The Oligarchs (74 page)

Every day in the early summer of 1998, Sucher watched the stock markets slide. The quotations on his computer screens never reflected the real price of stocks; any genuine attempt to sell chased the prices down still further. The effect was punishing. “It was like being on the wrong end of a Rocky fight,” he said. “It was like one of those idiotic sequences in the movie where there is just once punch after another landing on your chin and on your belly, and no human being can handle that punishment. Nobody could possibly throw that many punches and nobody could possibly take that many punches.”
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“Every single day you had the stock market going down 3 percent, 5 percent, 7 percent, 10 percent! Every single day! You come in the morning, and you try and see if there is any possibility, if things will be better than they were last night.” As an example, he said, for a hypothetical stock, he would see that the previous day's price was
$10. Sucher would offer $9.75 just to test the waters. No action. Also, he said, a client in New York who bought the stock at $15 might want to sell it at $10, but not at $9.75. Forced to hold deteriorating positions, clients and brokers grew increasingly frantic. “And the same thing happens the next night. And before you know it, the price has gone down to $9.50 or $9.40.” A sickening pattern was taking shape.

The downward spiral was fueled by what the traders could easily understand—the Russian government was living beyond its means, and the ruble needed to be devalued. But the officials in government would have none of it. A dangerous gulf opened up between the perception of the markets and the view of the government. The markets heard the roar of the dragons, but the government did not.
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In June, Kiriyenko summoned private foreign investors to Moscow, including representatives of the major investment houses on Wall Street and in London. Kiriyenko and other officials all but begged the bankers not to flee, not to give up hope that Russia could straighten out the mess. But the jawboning betrayed a nervousness that had the opposite effect. “Foreign investors listened to the officials very attentively,” recalled Illarionov. “They were amazed at the amount of attention devoted to them during the two weeks and drew what was a natural conclusion: the situation is serious and they should leave as soon as possible.”
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Augusto Lopez-Claros, a former IMF resident representative in Moscow and later an economist for Lehman Brothers in London, recalled that investors asked Kiriyenko whether the government needed a bailout package from the IMF. “No, we really don't need it,” Kiriyenko said, promising that his government would get the budget deficit under control. “The fiscal measures are going to bear fruit and the market will rebound.”

“They were slow in coming to the realization that Russia was the next domino,” Lopez-Claros told me. “They were late.”
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Kiriyenko faced a difficult choice. He very much wanted to avoid wrecking the banking system. He also wanted to keep his distance from the oligarchs. But at the same time, it became increasingly obvious that the tycoons and the banks were one. There was no separating them. Devaluation would wreck the banks, including the ones at the core of the oligarchs' empires. Gaidar recalled, “There was no easy way out.” Yeltsin recalled that Kiriyenko “knew that a horrible financial crisis was bearing down on the country.”
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Still, the Kremlin was sanguine. Yeltsin was getting optimistic
reports from the government and the Central Bank that the worst scenarios could be avoided. He was told that July was the “peak” of their troubles and that in the autumn there would be more money, perhaps new sell-offs of both Gazprom, the natural gas monopoly, and Svyazinvest could be arranged to raise more cash.
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It was nonsense.

The tycoons were hurting more every day as the price of their ruble assets dropped. The squeeze was excruciating for them all. Gusinsky suffered his own disappointment. After a long wait, he was prepared to float shares of NTV in the United States. But at the last minute, his financial advisers said the market was too uncertain. They urged him to wait until the fall—when conditions would surely be better. Gusinsky agreed to wait, but it was a fateful decision. He never made it to the stock market.
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Finally the oligarchs could remain on the sidelines no longer. After six months of drifting, they woke up. On June 16, the “board of directors” met at Berezovsky's Logovaz Club. They invited Chubais, who recently had taken on a major new job as chief of Unified Energy Systems, the electricity monopoly. Sensing danger, they implored Chubais to take on the added duties of Russia's special envoy to the IMF and World Bank. They wanted him to go Washington and come home with a multibillion dollar bailout. They realized that an international rescue package was the only hope. There was no other source of money to save Russia: not the markets, not the Central Bank.

Chubais had repeatedly denounced the cozy clubhouse of oligarchs and vowed to break their hold on power. Now the oligarchs, gathered under Berezovsky's roof, as well as a dozen of their top lieutenants, were begging him to save the country and save their necks. At the meeting, Chubais recalled, he insisted that someone else should take on the new responsibility, perhaps Gaidar or Boris Fyodorov, who was serving as tax minister, or Alexander Shokhin, a member of parliament who was close to the reformers. But the tycoons insisted on Chubais. They decided to take a secret ballot. Chubais got twenty votes, the others got one or two each. Chubais relented. “I accepted the rule that there would be a vote,” he told me, “which means I accepted the result.” It was his birthday, and the businessmen presented him with an expensive watch while Mikhail Friedman played “Happy Birthday” on a piano and they all joined in singing to him, in English.
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Even Berezovsky was willing to extend his hand to Chubais, reluctantly.
Berezovsky recalled later, “At the time, I believed Chubais was the best negotiator. No one could solve this problem better than Chubais, so I thought.”
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Badri Patarkatsishvili, Berezovsky's deputy, turned to him in amazement. “Listen, like idiots we spent two years destroying this man, and now we ask him to rescue us?”
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The tycoons then went to the Kremlin and got Yumashev to sign off on the deal. Yumashev got Yeltsin to sign the decree, and the oligarchs headed out to see Kiriyenko at an old government rest home in Volynskoye, in western Moscow. “Kiriyenko was forced to back off from his vow never to deal with the oligarchs or depend on them in any way,” Yeltsin recalled. “Kiriyenko told them bluntly that he needed help.” He realized he had no choice.

Chubais announced that he would seek a $10 billion to $15 billion loan from the IMF. Chubais thought that just a show of force—a big credit to boost the Central Bank reserves—would be sufficient to calm the markets. He was still not prepared to think about devaluation. Grigory Glazkov, the friend of Chubais who had argued with him at the collective farm in 1979, had become a deputy finance minister at the time. He recalled talking to Chubais just after he was appointed special envoy.

“You have to devalue,” Glazkov told Chubais.

“No!” Chubais responded. “Can you imagine the consequences of what will happen?”

Glazkov replied, “You have no choice. You will devalue anyway, but it will be much worse than if you do it now.” Chubais stuck by his position—there would be no devaluation.
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He stubbornly told journalists, “The rumors about a devaluation of the ruble are absolutely the reverse of the truth.”
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As Chubais spoke, things were beginning to unravel. On June 17, the Central Bank returned to the practice of the previous year and began to give rubles to the Finance Ministry to pay for the GKOs coming due; on that day, the “credit” was more than $1 billion worth of rubles.
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The Central Bank was under fierce pressure to prop up the ruble and to prevent the GKO pyramid from crashing. But the reserves had shrunk even lower than the previous November, when the bank gave up trying to do both.

In these critical weeks, Russia's addiction to borrowing deepened further. On June 18, Goldman Sachs celebrated the opening of a new Moscow office, flying in former President George H. W. Bush and paying
him more than $100,000. “I am optimistic,” Bush, having just come from a meeting with Yeltsin, told the city's financial elite at a reception in the elegant baroque House of Unions in central Moscow. “I believe Russia is going to thrive.” The boys at Goldman Sachs were feeding Russia's debt addiction. Goldman had pulled out of Russia in 1994 but came rushing back three years later, arranging its loan to Yukos in 1997 and arranging Eurobonds for the cash-strapped Russian government in the summer of 1998.

The Eurobonds were essentially loans from overseas investors to Russia. The first that Goldman Sachs arranged was a $1.25 billion Eurobond on June 3. Two weeks later, in a surprise move, Russia went back to global capital markets and borrowed $2.5 billion, with Deutsche Bank as the underwriter. Although it was not known at the time, the Finance Ministry had secretly taken out $500 million “bridge loans” from Goldman Sachs and Deutsche Bank. When the proceeds of the Eurobonds came through, some of the cash was turned right around to pay back the banks.

In July, Goldman Sachs came through with the biggest deal of the year, a $6.4 billion Eurobond. This transaction was a swap in which Russia said to investors, Give us back your short-term, high-yielding GKOs, and we'll pay you back later on, in dollars. The holders of the short-term, ruble-denominated GKOs would be offered seven-year and ten-year dollar-denominated bonds with lower interest rates. The GKOs were paying about 50 percent while the Eurobonds paid 8.75 percent and 11 percent. The deal promised to temporarily relieve pressure on the Finance Ministry's weekly GKO squeeze; about $4.4 billion in GKOs were retired. But in other ways, it was a fateful mistake for Russia. If devaluation was coming—and the dragon was roaring ever louder—then those Eurobonds would be much more expensive for Russia to pay back in the future in dollars than to pay back the same amount of GKOs in devalued rubles. Russia was mortgaging itself down the line for a possible short-term fix. Goldman Sachs was walking away with a handsome commission as a reward—about $56 million for the June and July bond issues. Goldman Sachs did not want to take any risks in Russia and just skimmed the profits.
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Yeltsin's advisers later concluded that the deal “failed to rescue” the government, and several economists also concluded that the swap failed to achieve its advertised goals.
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At the same time Goldman Sachs was sponsoring its glittering
coming-out party, the firm stonewalled the Russian Securities Commission, which was looking into charges that Yukos had hurt minority investors. Goldman Sachs, which surely would not have been so cavalier with the U.S. Securities and Exchange Commission, essentially told the Russian regulator, “Forget it.” When Dmitry Vasiliev, the Securities Commission chairman, wrote to Goldman and the other loan arrangers asking for information about the Yukos loan, he got back a curt reply. Although they would like to help, the bankers said, “we are unable to provide you with any of the information requested.” Goldman, which
Fortune
magazine described that month as “the most powerful investment bank in the world,” was more than willing to enjoy the juicy commissions from Russia's Eurobonds, but when it came to answering a basic question from the Russian Securities Commission, the response was silence.
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Chubais finally succeeded in winning approval for an IMF rescue package in mid-July. The total was $22.6 billion in loans from a variety of international sources, but the critical first installment would be $5.6 billion. The idea was that the money would bolster the Central Bank's currency reserves and persuade the markets that Russia could weather the storm. At the last minute, the IMF cut $800 million off the planned first installment of its package because the Kiriyenko government had been unable to get promised tax legislation enacted. Kiriyenko struggled valiantly to cut spending and push a legislative package through the Duma, but the bills were only partially adopted. Nonetheless, Chubais was relieved when the IMF board approval was made final on July 21. He told one of his aides, Leonid Gozman, after the negotiations with the IMF, “Now we are safe.” He added, “If it hadn't been for this, we were several days away from catastrophe.” Gozman recalled, “He was really happy.”
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But Chubais had miscalculated again.

The rescue package had the desired effect for a week or so. The markets calmed down. Chubais concluded that the bailout was working. “So, what is a crisis? A crisis is a matter of trust,” Chubais told me later. “The financial markets' trust of the government's policy. We hadn't been able to create that trust, but the IMF enabled us to create it. After that decision, the interest rates went down, the market went up a little bit.” Chubais went on a vacation to Ireland.

But then the twin dragons began to roar again. Illarionov, who had at first predicted devaluation quietly in his conversations with
bureaucrats and politicians, spoke out more loudly in newspaper articles, especially in
Nezavisimaya Gazeta
, Berezovsky's paper. Illarionov gave a press conference July 29, saying devaluation was “inevitable.” Illarionov said it would be dangerous to wait, just as he had argued in the spring that it was better to let off the pressure at the outset than all at once. “It is better to accept the inevitable,” he said, “and it will be less painful than the subsequent devaluation.”

As the government continued to insist there would be no devaluation, Russian and global financial markets concluded it was coming. Lopez-Claros, the Lehman Brothers economist, recalled meeting with Finance Ministry officials in early August. The government showed private bankers its assumptions, including the wildly optimistic hope that investors—Russian and foreign—would not exit the GKO market. The same assumptions were built into the IMF deal, and they were dreadfully wrong. “We were aghast,” Lopez-Claros said. “They didn't realize the foreign investors were getting out.” The departures turned into a stampede. “By the time the IMF package had come down,” Boris Jordan told me, “most of investor sentiment was—great, we are going to get liquidity and we'll try and get what we can out.” In other words, investors were not reassured about anything except the prospect that they might be able to cash in their stocks and bonds for dollars and then run for the exits. The issue of “liquidity”—the ability to switch the ruble assets to dollars—was key. The banking system was increasingly illiquid. Not everyone could make it to the exits. Why some investors got liquidity and others did not was a combination of factors—connections, luck, rumors, bribery, and sheer timing. The Central Bank spent $3.5 billion between July 20 and August 19 trying to support the ruble. The ratings agencies, Moody's Investors Service and Standard & Poors, lowered the credit ratings of Russia and its leading banks. Smolensky's SBS-Agro tried to unload truckloads of government securities, desperate to raise cash. The Russian banking system sank into a full-blown liquidity crisis, and banks stopped making loans to one another. One worrisome sign to the markets was that Sberbank, the state-owned savings bank that held a total of $17 billion in government debt, refused to roll over, or reinvest, its maturing GKOs one week when they came due in late July. The cash-strapped government was forced to dig deeper to pay off the maturing bonds. Sberbank was controlled by the Central Bank. Why did they suddenly stop playing the game? Were they fleeing their own market? If so, that
was very bad news indeed.
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“Russia gets the $4.8 billion from the IMF, and it gets blown out the window because nobody rolls over their GKOs,” Jordan said. “Everybody is exiting the market, including the Russians!”