‘Russian Clean-Up’: Expectations of Western Bail-Out Artificially Buoy Markets, But Serve to Compound the Problem

(Washington, D.C.): In a rare Sunday public statement — calculated to be digested by
international financiers prior to market openings — President Clinton announced that the United
States was prepared to help ease Russia’s financial crisis. His statement was transparently
intended to buy time for the Kremlin by restoring private investor confidence through the prospect
of a multilateral rescue package. What this initiative is likely to produce, however, is a
cascading of Russian short-term debt obligations, fattening the wallets of Western investors
and bankers while staving off needed, systemic reform and off-loading new, multi-billion
dollar costs onto U.S. and allied taxpayers.

‘Dead Cat Bounce’

The next day’s verdict on the President’s effort by the market was a harsh one — another 10%
slide in the Russian stock market, down more than 40% in recent months. While some recovery
occurred over the next two days, there is reason to doubt that it amounts to evidence of new,
durable market stability. As yesterday’s London Financial Times put it:
“Traders…cautioned
that the rebound in Russia’s financial markets was on the back of low volumes and might
simply reflect a ‘dead cat bounce’ after weeks of heavy selling.”

This assessment seems to characterize accurately yesterday’s ruble-denominated Russian
treasury
bills (known as GKOs), as well. While $946 million was raised in a debt sale, it was all
in bonds
with short maturities, i.e., less than a year. Roughly $80 million of it was in
bonds with a
redemption date of just seven days! The rest was in maturities of 126 days
or 343 days, with
yields of between 50% to 60%, depending upon the repayment schedule.

In addition, the Russians also went to the international market via a $1.25
billion dollar-denominated Eurobond offering lead managed by Goldman Sachs. href=”#N_1_”>⁽¹⁾ And, according to Reuters,
Finance Minister Mikhail Zadornov announced today that “Russia will launch two
more dollar-denominated Eurobond offerings this year and will put the finishing touches on
a foreign
borrowing package in the next few days.”

Just How ‘Dead’ is the Cat?

What is going on here, anyway? In the words of today’s Washington Post:

Prime among
these is what economists call ‘moral hazard’ — the problem that bailouts may
encourage imprudent behavior by governments and investors.

knowing that the economic fundamentals aren’t very strong,
but taking comfort that when the chips are down, the IMF and the [Group
of Seven industrial countries] aren’t going to let that country fail,”

To be sure, Russia’s forays into the market have been heralded as successes, indicating a
restoration of investor confidence. The reality is quite different:

First, the Ministry of Finance fell as much as $250 million short in its effort to cover Russia’s
debt
scheduled to come due this week, thereby necessitating yet another raid on
its already
seriously depleted hard currency reserves.⁽²⁾

Second, the exceedingly short-term maturities the Kremlin was forced to
accept are
almost unheard of for sovereign borrowers. This is all the more astounding given the
high
rates of interest demanded by the marketplace. These are obvious bellwethers of a lack of
investor confidence.

Third, there is the matter of the overall size of the debt coming due, week-to-week.
According
to today’s New York Times, Russia is facing $900 million worth of GKOs
coming due next
week. Another $1.3 billion in debt will mature the following week. According to a
Bloomberg report of 3 June, “the [Russian] government still must make another $3.9 billion in
debt payments this month, and a total of $33 billion this year.” Wednesday’s New York
Times
cites Erik Nielsen, an economist at Goldman Sachs in London, as saying that “Russia will need
to finance the redemption of $50 billion in the next year” — an amount that translates into a
staggering average of more than $1 billion per week for the balance of this year. While
there
may be some overlap in these estimates, the point is clear: Russia’s high interest rates and debt
structure have become what Desmond Lachman has called a “debt trap.”

Finally, the Washington Post telegraphed on 3 June that Russia was
contemplating the financial
equivalent of a “Hail Mary” pass: an unparalleled effort to reschedule some $70 billion
in
government ruble-denominated debt, almost all of which is in the form of traditionally
non-reschedulable bonds held by foreign and domestic investors.

From ‘Debt Trap’ to ‘Moral Hazard’

One need not be a banker to realize that something is very wrong with this picture.
No one with
a modicum of fiduciary responsibility would be lending unsecured to Russia now — unless
they expect to garner large profits from usurious interest rates, essentially risk-free thanks
to expected, large-scale infusions of Western taxpayer money.

Such a mindset was exhibited in remarks attributed to Denis Smyslov, investment director at
the
Moscow office of Global Fund Management, in yesterday’s Financial Times: “He said
the
markets were playing a ‘waiting game’ with the government until there was further evidence of
financial support from the International Monetary Fund or Russia’s Western partners.
‘At
current yields, I do not think there will be a big outflow of foreign money from the GKO
[treasury bill market],’ he said. ‘But everyone is waiting for a financial package
between
the Russian government and the IMF which will explain how to lower interest rates and
defend the rouble at the same time.'”

When In Doubt, Fear-Monger

As the William J. Casey Institute recently predicted,⁽³⁾
the Clinton Administration has begun to
utilize fear-mongering techniques to rationalize U.S. taxpayer underwriting of a continuing
flow of new money to Russia, despite its untenable short-term debt structure. The
Times
reported on 1 June 1998 that an unidentified State Department official declared that “The
Indonesians, the Koreans and the Thais weren’t sitting on tens of thousands of nuclear
weapons.
The disaster here would be an economic meltdown that aided Yeltsin’s enemies on the right.”
(Emphasis added.) Then, Deputy Secretary of Treasury Larry Summers — the Administration’s
point man on global bail-outs — chimed in with the warning of a “contagion effect,” stating that
“Russia’s problem has the potential to become Central Europe’s and the world’s.”

An important component of what is really at work here was laid bare by the
Wall Street Journal‘s
George Melloan in an editorial published on 2 June. He wrote:

What it means is
that the crisis is taking place in a rather narrow and rarefied sector, one chiefly
inhabited by multi-millionaire Russian bankers who mostly ‘inherited’ their
properties from the state and by Western lenders and investors — hedge funds,
for example.”

The Bottom Line

If the Clinton Administration has its way, the U.S. taxpayer will be put in the position of
helping
Russia perform what is known in banking circles as a “Chinese clean-up,” the sort of financial
legerdemain familiar to consumers who use their Visa credit line to pay down their
MasterCard
overdrafts. What makes this “Russian clean-up” even more unsavory is the
fact that it
arises from the deliberate collaboration of the Russian government and primarily
Moscow-based tycoons with Western investment and commercial banks. The latter are
reaping near-term, windfall profits while seeking to protect themselves, week by week, against
Kremlin non-payment while awaiting a multilateral taxpayer bailout (read the International
Monetary Fund,
World Bank and others).

No one can say they have not been warned of this “moral hazard.” For example,
former Federal
Reserve Governor Lawrence Lindsey warned last December that: “One of the reasons
we have
the Asian crisis is that we bailed out Mexico. We signaled to creditors around the world that you
could feel free to lend in Asia and the U.S. Treasury and the IMF would bail you out if you got in
trouble.”⁽⁴⁾ The same can be said of expectations
concerning Russia.

The West could experience strategic, as well as financial, repercussions if the
Clinton
Administration’s “Russian clean-up” is unaccompanied by wholesale, systemic reform in Russia.
Fortunately, a powerful 28 May letter to the President from House International Relations
Committee Chairman Ben Gilman (R-NY) — see the attached — signals that the Congress
will not permit such a travesty.

– 30 –

1. The New York Times reported on Wednesday that
Goldman Sachs economist Erik Nielsen said
that “Russia was now hoping to raise up to $6 billion this year on the European markets, up from
$3.5 billion under a previous plan.”

2. By some estimates, these are now as little as $10-12 billion, of
which as much as $4.5 billion
may be in less-liquid gold in a depressed precious metals markets. This amount is sharply reduced
from what was believed to be a $14 billion reserve level as recently as last Friday.

3. See the Casey Institute Perspective entitled
Jakarta With 10,000 Nuclear Warheads? Fear-Mongering Begins On Behalf of
IMF’s Next Bailout — Of Russia (No. 98-C 95, 29
May
1998).

4. See the Casey Institute Perspective entitled
The Dog that Didn’t Bark: Moody’s Et. Al. Fail
Investors in Asian Markets, Miss Warning Signs in China Russia ( href=”index.jsp?section=papers&code=97-C_200″>No. 97-C 200, 23 December
1997).