsin, who somehow had to pilot Russia towards democracy.  In 1994, he was approached by officials at oneksim Bank, the only Russian financial institution to be accredited by the Swiss Central Bank.  Russia needed cash and wanted to transition most state-owned business to private hands.  Oneksim led a consortium of banks that would lend Moscow money in exchange for “temporary” shares in those companies.  Pay off the loans and no harm no foul, but failure to pay them meant the banks got to keep their shares.  This became known as “loans -for-shares” (LFS).

LFS was rigged from the start.  There was no way the Russian government could pay back these loans and the banks knew it, so when the loans came due and the money was not there, a few lucky Russians became owners of the dominant entities in many sectors of the Russian economy.  The LFS banks involved in the program were well-connected to the Kremlin and had the clout to help a shaky government survive the looming presidential elections.

The LFS banks organized “auctions” for the prime pieces of the Russian economy and the results were laughable.  The very banks which organized the auctions won many of them, paying just over the opening bid in some cases.  Foreign investors were shut out of the bidding for the prime assets and the organizers would identify the smallest of infractions to disqualify competing bids.  In one case Oneksim Bank, the brainchild behind the entire LFS program, refused to accept a bid from a rival bank because the paperwork was supposedly late and for the reason that part of the rival bid was secured by treasury bills. Oneksim walked away with 38 percent of Norilsk Nickel for half of their rival’s disqualified bid, one that exceeded the minimum asking price by only $100,000.  This one sale cost the Kremlin $171 million.

Other bargains included oil giants Lukos and Lukoil, two others names that will come up again soon enough.  When the tab was paid, Moscow received barely half of the $2 billion they expected at the outset of the auctions.

The president of Oneksim at the time was one of the big beneficiaries of the auctions. Vladimir Potanin would soon become a billionaire, and as of last spring was the seventh richest Russian with a net worth of $14.3 billion.  He had a head start over many of the others on the list, as he was born into the communist hierarchy.  After graduating from university he got hired by the Russian Ministry of Foreign Trade.  Together with some comrades from the ministry, he started a trading company that succeeded because of the support of many different sectors of the Communist Party as well as the Foreign Ministry.

In the wake of the success of the trading company, Mr. Potanin started two banks, Oneksim and MFK.  They immediately benefited from deposits from many of the state industries.  At the same time he teamed up with Mikhail Prokhorov to create Interros, one of the largest Russian private investment firms.

The aftermath of LFS saw Potanin and Prokhorov with control of Norilsk and oil company Sidanco.  The last five years has seen him shed some assets, including a portion of Norilsk, Polyus Gold, and ProfMedia, Russia’s biggest private media holding company, to Gazprom.  Mr. Potanin was tapped by Vladimir Putin to build Rosa Khutor, the Russian ski resort which hosted skiing and snowboarding at the Sochi Games.  The tab was $2.6 billion.

Now we all know how Sochi was a breeding ground for corruption, and how it nearly perfectly illustrates how corruption results in disaster. Obviously, the Russian oligarchs got their money, reporters got plenty of good stories, Russia looked a little silly and Putin took the opportunity to invade Ukraine while all eyes were already on him. Does that mean everybody’s a winner? It’s hard to say, but it was a strange time indeed. It gets weirder the deeper down the rabbit hole you go. Check out the next installment for a near-comprehensive list of Russia’s lesser known oligarchs and their arguably undue influence in this powerful country. It will be a good time, guaranteed.

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