Marshall I. Goldman, a prominent expert on the Russian economy and the associate director of Harvard's Davis Center for Russian and Eurasian Studies, explains how Mikhail Khodorkovsky became an oil billionaire in just a few years, and how his involvement in politics led to his arrest on charges of fraud, attempted murder, and money-laundering. Golden says there is considerable support among Russians for the crackdown on Khodorkovsky, who was sentenced May 31 to nine years in prison. But President Vladimir Putin's actions are also affecting Russia's developing economy adversely.
"What he [Putin] has discovered is that, in this crackdown, he has really scared the domestic and foreign business communities. That's not to say that people have stopped investing. Some are investing, but others have gone off in a different direction. Foreign direct investment in Russia is less than in Poland and other East European countries and is, at best, a tenth of what it is in China," Goldman says.
He was interviewed by Bernard Gwertzman, consulting editor for cfr.org, on June 2, 2005.
Mikhail Khodorkovsky, the former head of the Yukos oil conglomerate in Russia and purportedly one of the richest men in the world, has been sentenced to nine years in jail after a celebrated trial in Moscow. Can you give us some background on who he is, and how he became so rich in such a relatively short period of time?
Sure. First, let me say one thing: Khodorkovsky, two years ago, was Russia's richest man. Forbes magazine estimated he had a net worth of $15 billion. That's far below Bill Gates, Warren Buffett, and some others. But I don't want to dismiss $15 billion as small change.
How he came to power and wealth of that extent is typical for what happened to almost all of the so-called "oligarchs" in Russia, although none of the others accumulated that high an income. He started out in a cooperative in 1987, which then-Soviet leader, Mikhail Gorbachev, allowed. He had graduated in 1986 from the Mendeleyeva Chemical Technological Institute, and he and a bunch of his friends got together. Gorbachev had announced that, for the first time since the NEP [New Economic Policy] period of the 1920s [in which the Soviet government tolerated private business], you could set up your own business. It would be better if it was a cooperative, but it could also be private.
They began to offer their services. They were technicians. They began to work with computers and exchange in barter. Remember, in the late 1980s in Russia, goods became increasingly scarce. If you were willing to do some extra work on the side, show some extra initiative to arrange for the procurement of scarce goods, and you knew where to get them, you had an enormous advantage because the planning system was beginning to atrophy. People were willing to pay a lot of money for this, so if you got these goods, if you got these consulting services as the system was changing, you were really in a very opportune moment.
Khodorkovsky did that. Gradually, he built up lots of rubles. With those rubles, he got the idea that, "We've got to do something with them. Maybe we can lend them to other people." Gorbachev also passed legislation in 1987 that allowed the creation of private commercial banks. Again, this was brand new. Until that point, everything was owned by the state. Khodorkovsky and his partners formed a bank called Menatep, with which he was able to generate money like a personal ATM machine. With this bank, they were in a position to buy up the vouchers that were issued after Boris Yeltsin came to power in 1991.
These vouchers were issued to all Russians?
Every Russian was issued a voucher, and close to 140 to 150 million were distributed. The Russians were told that these vouchers could be exchanged for a share of stock that would give them a stake in what had been the Soviet Union. This was a program that had been promoted by some Western advisers and implemented by Anatoly Chubais, who was in charge of privatization. They did this quickly, because they were concerned that the Communists might come back to power. They wanted a "People's Communism," with everyone having a stake.
But most Russians, used to the old system, said "What's a piece of paper, what's a share of stock? We were always told this was a capitalist delusion, a device to deceive people. The share of stock may have some value in the future, but I live in the present." So most Russians got rid of them very quickly, or for a pittance, or for a bottle of vodka. The vodka was now. It's real.
What was the face value of the vouchers?
The face value was 10,000 rubles. They developed a market for them, and the market ultimately fell to the equivalent of $35. This was to be what each Russian's stake was after 70 years of Communism. It was absurd. It was a travesty. Very few Russians kept them. Very few Russians benefited. But people like Khodorkovsky thought this might be a valuable asset, and they began to buy them up. He used his bank to finance this. This was how they started from almost zero net worth and began to build up this equity.
The big event for Khodorkovsky came in 1995 when the government decided it had to go to the banks to borrow money because people were not paying their taxes and the government could not pay its bills. What was worked out was called "loans for shares." It was designed by another banker, Vladimir Potanin. The scheme was this: "We bankers will lend you, the government, money, and when you collect taxes, you can pay us off. In the meantime, we want collateral. What kind of collateral do we want? Well, give us some of the stock of some of the companies that have not been privatized." The government had held back [from the voucher system] the most valuable oil and natural gas companies, such as Yukos and Sibneft, which were still state-owned.
Of course, who is not paying taxes? The oligarchs are not paying taxes. Khodorkovsky is not paying taxes. So the government doesn't collect the [tax] money and can't pay back the loans. The banks then say "OK, we'll be fair about this. We'll auction off this collateral, so you will get more than your money back." Who conducts the auctions? The bankers. And what happens? The auctions are all rigged. So Khodorkovsky ends up paying something like $310 million for a property that is quickly recognized as being worth as much as $5 billion. That's the pattern that happened with all of the oligarchs. They all got these properties at very advantageous prices. That's how all of these oligarchs became billionaires.
In the meantime, the public got nothing. And if you go back and look at what was happening to the macro-economy at the time, by 1998, it had collapsed, so the GNP [gross national product] was half the size it had been in 1991. Statistics are bit fuzzy, but in any case, there was a drastic collapse. What you had was an economic pie half of the size it had started out as, and what you also had were these oligarchs taking a bigger and bigger chunk of the smaller and smaller pie.
Politically, it was really dynamite. Sooner or later, there would be retaliation. To some extent, that explains why the Russian public even now is generally very critical of Khodorkovsky and very supportive of Putin and the government as it begins to slap down some of these oligarchs.
In 1995-96, President Boris Yeltsin was trying to get reelected.
Yes, and after the reelection in 1996, there was another flurry of loans for shares as a reward for the oligarchs who supported his campaign.
Did Khodorkovsky support Yeltsin?
Yes, all of the oligarchs did. They were worried that Gennady Zyuganov, the Communist Party leader, would end up the victor and would undo all their profits.
So there was no effort by Yeltsin to crack down on them?
No, none at all.
But wasn't there a great economic collapse in 1998? How did Khodorkovsky survive with his fortune?
Khodorkovsky's Menatap Bank, along with the other oligarchs' banks, took an enormous hit in 1998 during the August 17 financial collapse. Basically, it became a bank holiday and all the banks closed down. Khodorkovsky took whatever good assets survived and diverted them to another bank of his, and left the depositors with nothing.
So he got all the assets himself, leaving everyone else high and dry?
So he was not exactly a financial saint.
Not only is the bank an example of how badly he behaved, but there were other investors, people like Kenneth Dart, an American, who had invested as much as $2 billion in some of the oil-producing subsidiaries. Khodorkovsky came along and basically watered down the value of the stock of those companies and pushed Dart out. There was an eventual settlement, but I'm told Dart lost about a billion dollars. So Khodorkovsky's record was not pristine by any manner or means. There are also accusations that he had supported the assassination of some government officials who had resisted what Yukos was doing, and there were accusations of all kinds of fraud and other bad activity.
When did his reputation improve?
In 1999, as oil prices rose, he turned a new leaf and became the poster boy for transparency. That's the irony. He brings in American oil specialists, honest people. The chief financial officer was an American who had worked for Marathon Oil, Bruce Misamore. Then he revamped the board of directors, throwing out insiders and bringing in Western board members, including a very good Washington lawyer, a graduate of Harvard Law School, Sarah Carey, who is one of the most reputable and knowledgeable lawyers dealing with Russian trade. He set up a foundation, a la Rockefeller and the Russian Open Society Foundation, patterned on George Soros. They gave a million dollars to the Library of Congress and money to Russian charities.
So what got him in trouble with the government?
His problem was he also had political ambitions. He gave money to some of the "good" opposition parties, parties that you or I would support. He did that because one, he believes in democracy; two, he believes in pluralism; and three, he wanted to make sure that Vladimir Putin, who was by then in control, didn't gather too much power unto himself. He wanted to have some assurance Putin would not introduce legislation that would undo the privileges and power of the oil companies.
He was rumored, at one point, to have had as many as 100 members of the Duma [Russia's lower house of parliament] responsive to his control. We do know there were two attempts to raise taxes on the oil companies and they were defeated in the Duma. The government could not implement its will in the Duma. In addition, Khodorkovsky told one of the government officials, Gherman Gref, that if you push through these oil taxes, I'll have you fired. He flaunted his power and, on top of that, he began to challenge Putin.
At a meeting in February 2003, he criticized one of Putin's old KGB buddies who was running a state oil company and accused him of making a sweetheart deal, paying triple the price he should have paid for an oil property that Khodorkovsky himself wanted to buy for Yukos. This hubris of, "I am going to straighten out the country," began to threaten the people around Putin and they subsequently pushed the actions that led to the trial.
What was he actually charged with?
Fraud, tax evasion, attempted murder, embezzlement. Now, most recently, a new charge has been introduced that has not been heard— money-laundering. What is tragic in all this is that now, this has given an excuse for the people around Putin to go after these oligarchs, and in the process, put themselves in a position where they can take over these assets and make themselves just as rich.
So now, the people working in the Kremlin [will] end up being associated with the state oil companies. The chairman of Gazprom, for example, is a man by the name of Dmitri Medvedyev. His day job is being the head of the Kremlin administration. His deputy, Igor Sechin, is now the chairman of the board of Rosneft. Rosneft is the company that has taken over control of the subsidiary that was spun out of Yukos.
So, is this pure cronyism?
It is coming back. It is a form of re-nationalization, but in a different environment, where individuals are able to build up a stake for themselves, not only of influence, but of personal wealth.
There are a lot of oligarchs still out there, right?
Yes. They have to worry they will be next. There are signs that once this cools down, they may very well be next, because of statements that have been made.
I was part of a group that met in April 2004 for a one-day retreat in Moscow sponsored by the government's Audit Chamber, the Russian counterpart of the General Accounting Office. It was headed by a man named Sergei Stepashin, who used to be prime minister and who was commissioned by Putin to reexamine what could be done to readjust the abuses of the privatization. Their report has been prepared but, so far, not released. But the summary lists abuses of the privatization process by almost all of the other companies controlled by the oligarchs.
What should be done?
The first thing is that all these companies should be paying their taxes. Now, after the Yukos affair, they are beginning to do so. Suddenly, they are all boasting about how much they are paying in taxes. My proposal was that they have something comparable to a tax amnesty, that they look at what the property originally worth, and what they paid, and ask the companies to make payments to make up that difference.
Is Putin aware of how bad it looks?
There is some question about how much control he has now. This "czar" is a lame duck. The people who the Russians call siloviki, the alumni of the KGB and senior military, are beginning to stuff their own pockets and carry out their own agenda. Putin is caught in the middle. What he has discovered is that, in this crackdown, he has really scared the domestic and foreign business communities. That's not to say people have stopped investing. Some are investing, but others have gone off in a different direction. Foreign direct investment in Russia is less than in Poland and in other East European countries and is, at best, a tenth of what it is in China.
This has had an impact on oil production. It is still increasing, but in 2003, it increased by double digits [per month]. Now it is down to maybe 4 percent a month. That has affected industrial output and GDP [gross domestic product]. Putin has promised his people he will generate at least a 7 percent per year increase in GDP so that, within 10 years' time, it will have doubled. He's not able to do this now. He recognizes there are restraints from the business community on his behavior. He cannot tell the tide it cannot come in. He has to recognize there are independent forces out there that, in a centrally planned economy, may not have had any influence, but do now.