Russia’s Financial Crisis Puts Its ‘Oligarchs’ on the Ropes

Alexander P. Smolensky, until recently one of Russia’s richest men, fumbled in his leather bag for cigarettes and instead pulled out three dollar bills. With a wry smile, he explained that he got the money from a friend who tips him a dollar every time Smolensky holds the door for him.

“This is very important for me because I realize I’m still capable of doing something,” joked the SBS-Agro bank chairman, holding up his earnings. “It gives me hope I will not starve to death now that I have another profession.”

Until August, Smolensky, 44, was counted among Russia’s so-called oligarchs--seven tycoons who helped President Boris N. Yeltsin win reelection in 1996 and were said to help rule Russia from behind the scenes. Now, the financier who donated 110 pounds of gold to gild the domes of Moscow’s newest cathedral cannot repay the 5.7 million customers who put money in his bank.

Russia’s economic collapse has brought about a dramatic realignment of power. The ruble has plunged to barely a third of what its value was in mid-August, and Smolensky and the other magnates--whose vast holdings include oil companies, media outlets, telecommunications firms and airlines--are struggling to save what’s left of their empires.

With Yeltsin sidelined by illness and Communists gaining a stronger voice in the government, the crisis has ushered in a new prime minister who no longer lets the tycoons call the shots. Some leading politicians have begun to advocate nationalizing the oligarchs’ assets.

“In essence, the word oligarchs has become history now,” said Vladimir O. Potanin, 37, once said to be the wealthiest of the tycoons. “The crisis is some sort of survival of the fittest, which will draw a line between those who survive and those who do not.”

Some officials say it was the oligarchs who precipitated the August crash by mismanaging their holdings and playing money markets instead of making long-term investments in industrial production. The tycoons also are criticized for pushing the government to protect their banks on the eve of the collapse--a move that backfired and accelerated the crash.

Tycoons Could Face Arrest, Prosecution

Prosecutor General Yuri Skuratov, who is investigating government decisions that led to the collapse, hinted that one or more powerful entrepreneurs could face arrest and prosecution--especially those unable to repay the deposits of their banking customers.

“I think that in a country where not everything is well with finances--the more so with banks with thousands of people who have suffered--it should not be surprising if some bankers were arrested,” Skuratov told reporters.

The collapse of the economy also has prompted high-level calls for nationalizing former government property acquired by wealthy businessmen through insider deals and questionable transactions.

“We have a huge amount of property that was unlawfully privatized by its new owners,” said Moscow Mayor Yuri M. Luzhkov, who has emerged as the front-runner to succeed Yeltsin. “Debts should be repaid by taking away that property under a procedure established by law because colossal irregularities occurred in the process of privatization.”

The rise of the oligarchs came with the transfer of Russia’s economy from Communist control to private ownership. Privatization produced schemes to extract wealth from the government, and a handful of well-connected insiders became fabulously rich. But while the Soviet Union managed to stay afloat for seven decades, the oligarchy collapsed in seven years.

The belief that a group of rich financiers was ruling the country was popularized by onetime billionaire Boris A. Berezovsky, 52, who bragged in a 1996 interview with the Financial Times of London that he and six other businessmen had bankrolled Yeltsin’s reelection victory that year by contributing $3 million.

Berezovsky said the exclusive club of tycoons included Smolensky and Potanin, along with banker and media mogul Vladimir A. Gusinsky, now 46; oil magnate and banker Mikhail B. Khodorkovsky, 35; and bankers Mikhail M. Fridman, 34, and Petr O. Aven, 43, who together head the Alfa Group of financial firms. Among them, Berezovsky claimed, they controlled 50% of Russia’s economy.

The financiers met weekly after Yeltsin’s reelection in July 1996 and were the main force shaping Kremlin policy, Berezovsky said. Potanin was named a first deputy prime minister. Berezovsky was appointed deputy secretary of Russia’s Security Council.

Some Dispute Claim as to Group’s Power

Some accuse Berezovsky of overstating the group’s role in politics and the economy. Analysts estimate their share of the economy at a more conservative 15% and note that other wealthy businesspeople should also be ranked among Russia’s ruling elite.

“At least for Alfa, we don’t feel ourselves as powerful, as influential and as strongly in the center of events as Mr. Berezovsky was trying to show,” said Aven, who served as foreign trade minister in the early 1990s under acting Prime Minister Yegor T. Gaidar.

Nevertheless, the appellation oligarch stuck and redefined the public understanding of the relationship between the government and Russia’s new tycoons.

Often likened to the U.S. robber barons of a century ago, the group of seven were survivors of the Soviet system. Some, such as Potanin and Khodorkovsky, were Young Communist leaders who were able to capitalize on connections when the Soviet Union collapsed. At the other extreme was Smolensky, a typesetter who rebelled against restrictions on earning money and was arrested by the KGB for helping print Bibles on the side.

Berezovsky, a math professor who made his fortune by taking over the sale of Russian-made Lada cars, later acquired holdings in oil, banking, television and Aeroflot airlines. At one point, he was worth an estimated $3 billion.

After losing his Security Council post a year ago, Berezovsky was appointed executive secretary of the Commonwealth of Independent States, the loose association of 12 nations that were once part of the Soviet Union.

Berezovsky has developed such close ties with Yeltsin’s family that he has been called “a modern Rasputin” after the mystical monk whose hold on the family of Czar Nicholas II helped bring down the Romanov dynasty.

“Of the old oligarchs, only Berezovsky is influential now,” said Vyacheslav Nikonov, president of the Politika Fund think tank. “Not because he’s a financial tycoon, but because he’s a perfect political manipulator close to the family of the president.”

Various analysts say government officials also belong to the elite group, including two who helped create the system of oligarchy: former Prime Minister Viktor S. Chernomyrdin, reputedly worth billions as a former manager of energy giant Gazprom; and Anatoly B. Chubais, who headed the privatization program, managed Yeltsin’s 1996 campaign and is now chief executive of Unified Energy Systems, an electricity monopoly.

In fact, some say it was government officials, including Chernomyrdin and Chubais, who anointed each of the oligarchs and helped them rise to power as Russia distributed the spoils of the Communist system.

The first stage in the oligarchs’ rapid accumulation of wealth wasthe acquisition of money through currency trading. Entrepreneurs bought rubles at cheap rates and sold them in other regions of Russia where they were valued higher.

This helped them prepare for the first round of privatization in the early 1990s. Under this program, every citizen received a voucher for a share of government property. While the plan had an egalitarian appearance, most people had little idea what to do with the vouchers. Enterprising companies sprang up to buy the seemingly worthless pieces of paper, sometimes for as little as a bottle of vodka. Later, businesspeople showed up at government auctions with suitcases full of vouchers and bought property and enterprises at low prices.

Banks Established to Finance Empires

The more successful businesspeople set up banks to handle transfers of money to finance their growing empires. The best-connected banks won the exclusive right to handle the accounts of certain government agencies. Departments such as the State Tax Service or the State Customs Committee would deposit billions of rubles in their accounts, which the lucky banks could use for months at a time as interest-free loans to acquire more government assets.

“By holding budget money for some time, you can become quite rich,” Nikonov said.

By 1995, the banks were well-established and the government was short of cash. Potanin, whose Uneximbank had the lucrative customs agency account, proposed to the Cabinet that Russian banks lend the government money in exchange for shares in government enterprises not yet privatized. Under the plan, the government would later have the option of recovering the shares by paying back the loans.

Chernomyrdin’s government agreed. Through government auctions widely regarded as rigged, Potanin won controlling shares in two of Russia’s biggest companies, Norilsk Nickel, a metal producer, and Sidanko, the country’s fifth-largest oil company, at greatly discounted prices. Others in the group of seven also acquired shares in major companies for a song.

By September 1996, the Cabinet was due to decide whether to pay the loans back and reclaim control of the companies. Two months earlier, Yeltsin had won reelection with the tycoons’ help. One of their rewards was the appointment of Potanin as first deputy prime minister in charge of finances, economics and state property.

Days after Potanin took office, the government decided to forgo repayment of the loans and let the banks keep the company shares. Six months later, Potanin left the Cabinet.

Aven, who said his Alfa Bank was not a beneficiary of the loans-for-shares deal, now criticizes the arrangement, saying its unfairness has opened the door for a backlash in which private holdings could be renationalized. “To start the process of renationalization would be very, very dangerous because then there would be a question where to stop,” he said.

After selling many of its prime assets at low prices, the government was increasingly strapped for cash. It began selling short-term treasury bonds, known as GKOs, at interest rates up to 200%. Investing in these bonds was far more profitable than putting money into factories or farming, and the banks poured hundreds of millions of dollars into GKOs.

In Moscow, Russia’s economy seemed to be booming. Stocks soared. The magnates built glittering new office buildings, flew in private jets--and began fighting among themselves over who would receive the remaining prizes.

Last spring, Berezovsky helped engineer the ouster of Prime Minster Chernomyrdin, which proved to be a costly mistake. Yeltsin named as premier the inexperienced Sergei V. Kiriyenko, who paid less attention to the oligarchs’ wishes than had his predecessor.

By mid-August, it was clear that the government had run out of money. Kiriyenko was about to allow devaluation of the ruble and freeze payments on GKOs. At the urging of some tycoons, he cushioned the blow by imposing a 90-day moratorium on the repayment of banks’ foreign debts. That angered foreign creditors, helped destroy faith in the banking system, and contributed to the ruble’s plunge and Kiriyenko’s eventual replacement by Prime Minister Yevgeny M. Primakov.

“The decision that was announced by Kiriyenko at their suggestion--well, the bottom line is that they did not foresee how events would develop, and the crisis hit the oligarchs themselves,” said Luzhkov, the Moscow mayor.

“I do not think the so-called oligarchs will return and again run things in society, decide on whom to appoint in government,” Luzhkov said. “My dream is that Russia should understand that it has survived Gaidar, Chubais and the oligarchs and that it should not go back to all that. The oligarchs should not be succeeded by some [other] tycoons.”

But it may be too early to count the oligarchs out. They still control some of Russia’s biggest enterprises and will try to hold on to them--with or without the insider deals that helped make them rich.

New Government May Beget Its Own Tycoons

Some predict that the change in government means only that new oligarchs will rise to join the survivors of the crash, broadening the base of economic power but leaving the system of oligarchy intact.

“Some of them may go, but new people will come to take their place in shaping the new liberal and democratic Russia,” Berezovsky said. “A country as great as Russia can’t live without such people, without big capital. . . . They will never disappear.”

Aven, for one, said his company can succeed in a system in which financiers have less influence over the government. Despite losing $100 million on GKOs, he said, Alfa does not need special favors from the government.

“We never pretended to rule the country,” Aven said. “Especially now, nobody wants us to rule the country. I think that’s what the country needs. First of all, the government has to be independent.”