Russia: Don't Cry for Yukos

0:00What I'd like to talk to you about today that I think might be actually a more immediate use to all of you is Russia. So I'm retitling my talk, Don't Cry for Yukos. So as we go forward and Russia does continue to accumulate wealth and reserves as investors, you're going to become interested again in that country. So I'd like to talk to you a little bit about what happened most recently with Russia and what we might anticipate going forward as well as what Mr. Putin is really up to. Is he bringing back communism, authoritarian government? Is the Wall Street Journal cries out daily? Is he out to destroy Russia?

0:45Well, no, not really. So to understand this, we got to actually go back a little bit further in history. And we're going to end on a historic note in order to understand what we might expect. The problem, the real riddle of Russia is property rights. Property was never distributed in Russia in all the millennia of her history. It began, really, the Russian people initially were amongst the freest people on earth through an institution known as the Vache. It gave every household adult, every household adult male a right to vote. And unlike Western Europe where you had a hierarchical system and property was held by a lord and lady and then different gradations down through the population till you reach serfs, in Russia the property was owned by the entire clan, the Vochina.

1:48They all voted, they voted on the Lord and Lady, and when they didn't deliver, when the Mongols overran them, or Polish brigands appeared and were not successfully repelled, they were quick to vote these leaders out. They had a new Lord and Lady. Well, that really didn't suit political leadership. So, over time, as the Vochina developed, the idea was that each member of the clan had an entitlement or a claim to some part of the whole. It's very important to understand this because the mistake the West made was they did not understand where communism ended and Russia began. Russia began with Vochina property rights.

2:35There's nothing wrong with owning property this way. As a matter of fact, it's quite comparable to a shareholder. What is a share? But a claim on future earnings of an enterprise. The problem with the Russian property right from the West's point of view. In the West, we have three elements to the property right. As a property owner, you are entitled to the use of the property. Number two, you are entitled to the yield of the property, whether that is wheat or apartment houses, retail space, whatever. That is your earnings. And the third right you have is the right of transfer, either to heirs, your pals, a charity, or a bank as collateral.

3:22This was the element that the Russian property right lacked. It was non-transferable. This led over time through a lot of other history and developments to serve them with people being attached to the land, so it did pervert their development. The other problem was that without private property, it is impossible to build a civil society. Russians, it is a hackneyed notion to think that Russians long for tyranny. Simply isn't true. They need what human beings and civilizations all over the world need, which is a system of predictable event undergirded by institutions of man's creation.

4:09But without private property, they could not create these institutions from the civil sector. So they were forced to turn to the state to create civil order. That is what Mr. Putin is doing today. has been distributed, brought back, distributed cyclically throughout Russian history. If you think about the origins of the secret police, that was under Ivan Grozny, Ivan the Terrible, the Oprichnina. But what were these people really doing? The Oprichnina were agents of the crown. Dressed all in black, rode black horses, and attached to their saddle was a broomstick and a dog's head.

4:57So the symbolism is rather interesting, but they were driving out the last of the Russian freeholders, taking the property so that then Ivan could redistribute this property to a servile aristocracy that he was creating. It's happened repeatedly throughout Russian history and actually communism was simply a 70-year aberration of this nation's history and also another property confiscation and redistribution. What collapsed in 1991 was not simply the system of communism, it was the 400-year-old Russian Empire. So, that is the situation. You had it. You did have property, but it was held by the Vochina.

5:48Even today we can still see this deeply influences Russians. Yuri Lushkov, the mayor of Moscow, is re-elected with very high majorities repeatedly. It's interesting to know why. First of all, Mr. Lushkov has retained the dreaded system of the propiska, which is a residential permit. You cannot, under the Soviet system, you could not simply move from Moscow to Perm or to Kiev. You had to have permissions and this all-important residential permit. Well, that's outlawed now according to the Russian Constitution, but Mr. Lushkov has retained it. And the Muscovites are very grateful because that is what a hazyai, a master of a great vochina should do.

6:39Volchina should do, keep out that provincial riff-raff. Also, he sunk an awful lot of money into Moscow. Life there is so vastly improved to the city. Muscovites are very proud. Moscow is a great Volchina, Luzhkov manages it properly, and therefore he deserves re-election, and he gets it, repeatedly. So that's, don't always be lured into this idea of Communism, that was an ideology, separate, imposed upon the Russians but what is native to them is going to influence property holdings going forward. Now the West came into this system in the 1990s or into this culture and basically had absolutely no idea what it was doing in terms of the Russian people or Russian culture but they had a pretty good idea of what to do for themselves And what was the idea? To get that property.

7:41So if you go back and look at news reports early on, you will see that there's a lot of analysis, a lot of words given in late 80s, early 90s to something known as the ruble overhang. To hear these economists talk about the ruble overhang, you would have thought it was something that was going to come crashing down the mountains was in various all, something perfectly horrible. Well, in fact, the ruble overhang was the savings of the Russian people. The economy, the Soviet economy was organized around the military. There was very few consumer opportunities for the population. Therefore, the Soviet tended to have large savings and nothing to spend it on.

8:29So here comes privatization. Well, the West didn't want that money because that was, in the words of one Harvard economist, a competing claim for the property. Thus was devised a system of voucher privatization that went into place only, only after prices had been freed, again at the urging of Harvard economists, in what was a monopolistic economy. What happened? The producers raised their prices without limit and a 2,500% inflation was suffered by the Russian people in 1992-93. And now you no longer had the problem of the ruble overhang. It was gone. And you could begin the privatization of property. They They devised a voucher system, now that the Russian people had no money.

9:29And let me tell you how this worked. They estimated the value of all Russian property at 150 billion rubles in 1991. They divided that by a population of 150 million, which left a value of 10,000 rubles to each citizen. That was the value of the privatization certificate or voucher that each citizen received. Now we go to the actual process. What happened? Two-thirds of all that property was immediately excluded from privatization. The remaining third was divided again.

10:14Half of that third was immediately excluded. The remaining half of the one-third was privatized, but divided again. Small property, mostly municipal holdings, was auctioned for cash. Only what remained of the last division was subject to voucher privatization. Once the enterprise that was privatized, the process was completed, It had 46% of ownership to workers, 5% to management, 29% sold at cash auctions, which left, 20% at a minimum in the hands of the state.

10:59In fact, what the U.S.-led privatization effort actually achieved was to return control of all property to the Russian state. Under the Soviet Constitution, property belonged to all citizens undivided. Free marketeers in Russia wanted that to remain, except that the property be divided. So the West took the attitude that the Soviet government owned the property, always owned the property, not true. But we made it true in the privatization process. You were left with a lot of enterprises where the state was the main shareholder, the controlling shareholder, and a lot of workers with small holdings that couldn't control or direct the enterprise at all.

11:49How did you solve that? Well, you quit paying them wages and pretty soon they sold their shares to the skupas, which were wagons that went around to enterprises and purchased these vouchers. Well, I've gone through all that so that you might understand how a Soviet citizen or a Russian citizen felt about their first opportunity to own property after 70 years. It was squandered, it was lost, and the West in its own greed squandered a tremendous opportunity to correct what has always been the problem of Russian society, which is the transferability, non-transferability of property. Now into this mix, after this voucher privatization had been done, And if you want to know how bad it was, really, I had a mother and daughter friend who invested their vouchers with Alpha Capital in 1993 and that was one of the more aggressive funds.

12:49They finally received their payout in 1996 and for both ladies, the accumulated value of their investment was the U.S. dollar equivalent or the ruble equivalent of one U.S. dollar. In fact, people who sold their vouchers quickly for vodka actually realized the greatest economic gain. So you had the problem, you still didn't have the property completely transferred. And of course these vouchers were bought by voucher dealers, sold to Western investment banks, a lot of shenanigans, a lot of violence, a lot of injustice incurred. I'm simply telling you the straight process without a lot of the more colorful details and colorful and tragic, I might add.

13:38So then they moved to shares for loans. This was a scheme where Russian banks would lend the Russian government money for control of shares in large enterprises for two years. At the end of two years, the bank either had to repay, the government had to repay the banks the loan or forfeit the property or sell those shares into the market and give the bank theoretically 30% of whatever increase they would allegedly have been responsible for through their restructuring efforts. Well, this was another scam so to speak because this property never moved, the banks bid on these properties but they simply opened accounts for the state property fund.

14:32They were never funded, no credit, nothing was ever drawn from these accounts. It was really a device to get money to Yeltsin for his reelection in 1996. Now into this mix came Haderkowski, the head of UCOS who is now in prison. To give you the flavor of it, at these auctions, he bid as the president of Minitep Bank. Minitep organized the auction. Minitep had two bidders there because the law required two bidders. And this happened frequently, that the winning entity actually organized the auction and provided the bidders. Even though they were from the same institution, there were two of them. Therefore they fulfilled the law. Mr. Khodorkovsky got this enormous asset of Yukos for absolutely nothing. He then proceeded to accumulate property. He was not alone. Six or seven others were very much in this game and eventually he did consolidate enormous interests in Yukos from Russian oil and gas. Now it was of Of course, not always pleasantly done, there was a lot of violence, many controversial elements to this whole story,

15:55but he changed his tune in 2000. Early 2001, he paid an absolutely enormous dividend to Western investors and himself. This thrilled everyone, never mind that the lion's share went to him. But he also promised, hey, I'm all done with this consolidation and I'm hiring professional auditors and we're all gonna fly right here. And this was terribly exciting because the West had been waiting for this moment all along. As one aid worker confessed to me, let them steal, let them take all they can because they can't run those companies. And that means, eventually, they'll have to sell to us.

16:45Well, no one sold to the West. But here was Mr. Hoteckowski after 9-11. He very magnanimously sent a tanker of oil to Houston for refining as a statement of solidarity with the United States. He began visiting with members of the presidential administration. It was all getting very chummy. What happened? Suddenly, he decided to sell his shares to Exxon Mobil for $8 billion. Within one week, Mr. Hodorkovsky was in jail, and he has yet to emerge. In fact, Mr. Putin really didn't have any choice. He couldn't possibly have allowed the sale of the nation's patrimony to foreigners in the current condition in which Russia was at that time.

17:38So what's happening now? Well, Mr. Putin is going to build enormous state energy companies. He's almost forced to do so because of the provocative actions of the West. What he sees is a state lousy with corporate welfare, cronyism, special deals, moving aggressively in the Middle East into Central Asia, moving against him from Europe through the Baltics into Ukraine so he really has to gather up this property again and make a second effort in order to rebuild the state. We may not like that but that's what's going to happen and even though the private property was a failure he is going to restore and is in and the process of restoring civil order.

18:35So before we condemn him, let's think a little bit about what Mr. Putin has done in his years in office. Number one, he is now the head of a creditor state. Russia is no longer a debtor state. He has repaid the loans, some ahead of schedule. I think he's about to make the last payment to the IMF. They are not taking further loans. So Mr. Putin has regained Russian sovereignty. They are going to be free of the World Bank and the IMF. And he has additionally instituted a 14% flat tax rate. I think we'd all like that. He is making gold available to his citizens and the chevronets coin.

19:25He encourages them to clean out their mattresses of Paper Dollars, and think about putting their savings into gold.

19:37And overall, though you may read differently in the future, Putin is not, he will make errors, he has made mistakes, but his intention is certainly not to harm Russia. So I don't think he cares very much about the share market, which is still two-thirds of the participants in the Russian share market are foreigners. There is no retail share market. This has no impact whatsoever on the average Russian citizen. The other third is ownership by Russian companies and oligarchs. So going forward, you will see a nation that is trying to return to its greatness, rightly or wrongly and using methods that most of us certainly wouldn't approve of.

20:24But when you think about investment, and as I say, you will in the future, I hope you will take this information I've given you about Russian property rights and Mr. Putin's determination to pay off debt and make your choice regarding equities or bonds.