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Saturday, July 2, 2011

Bank of Moscow Bailout/Takeover: All You Need to Know About Crony Capitalism

Russian bank regulators and state-controlled bank VTB Group announced a $14 billion loan (at half a percent interest) to take effect after VTB boosts its share of Bank of Moscow to 75%. According to regulators, the bailout of Bank of Moscow was needed because it made more than half of its loans to its own businesses, including to a real-estate company of Elena Baturina, the billionaire wife of the recently fired Moscow mayor. No one outside of a narrow circle knew the bank’s loan portfolio because former Mayor Yuri Luzhkov prevented anyone from asking "unwelcome questions." The results shown to investors and the central bank, according to one banking official, were pure fraud."

In an understatement, a bank analyst stated: "We cannot rule out problems in many banks."

Bank of Moscow’s former head expressed surprise (after fleeing to safety abroad) at the size of the state aid to VTF and cited “political motivation’ as the real reason for the takeover and bailout. After all, he conducted Bank of Moscow business like any other bank.

This example shows crony capitalism in action. It is repeated daily in China, Brazil, Kazakhstan, Nigeria, and the majority of countries around the globe. A non-crony banking system is the exception rather than the rule.

Crony banking works as follows: A politician or a politically-connected figure gains control of a bank. The bank makes “friendly loans” at low rates of interest to friends, relatives, connected businesses, and to persons from whom they need business or political favors. The borrowers either earn low returns (after sharing the loan proceeds with the banker) or are unable to repay, at which time they receive another loan. If necessary, the crony bank receives new capital from municipal, state, or national authorities (that is from taxpayers) to continue the Ponzi scheme. All the while, credit worthy businesses sit on the sidelines deprived of loans.

The current round of the Ponzi scheme ends when the politician-banker falls out of favor, is fired, and becomes a convenient scapegoat. At that point, banking officials and politicians express surprise and dismay that such things were going on under their very noses. They bring in new owners, currently in political favor, to start the Ponzi scheme over again. They lend to friends, relatives, and patrons, not to real businesses in real need of finance.

Every Moscow resident knew what former Mayor Luzhkov and his wife were up to. In fact, he was popular. At least he gave a little of what he stole back to Moscow.  They probably had some feelings of regret when Putin and Medvedev decided it was time for him to go.

The story is not about Luzhkov and his bank-for-himself-and-friends. It is about how crony capitalism can ruin an economy. In an economy that is starved for capital, crony capitalism directs capital to projects that have low or perhaps no return and most capital ends up in the pockets of cronies. There is no way an economy can grow and raise its standard of living under these circumstances.

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