How Not to Lend To A Bankrupt Russia: Eximbank Energy Deal Should Be Iced, Reworked

The terms of a multi-billion dollar series of loan guarantees to the Russian oil and gas sector in preparation by the U.S. Export-Import Bank (Eximbank) is a disaster in the making. As presently structured, this deal threatens to create major new revenue streams likely to be tapped principally by the old Soviet military-industrial complex — while exposing American taxpayers to vast new losses in Russia.(1) Under no circumstances should such a deal be finalized prior to a critical evaluation by the incoming Clinton Administration of the strategic implications of aiding the Russian energy sector and the dubious precedent it would set for lending to a bankrupt Russia.

As the Center first reported in a Decision Brief published on 22 December 1992(2), the impetus for a hasty and incompetently structured Eximbank energy-related loan guarantee program to Russia appears to have come from an interested party: the Bank’s outgoing Acting Chairman, Eugene Lawson. The latter transparently hoped to complete this transaction prior to his departure on 8 January 1993 and his subsequent assumption of the presidency of the U.S.-Russia Business Council — a Washington-based lobbying group recently established to expand bilateral trade, particularly in the energy sector. A number of the Council’s members (e.g., Texas-based oil and gas equipment manufacturers) would be among the principal beneficiaries of this deal.

Formula for Disaster — Strategic Trade Prior to Structural Reform

As the Center noted on the 22nd of December:

"In the hands of Communist Party alumni like the newly-appointed Russian Prime Minister, Viktor Chernomyrdin, $2 billion in taxpayer loan guarantees will produce a major new source of hard-currency revenues. Hardliners in Moscow can use these funds to consolidate further their power and expand the former Soviet Union’s future economic leverage against countries heavily dependent on Russian energy supplies, such as Ukraine and the Baltics.

"In fact, the increasing success of these factions in blocking efforts to decentralize and privatize key energy production facilities has already contributed to recent interruptions in energy supplies to Ukraine and Eastern Europe. Should the pressure for such reforms now be relieved thanks to American capital infusions, it is predictable that the Russian energy sector will simply serve once again as a multibillion-dollar annual revenue stream for the preservation of the military-industrial complex.

"Given the strategic importance of energy and the large-scale hard currency cash flow it could generate, the importance of democratic and free market reforms being irreversibly in place prior to such assistance cannot be overstated."

Strategic Considerations Aside — No Genuine Collateral, No Deal

In the process of trying to slam-dunk this "framework agreement" before he left office, Lawson appears to have run roughshod over Exim’s professional staff — bankers who understand that new loans to a bankrupt sovereign borrower have to be structured carefully if the Bank is to comply with its fiduciary and statutory responsibilities. Under present circumstances, this means establishing disciplined, transparent and carefully conditioned lending arrangements whereby the initial $2 billion (with the potential to increase to as much as $5 billion) in U.S. taxpayer-guaranteed funds would be fully collateralized.

Unfortunately, Acting Chairman Lawson’s eagerness to close this deal seems to have promoted implementing arrangements that are far less disciplined, transparent, conditioned or collateralized than are clearly required. Importantly, while export revenues derived from selected oil and gas ventures in Russia are supposed to be specifically earmarked for repayment of Eximbank’s principal and interest, the specific terms under negotiation raise serious questions as to whether repayment will be assured.

The obvious hedge would be for such revenues equivalent to the amount of loan disbursements to be deposited in an "offshore trustee" account (i.e., one outside of Russia) in the charge of the lenders. Initially, Lawson appears to have hoped to use a Potemkin "offshore" trustee — the Russian- owned Moscow Narodny Bank in London. Even this approach evidently proved too stringent for the Russian government, however. When it indignantly complained that such an arrangement would suggest a (justified) lack of U.S. trust in Russia’s ability to service these new credits, Lawson agreed to consider an "onshore trustee," instead.

The leading candidate for such an onshore trustee currently appears to be the International Moscow Bank (IMB). IMB is a three-and-a-half-year-old banking institution located in Moscow, conceived and established by Mikhail Gorbachev’s communist regime to finance joint ventures.

The International Moscow Bank has the advantage of being perceived as other than a Russian-controlled institution. After all, IMB is only 40 percent-owned by Russian government banking institutions (Vnesheconombank-20%; Promstroybank-10% and Sberbank-10%). Other partners include Western financial institutions with long-standing banking and political ties to the former Soviet Union (such as France’s Credit Lyonnais-12%; Austria’s Creditanstalt Bankverein-12%; Germany’s Bayerische Vereinsbank-12%; Italy’s Banca Commerciale Italiana; and Finland’s Kansallis-Osake-Pankki-12%).

Still, Russia appears to exercise practical control of IMB. For one thing, of course, IMB — unlike Moscow Narodny — is physically located in Russia. For another, according to a 24 November 1991 report by Agence France Press, with the exception of five expatriate foreigners, all of the Bank’s 100 staff members including its chief executive officer are citizens of the former Soviet Union. Sixty out of this hundred have spent time in the past working for IMB’s European shareholders.

In short, utilization of institutions like Moscow Narodny and even more so IMB as trustees or agents for the Eximbank loans would appreciably reduce the confidence the United States government could have that funds ostensibly earmarked for repayment of U.S. loans would actually be retained by such institutions — let alone accessible if the loans have to be called. Such an arrangement also lends itself to another, potentially even more troublesome form of abuse: the use of the same earmarked funds to collateralize loans from other Western institutions.

Previous Experience With Moscow’s Double-bookkeeping on Energy Loans

In the late 1970s, the Soviet Union used precisely this scam to double-finance much of the costs of the $2.2 billion Orenburg gas pipeline project.(3) Moscow is believed to have hoped to perpetrate similar financial sleights of hand or bookkeeping irregularities in connection with its far larger Siberian gas pipeline initiative of the early ’80s. Fortunately, the West was spared the substantial losses — to say nothing of strategic vulnerabilities — associated with this pipeline when, thanks to the Reagan Administration’s forceful opposition and alliance leadership, it was substantially down-scaled.

Russian Default — A Showstopper?

Unfortunately for Acting Chairman Lawson and his friends, the proposed Eximbank lending facility for the Russian energy sector cannot be implemented so long as Moscow is in default to Eximbank, as it is at present. As of 7 January 1993, some $2.5 million in payments due from Russia are in arrears (read, default). Still, incredible as it may seem, once its own Russian account is squared away, Eximbank may proceed with further taxpayer-guaranteed lending to Moscow — even though Russia remains over $147 million dollars in default to another U.S. government lending institution, the Agriculture Department’s scandal-ridden Commodity Credit Corporation.(4)

Even if Russia cleans up its arrearages with Eximbank, another problem confronts conscientious professionals at the Bank: The Export-Import Bank is required by statute to determine that there is a reasonable assurance of repayment from the borrower.

To get around this obstacle, the Lawson "framework agreement" contemplates portraying these new energy-related credit guarantees as other than Russian sovereign risk that is currently on U.S. books to the tune of almost $6 billion. They would, instead, be construed as "self-liquidating" loans to purportedly "independent" Russian energy enterprises — a notion that, for the most part, contradicts the facts on the ground.

Toward a New, Secured Precedent for Lending to a Bankrupt Russia

The Center for Security Policy believes that the Clinton Administration must be given an opportunity to redress the serious flaws in the Lawson plan for Eximbank lending to Russia and to consider whether adding to Russia’s estimated $80 billion external debt burden at this juncture is prudent policy. As bolstering the Russian energy sector represents a strategic initiative, such lending activities should be put on ice pending a thorough assessment of the prospect that the primary beneficiary of newly generated energy export earnings would be the still-menacing ex-Soviet military and its associated industrial complex.

With regard to non-strategic trade transactions — such as grain shipments, consumer goods, medical equipment, pollution control technologies, etc. — the Clinton team should ensure that all federal government agencies (including, of course, Exim’s professional staff) are instructed to transform U.S. loan guarantees to Russia into genuinely collateralized transactions. Such disciplined measures would include: taking physical possession of Russian assets of equivalent value at the outset of each loan disbursement; loan documentation that provides for shipment of goods under letters of credit; restricted loan drawdowns (where appropriate); on-site inspections by independent experts retained by the creditors; offshore collateralized accounts; etc.

In addition, the Clinton Administration should compile a list — to be shared with relevant congressional committees — of alternative Russian assets that could be attached by official or private bank creditors in the likely event of new Russian defaults. These might include commercial aircraft and ships, foreign deposits, overseas real estate, etc.

In the case of project financing, a credible Western agent bank (not the International Moscow Bank or Moscow Narodny) located outside of Russia and Russian control should be utilized for deposit of newly generated income streams. Indeed, the Western purchasers of Russian goods or commodities should be the parties that make the deposit into the agreed Western collateralized account. Only after the respective loan repayments are covered should cash be transferred back to the Russian enterprise in question.

It is particularly important that a mechanism be set up — both domestically (at the Federal Reserve or Treasury) and internationally (OECD or the Paris Club) — to ensure that the same Russian assets used as collateral are not repeatedly pledged to different Western official and private bank creditors. In the absence of such mechanisms, the Russians could make a sham of the creditors’ ability to liquidate such collateral in the likely event of new instances of Russian default.(5)

What is more, the Center believes that the time has come for the Western industrialized nations to develop and institute common, disciplined guidelines whereby all future lending to Russia would be properly secured. The urgency of such an initiative was underscored by Roger W. Robinson, Jr., a distinguished member of the Center’s Board of Advisors and former senior economist at the National Security Council and Vice President of Chase Manhattan Bank with responsibilities for Chase’s loan portfolio in the Soviet Union and Eastern Europe:

"The issue of genuinely collateralized Western lending to Russia and other successor states should be made a formal agenda item for the Tokyo Economic Summit, with the preparatory work conducted during the OECD ministerial this Spring. Without a coordinated, multilateral strategy, Russia will be free to play off one creditor against another with the likely losers being taxpayers throughout the West."

Such allied discussions should institute, among others, the following preconditions to new secured Western lending:

• An immediate termination of the commitments of Russian supplier credits to China, Iran, Pakistan, Cuba and elsewhere for nuclear reactor and other export items currently estimated to total some $4-6 billion;

 

• The raising of Russian oil prices to world market levels as demanded by the IMF.

 

• Full disclosure by Moscow of all of Russia’s hard currency (or equivalent) assets and their location.

 

• A comprehensive allied effort to determine the disposition of the estimated $5-15 billion which was secretly transferred out of Russia to Eastern and Western Europe by Soviet officials to serve as a kind of "war chest" for the recentralizing forces now increasingly dominating the political scene in Moscow.

The Bottom Line

The Center for Security Policy believes these recommendations need to be acted upon urgently by the executive branch and the Congress insofar as these first "secured" financial transactions will establish the precedents for others to follow. In the wake of the debilitating blows already dealt the U.S. Treasury by the S&L crisis, the BCCI fiasco, the BNL scandal and the likely write-off of almost $6 billion in CCC loan guarantees to the former Soviet Union, neither the U.S. Export-Import Bank, its professional staff or the American taxpayer should be allowed to take the fall in yet another instance of massive fiduciary malfeasance.

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1. The Center for Security Policy has long warned of the dangerous uses energy resources can be put to by malevolent forces in the Kremlin — either as a revenue stream to support militaristic activities or as an instrument for economic warfare. For example, see "Soviet Economic Leverage: Moscow’s Tool for Denying Baltic Independence Without Force," (No. 90-3, 8 January 1990).

2. See "Revolving Doors; Eximbank Official’s Scandalous Self-Dealing is a Blow to U.S. Taxpayers, ‘Red Carpet’ for Returning Russian Hardliners — And Their American Friends" (No. 92-D 148).

3. See, for example, "Follow the Money," an award-winning American Interests special which aired on the Public Broadcasting System on 12 July 1989, which was produced by the Blackwell Corporation and moderated by Morton Kondracke.

4. According to a report issued by the Government Accounting Office on 5 January 1993 entitled, Loan Guarantees: Export Credit Guarantee Programs’ Costs are High (GAO/GGD-93-45), the export lending programs of the Commodity Credit Corporation are exceedingly expensive to U.S. taxpayers because of exposure to such credit-risky countries as Russia and Iraq. What is more, the GAO was unable to substantiate USDA claims that the program is needed to boost U.S. exports of agriculture. Instead, the evidence appears to indicate that the CCC lending program merely reroutes existing trade flows.

5. In this connection, it is important to note that the World Bank, which itself is close to providing $500 million to the Russian energy sector, has objected strongly to Eximbank’s plan to "strip away" Russian assets needed for repayment of World Bank credits.