Leniency for Khodorkovsky

Vladimir Putin’s state of the nation address could affect the sentence to be passed in the case of former Yukos CEO Mikhail Khodorkovsky, the president’s economic adviser Andrei Illarionov said Tuesday.

for a while now, i've been wanting to post a few comments about the misunderstood and underappreciated subject of oligarchies in russia and the former soviet bloc countries and the khodorkovsky situation presents a good opportunity...

first, we need to hear from the "wealth is good, government is bad" camp, so well represented by the financial times...

The president's commitment to those values [foreign investment and protection for private property] face an immediate test with judgment due on Wednesday in the trial of Mikhail Khodorkovsky, formerly Russia's richest man, on fraud and tax evasion charges. The case against Mr Khodorkovsky, and the Yukos oil company he founded hit with a $28 billion back tax claim are widely seen as politically-motivated punishment for his attempts to use his wealth to gain political influence.

Concerns provoked by the case have slowed investment and growth in Russia. Mr Putin tried to draw a line under the affair last month, telling Russia's “oligarchs” he would rein in the tax authorities and make impossible further legal challenges to the murky 1990s' privatisations in which they built their empires.

But his move to improve confidence among foreign and domestic investors was undermined when TNK-BP, the oil joint venture and Russia's biggest foreign investment, was hit by a $1bn back tax claim two weeks ago."

some background is called for...

in the rush to install market economies after the berlin wall fell and capitalism "triumphed," many of the former soviet bloc countries took imf advice* and leaped into privatization... many of the former state-run enterprises were converted into stockholder companies... ok so far...? well, how did that actually take place...? different countries approached it differently but, generally speaking, some sort of formula was devised which awarded stock based on position within the company... senior managers got more and the frontline workers got less and often nothing at all... not necessarily equitable but, given how our own market economy works, understandable... this is where it starts to get interesting...

how did the senior managers in a company in a command economy, again, generally speaking, acquire their positions...? ok, to some extent, it was talent and skill but there was also a sine qua non... they had to be solid party members... so, what you had after the transition was, in effect, a different circus with the same clowns... a lot of these guys (and they were virtually all guys), when they suddenly found themselves sitting on a pile of assets that they could essentially do with as they pleased, went, to put it crudely, batshit...

the former soviet bloc countries are rife with stories of the "newly rich" (in capitalistic terms) stripping companies of physical assets, selling them and/or the stock for cash and then shifting the cash out of the country, usually to swiss bank accounts... you can spot these oligarchs in macedonia, the ukraine, georgia, kazakhstan, and many other countries, living in (very) luxurious homes, driving (very) expensive cars, opening posh new restaurants, and basically living the live of a fat cat in a country where their foreign stash will last them, their children, and their children's children for a long, long time...

not all of the oligarchs took the fast cash route... a number of them stayed on to help their companies transition to the new, competitive economy... some managed to make the shift... a lot didn't... to no one's surprise, the skills required of a manager in a command economy where the products, the customers, the quantities, and the sources of supply were all dictated, differ dramatically from the skills required in a competitive, free market environment... to make matters worse, the skills required of a manager in the old command, party-driven economy frequently had little to do with actually being able to effectively operate the business and a great deal more to do with staying in the party's good graces...

so, what do you have now, in 2005, a good sixteen years after the break-up...? well, it's not pretty... if you divvy up the former soviet countries into northern tier countries (estonia, slovakia, czechoslovakia, hungary, lithuania, poland, slovenia, and latvia), the southern tier countries (bulgaria, romania, serbia, macedonia, albania, croatia, and bosnia), and the eurasian countries (tajikistan, kyrgyzstan, armenia, moldova, kazakhstan, belarus, turkmenistan, uzbekistan, azerbaijan, georgia, ukraine, and russia) and start comparing where they are now economically with where they were in 1989, it's positively ugly... using the very significant index of real gdp as a % of 1989 gdp, of the three country categories, only the northern tier has surpassed the level they held at the time of the break-up and that only since 1997... as of 2003, the northern tier countries, as an aggregate, were climbing in excess of 120%...(See EBRD Transition Report 2003, 2004, and 2005...) of the remaining 26 countries, croatia is currently leading the pack at 90% of 1989 gdp and the rest are hovering somewhere slightly south of 80%... the northern tier fell to a little over 80% in 1992 before rebounding, the southern tier tanked in 1993 at between 60 and 70%, and eurasia hit a ghastly low of 55% in 1996, didn't climb above 60% until almost 2000 and is now pushing 75%... ah, the miracle of capitalism...!

in case it slipped by you earlier, russia falls in the eurasia group of countries, the laggards in the economic transition... in % of 1989 gdp, russia is near the top of the eurasia category but they trail kyrgyzstan and are roughly even with tajikistan and southern tier macedonia... now we can turn to mikhail khodorkovsky and sketch the portrait of an oligarch...

As of 2004, Khodorkovsky was the wealthiest man in Russia, and was the 16th wealthiest man in the world, although much of his wealth evaporated due to the collapse in the value of his holding in the Russian petroleum company YUKOS. Until he was jailed, he was considered one of most powerful of the Russian business oligarchs.

Khodorkovsky grew up in a typical Soviet environment in Moscow in a two-room communal apartment. The young Khodorkovsky worked hard, received excellent grades and was deputy head of Komsomol (the Communist Youth League) at his university, the Mendeleev Institute of Chemical Technology.

With partners from Komsomol, and technically operating under its authority, Khodorkovsky opened his first business in 1986, a private café; an enterprise made possible by Soviet leader Mikhail Gorbachev's programme of perestroika and glasnost. Successful, they also imported computers, other technology, brandy and a wide range of goods to sell at a profit.

He proved himself a capable entrepreneur by building an import-export business with a turnover of 80 million rubles a year (about $10 million USD) by 1988.

Armed with cash from his business operations, Khodorkovsky and his partners bought a banking licence to create Bank Menatep in 1989. As one of Russia's first privately owned banks, Menatep expanded quickly, by using most of the deposits raised to finance Khodorkovsky's successful import-export operations.

Bank Menatap also got government business, awarded the right to manage funds allocated for the victims of the Chernobyl nuclear accident. By 1990, critics suggest the bank was active in facilitating the large-scale theft of Soviet Treasury funds that went on at the time prior to and following the collapse of the USSR in 1991.

Boris Yeltsin's elevation to power in 1991 meant an acceleration of the market reforms under Gorbachev and created a dynamic business environment in Russia for entrepreneurs like Khodorkovsky. By then Bank Menatep was by Russian standards a well-developed financial institution and became the first Russian business to issue stock to the public since the Russian Revolution in 1917.

The bank grew quickly, winning more and more valuable Government clients such as the Ministry of Finance, the State Taxation Service, the Moscow municipal government and the Russian arms export agency, all of whom deposited their funds with Menatep, which Khodorkovsky mostly used to expand his burgeoning trading empire.

Bank Menatep provided the foundation for Khodorkovsky's bidding for Yukos in 1995. Yukos says that approximately $1.5 billion USD has been spent purchasing the assets that now make up Yukos, with a market capitalisation of $31 billion USD.

In 1995, the Yeltsin Government decided to privatise sclerotic state industries, including the state owned oil company Yukos. They appointed Khodorkovsky's bank Menatep to conduct a public auction process.

A higher bid from a group of rivals was ruled out of the process by Menatep on a technicality. Menatep paid $350 million USD for 78% of the company, which inferred a value of $450 million. When the company was listed two years later, it was valued at $9 billion. That transaction—and dozens like it—has fed the envy and suspicion of many Russians, some of whom believe the oligarchs like Khodorkovsky have stolen their fortunes from the state.

watching the rise of the oligarchs has produced envy and suspicion, much of it warranted, in citizens throughout the former soviet bloc countries... they've watched as their national resources and wealth have been plundered by those only interested in their own gain while the common folk find themselves worse off in most every index of quality of life than under the former communist regime... i've been party to many a conversation where people yearn for the days of the former yugoslavia when there was a reasonably decent standard of living and they had some self-respect... yes, everybody acknowledges tito's failings but they still credit him with building a solid and functioning country...

enter vladimir putin, heir to the anything-goes, russian mafia days of yeltsin... very legitimately, i believe, he's trying to rein in the excesses and to send a message loud and clear that the days of the russian wild west are over... from the russia journal...

So many companies and their advisers had based their strategies on blatant defiance and absolute disrespect for the law, sponsoring corruption and funding political opposition, that the new Russia with enforceable laws under President Vladimir Putin seems an alien place they will have to get used to fast. Russian corporate public-relations agencies and executives who took on the role that the electorate deprived the Yeltsin power elite of by voting it out of parliament in 2003 will have to assume lesser roles of being corporate executives with commercial aims only. Anything more - any political games, meddling with sovereign affairs and fuelling anti-Russia fires - will put their businesses at immeasurable risks.

putin definitely is facing a real challenge... on the one hand, he has the west, particularly the united states (and condoleezza rice), hammering at him about putting constraints on democracy (read: unfettered free markets) and on the other, the very real ire of russian citizens tired of being taken to the cleaners by the oligarchs... here's an snippet from an article condi probably hasn't read...

In the West, hostility toward Russian President Vladimir Putin stems from two beliefs: that Russia should move quickly toward Western-style democracy and that there is a strong, popular, liberal opposition ready to lead such a transformation. The first is mistaken, the second, pure fantasy. It will take at least a generation for Russia to build the foundation for a modern market economy and democracy. It’s an uncomfortable reality, but, for the foreseeable future, only a semiauthoritarian government such as Putin’s can keep Russia moving in the right direction. If Putin weren’t there, we’d soon miss him.

meanwhile, khodorkovsky is busy spinning a new image...
from the washington post...

Khodorkovsky is aware of the public's resentment. When the 40-year-old businessman spoke at the conclusion of his trial earlier this month, he sought to distinguish himself from other so-called oligarchs and to align himself with Putin. [...] Khodorkovsky stressed that he lived in a modest home and said the prosecutors had proven only that he had pursued, "normal, stable business activities with the purpose to produce goods, provide services, earning legal revenue."

the verdict is set to be delivered tomorrow...

* Note: IMF policy and loan conditions have been creating economic distress in countries around the world for years. I am not anywhere close to being an expert, even an aspiring one, so I won't attempt to get wonkish here. Perhaps the best analysis and most illuminating insights have been set forth by Joseph Stiglitz in his book, Globalization and Its Discontents. The publisher's comment sums up the book rather well.

This powerful, unsettling book gives us a rare glimpse behind the closed doors of global financial institutions by the winner of the 2001 Nobel Prize in Economics. Renowned academic economist Joseph E. Stiglitz served seven years in Washington, as chairman of President Clinton's Council of Economic Advisers and as chief economist at the World Bank. In this book, Stiglitz recounts his experiences in such places as Ethiopia, Thailand, and Russia. He finds repeatedly that the International Monetary Fund puts the interests of its "largest shareholder," the United States, above those of the poorer nations it was designed to serve.

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