ConnectionsRussia: Virtual Economy/Bear Trap

Russia – Cyprus: Money Laundry/EU Entrèe

Russian Underworld Cyprus Crisis

Global Underworld Iceland Crisis

Global Financial Crises

Virtual Economy – Bear Trap• Manufacturing destroys value: Value of Inputs > Outputs– Survives on fictitious prices/Underpriced energy– Energy sector underpins domestic economyProfits from exports

• Capital goods costs and prices relatively high– Dinosaur heavy industry vs. ease of entry in consumer sector

– Soviet “demand” for investment raised PI

– Get much less bang-per-buck from investment than in West– Putin’s aim: double GDP in 10 years 50+ % investment rate– Inputs that compensate for adverse environment – Siberian cold –

counted as output, not cost

Handicapped capital Overstatement of capital stock

• Cold and distance from market– Duluth and Perm: A contrast in adjustment

A World of Crime: The Underside of GlobalizationCrime tracing to collapse of Soviet empire• Discriminated minorities: Jews, Chechens, Georgians

• Tolkachi...go-betweens in the Soviet planned economy, matching S-D

• Hyperinflation – caviar as money – police for hire – protection racket• Natural resource price controls windfall for “robber barons”

• Grandest larceny in history – biggest capital flight ever• Switzerland and Cyprus favored laundries ... Israel too

Cyprus: Non-European entity in EU w/o European financial standards• 1970s: Accommodating financial services/legal environment for shell

companies/flag of convenience shipping/weapons and narcotics trafficking/cold-war espionage/home of Soviet foreign trade bank

• 1990s - : fee-for-service money laundering for oligarchs entrée to EU• Cypriot banks buy high yield Greek bonds insolvency• Lender of last resort surprise

• German view: financial crisis as morality play won’t bail out oligarchs• Russian view: Deposit tax = theft...European conspiracies against Russia

Simeon Mogilevich: “Boss of Bosses”• Ukrainian born Jew, 1946• Economics degree, 1968• Russian prison for currency-dealing, 1970s• Fortune based on “sale”/theft of Jewish émigré property• Legal enterprises

– Israel– Hungary: armaments factory– Russia: Inkombank

• Sukhoi, military aircraft• 1998 money laundering via BNY with Khodorkovsky’s Bank Mentep

• Worldwide criminal enterprises– Prostitution– Arms smuggling– Drug smuggling

» FBI 10 Most Wanted List

Boris Berezovsky: Prototypical Oligarch, 1946- 2013• Mathematician...Member Russian Academy of Sciences

– Binary relations in multi-criteria optimizations

• Media mogul: gained national TV station in privatization– Yeltsin inner circle...Proponent of Putin ... “The tsar’s Jew”– Godfather of the Kremlin: Boris Berezovsky and the looting of Russia– Oligarch vs. Oligarch: Berezovsky’s KGB guys vs. Gusinsky’s KGB guys

• Fell out with Putin...dropped out to Britain– Name change – conversion to Orthodox– Retained assets in Georgia, Europe/Fisher Island off Miami coast

• Investment in Neil Bush’s Ignite! Learning

– Political agitation: International Foundation for Civil Liberties• Financed Ukraine’s Orange Revolution• Political power in Latvia

– Philanthropy: Kensington Castle upkeep– Lost suit to Roman Abramovich fortune evaporates

• Suicide in Ascot, March 23, 2013

Iceland: Another Banking Island/Another Banking CrisisMichael Lewis: Fishermen get PhDs, become investment bankers

No longer a country but a hedge fund.

Statistics @ 2007 peak 2003-2007• Population.......0.3 million Stock market up nine fold• GDP...............$20.5 billion Real estate prices tripled• Bank assets...$140 billion Global asset purchases

Speculative mania: You have a dog, I have a cat...

Carry trade: Borrow yen @ 3%...Lend krona @ 15%

2008 Collapse• Stock market down 85%• Krona down 80% against euro Current account surplus• Public and private debt...850% of GDP• Inflation of 17%...Real GDP down 5.5%...IMF loan of $2.1 billion

Banks nationalized...Icesave program rejected– Each Icelander would have paid $135/month to Brits and Dutch for 8 years

Domestic savers bailed out/British and Dutch savers screwed

Iceland: Another Banking Island/Another Banking Crisis

Preludes to the Icelandic Financial Crisis, Aliber and Zoega,eds.• IMF, 2006 Warnings of overheating but banks are okay• IMF, 2008 ...challenge of orderly rebalancing...of mitigating risk• OECD, 2006 Financial markets are thriving: controls lifted, banks

privatized, sector opened to international capital. Liberalization rocks!• Hebertsson & Zoega, 2005 Analogies to Mexico and Sweden in ‘90s• Fitch, 2006 Sovereign debt downgraded...risks of hard landing seen

• But banks okay• Danske Bank, 2006 Critical study dismissed: Danish spite• Hebertsson & Mishkin, 2006 (Chamber of Commerce)

Strong fiscal position/excellent institutions/ability to rewind current account deficit/high quality financial regulation and supervision crisis unlikely

• Portes & Baldursson, 2007 (Chamber of Commerce)– Financial sector responded “quickly and decisively” to external criticism

• Buiter & Sibert, 2008 (Landsbanki...kept confidential)– Need credible lender of last resort Join EU and eurozone

Preludes to the Icelandic Financial Crisis, Aliber and Zoega,eds.

Critical Voices• Gros, 2008 Iceland on the Brink (Center for European Policy Studies)

– Iceland as “hedge fund” exposed to global crisis/No lender of last resort– Primed for classical banking crisis/currency crisis and real estate bust

• Gylfason, 2008– Implicit state guarantee allowing banks to borrow huge amounts internationally

• Aliber, 2008 Manias, Panics and Crashes (update of Kindleberger)– International borrowing by banks expansion of credit in Iceland– Debt financed stock market boom– Icelandic banks owned Bank capital grew with stock prices– High bank capital Additional bank borrowing

A Giant Ponzi Scheme– Asset price decline...Banks shut out of credit markets...Bank Runs

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