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07/30/1999

The Russian Financial Crisis, Part II

George Soros, billionaire, has made a lot of smart investment
decisions in his life. Throwing tens of millions at Russia was not
one of them. I know this country as well as any other (yes, that''s
cocky) and I remember watching a "60 Minutes" puff piece back
in January of 1998 that glorified the new Russian capitalism.
Yeah right, I thought (and commented to that effect on
pimcofunds.com). But let''s give Soros a chance to explain why
he did what he did, courtesy of an interview he gave for the PBS
"Frontline" program.

Soros: Well, you see, it''s really a tragic situation, because again,
everything that could be done wrong, we have done wrong. We
failed to provide the kind of aid that Russia would have needed,
which would have been more in the nature of a Marshall Plan or
something more intrusive that the Marshall Plan was in Europe.
[I agree].

Instead of that, we left it to the IMF to provide support. The
IMF deals with countries where the government promises to fulfill
certain conditions, and the IMF then lends them the money. But
actually, in Russia, you did not have a functioning central
government. Therefore, they kept on promising, but they
couldn''t possibly deliver. So the IMF was actually the wrong
institution to be helping Russia, but we were not willing to put
taxpayers'' money at work. We gave it to the IMF, which had its
own resources, so we could do it costlessly (sic).

That''s the background. Now, gradually, Russia tried to change
from this robber-capitalist system that prevailed, to something
more legitimate. Just at the time that the crisis came, they
actually had the best government, the most honest, the most
committed to reform, who actually tried to do battle with the
robber-capitalists, and tried to get them to pay their taxes.
[Yes, but Soros should have realized that the robber barons like
Boris Berezovsky had the power, not some weak idealists]

The robber-capitalists then fought them. They controlled the
media [well, you knew that going in, George]. They actually
destroyed the reformers and created or, let''s say, coincided with
the crisis. The IMF had a program which was unfortunately short
on money. The deficiency was not that great. I, at the time,
estimated it to be $7 billion, which is really peanuts in this
context.

I think that providing that extra money could have given that
government, let''s say, six months breathing space, during which
they could have proven whether they are, in fact, able to collect
the taxes that they had to do. So, it would have been a very small
price to pay. But for various reasons, the international
community didn''t come through. [Because all that would have
done is give you, George, a chance to get out the back door].

You then had a collapse, effectively a default, which shook
markets. The government immediately fell. You now live in a
kind of a twilight period, when things are drifting. You have a
government that has proven itself quite good in sort of holding
things together, so that cushioning the rate of decline, but not
showing any ability to turn things around. [I agree with this].

Q: How did the debt get so out of hand?

Soros: "The IMF plan (spring / summer of ''98) assumed that the
maturing treasury bills will be rolled over or can be rolled over,
even if the interest rate is atrociously high. That at some interest
rate, there will be some buyers. But what they''ve left out of
account is that the holders of the GKOs (equivalent to treasury
bills) were banks that borrowed dollars to buy the GKOs and then
couldn''t repay the dollars. The foreign banks were not willing to
lend them any more money. So they could not roll over the GKO
at any price. So there was a hole there. As the Russian public
started withdrawing its savings from the national savings bank,
the hole got bigger. What started out as a hole of $7 billion,
within a week or two became a hole of $15 billion.

Q: Tell me about that last weekend, before Monday, August 17th,
of the feelings that wee going on in your conversations with
people.

Soros: I know of an international conference call among the G-7
countries, who discussed this issue. But, as I said before, no
package could be put together. Whereupon, the Russians took it
upon themselves to act unilaterally (to default on their debt).

That really shocked the market, because it was effectively a
unilateral default. The shock then reverberated through the
financial markets. Banks became very anxious about their
outstanding loans. Certain relationships between different
markets, which had been sort of moved way out of normal. At
the same time, you had a number of hedge funds, investment
banks that had speculated on those relationships going back to
normal. They had large positions, which normally turned out to
be profitable. At this time, disparities, the divergences, just grew
out of all proportion, since these operations are carried on with
very high leverage meaning that it''s all done with borrowed
money.

There was a hedge fund, Long Term Capital Management.this
entity lost a lot of its capital.The banks started asking for
additional collateral, which they didn''t have. There was
tremendous danger that if these positions had to be liquidated,
then the disparities would get even bigger. Not only would the
Long Term Capital Management be unable to meet its
obligations, but a lot of the banks, and investment banks, that had
lent to LTC, and also had similar positions in their own
proprietary trading debts, would also be called up on to liquidate
their positions.

So you would have sort of an avalanche of selling, where you
wouldn''t know who is a good counterpart and who isn''t. You
wouldn''t know which institution is solvent and which is broke.
That would have been a meltdown of the financial markets. That
would have then had a devastating effect on credit all around.

Seeing it develop, the New York Fed intervened, and got the
major counterparties of LTC to put in additional capital. So that
they didn''t have to liquidate their positions. That move prevented
this meltdown.

Q: You lost a bunch of money in Russia.

Soros: Yes. Yes.

Q: You said it was the worst investment decision in your life.

Soros: Right. Right.

Q: Do you think people understand the seriousness of what
happened in Russia, that there are still potential repercussions?

Soros: I think that people generally realize the situation is pretty
hopeless right now. It''s probably not quite as hopeless as it
seems to us, who have sort of orderly minds [classic Soros], and
we want to see Russia be able to get by. At the time, a lot of
people were aware how serious the internal situation was. That''s
why the markets fell. But it was a temporary panic. Through the
intervention of the Fed, bailing out LTC, and very shortly
thereafter, lowering interest rates, which was a very important
move - markets took heart. It''s now sort of like an episode that''s
almost forgotten.

Q: But shouldn''t be?

Soros: Well, it should not be forgotten, because these kinds of
episodes are liable to reoccur. No reform will ever eliminate the
risk of some kind of a breakdown. But when you identify what
has gone wrong and what could be done to fix it, you actually do
need to fix it. Because without it, we couldn''t have developed
the financial markets we have.

Financial markets have always failed from time to time. Then,
they got fixed by some advance in central banking or in a
regulatory environment. As a result, financial markets got
increasingly sophisticated, refined and effective. If you now allow
this belief that markets are best left alone to predominate and
refuse to fix the deficiencies, then you run the really serious risk
that you will have a very serious breakdown.

Editor: *This last point has to do with Soros controversial view
that a currency board is needed to avert future crises. Believe me,
you don''t want to read a discussion on that right now.

What Russia needs now is a dictator like General Alexander
Lebed to establish law and order. Without that first step, it will
be impossible to achieve true economic reform.

Brian Trumbore







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-07/30/1999-      
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Wall Street History

07/30/1999

The Russian Financial Crisis, Part II

George Soros, billionaire, has made a lot of smart investment
decisions in his life. Throwing tens of millions at Russia was not
one of them. I know this country as well as any other (yes, that''s
cocky) and I remember watching a "60 Minutes" puff piece back
in January of 1998 that glorified the new Russian capitalism.
Yeah right, I thought (and commented to that effect on
pimcofunds.com). But let''s give Soros a chance to explain why
he did what he did, courtesy of an interview he gave for the PBS
"Frontline" program.

Soros: Well, you see, it''s really a tragic situation, because again,
everything that could be done wrong, we have done wrong. We
failed to provide the kind of aid that Russia would have needed,
which would have been more in the nature of a Marshall Plan or
something more intrusive that the Marshall Plan was in Europe.
[I agree].

Instead of that, we left it to the IMF to provide support. The
IMF deals with countries where the government promises to fulfill
certain conditions, and the IMF then lends them the money. But
actually, in Russia, you did not have a functioning central
government. Therefore, they kept on promising, but they
couldn''t possibly deliver. So the IMF was actually the wrong
institution to be helping Russia, but we were not willing to put
taxpayers'' money at work. We gave it to the IMF, which had its
own resources, so we could do it costlessly (sic).

That''s the background. Now, gradually, Russia tried to change
from this robber-capitalist system that prevailed, to something
more legitimate. Just at the time that the crisis came, they
actually had the best government, the most honest, the most
committed to reform, who actually tried to do battle with the
robber-capitalists, and tried to get them to pay their taxes.
[Yes, but Soros should have realized that the robber barons like
Boris Berezovsky had the power, not some weak idealists]

The robber-capitalists then fought them. They controlled the
media [well, you knew that going in, George]. They actually
destroyed the reformers and created or, let''s say, coincided with
the crisis. The IMF had a program which was unfortunately short
on money. The deficiency was not that great. I, at the time,
estimated it to be $7 billion, which is really peanuts in this
context.

I think that providing that extra money could have given that
government, let''s say, six months breathing space, during which
they could have proven whether they are, in fact, able to collect
the taxes that they had to do. So, it would have been a very small
price to pay. But for various reasons, the international
community didn''t come through. [Because all that would have
done is give you, George, a chance to get out the back door].

You then had a collapse, effectively a default, which shook
markets. The government immediately fell. You now live in a
kind of a twilight period, when things are drifting. You have a
government that has proven itself quite good in sort of holding
things together, so that cushioning the rate of decline, but not
showing any ability to turn things around. [I agree with this].

Q: How did the debt get so out of hand?

Soros: "The IMF plan (spring / summer of ''98) assumed that the
maturing treasury bills will be rolled over or can be rolled over,
even if the interest rate is atrociously high. That at some interest
rate, there will be some buyers. But what they''ve left out of
account is that the holders of the GKOs (equivalent to treasury
bills) were banks that borrowed dollars to buy the GKOs and then
couldn''t repay the dollars. The foreign banks were not willing to
lend them any more money. So they could not roll over the GKO
at any price. So there was a hole there. As the Russian public
started withdrawing its savings from the national savings bank,
the hole got bigger. What started out as a hole of $7 billion,
within a week or two became a hole of $15 billion.

Q: Tell me about that last weekend, before Monday, August 17th,
of the feelings that wee going on in your conversations with
people.

Soros: I know of an international conference call among the G-7
countries, who discussed this issue. But, as I said before, no
package could be put together. Whereupon, the Russians took it
upon themselves to act unilaterally (to default on their debt).

That really shocked the market, because it was effectively a
unilateral default. The shock then reverberated through the
financial markets. Banks became very anxious about their
outstanding loans. Certain relationships between different
markets, which had been sort of moved way out of normal. At
the same time, you had a number of hedge funds, investment
banks that had speculated on those relationships going back to
normal. They had large positions, which normally turned out to
be profitable. At this time, disparities, the divergences, just grew
out of all proportion, since these operations are carried on with
very high leverage meaning that it''s all done with borrowed
money.

There was a hedge fund, Long Term Capital Management.this
entity lost a lot of its capital.The banks started asking for
additional collateral, which they didn''t have. There was
tremendous danger that if these positions had to be liquidated,
then the disparities would get even bigger. Not only would the
Long Term Capital Management be unable to meet its
obligations, but a lot of the banks, and investment banks, that had
lent to LTC, and also had similar positions in their own
proprietary trading debts, would also be called up on to liquidate
their positions.

So you would have sort of an avalanche of selling, where you
wouldn''t know who is a good counterpart and who isn''t. You
wouldn''t know which institution is solvent and which is broke.
That would have been a meltdown of the financial markets. That
would have then had a devastating effect on credit all around.

Seeing it develop, the New York Fed intervened, and got the
major counterparties of LTC to put in additional capital. So that
they didn''t have to liquidate their positions. That move prevented
this meltdown.

Q: You lost a bunch of money in Russia.

Soros: Yes. Yes.

Q: You said it was the worst investment decision in your life.

Soros: Right. Right.

Q: Do you think people understand the seriousness of what
happened in Russia, that there are still potential repercussions?

Soros: I think that people generally realize the situation is pretty
hopeless right now. It''s probably not quite as hopeless as it
seems to us, who have sort of orderly minds [classic Soros], and
we want to see Russia be able to get by. At the time, a lot of
people were aware how serious the internal situation was. That''s
why the markets fell. But it was a temporary panic. Through the
intervention of the Fed, bailing out LTC, and very shortly
thereafter, lowering interest rates, which was a very important
move - markets took heart. It''s now sort of like an episode that''s
almost forgotten.

Q: But shouldn''t be?

Soros: Well, it should not be forgotten, because these kinds of
episodes are liable to reoccur. No reform will ever eliminate the
risk of some kind of a breakdown. But when you identify what
has gone wrong and what could be done to fix it, you actually do
need to fix it. Because without it, we couldn''t have developed
the financial markets we have.

Financial markets have always failed from time to time. Then,
they got fixed by some advance in central banking or in a
regulatory environment. As a result, financial markets got
increasingly sophisticated, refined and effective. If you now allow
this belief that markets are best left alone to predominate and
refuse to fix the deficiencies, then you run the really serious risk
that you will have a very serious breakdown.

Editor: *This last point has to do with Soros controversial view
that a currency board is needed to avert future crises. Believe me,
you don''t want to read a discussion on that right now.

What Russia needs now is a dictator like General Alexander
Lebed to establish law and order. Without that first step, it will
be impossible to achieve true economic reform.

Brian Trumbore