The Center for Security Policy has discovered that major U.S. banks have been invited by the Soviet Union over the past several days to lead the underwriting of a Soviet bond offering. Some experts speculate that the amount involved in this Soviet credit transaction could be as much as $250 million or more.
According to reports reaching the Center, Citibank — the United States’ largest financial institution — has already accepted such an offer made through Yevgeniy Ulyanov, manager of the representative office of the Soviet Bank for Foreign Economic Affairs in New York (opened this summer without fanfare). Citibank’s West German subsidiary, Citibank, A.G., was a senior co-manager in a Soviet bond offering in the West European market in the summer of 1988 worth $270 million (DM 500 million) with the German banks Dresdner Bank, Deutsche Bank, and Westdeutsche Landesbank in lead positions.(1)
If this Soviet-style "junk bond" comes to fruition, it would be the fourth such Soviet bond issue since January 1988. Taken together, these represent the first securities issued by the Soviet government since the 1917 Russian Revolution at which time the Soviets defaulted on debts incurred by Czarist regimes.
As a result of this default — and other unsatisfied claims by the United States — the Soviet Union has since 1934 been barred entry into the U.S. bond market under the Johnson Debt Default Act. This act prohibits such untied borrowing by countries which in the past have defaulted on U.S. government obligations.
At Moscow’s request, however, negotiations were initiated between the State Department and the Soviet Union in November 1988 to settle these defaulted Czarist debt obligations. A second round of negotiations was held last spring and a third round is scheduled. Obviously, structuring a bond offering led by U.S. banks — even if floated offshore — will give the Soviet Union considerable political leverage to accelerate the conclusion of these negotiations on terms satisfactory to the USSR.
"The Soviets are making an urgent bid to establish themselves in Western securities markets in the event that perestroika slips under the waves and access to private credit markets is limited by deteriorating creditworthiness," observed Roger W. Robinson, Jr., former Senior Director for International Economic Affairs at the National Security Council and a member of the Center’s Board of Advisors. "Given its grave financial situation, the USSR is determined to expand and diversify its sources of borrowing in the West, notably through what are likely to be termed ‘perestroika bonds.’"
Soviet indebtedness has been growing at an unusually high rate in 1989 with new borrowings estimated at roughly $1 billion per month during the first quarter. Total Soviet debt is currently estimated to be in the range of $46-$50 billion. The USSR’s debt service ratio has doubled since 1984 to roughly 28 percent.
Robinson said, "This intensified borrowing reflects the gradual abandonment of traditional Soviet financial conservatism in order to meet urgent domestic and external spending requirements."
Frank J. Gaffney, Jr., the Center’s director noted, "Since 1917, the USSR has basically been restricted to only two sources of credit in the West — banks and governments. If the Soviet Union is permitted to enter the U.S. securities markets, however, it could breakout of this constrained borrowing base. In due course, the Soviets would be able to tap into large numbers of new non-bank lenders such as: securities firms, pension funds, insurance companies, corporations, and even individuals."
Gaffney observed, "This development would not only allow Moscow to attract largely unrecorded, general purpose credits. It would also create potentially huge and politically influential new constituencies in the United States with a vested financial interest in continued economic and even political concessions to the Soviet Union."
Robinson added, "Indeed, over time, millions of Western citizens and thousands of non-bank institutions could — wittingly or unwittingly — find themselves holding Soviet paper in their bond portfolios and pension funds. Accordingly, Soviet willingness or ability to redeem bonds at maturity could directly affect the economic well-being of those who hold such Soviet debt instruments."
Other possible benefits to the USSR from seeking urgent entry into the U.S. securities markets include:
- Securing needed political signals from U.S. officials and financial institutions which would catalyze large-scale Japanese participation in the Soviet Union’s bond and note offerings — and help assuage Japan’s more skeptical attitude toward Soviet commercial and political risk.
- Accelerating the transformation of the New York representative office of the Soviet Bank for Foreign Economic Affairs into a full-fledged banking office, thereby enabling the Soviet Union to engage in a wide range of banking activities in the United States and increase Soviet personnel, including KGB presence, in New York.
- Advancing the Soviet demand for a full-blown bilateral Trade Agreement to be consummated at the upcoming 1990 summit between Presidents Bush and Gorbachev.
It should be noted that the mother lode in terms of Moscow’s financial agenda is located in Tokyo. Even generous assistance from Western Europe and the United States cannot compensate for sustained reluctance on the part of Japan’s banks, non-bank lending institutions or government to commit their vast capital resources to bankroll perestroika.
Finally, the Soviets have thus far failed to meet the minimum data disclosure requirements for a legitimate bond offering. The economic and financial information contained in past securities prospectuses have been extremely general; the Soviets have gotten away with this only because Western markets have acquiesced to Moscow’s fatuous assertion that compliance with standard data disclosure obligations would compromise the Soviet Union’s "economic security."
In light of the strategic threshold that would be crossed should this Soviet bond offering come to market, either in the United States or offshore, the Center for Security Policy recommends:
- Immediate Congressional hearings on the foreign policy and economic security implications of Soviet entry into the U.S. securities markets, as well as the impact of allowing an expanded Soviet banking presence in the United States;
- Full factual disclosure by the Treasury Department and the Federal Reserve of the exact status of any Soviet application to open an agency or branch of the Soviet Union’s Bank for Foreign Economic Affairs;
- A classified and unclassified intelligence assessment of the national security implications of the Soviet strategy of entering new Western credit markets, broadening Moscow’s access to inexpensive, untied credits and gaining politically influential new constituencies in the West through the expanded holding of Soviet debt instruments.