A free lesson from Russia: how to manage a banking crisis

One of the saddest aspects of 21st America is our parochialism, esp in public policy.  We consider America the exemplar of best practices — sometimes along with the UK —  usually with little knowledge of the ROW (a revealing phrase, “rest of the world”).  Often global phenomena are seen purely as resulting from US developments, as if we are the dog and ROW the tail.

Often nations — each with their own problems — do things we can learn from, and often emulate.  Such as Russia’s response to its banking crisis, in the midst of a recession and currency crisis worse than our own (so far, at least).

For a brief description we turn to “Too Early to Tell“, Eric Kraus, Truth and Beauty, 15 January 2009, pp 17-18 — Russia shows how to handle a banking crisis.  Excerpt:

What Happened?

We readily acknowledge that we were taken by surprise by the havoc in the Russian economy. Russia had been motoring along quite nicely when it was suddenly blind-sided by the combination of a historic collapse in commodity prices and the sudden, radical drying up of all global credit. As Roland Nash put it:

“in August, Moscow hotels were packed with Western bankers desperate to lend to Russian corporations – by October, the same corporates could not even roll over their maturing credit lines.”

Similarly, while a 75% collapse in the price of the main export product would have seriously affected any commodity producer, the high export dependency of Russia increased said vulnerability. Given the combination of these two shocks, it is a testament to the quality of Russian macroeconomic policy adjustments that the crisis has not been far worse. …

The Autum of the Oligarch

… The deadly combination of easy credit, the widely-shared illusion that prosperity would never cease, and what can only be described as the great Russian tradition of mood swings between the blackest pessimism and the wildest exuberance led to a large coterie of top Oligarchs becoming dangerously overleveraged and thus highly exposed to equity price swings. They were caught offsides by the sudden onset of the economic crisis after pledging large blocks of stock in their core holdings to the global banks, generally as security for loans used for the purchase of further assets, both in Russia and abroad.

With the likes of Deripaska and Potanin pushed deeply into margin call territory by a combination of the sudden global credit crunch and the collapse of the Russian equity market (driven largely by the forced liquidation of repoed assets) and with no alternative sources of finance available, there was a real danger that prime Russian assets would fall into the hands of foreign lenders – anathema to the Putin administration.

In order to avoid a fire-sale of pledged assets to the Western banks, the Russian administration chose to deploy sovereign reserves, either directly or via VEB, to substitute for Western credit lines to defaulting local entities. Unlike the situation in some Western countries where taxpayer finance was provided essentially gratis, the Russian bailouts were generally granted at market interest rates, and required good collateral – usually the pledged shares.

Given that the terms of the loans have been relatively short – generally 12 months – we think it likely that at least some oligarchs will be unable to reclaim their shares which will thus revert to state-controlled banks, thus resulting in a shares-for-loans swap, i.e. a belated reversal of the infamous loans-forshares auctions.

Statements from various high-level officials suggest that the Russian State will retain the shares for several years, possibly restructuring the holdings before auctioning them off again. Top Putin aide Arkady Dvorkovich declared that the Russian government was not interested in long-term ownership of the assets, however we cannot exclude the possibility that a sovereign holding company will instead be established to manage assets in sectors adjudged to be strategic.

Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For information about this site see the About page, at the top of the right-side menu bar.

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

Other posts about Russia (the last is the most important):

  1. Forecasts – Why wait? Read tomorrow’s news … today! (part I), 11 July 2006 – Rise of the petro-empires
  2. More news about Russia’s demographic collapse, 6 June 2008
  3. Perhaps *the* question about the Georgia – Russia conflict, 10 August 2008
  4. Keys to interpreting news about the Georgia – Russia fighting, 12 August 2008
  5. What did we learn from the Russia – Georgia conflict?, 13 August 2008
  6. Comments on the Georgia-Russia fighting: Buchanan is profound, McCain is nuts, 15 August 2008
  7. Best insight yet about America and the Georgia-Russia fighting, 15 August 2008
  8. Georgia = Grenada, an antidote to Cold War II, 16 August 2008
  9. “The Medvedev Doctrine and American Strategy”, by George Friedman, 4 September 2008
  10. Before we reignite the cold war, what happened in Georgia?, 12 December 2008
  11. Rumors of financial war: Russia vs. US, 22 December 2008
  12. More weekend reading; information you want to have!, 23 December 2008 — Russia as the last man standing in a region of demographic collapse.

18 thoughts on “A free lesson from Russia: how to manage a banking crisis

  1. Eric Kraus:”By contrast with some of its more democratic peers in the West, Russian policy been singlemindedly focused upon supporting the poorer segments of the population – raising wages and pensions, rather than on bailing out the owners of financial assets. Medvedev has stressed the vital importance of maintaining the >50% decline in poverty acheived over the past decade.”

    Sounds like a breath of fresh air compared to the US policy of giving ‘free money for Citigroup/Bank of America.’ The American middle-lower classes, well, they get the scraps, any more would be inefficient stimulation. You know we must be efficient. Can’t argue with that.

  2. China and Russia have also cut corporate taxes. “Russia to Cut Corporate Taxes, Washington Dithers“, Scott A. Hodge — Excerpt:

    “The tax changes in Putin’s plan would cut the Russian corporate tax to 20 percent from 24 percent on January 1st and “reduce taxes for small businesses and speed refunds of value-added tax. Meanwhile, China—which cut its corporate tax rate to 25 percent this year from 33 percent—recently announced reforms to their VAT in order to reduce the cost of the tax on businesses.”

    There are good and bad regulations but we seem hell bent on doing everything backwards. Between the previous theft followed by next theft, the so called stimulus package, we are in for a very bad ride.
    .
    .
    Fabius Maximus replies: Nominal corporate tax rates mean zip, and are not remotely comparable across nations. Effective tax rates are far below nominal in some nations — such as the US.

  3. To show the full extent of the devolution, compare the American discourse with Vladimir Putin’s speech on the economic crisis at Davos.

    What’s the American version? Instapundit, Michelle Malkin and Joe the Plumber discuss economics for 20 minutes.

    Wow. This example of Americans trying to discuss the economic crisis is, like, the Olympics of stupidity. It’s like the Stockholm Nobel awards for ignorance. It reminds me of that scene early in the film 2001: A Space Odyssey, where the apes are fumbling around with pieces of bone in front of the monolith. Except here, every time the apes touch the black monolith, their intelligence decreases.
    .
    .
    Fabius Maximus replies: You win the thread award for the most depressing comment. Really brutal to imagine anyone listening to “Joe the Plumber” talk about economics. For a summary see “You’ll Never Get This 21 Minutes Of Your Life Back” at John Cole’s Balloon Juice:

    “There is so much to love about this, I don’t know where to start, but certainly Joe the Plumber bemoaning the lack of spending cuts and general program cuts in the stimulus bill was a highlight. It is almost as if he doesn’t have the first damned clue what he is talking about.

    … “I really don’t understand how bipartisanship is ever going to work when one of the parties is insane. Imagine trying to negotiate an agreement on dinner plans with your date, and you suggest Italian and she states her preference would be a meal of tire rims and anthrax. If you can figure out a way to split the difference there and find a meal you will both enjoy, you can probably figure out how bipartisanship is going to work the next few years.”

    For a wider context on this see Roddy McCorley’s comment to “Economist of the People” by Brian Beutler, posted at Think Progress, 3 February 2009:

    “The GOP is all about marketing now, and niche marketing at that. They need to keep the donations coming in, and the only people still motivated to do that are the True Believers. The crazies. The ones who think Obama is a Muslim terrorist and Bush was the best president ever. Thanks to an interesting convergence, those people are also the leadership of the GOP. The con is now being run by the marks.

    “The GOP simply is not a political party anymore. They have no conception of actual government, and no sense of the common good. They cannot distinguish between image and substance.”

  4. We could benefit from a sort of best-practices global out-reach, similar to what the Japanese did economically after WWII. They sent their businesspeople, engineers and scientists to the far corners of the globe to study how others did things, then they took home those lessons, improved them as necessary, and took them to the bank. Seems simple enough, but it requires an emotion – a mindset – we Americans don’t seem to possess much these days, being humble. But then, if the crisis deepens as it seems sure to do, that won’t be our problem for too much longer, will it?

    We seem to behave as if we are the nation of 1945, when we were at the peak of our economic, military and cultural might, even though we are now at least partly scenescent, an aging society that is failing to keep pace with our more adaptive and agile competitors. We can rejuvinate in part by recognizing what we’ve been doing hasn’t worked, and begin seeking out what has. That means getting over the “not invented here” mindset.

  5. Despite all of the clueless punditry, no one in the West truly understands China – yet therein
    lies the key to the global economic outlook. If China surprises to the upside, the emerging
    universe will outperform strongly (if it melts, readers may wish to seriously consider
    emigration to another planet
    ).

    Perhaps the most useful suggestion I have read so far. Hopefully interplanetary travel will be part of the stimulus package.

  6. Eric Kraus: “Almost certainly, sooner or later the US will embark upon massive monetization of its debt (quaintly referred to as “quantitative easing” i.e. buying treasuries with freshly-minted dollars); ultimately, the choice will be between a deep and prolonged recession, followed by a decade of austerity and sacrifice – or simply inflating away the debt load (take a wild
    guess, anyone?).”

    We can have banks borrow from the fed, and then buy Treasuries and pocket the difference in interest. That keeps the illusion going for now. The fed buying treasuries directly is an important psychological barrier. That once this happens, the illusion of an independent fed is further eroded. S&P would never do this, but really the USA should drop a credit rating if this happens. A bond that is paid back with taxes is a better thing than a bond that is paid back with a printing press.

    Eric Kraus: “We are waiting the moment to re-enter our short-USD trade against the Euro, CHF, SGD; we would take 2: 1 odds on the UK requiring IMF support by year-end.”

    Here’s a friendly warning to those who believe bank nationalization is without risk. Oh man, hopefully this is just the vodka talking here, but I don’t know. I can’t imagine the IMF is close to being large enough to bail out the UK. More likely the EU would come to the rescue, but with strings. They’d kill the Pound, and UK sovereignty would be gone apart from the Queen as a tourist attraction, the WOrld Cup, and the Olympics.

    A UK default/rescue plan is the ultimate next-level disaster and trigger for a wider depression. It’d make Citigroup problems seem like small change.
    .
    .
    Fabius Maximus replies: Two points about this. A correction and an extension.

    (1) Please do not exaggerate or make stuff up. IMF aid to the UK is not necessarily a “bailout”, and would not necessarily strain the IMF. The UK was on its knees when Callaghan begged for IMF aid in 176, and yet the world still spins. The pound is still the currency, they the UK is still a soverign nation.

    (2) Much of what Americans believe about their government is an illusion. Just nonsense to keep the sheep citizens docile.

    * The Fed is just another government agency, part of the “good cop – bad cop” game our politicos play on the sheep citizens.

    * There is no social security trust fund (Write a billion dollar IOY to yourself. Are your richer?).

    * FICA taxes are just a tax on payrolls (and a regressive tax at that). The money goes into the kitty and is spent along with the rest of the booty. This is why the folks in Versailles Washington will not do a “payroll holiday”, as it would ruin the illusion.

  7. Re 3. Gosh, just imagine how painful it is to hear Nancy Pelosi discuss economics. 500 Million American jobs a month. Oh, the agony. Assuming Dick Cheney really did secretly control the entire world from his evil, secret hideout beneath Cheyenne Mountain, that would lay off the entire planet in a shade over a year.

    At that point, let’s all go the beach!
    .
    .
    Fabius Maximus replies: This focus on bloopers is IMO just dumb. Everyone who talks on record as much as a major politico makes bloopers. The ink they receive depends on the major media’s whims. I have done a little public speaking and made more than my share of them.

  8. The Russian plutocrats and Putin have been at odds for awhile. The one-time owner of Gasprom (I forget his name) is now in jail where Putin put him. Most of the plutocrats made their fortunes (or started them) under Yeltsin, following the reckless dismantling of state enterprises under the guidance of western neo-liberal economists.

    Putin and Medvedev are rivals of the plutocrats — an entirely different relation than that between western financial elites and their governments.

    Some of the commenters above make the mistake of assumning that the US government has an independent brain, capable of gathering information and coming to conclusions on its own, rather than simply following the suggestions of its primary funders.

    (FM: does this qualify me for at least sharing the prize of most depressing comment on the thread?)
    .
    .
    Fabius Maximus replies: I believe you are thinking of Mikhail Borisovich Khodorkovsky, Chairman of Yukos.

    As for thread prize, not even close. You will know that a comment approaches the truth when the very pixels on the screen weep.

  9. Re 8: Khordorovsky(sp?) was the gentleman’s name. I use the term gentleman loosely; he was T. Boone Pickens without the plan; or the legal restraints that Western entrepreneurs often operate under.

    I guess the Russians have a problem similar to what Theodore Roosevelt faced with Getty and Rockefeller. Perhaps the whole “too big to fail” mantra suggests we have similar issues today.

    To extrapolate further, what AIG, GM, BOA, et al. nned is not a bailout, but rather a Judge Greene. I don’t get “too big to fail”. When AT&T got trust-busted, the phones continued to work.

  10. I agree that too big to fail is a dangerous term and should be raising a lot of questions. If that’s true, why was the SEC allowing citibank to bid on wachovia and all this other consolidating nonsense going on? It’s a bit more complicated than that, but if such a thing exists regulators should be sharpening their axes.

    That being said, I think the main difference between AT&T and the banks is that if AT&T disappeared forever, the phone lines are still around. If Bank of America or another giant disappears, there’s no infrastructure of credit that remains in their place.

  11. Well, all taxes have an impact. The accounting costs used to reduce it and then pass it on to the buyer or if in a very price sensative market, not hiring, laying off, reducing benefits, etc. But detail discussion is for another time. Perhaps in the future you can do a comparison between our tax structure and others, like VAT. I thought it would be worthwhile to show the whole spectrum of what they were doing.

    Then theres this about Volker (hat tip Instapundit): “Volcker Chafes at Panel Delay, Clashes With Summers“, Bloomberg — Excerpt:

    “Volcker, 81, blames Obama’s National Economic Council Director Lawrence Summers for slowing down the effort to organize the panel of outside advisers, the people said. Summers isn’t regularly inviting Volcker to White House meetings and hasn’t shown interest in collaborating on policy or sharing potential solutions to the economic crisis, they said.”

    He’s the one positive that I was happy with but if this is true we are missing a valuable level of experience that could help get us out of this mess.
    .
    .
    Fabius Maximus replies: This is now old news. See “Who’s who on Obama’s new economic advisory board“, LA Times, 6 February 2009.

  12. Underscore:”That being said, I think the main difference between AT&T and the banks is that if AT&T disappeared forever, the phone lines are still around. If Bank of America or another giant disappears, there’s no infrastructure of credit that remains in their place.”

    Bahhh, the USA can live without Bank of America. A lot of banking names have gone away and life has continued. We might have leveraged the TARP to a very sensible level of 5×1 to 3.5T and then built one hell of a bank. Sounds like this is about what the Russians did. Credit dried up, so the government became the bank.

    And, that credit infrastructure consisted of guys who made loans without checking the credit-worthiness of the borrowers. For a mere few billion, we can hire a lot of infrastructure. The amount of money being thrown at this vastly exceeds the value we’re getting back.

  13. Re 11: On the 1st TARP Tranche, we got $0.70 per $1 expended. (Re a comment I posted on the last FM econ thread) This, I believe, discounted the financial cost of money associated with creating the TARP money out of thin air. Real Net Asset Value is closer to $0.65 per $1 expended.

    Another complicating factor is the time value of money concerns. If the markets are nice and like the Americans, things will stay around the 3% and the net present value of the asset held equals $0.65/(1.03^N), unless appreciation or depreciation occurs.

    In otherwords, the longer we hold the assets, awaiting a change in our economic fortunes, the more the economy has to recover in order for TARP to sell the toxic assets at non-carcinogenic prices….

  14. Depsite financing shortfalls, microbanks apparently are doing pretty well::

    “The World Bank and the German government said Thursday that they hoped to inject as much as $600 million into microcredit banks, fledgling institutions in developing countries that are being starved of financing as the credit markets have tightened.

    “The effort highlights how even small banks in poor countries are getting caught in the financial crisis — and it offers them a chance to get public money to replace rapidly diminishing private capital.

    “… Mr. Zoellick emphasized that the cash being offered was not a recapitalization of microcredit banks after heavy losses.

    “‘Microfinance banks are generally solvent, have a strong record of making sensible loans and did not speculate in the complex mortgage-linked securities that have caused so much pain among Western banks. Only 2 to 3 percent of their loans tend to go bad’, Mr. Zoellick said.

    “‘It always depends on the institution,’ he said. ‘But what we find in general in the microfinance industry is that their problem loan percentage is quite low.'”

  15. FM: “Please do not exaggerate or make stuff up. IMF aid to the UK is not necessarily a “bailout”, and would not necessarily strain the IMF. The UK was on its knees when Callaghan begged for (and got) IMF aid in 1976, and yet the world still spins. The pound is still the currency, they the UK is still a soverign nation.

    We can only speculate what kind of situation the UK would ‘need IMF support.’ It implies that obligations of nationalized British banks would be so large that the UK government would be unable to meet them. From their website, the IMF has a total capacity of $352BUS, and there will be others looking to use this money: “Total Quotas: $352 billion (as of 5/31/08).” Quotas is IMF-speak for their ability to loan out money.

    Actually Britain is lucky to have the Euro as a possible ’emergency backup currency.’ Especially if the article is right and the Euro holds together. The EU member states are still ostensibly sovereign, though they’ve all signed away a lot. It’s a speculation, but I don’t think an unreasonable one that some kind of crisis where the UK needed emergency outside funding would accelerate this process.

    FM:”(2) Much of what Americans believe about their government is an illusion. Just nonsense to keep the sheep citizens docile. ”

    Fed independence is an illusion created for the sake of owners of US bonds and other dollar assets, not for American citizens. Yes, fed independence is eroding. There is a reason why it was setup this way. If we’re unlucky we may discover why all over again.
    .
    .
    Fabius Maximus replies: Seriously, we can only speculate why the Fed was created a century ago. I prefer the conventional explaination, that is allows a senior unelected offical to take the punch bowl away from the party (source). The politicos can scream about this horrible deed.

    Also, you seem unclear on how these things work.

    (1) The UK can print money as needed for domestic purposes. IMF aid might be needed to provide foreign currency, in case there is a run on the pound that the UK fx reserves cannot handle (that is, preventing the pound from dropping excessively or in a “disorderly” fashion). That’s why they borrowed the 2.3 B pounds in 1976. The cost to the UK seems easily within their resources, as Martin Wolfe notes in the 22 January Financial Times:

    This last is the spectre that Willem Buiter has been raising for the UK in his Maverecon blog. He notes that, with balance sheets equal to 440% of gross domestic product, these institutions might imperil the fiscal soundness of the UK itself. I suspect this danger is exaggerated. A recent analysis from Goldman Sachs suggests that the cost to the state should not exceed 8% of GDP.

    (2) The IMF is just a conduit for money from its members. It’s resources at any time are whatever its members are willing to provide.

    (3) The UK will not get a bailout from the EMU. It’s too big, and they have far more seriously wounded nations needing aid: the PIGS (Portugal, Italy, Greece, Spain). Keeping them afloat is necessary for the survival of the EMU, as they might exit if the internal pressure grows too great.

  16. Global crisis as Russians see it“, posted at ua-ru-news (hosted at blogspot), 12 February 2009

    The corridors in office buildings have either pluses or minuses. Let’s not speak about minuses but about pluses. Everybody knows each other; you can hear helloes, greetings, goodmornings.

    But the last few months silence dominates here.

    … The silent horror cut out words “normally and”perfectly” from our everyday conversations and pasted cautious “while” and “so far” instead.

    The former schoolmate whom I hadn’t seen for 15 years asked me not about my family and our pals but shouted the foolish request to write about “this son of a bitch, my boss, who stopped paying four months ago”. He thought that would matter. Sorry, lad, I will not write, that doesn’t makes sence. And he told me in a back – “fat bustard”. I ran away with no offence, and not being insulted, but ashamed. For what, for whom?

    .
    .
    FM Note: There is no source given for this material; the site gives not even a hint.

  17. The lesson from Russia is that if the state already controls the banking sector, there is no need to take it into state ownership to save it. This should not be mistaken as a sign of healthy banks.

    As for Russian bailouts being at “market rates” – what complete rubbish. If so there would have been no need for them.

Leave a Reply