Jan/Feb 2002 - VOLUME 23 - NUMBER 1 & 2
An Interview with Paul Klebnikov
Paul Klebnikov is author of Godfather of the Kremlin: Boris Berezovsky and the Looting of Russia. He is a senior editor at Forbes magazine and has reported from Russia since 1989. A fluent Russian speaker, he has won four press awards for his writing on Russian business. He holds a Ph.D. in Russian history from the London School of Economics.
|The vast majority of the Russian population got nothing out of the voucher privatization. The people who did benefit ó the insiders and financial operators who bought up all the vouchers ó ended up buying up control of the main enterprises at a fraction of their market value.||
Multinational Monitor: The initial plan for handling privatization
in Russia was a voucher distribution system. What was the voucher plan,
and how did it work out?
It all went terribly wrong. Initially, it was simply a case of mismanagement
and incompetence. The so-called young reformers in the Yeltsin government,
led by Anatoly Chubais and Yegor Gaidar, decided to carry privatization
out too quickly. They made the fundamental mistake of putting too much
of Russias state-owned industrial and natural resource wealth onto
the market at once. Its an elementary mistake that could be predicted
by anyone with even a minimal understanding of how a market works. If
you throw a huge quantity of products onto the market at once, your price
is going to be very low because theres not that much demand for
it at that point. Moreover, the face value of the voucher was very low.
All this meant that the average citizen, after having received the voucher,
said to himself , this thing isnt worth anything. So
most people immediately sold their voucher on the street for about seven
dollars. You could get two bottles of cheap vodka for the price of one
voucher. At that price, all of Russias industrial and natural resource
wealth was valued at $5 billion. You can see for yourself that something
in this operation went horribly, horribly wrong.
The whole concept was a mistake. I dont think it was a cynical
maneuver at that stage, but simply a product of incompetence. Of course,
there was also a cynical calculation behind the decision to privatize
one-third of Russias national resource wealth in a single year.
The young reformers were motivated not by economic considerations, not
by considerations of how to get the most money into the governments
coffers, not by a desire to promote the greatest efficiency of those enterprises
that they were privatizing, but by purely political considerations. They
saw that they needed to move very quickly to break the back
of the power of the red directors who controlled the state-owned
enterprises. These were the old industrial managers. Some were very competent;
some were incompetent.
Gaidar and Chubais thought that they needed to act quickly, radically
and dramatically to get these guys out of power. Thats why they
took this step.
As a result, ultimately the value of these enterprises shrank to almost
meaningless amounts. The vast majority of the Russian population got nothing
out of the voucher privatization. The people who did benefit the
insiders and financial operators who bought up all the vouchers
ended up buying up control of the main enterprises at a fraction of their
MM: Who ended up with control of the vouchers?
Lets say there is a timber company. The general director, together
with five or six of his closest subordinates, would get together and buy
all the vouchers from their workers. They could do this because they had
grown rich or moderately wealthy by embezzling funds from the enterprise
in the preceding years. Because the market price was so low seven
dollars per voucher the general director and his cronies would
end up buying control of the company for almost nothing. So the workers
got expropriated albeit voluntarily.
Ordinary citizens who didnt work in a plant and didnt invest
their vouchers in the shares of that plant either sold their voucher in
the street or invested it in a so-called voucher fund, a kind of mutual
fund for vouchers. The government licensed 600 mutual funds without any
supervision of how they operated or whether they respected the rights
of their shareholders. The vast majority of those voucher funds turned
out to be pyramid schemes that enriched the crooks who started them up,
while the citizens lost everything.
MM: Gazprom, the largest Russian company, was privatized through
the voucher operation?
Gazprom, which is the natural gas monopoly of Russia, owns one-third
of the global reserves of natural gas. If you valued it as an American
company per cubic meter of reserves, it would be valued anywhere between
$300 billion and $900 billion. Of course, its not an American company
and property rights in Russia are weaker and so forth. But even in the
Russian context, this is a company that had a stock market value in 1997
of $40 billion. So, when the government decided to privatize 29 percent
of Gazprom in the 1994 voucher auctions, what happened? First, they gave
the right to design the whole voucher auction to the Gazprom management.
The general director of Gazprom, probably Viktor Chernomyrdidn, the Prime Minister of Russia (who was the former director of Gazprom), and the top 100 or 200 managers of Gazprom got together and did several things. First of all, people who wanted to buy shares could only buy them in the tiny Siberian and Arctic villages where Gazprom had its deposits. Secondly, Gazprom management reserved the right to buy your share if you were an outsider at a price it dictated. The result was that only Gazprom people ended up buying the shares, and of course it was the managers who had the money to buy the vast majority of those shares and who ended up benefiting from the auction. As a result, the price at which Gazprom was privatized in 1994 through the vouchers was $250 million, which is 160 times less than the price the stock market would put on the company a mere three years later. So it was less than 1 percent of the stock market value of the company. That makes it one of the great robberies of the century.
MM: You talk about the privatization of profits, borrowing
the quote from Boris Berezovsky, one of Russias former oligarchs.
The case you highlight is Aeroflot, the airline. What was the scheme there?
What do you do? One way or another, you get the managers of a state-owned
company into your pocket either by bribing them or by placing your
own subordinates in the controlling position of the management. Once you
have your managers running the state-owned company, they then sign all
these deals that surround the company with a whole series of your middlemen
banks, financial advisers, consulting companies, marketing companies,
equipment supply companies, etc. In other words, all the channels whereby
that company interacts with the outside world become controlled by your
particular little companies. Theyre usually unknown little enterprises
that are registered either in Cyprus, Switzerland, Luxembourg or the Caribbean
They then sign the contracts that result in elementary transfer pricing
whereby all the profits, and most of the cash revenues, accumulate in
those intermediaries. The cash cow the state-owned corporation
becomes bankrupted, because its bleeding all its cash out
to these intermediaries. So the state and government end up with a bankrupt
company and you end up tremendously wealthy.
Berezovsky did this with a number of companies; the most clearly documented
case is Aeroflot. In fact theres currently a warrant out for his
arrest in Russia on charges of fraud and embezzlement at Aeroflot. A number
of his top managers who ran Aeroflot for many years are due up for trial.
They will be up for trial in the next couple of months in Moscow. Berezovsky
himself is living in Britain and France and, of course, is not returning
to Russia, because if he did he would be arrested and put on trial for
What Berezovsky did, specifically, is set up a company that would pay
Aeroflots foreign bills. Aeroflot had fuel bills, landing fees at
foreign airports, leasing fees for foreign aircraft, etc. This little
company owned and set up by Berezovsky and his top manager at Aeroflot
paid Aeroflots bills in the West. The money they did that with was
considered a loan with an effective dollar-based annual interest rate
of 50 percent. But they werent satisfied with that profit margin,
so they in turn contracted with another company, also owned by Berezovsky
and his top managers, and registered in Ireland. They had this company
give a loan to the first company, charging an interest rate of 30 percent.
Effectively, you had a kind of daisy chain of ridiculous, extortionate
loans being granted to Aeroflot. You ended up with Aeroflot having to
pay a 95 percent dollar-based interest rate on hundreds of millions of
dollars of completely unnecessary loans given to it by financial companies
owned and operated by Berezovsky and top Aeroflot managers.
A simpler way in which this was done was with natural resource companies.
Most oil companies, metal companies and timber companies would set up
a trading company to handle their exports. The company in Russia would
sell the oil, for instance, to a trading company in Cyprus or somewhere
for a fraction of the world oil price. The trading company, which would
be directly owned by the oil company managers, would turn around and sell
the oil for the world market price and keep all the profits in personal
bank accounts offshore.
As a result of all this, you had huge capital flight out of Russia. No matter how many billions of U.S. taxpayer dollars were going into Russia through the IMF and other institutions, several times that amount was flowing out of Russia through these kinds of criminal schemes. Thats the way the Russian state was bankrupted. It got no tax revenues. Russian enterprises were eviscerated, left short of capital because they had no money. The Russian currency eventually collapsed, because it had no foreign currency to back it up. All the foreign currency reserves were being stashed abroad by a handful of very unscrupulous traders.
MM What were the loan-for-share schemes that came in the next phase
What Chubais did was gather a group of six to eight top Russian financiers
the crony capitalists who later would be called the oligarchs.
They agreed among themselves who would bid for which company and at what
Theoretically, these 51 percent stakes would be put up for auction with
a starting price and it would be open to everybody to bid. But no foreigners
were allowed to bid, and, in fact, all outsiders, even if they were Russians
who came to try to bid, were disqualified for one reason or another.
Each of these companies then fell into the hands of the oligarch who
had been chosen to get the company. The prices they paid were anywhere
from 10 to 30 times less than the price at which these companies were
selling on the market in the mid-1990s. In other words, the insiders bought
these companies at these rigged auctions at anywhere from 3 to 10 percent
of their market value.
This was a very cynical ploy by Mr. Chubais to sacrifice the interests
of the state of Russia, the interests of the national treasury and therefore
of the citizens of Russia for political purposes. The reason was that
he wanted to get the oligarchs support for reelecting Yeltsin in
1996. He essentially gave them Russias dozen best exporters in return
for an ironclad commitment that these people would support Yeltsin and
finance his campaign in 1996.
The economic interests of Russia, the legal propriety and financial soundness
of the Russian state, was sacrificed for the narrow political goal of
getting Boris Yeltsin elected in 1996.
In the final analysis, the Russian economy suffered its worst decline
since the Nazi invasion of 1941 a 42 percent decline in GDP. The
population was impoverished. Mortality rates skyrocketed and the Russian
state was essentially bankrupted. In August of 1998, the ruble collapsed
and the government defaulted on its debts. Essentially the government
had declared bankruptcy. This was a result of all of these misguided privatization
MM: How did the oligarchs pay back Yeltsin in the 1996 election?
The second way was that Berezovsky, Chubais and the other oligarchs organized
a secret financing of the Yeltsin campaign, collecting at least 300 times
the legal limits on campaign contributions from themselves and other businessmen.
MM: What kinds of sums were involved?
MM: In the evolution of the various privatization schemes, how
important was the role played by outside advisers, such as the IMF and
The Western politicians may have had their own rather cynical reasons
for pushing the young reformers and other parts of the Yeltsin government
to carry privatization out in this way. Perhaps the academics were simply
misguided. Academics are often very intelligent but wrong. In this case,
you had highly intelligent people coming to Russia and saying, Listen,
this is the only way you can do it. Youve got to do shock therapy.
Youve got to do it quickly; youve got to do it radically,
and so on. The Russians were fools for accepting this advice unquestioningly.
And the Western academics, if they really believed they were giving the
right advice, were fools for giving it.
The Yeltsin government was highly sensitive to the advice of both Western
governments and Western academic institutions, and almost slavishly followed
the advice given to them. So the role of the advice coming out of the
West at the time was huge.
MM: By way of contrast, though, its not the case that foreigners
were part of the acquiring teams in the privatization?
For all their faults, Western investors, Western financial institutions
and Western multinationals do maintain an ethical standard which prevented
them from participating in the kind of blatantly crooked scheme which
was Russias privatization in the 1990s.
Western investors tended to come in and play by Western rules. Theyd
invest in these Russian stocks and the Russian companies once they were
already selling on the stock market. Or they would grant loans to Russian
companies. Or they would occasionally buy the rights to produce oil. But
they would function according to the rules of a civilized market; they
were not privy to the inside of the market where the vast majority of
Russian money was made.
MM: Are there any significant counter-examples of privatizations
in Russia that actually worked?
There was also a good privatization scheme where people got their apartments
for a nominal price. Many people got something of real value. But this
is very small scale.
The Yeltsin government shouldve proceeded in that manner. They
should have started with the small shops, small enterprises, small plots
of land, and then moved up gradually to slightly bigger ones and pieces
of the bigger ones. The market has to evolve. You cant just create
it in a year or two. You cant hope that by privatizing the vast
majority of Russias natural resource wealth in two years that all
of a sudden youre going to create a market or make anyone but a
handful of insiders wealthy.
MM: Whats happened with the looted privatized enterprises?
Is the state taking them back? Do the enterprises continue to function?
What happened is that most of the so-called oligarchs were very bad managers.
As soon as President Putin came in, and after the bankruptcy of the Russian
state, the devaluation of the ruble and the debt default of 1998, there
was a change of tone in the Russian government and a groundswell of outrage
in the Russian population. There was an understanding among the oligarchs
that they would have to change their tactics. They couldnt just
simply strip the assets and strip the wealth from these companies. They
had done their looting, and now if they wanted to hang onto their companies,
they had to suddenly act like real managers and build the companies up.
This is something that Putin made very clear when he came to power. This
was unexpected. People like Berezovsky expected him to be a wishy-washy
But an informal deal was struck. Putin said he wouldnt look into
the past and the criminal way in which the oligarchs acquired the companies,
but from now on, they were going to pay taxes and stop sucking all the
money out of these companies and parking it in their personal bank accounts
abroad. They were going to have to take the profits from the companies
and reinvest them, or at least reinvest them into the Russian economy.
And those financiers that agreed to this deal started acting differently
and are now acting in a more civilized manner. There were a few that did
not want to make the transition and took whatever wealth they could carry
and are now living abroad.
Not a single major Russian industrialist or financier to date has been
put on trial for any significant misdeed or criminal act, which points
to the weakness of the legal system in Russia.
MM Are there any significant assets left to be privatized in Russia?
|The general director and his cronies would end up buying control of the company for almost nothing. So the workers got expropriated ‚‚ albeit voluntarily.|
|The price at which Gazprom was privatized in 1994 through the vouchers was $250 million, which is 160 times less than the price the stock market would put on the company a mere three years later. So it was less than 1 percent of the stock market value of the company. That makes it one of the great robberies of the century.|
|No matter how many billions of U.S. taxpayer dollars were going into Russia through the IMF and other institutions, several times that amount was flowing out of Russia through these kinds of criminal schemes. Thatís the way the Russian state was bankrupted.|
|Chubais essentially gave them Russias dozen best exporters in return for an ironclad commitment that these people would support Yeltsin and finance his campaign in 1996. The economic interests of Russia, the legal propriety and financial soundness of the Russian state, was sacrificed for the narrow political goal of getting Boris Yeltsin elected in 1996.||I can only hope that the privatization of urban lands wont be carried out in such a destructive and crooked fashion as the privatization of Russias natural resource wealth.|