Streetwise Professor

Both the WSJ and NYT ran articles to the effect that Russia had decided not to extend additional bailouts to various oligarchs drowning in a sea of debt.  Some are interpreting this shift in policy as evidence that (a) Russian resources are dwindling, and the government needs to conserve them to bolster the real economy, and (b) the government is backing away from exploiting the crisis to re-nationalize “strategic” sectors of the Russian economy.

I do not believe that the evidence supports either conclusion.  I wrote some months ago that it would be foolish for the Russian government to, in essence, assume the obligations of the oligarchs to the Western banks.  The loans, even taking into account any haircut on the shares the oligarchs provided as collateral, reflect the values of the borrowers’ companies when they took out the loans.  These values are now far in excess of the current market values of the collateral.  Sure, if the government lent money to the oligarchs, who paid the banks, and took the shares in collateral, it would probably end up owning the companies.  But it would obtain this ownership by paying the old, higher values.  This would make the Western banks very happy.

But there is a far cheaper way for the government to achieve the same end.  Just let the oligarchs default on their debt to the Western banks.  I doubt, under current circumstances, the banks have much of a desire to hold the equity they would receive in this event.  The government could buy it back at current market value, far below the amount the oligarchs owe the banks.  Moreover, the government would be in a very strong negotiating position.  It could always threaten to nationalize the companies, a la Chavez, leaving the banks with zip.

So, by letting the oligarchs fail, the state–and those who control the state–can pick up control of their companies for a small fraction of what it would cost to bail out the oligarchs, and then seize the companies when the oligarchs almost inevitably would default.

My only question is: why didn’t Putin et al do this earlier, instead of giving Derispaska and others billions?  My earlier conjecture was that Putin and the siloviki were loath to allow prying Western eyes inside these companies even for a short period of time.  Maybe they are still reluctant to do that, but compared to the alternative (bailout and vastly overpay) this is a problem they are willing to deal with.  Indeed, they may have used the intervening period to sanitize records and clean up embarrassing trails, thereby minimizing this problem.

The WSJ interview with Arkady Dvorkovich provides a hint that nationalization is still on the table:

“The authorities don’t have any plans to take things away from people and nationalize them,” Mr. Dvorkovich says. “But that doesn’t mean that one shareholder can’t sell to another investor. It doesn’t mean that the state won’t wind up owning some assets that were held as collateral.”

The government needn’t take anything away from anybody under current circumstances.  It can let the Western banks do that for it, and then scoop up the assets for a pittance as compared to the cost of bailing out the oligarchs–and the Western banks.  This is a three-fer for the government: no oligarchic threat; a blow at the Western banks and the West; and the extension of control over Russia’s strategic industries.

This course would put the oligarchs in a situation where they would have far less to lose by openly opposing the government.  They still have resources at their disposal, and could conceivably make things more difficult for Putin.  Perhaps they would avoid outright rebellion, but they could help fund opponents in the regions, for instance.

Perhaps this is the real reason why Khodorkovsky and Lebed are on trial again.  They provide a living demonstration of the hell that Putin can dish out to those who dare buck the power vertical.  In the current environment, any “liberal” gesture towards the Yukos defendants could send a very dangerous message to the other oligarchs.  Therefore, despite all the yammering about how Medvedev needs to show leniency to Khodorkovsky in order to establish his independence, and his liberal bona fides, this is not going to happen.  Especially now.  The political situation is too explosive in Russia.  The oligarchs face financial extinction, and the only thing that can reasonably keep them from open resistance is the threat of legal extinction–or literal extinction.

In other words, Khodorkovsky is on trial pour encourager les autres.  To keep them from getting any funny ideas.  To ensure that they realize there are far worse things than going broke–like being broken.

There are other indications that fears of intra-elite conflict pervade the Kremlin and the White House.  Governors, including powerful, long serving ones, are being sacked.  The governor of Bashkorostan is supposedly on the way out–though he denies it (they’re always the last to know).  (H/T-R).  Medvedev just fired Orel Oblast’s venerable Yegor Stroyev, and he has been subjected to intense questioning on corruption charges.  He’s lucky (for now)–his son-in-law was recently died from 9mm lead poisoning.

Echoing Russian sources, the FT is rife with rumors about a panicky elite, and the prospect for brutal intra-elite infighting.  Clearly, the objective conditions for such infighting are in place.  The personalized, a-institutional, natural state nature of the Russian polity makes such conflict highly likely in periods of acute economic stress, especially when the rents that hold it together have all but disappeared.  The crackdowns–against Khodorkovsky, the governors, not to mention dissenters–provide tantalizing suggestions that such conflicts are taking place.  So does the public squabbling between Kudrin and his allies on the one hand, and made capos like Yakunin on the other.

In other Russian economic news, inflation continues apace, running 2.4 percent in January and 1.7 percent in February.  (Interestingly, a time when China and other nations experienced deflation, and US inflation was relatively tame–for now.)  This is further evidence that, as I opined in an earlier piece, Russians are exchanging rubles for goods at a rapid pace, reflecting their pessimism about the future value of the currency.

As Dvorkovich mentions in his interview, Russia is suffering stagflation (as I pointed out to Michel a couple of weeks ago).  Stagflation is a severe policy challenge: fight inflation, and risk strangling the real economy; stimulate the economy, and fuel inflation.

Given these monthly figures, the government’s forecast of inflation for 2009 in the 14 percent range seem extremely optimistic.  The potential for a continued hemorrhaging deficit similarly makes such a rosy outcome–less than a percent higher inflation than in 2008–highly unlikely.  (Note that the government has announced another cut in the oil export tariff.  That’s less money coming into the government’s coffers.)

The stagflation problem is just another reason why I believe that Russia faces more acute policy dilemmas than virtually any other large nation.  This places tremendous strain on the political/governing structure.  Thus, expect to see more crackdowns, especially on regional governors who might be getting ideas about opposing the Kremlin/White House, and on any oligarch that gets the least bit uppity.