The Oligarchs (10 page)

Alexander Bekker, then a journalist at
Moscow News,
remembered Smolensky telling him that Stolichny Bank was number sixty-four on the state registration list of commercial banks. “I am working for number sixty-four, and someday it will be working for me,” Smolensky boasted. “I will have a credit history and a reputation.”
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“I don't think he had a very clear-cut strategy at the time,” Bekker recalled. “It was difficult to even know what a commercial bank should be.” Smolensky's old army friend, Krasnyansky, said the key issue was avoiding the state. “The important thing was to find freedom for his money, so he could send it where he wanted without explanation,” Krasnyansky said. “Only later did clients appear, and he saw that the bank could bring in a lot more money than sawing wood at the cooperative.”

In the blossoming world of banking in the final years of Soviet socialism, much of the sustenance came from the state itself in the form of cheap credit. Many of the new banks were carved directly out of government ministries, industries, and special interests. The Ministry for Automobile Production created Avtobank; the Ministry of Oil and Chemical Engineering created its own Neftekhimbank; the state airline had Aeroflotbank. These banks and dozens of others were built to serve the state-owned industries behind them, and they could always count on a ready supply of subsidies. Big industries, regional governments, and the Communist Party and its many affiliates were the driving force in the explosion of the new banking sector, and their political clout and money dwarfed the more independent young cooperatives.

Smolensky, whose major asset a few years earlier had been his dump truck, was still the outcast. His bank had no government ministry at its back. Compared with the others, which had powerful patrons, the cooperative banks were small. Smolenksky's bank was not on the list of the twenty largest commercial banks in the Soviet Union in 1990.
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Smolensky's overriding principle was that he wanted nothing to do with the state, except the freedom to do what he wanted. He insisted that none of his employees come from the state banks. He found young people to work for him who had no prior memory of Gosplan or Gosbank.

Smolensky was moving to a new level of business. He no longer wanted to saw logs. He closed down Moskva-3, his cooperative. A banker was born.

 

In the years after the American Civil War, huge quantities of British capital poured into the United States, chiefly as loans to the railroads. England, which had given birth to the Industrial Revolution and inspired the wisdom of Adam Smith, had become the world's financial center, flush with surplus capital that had to find a home. According to Ron Chernow, biographer of the great merchant banker J.P. Morgan, British investors were put off by the helter-skelter growth of the American railroads, and they feared the swindlers and fast-talkers who ran them. Morgan became a transatlantic intermediary between the source of capital in London and those who needed it in the United States. The London investors were often clueless and depended on Morgan's knowledge about the railroads. In the United States, the railroads
were often in such a chaotic state that their only hope of attracting capital was through Morgan. As a journalist noted at the time, Morgan's great power came not from the millions of dollars he owned, but from the billions he commanded. He was one of the great middlemen of American history. The lore of American tycoons is often wrapped up in their role as masters over the railroads and steel trusts. But the key factor was the American hunger for capital; the capital itself had first come from England, as a result of successful commerce spawned by the Industrial Revolution.
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Consider the landscape that spread itself out before Alexander Smolensky in 1988. There were shortages of sausage in the state stores and the grim reality of a system in decay. No distant bankers hankered to invest their capital. Smolensky had seen the wounded dinosaurs of Soviet industry, primitive and ailing, and he also knew that centuries of authoritarianism had sapped the Russian population, which was passive and lethargic and would be difficult to revive.

In 1990 Gorbachev had toyed with a plan to turn the country into a market economy in five hundred days but discarded it. His economic policy zigzagged inconclusively back and forth. The chances for a huge infusion of private capital from abroad were not good. When one of the authors of the five-hundred-day plan, Grigory Yavlinsky, went to the United States seeking aid, he was snubbed by President George H. W. Bush. The West was not yet ready to risk money on the Soviet Union. The biggest source of capital—indeed, the only real source of wealth—was the state itself. The state possessed a sprawling network of oil fields, mines, factories, and pipelines. The state, through Gosbank, also controlled the money supply and credits, as well as all foreign trade. If there was money to be made, it would have to come from the state, either directly, as property and subsidies, or indirectly, by manipulating or exploiting the state's control over prices and trade.

In the late Soviet period, trading companies run by young hustlers and well-connected bureaucrats made quick fortunes this way. They bought oil cheap inside the country, paid bribes to get it across the border, sold it at world prices for hard currency, bought up personal computers from abroad, paid bribes to get the computers back inside the country, and sold them for fantastic profits, to be reinvested in the next lot of oil. The state created the conditions for this hustle by keeping oil prices low, by making the computers scarce, and by collecting the bribes.

For Smolensky, whose gut instinct was to distrust the state, the search for early capital was fraught with difficulty and danger. He had no hope of becoming an intermediary between borrowers and lenders in the Anglo-American tradition. The Soviet Union and later Russia were light-years away from the conditions that spawned the early American tycoons. Instead of becoming a Morgan or a Carnegie, Smolensky took what there was before him—the wild, unfettered, and warped Russian protocapitalism of the day.

Bekker, who had kept in touch with Smolensky, told me, “In Russia, there were only two ways to get seed capital for a bank. One was to service suspicious accounts and have the principle that ‘I don't care what kind of money is in my bank. It's not my responsibility to check the passport of every depositor.' Another way was to work closely with the authorities and government officials and get budget accounts and profitable contracts.” But Smolensky, he recalled, “didn't have
any
political contacts.”

In the year before the Soviet Union collapsed, more than half of all the deposits in commercial banks were from the state.
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The other half came from the cooperatives and other disparate organizations and nascent businesses. This is how Smolensky began to build his bank. He danced with those who would dance with him—Bank Stolichny ran with the fast-money men, including the entrepreneurs who began the first cooperatives and the hustlers. They were engaged almost entirely in high-stakes, quick-turnover deals that yielded obscene profits in cash. One method was generally known as arbitrage, taking advantage of the gaping price differentials that existed at the time between the heavily subsidized, fixed prices of the state-run economy and the free, higher prices of the market, both inside the country and abroad. Another lucrative business was currency speculation, taking advantage of hyperinflation. Between the collapse of the Soviet Union in 1991 and the end of 1994, the ruble exchange rate against the dollar dropped 95 percent. Smolensky and other bankers made enormous profits by essentially gambling on daily fluctuations in the ruble-dollar exchange rate.

When Smolensky was at the peak of his power in 1997, I asked him about these early years, and he acknowledged that much of his bank's money was wrapped up in currency speculation. Unlike a traditional Western banker, he simply did not make many loans. He remembered giving one loan to a watermelon farmer who grew his melons in
Uzbekistan and brought them to Russia for sale. He gave the melon grower a million rubles. Then ethnic clashes broke out near the farmer's land in Uzbekistan. The whole district was closed and he could not get the melons out to market. The authorities sent troops to the region. “Our guy was sitting on those watermelons, and I was having a heart attack!” Smolensky recalled. The loan was eventually repaid, Smolensky said, but lending seemed to him to be too risky.

“You couldn't give loans, in a normal sense, with such hyperinflation,” he said. “We engaged in more speculative operations, that's true. Otherwise you couldn't survive. There was no real industrial production. So, who do you give loans to? They would go bankrupt the next day.”

The young Russian bankers were intent on making a killing and at the same time were burying Soviet socialist ideology. The socialists had scorned financial manipulation as sheer greed. In the Soviet socialist economy, production and industry were king; money was just a tool for the larger goal of fulfilling the plan, for meeting the quotas. However, what Smolensky was doing had nothing to do with the plan. It was finance for its own sake, and that was a strange and utterly alien practice to the older Soviet generation, including many factory managers, bureaucrats, and KGB men. They did not inherit the new world of capitalism because they could not make this basic leap. The fleet-footed Smolensky and the boys on his currency trading floor danced right past the old guard.

In the last two years of the Soviet Union, currency transactions were still tightly controlled, theoretically. Smolensky's currency speculators had to be fast and invisible. By early 1990, Gosbank had only given two licenses to commercial banks for limited hard currency transactions, and the banks reported only a fraction of them to the authorities.
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Joel Hellman, a Columbia University doctoral student, was researching his thesis on the new Russian bankers in 1990 when he visited Smolensky. Hellman found that many of the bankers, as well as Gosbank officials, acknowledged that illegal hard currency transactions had blossomed well beyond the control of the authorities. Gosbank, which had once controlled all money and credit, was increasingly lost in the new environment. According to Hellman, Gosbank frequently threatened to fine the rambunctious banks—and did levy a $14 million fine against Smolensky—or freeze their accounts.
But the attitude of commercial bankers was cavalier. Smolensky told Hellman, “Our bank has outpaced events. We do something and official permission is granted after the fact. It would be impossible for us to wait for permission and then to act.”
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Hellman recalled that when he first met Smolensky, he was struck by the newly remodeled, Western-style bank offices, with luxurious sofas. Smolensky's vice presidents all wore Armani suits. Smolensky later told me that he deliberately arranged it that way, but the young vice presidents never bought the suits on their own. When he went to Europe, Smolensky routinely bought two suits, two dress shirts, and two ties and carried them back to Moscow in his suitcase, distributing them to his young vice presidents so they would look Western and prosperous.

Smolensky's capital was small, and his operations secret. He did not publish periodic financial reports, and if he had, they could hardly have been honest. One of Smolensky's early assets was a “manuscript” that he claimed he had written about banking and was worth 200 million rubles. Smolensky said he simply wrote down everything he had learned and set the huge value of the document himself. “It was just the description of the system that I had created,” he said. “How it works.”

Presto! Instant capital.

Smolensky also participated in a web of cross-ownership with some of the other early banks. His bank owned shares in others, and they owned shares in his, and everyone grossly pumped up the value, as Smolensky had done with the manuscript. It was a paper trick, one of many used by the young commercial bankers who thrived in a world of fictions and facades.

When Hellman visited Smolensky in 1990, he noticed that the banker had spread out on his desk brochures promoting the big American mutual funds, such as Merrill Lynch and Fidelity.
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Smolensky was looking for ways to ship cash overseas. It was a small glimpse of what, at that time, was already a torrent of capital fleeing Russia. Slowly at first, but later with more skill, the new Russian commercial banks built connections to the international financial system and discovered how to discreetly move cash into offshore zones. The goal was to avoid the risks of keeping money inside a turbulent and unstable country, and to dodge its confiscatory tax rates or keep the money away from partners, workers, or criminals. Smolensky, who was an
outsider anyway, thought it was a rather logical response to the threats that always lurked inside the country for anyone who had money. “There were restrictions—now, I don't remember clearly,” Smolensky said later when I asked if it had been difficult to transfer his money to Merrill Lynch. “Or actually, no restrictions. Anarchy.” In its first published annual report, for 1992, Smolensky boasted that Stolichny was one of the first twenty Russian banks to be linked into the SWIFT international bank transfer system, and that Stolichny had thirty-four correspondent bank relationships abroad.

“People were bringing money, but we didn't know how to preserve it,” Smolensky said. “We were looking for instruments to invest this money” in Russia, but “there were no instruments.” So they sent the money abroad.

Smolensky's bank was the most closed and secretive of the new commercial banks, and he constantly attracted the attention of the suspicious KGB and Gosbank, which was later turned into the Central Bank of Russia. The authorities, who looked askance at the young banker, were forever curious about what was going on inside the walls of Stolichny Bank, but Smolensky stubbornly refused to tell them or let them inspect his bank. For years, the security services tried to show that criminals were among Smolensky's customers, but Smolensky was never arrested. Certainly, Smolensky's bank was a haven for the easy money of the early 1990s. A list of the major loans made by the bank in 1996 showed that half of them were either trading companies or oil and gas companies, both adventuresome businesses that survived by speed, secrecy, and a healthy disrespect for national boundaries and authority.
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Among his colleagues, it was believed that Smolensky's Stolichny Bank had dealings with unsavory gangs and dirty money in its early years. A leading banker told me in 1998, “The main feature is being able to change. Smolensky is not what he was ten years ago. He is building a clear, open bank. Ten years ago, it was not. For sure, he had criminal elements—we all did. But I am sure no gangster can reach Smolensky, or even talk to him today.”
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