Crime and Corruption: Banks, Government, and Enterprises

1. SooKeun Kim and Kelly Nguyen Crime and Corruption:Banks, Government, and Enterprises

2. Overview Ersatz Banks Insider Lending Loans for Shares Credit Collapse Crime and Corruption Conclusion

3. Ersatz Banks • State-centered • Subsidies • Government debt • Do not make loans to businesses, ie. restaurants, hotels, retail buildings • Also focus on privatized assets • Insider information • Capital flight • Capital flight: when assets/money move out of the country due to loss in value (instability), causes decreased exchanged rate and purchasing power • “Privatizing of gains and the socializing of losses”

4. Outside Source: Ersatz Capitalism • http://wallstreetpit.com/3621-joseph-stiglitz-on-the-administrations-ersatz-capitalism • 500 billion-dollar proposal to help banks • Allow market to price options on “toxic assets” • "Win, win, lose: Banks win, investors win, taxpayers lose“

5. Diversion of Resources • Private banks established in 1991: created by large enterprises in order to pursue special benefits • Types of private banks: • 1. "wildcat": intermediaries between central bank and businesses • 2. domestic: dealers in government bonds and nonlending activities • 3. joint-venture: hostile banks, limited presence

6. Insider Lending "Russia formed a banking system unfit for survival." -Makarevich, 1995 hold major stakes and are sole lenders own banks outright and are principal borrowers

7. Double Moral Hazard • 1. Banks not independent • Cannot reject risky loans • Risky for depositors • 2. Government pressured to protect depositors • Prevent financial collapse

8. Government Finance • Budget deficit financed by central bank caused inflation and decreased exchange rate • Central bank power limited • Answer: sell T-bills--covered 70% deficit • Banks interested in government bonds due to existence of higher interest rates • 1996: Yields decline • Causes banks to collapse • Stock market keeps some afloat • "Russian stock market best-performing market in the world in percentage terms"

9. Privatization • Vouchers with cash value • Collected in large quantities from vulnerable holders • Money privatization • Artificially lower/raise selling prices of enterprises • Intended buyers get these enterprises • Most enterprises privatized by the mid-1990s • Employees and managers hold over 50 %of all shares • Corrupt privatization worsens Russia’s financial woes as the state disposes valuable assets at extremely low prices • “Loans-for-share” program established

10. Loans for Shares options in state-owned businesses loaned funds • Public DEFICIT reloaned funds portfolios offered to bank, not public

11. Loans for Shares cont'd • Banks interested: • Resell assets to foreign investors • Use profit to buy more government bonds • Government bond market open to foreign countries, makes ruble convertible to foreign currency via assets • Exchanged one form of financing for another (private banks & foreign countries vs. central bank) • Increased liquidity kept system afloat

12. Financial-Industrial Groups (FIGs) • At first, businesses owned banks • Government reversion: wants banks to control businesses and force firms to enter the market • Goals: • Get firms to be run by able hands • Hire Western managers in order to be efficient • Unsuccessful: politically-loyal banks still intermediaries between government and firms • Many banks "overextend" themselves • Try to gain hold of too many assets too fast

13. Secret Swaps • Rise of interest rates and liquidity crisis cause banks to not have enough funds to purchase enterprise shares • Swapped holdings of banks for government stake in oil corporations • Did not hold out, Asian debt crisis caused foreign investors to avoid markets • Russian banks collapse • During stabilization: • Bank activity declines • Number of loans fall 20% • Government debt triples

14. Credit Collapse • Banks did not create liquidity or create additional deposits (1991-95) • Real credit decline: 75% (1992-93) • Real interest rates on deposits : -93% • Ratio of money supply to cash normally 12 to 1—1991: 2.7 to 1 • Russian banks become irrelevant to households and enterprises • Lack of retail banking leads to lack of mortgages, consumer credit, and other forms of credit that offer growth - Sergei Yelkin

15. Veksels • Bank-issued checks redeemable for cash at later date • Cause: fixed exchange rate • Meant to solve liquidity problem • No real value • Added liability to financial system • Banks unable to pay off debts • Exceeded value of central bank reserves by 1997, made liquidity problem worse • Interest rate by 1997: 40%

16. Crime and Corruption: Soviet Roots • 1950s: loosening of state control leads to illegal activities in Russia • Under Khrushchev, limited autonomy granted to local officials and managers • Managers and local bureaucrats powerful through bribery • Executives quickly discover black marketand, thus, greater opportunities for profit • 1965: Central “branch ministries” reestablished • Managers and local bureaucrats still have considerable authority • End of Khrushchev’s regime: Communist Party begins to take their place

17. Shock Therapy • Gaidar Reforms • Quickly lift most government controls • Give government officials and top managers even more opportunities to collude • Political conflict leads to bloodshed • 1993: Parliament loses power • Presidency is only power that remains

18. Organized Crime • Embezzlement • Mishandling of funds • Burglary • Mafia • Business D Investments Clients • Business A • Business C • Business B

19. The Oligarchs • Corrupt young group that controls Russian economy • Control banks and government through: • Bribes • Blackmailing • Interfered in Yeltsin campaign • Profit from the weakness of the legal system and corrupt officials • Use state funds for their own agendas • Central bank settles debts • Don’t allow growth of wealth in Russia • Capital flight

20. Conclusion • Banks reinforce financial repression • No role between saving and investment • Lack of credit prevents growth • Private firms deduced to schemes • Must fix FIGs • Crime and corruption thrives if banks and government continue to interfere with market economy