& Tornado Alley
of the 1990's
There were some individuals who became so immensely rich in the privatization of the assets of the Soviet system that they became known as the oligarchs. The name implies that they were powerful. They were not the only ones who became rich, but their success put them into a separate class. Some have lost their status as a result of the August 1998 financial crisis but all of the original seven oligarchs are included here. Their names are:
Boris Berezovsky came to the business world of Russia by an odd route. He was a software engineer. He was born and raised in Moscow and received a high quality education in electronics and computer science at an institution that was involved in the Soviet space program. Berezovsky went on to graduate school at Moscow State University where he earned the equivalent of an American Ph.D. in the 1970's and finally a Russian Ph.D. which is more advanced than an American Ph.D. in 1983 at the age of 37. He worked for twenty five years at the Soviet Academy of Science in the field of decision-making and in the field of computer automation of industry.
He decided to enter the business world. At the Academy of Science he had worked with the Avtovaz, an enterprise the Soviet government had set up to produce automobiles for the mass Soviet market. The Soviet government contracted for the Italian automaker Fiat to build a large scale auto plant 700 miles east of Moscow. The city in which the plant was located was named Togliatti after the head of the Italian Communist Party. The plant was not a technical triumph. It was vastly overstaffed and the quality of the product was low. The labor productivity was approximately one thirtieth of labor productivity in the American and Japanese automobile industries.
Berezovsky proposed to Avtovaz that he provide help to the enterprise for automation and computer control of operations. The structure of the arrangement was that Berezovsky would set up a company in Switzerland that would create a joint venture with Avtovaz. This would gain the benefit of the Soviet government program set up to encourage foriegn investment in the Soviet economy. One special feature of a joint venture is the foreign partner could take some profits of the enterprize out of the country.
Once the legal structure for the foreign partner in Italy, Logovaz, was set up Berezovsky became involved in operating a car dealership to sell the Ladas produced by Avtovaz. Car dealerships extremely profitable and were a favorite target of organized gangs demanding protection money. Berezovsky arranged his own protection from the Chechens and tried to keep out the other gangs demanding a shakedown.
The Russian gangs were not easily discouraged. Gang warfare raged. Berezovsky left the country. When he returned he was the target of more than one assassination attempt. The most serious one involved a car bomb. Berezovsky was riding in his chauffeur-driven Mercedes with his bodyguard. As his vehicle passed a parked car a bomb in that car was detonated. The chauffeur's head was blown off, the bodyguard was severely injured and Berezovsky was seriously burned. There was other assaults on Logovaz' operations, but when the leader of the Russian gangs was killed by a car bomb the assaults stopped.
The car dealerships were extremely profitable, in part, because of a process Berezovsky called the privatization of the profit of a state enterprise. Avtovaz produced Ladas at an average cost of about $4700 but sold them to autodealers at $3500 per car. The dealers then sold the cars for $7000 each. The underpricing of the cars by Avtovaz came as a result of the control of its management. Thus Berezovsky moved the potential profit of the state enterprise out of the enterprise and into the private enterprise of the dealerships. Since such a money-losing enterprise would not have much market value it would be cheap to buy ownership. This is the scenario proposed by Berezovsky.
In 1996 Berezovsky told Paul Klebnikov, the author of Godfather of the Kremlin,
Privatization in Russia goes through three stages. The first stage is the privatization of profits. The second is the privatization of property. The third is the privatization of debt.
He left out the essential zeroeth step: gaining control of management. It is this step which allows the privatization of the profits of an enterprise where, as in the case of Avtovaz, the profits can be transferred out of the enterprise by the under pricing of the product. The profits could just as well be transferred out of the enterprise by overpaying for supplies.
Berezovsky did go on to acquire ownership of Avtovaz, but there were bigger prizes available to occupy his attention such as the airline Aeroflot. In Soviet days when people were asked what was the world's largest airline they would be to find that it was not one of the well known lines but instead Aeroflot, the single airline which served the Soviet markets.
In the 1990's Aeroflot was managed by Vladimir Tikhonov. Tikhonov was a competent manager who was improving the operations with equipment purchased or leased from American and European sources. Aeroflot had be converted into a public company in which the Russian State owned 51 percent and management and workers 49 percent of the shares. Berezovsky was not interested in buying up shares, instead he wanted management control in order to privatize the profits. Berezovsky used his influence in the Russian Government to get Vladimir Tikhonov replaced with a Soviet Air Force marshal. The marshal, though knowledgable about aviation, lacked the knowledge and experience required to run a commercial airline. Berezovsky imposed management personel from Logovaz on Aeroflot. The air marshal was no match for the Logovaz people. With the Logovaz people running Aeroflot it was not long before the Aeroflot profits had migrated to Berezovsky-controlled businesses.
In his twenties during the 1970s Vladimir Gusinsky started his business career as a cab driver, one without official sanction and thus called a gypsy-cap. He also engaged in black market trading. But by the 1980's he developed some close ties in the Communist Party. He organized events for the Communist Youth League. Gusinsky also developed a working relationship with Yuri Luzhkov, the mayor of Moscow. The City of Moscow was not just a city government. It owned an controlled an extensive system of economic enterprises. Under Luzhkov these enterprises functioned efficiently and profitably.
In 1989 or shortly thereafter Gusinsky created a bank called Most Bank, from the Russian work for bridge. As result of the connection with Luzhkov, Gusinsky's Most Bank was a very important institution in the Moscow economy and one of the biggest conglomerates in Russia. To protect his interest Gusinsky created a security division employing about 1000 people, many of them formerly employed by the KBG.
Once Gusinsky had created the basis for his financial success he began to create a media empire. In 1994 he had a newspaper, a weekly news magazine, a television guide magazine, a radio news station and the crown jewel of an independent television network.
As a child Mikhail Khodorkovsky wanted to be a factory director when he grew up. Factory directors were probably the most powerful figures in the lives of ordinary Russians. But being a factory director was not just an idle dream of Mikhail Khodorkovsky. He pursued his career goal rather diligently. He studied engineering in Moscow and simultaneously was active in the Communist Youth League (Kommosol) to the point of being deputy head of the Kommosol governing committee for his educational institute. He learned the protocols of dealing with Communist Party functionaries and he developed connections in the Party organizations.
Despite his careful preparation Mikhail Khodorkovsky was denied the opportunity to work toward a directorship in the Soviet defense industry. He felt it was because of the Jewish origins of his family. He then decided to enter the private sector. His enterprise was named the Center for the Scientific-Technical Creativity of Young People, which was soon abbreviated to MENATEP. It first existed as a cooperative, the only officially sanctioned form of private enterprise, but later became a bank. Like many other entrepreneurs Mikhail Khodorkovsky sought the quick, high profits that could be gained by importing and reselling computers. Menatep also engaged in various currency exchange transactions.
Although some in the Communist Party blocked his road to becoming a factory director Mikhail Khodorkovsky was on good terms with many Communist Party officials and went into business with their approval. He was appointed as an economic adviser to the prime minister of the Russian Federation in 1990, in the days before the collapse of the Soviet Union. This was a prestigious position and one that gave him important contacts.
When the old order collapsed many state enterprises needed credits while waiting for the new government to establish financial flows. Menatep provided such credit in return for substantial fees. Regional governments also sought Menatep's services in supplying credit. It was relative easy given Menatep's role as intermediary in the financial flows between the national government and the state enterprises and between the national government and the regional government to handle government bank accounts. This work also gave Menatep a web of relationships with government functionaries who could be called upon when Menatep needed bureaucratic approvals.
When privatization began Menatep acquired companies, many companies. There was not a systematic scheme to Menatep's acquisitions other than to snap up any bargain it found. The conglomeration of companies was characterized as a financial-industrial group. Some in government saw these financial-industrial groups as the appropriate replacement for the socialist industries.
Alexander Smolensky inherited a status as an outsider. His mother's father was an Austrian Jew who fled Vienna for political refuge in Moscow. But Stalinist Russia did not treat such political refugees as true comrades. They feared that they were an alien contamination even if they were devout communists, perhaps especially if they were devout communists because they might be heretics with respect to the currently correct Party-line. So Alexander Smolensky's mother, who had been born in Austria although she was raised in Moscow, was excluded from most jobs and opportunities for training. Life was very hard for the family especially since Alexander Smolensky's father divorced his mother and left her and their children to survive on their own. Alexander Smolensky developed a lifelong resentment and defiance of the system. He seemed constitutionally incapable of cooperating with the system. When he applied for his official identification document, the so-called internal passport, he could have listened his nationality as Russian on the basis of the nationality of his father but he chose instead to designate himself as Austrian on the basis of that of his mother. Such acts of definance shut him out of any career other than as an entrepreneur. But entrepreneurship in the Soviet Union was illegal and Smolensky lived a hard life.
His two year service in the Soviet Army was served in Tiblis, Georgia. He fought the system in the army but while doing so he and a friend used their access to the army newspaper's printing facilities to start an underground business in printing business cards. The business was not much but it enabled them to learn type-setting and the crafts involving in printing.
When Smolensky returned to Moscow after his two-year stint in the army, having had to grab his army release documents from the desk of the officer who was supposed to issue them to him, Smolensky continued in the printing trade. He found a job as a supervisor of the printing department of an industrial ministry. He had to work two jobs to survive and was on the lookout for ways to make money. He realized that in the days of the Soviet suppression of unsanctioned literature having access to a printing press was a potent thing. People were publishing writings by the laborious process of typing documents a few copies at a time, one original and as many carbon copies as the typewriter could produce. In addition to being tedious this was dangerous but people were willing to do it. Access to a printing press relieved the underground writers having to type and retype works. Smolensky printed Bibles among other things. Bibles were not technically subversive material but it was a criminal offense to use State facilities for private enterprises as Smolensky was doing.
During this time Smolensky developed and refined his skills at finding and acquiring materials. In the socialist economies shortages are chronic and there is no problem selling production but gathering the raw materials is the limiting factor. So that while the salesman is the key figure in western businesses it is the raw material acquirer, the procurer, in the socialist economies that is the key figure.
Smolensky's illegal printing operation was reported to the authorities and he was arrested. But instead of being charged with the more serious offense of running an illegal printing operation, which bordered on subversion, he was charged with the ordinary criminal offense of having stolen a substantial quantity of printer's ink. He was sentenced to two years of work in a construction crew outside of Moscow and prohibited for three years of having access to money and valuable materials. His career as a printer was effectively ended, but his introduction to the construction field was a valuable substitute.
After his sentence was served Smolensky continued in construction. His ability to get things done earned him an acceptance as a valuable, effective construction operator. In part, his effectiveness in construction depended upon his skills in acquiring the required materials for construction. Although authorities recognized that Smolensky was a rebel against the system they realized that his organizational skills were valuable for them to have access to. And Smolensky's defiance of the system was not so much ideological as individualistic so he was not looked upon as a subversive, just a roughneck.
As the supervisor of a construction crew Smolensky had to comply with the policy directives that flowed down the state hierarchy. Gorbachev initiated a campaign against alcoholism which required supervisors to report on their punishment of employees for excessive drinking. Smolensky saw the directive to be completely unrealistic but had to give some token compliance. Next, in 1986, there was a campaign against unearned income which was intended to curb corruption but also made a target of the second occupations and little businesses that most Russians had on the side. It was soon recognized that prosecuting people for these side sources of income was a mistake and a law was promulgated that stated that individual labor activity was permissible. This opened the flood gates. It was now officially permitted for people to set up stands on the street to sell goods. It was not a free market revolution but it was a step in the right direction.
The exact phrasing was important. Individual meant that hiring others was still forbidden as contrary to Marxist doctrine. But enterprises that could be carried out by one individual with the help of family member were severely limited. The authorities decided to remedy this limitation within Marxist dogma. It would be alright for a group of people to engage in enterprise if they constituted a cooperative. The drafters of the 1988 Law on Cooperatives did not place as many restrictions on the nature of the permitted cooperative enterprises as might be expected. In particular the Law allowed for the creation of financial services cooperatives.
Following the promulgation of the Law on Cooperatives Smolensky's administrative superiors ordered him to form a cooperative. Smolensky was at first reluctant because it was unclear what the cooperative would do and how it would operate. But Smolensky did register a cooperative named Moscow-3.
Without capital and a clear market the cooperative at first engaged in collecting scrap materials. Because the official sources of building material were bureaucratically allocated it is difficult to find building materials. Smolensky's cooperative would undertake demolition of structure and salvage building materials. From there the cooperative went into the business of building such things as country houses, dachas. Business was good.
After a while the profits had accumulated. Although technically a cooperative the enterprise was effectively Smolensky's business. He was reluctant to keep the profits in the state banks that existed at the time but in order to carry out business he needed the facilities of a bank. The banks were or had recently been state bureaucratic agencies. When the cooperative went to the bank to execute some transaction they would be questioned in detail about the cooperative's business activities. The bank's execution of the required services would be contingent upon the answering of their questions and soon it was necessary to offer gifts and bribes to get the required actions completed.
Smolensky then realized that the Law on Cooperative permitted the creation of banks as cooperatives. Smolensky then created his Stolichny Bank. It was the early 1990's at a time when financial matters were in great turmoil. There was hyperinflation due to the Central Bank of Russia (formerly the Gosbank of the communist central planning system) under the direction of Viktor Gerashchenko creating excessive amounts of money. The laws were uncertain and the future of Russia itself was not settled. Ordinary bank lending could not be carried out. Smolensky's Stolichny Bank had to make up policies and strategies as it went along. Probably much of the early operations were on the margins of legality. But the Stolichny Bank survived and profited. Soon Smolensky made the bank the core of his business. And as the financial market of Russia settled down the Stolichny Bank's operations also became more conventional. But he needed something with more opportunities. He decided to run a construction operation.
Vlaminr Potanin came from a family high in the Soviet Communist hierarchy. His father belonged to the Communist Party Central Committee and served in the Ministry of Foreign Trade. Vladimir Potanin after his university training also joined the Ministry of Foreign Trade. About 1989 he and associates in the Ministry of Foreign Trade established a trading company and with support from the Ministry of Foreign Trade and elsewhere in the Communist hierarchy the trading firm succeeded. His story seems related to the channeling of Communist Party funds into businesses.
After the success of the trading company Vladimir Potanin started two banks, the Onexim Bank and the MFK. Many of the state enterprises transferred their account to these two banks which became the third and fourth largest banks in Russia. The unavoidable suggestion is that Potanin's enterprises are Communist Party offsprings representing the the old organization shorn of ideological pretenses.
In 1995 Potanin with support from other oligarchs proposed his loans for shares plan to the Council of Ministers of the Russian Government. Under this plan the Russian Government traded ownership interest in unprivatized state industries for loans. The Russian Government was extremely short of funds at the time and welcomed the plan. The loans for shares program was administered in the form of auctions. Only a select set of bidders were invited to these auctions and the daughter of Boris Yeltsin, Tanya, had a strong influence in determining who would be invited.
In the uncertain times of the end of the Soviet era Vladimir Vinogradov, then an employee of a state bank, established in 1988 a commercial bank, Inkombank. Vinogradov and his friends create the facade of a bank operating on a shoe string until they secured a number of reputable investors. Among these investors were Sokol (the association of aircraft manufacturers), Transneft (a gas pipeline operator) and the Plekhanov Institute. These investors gave Inkombank enough credibility to apply for credit from the Central Bank of the Soviet Union. Against all odds, Inkombank did obtain 10 million rubles in credit.
Over a ten-year period Inkombank grew in deposits and acquisitions. By the time of the financial debacle of Russian in August of 1998 Inkombank had become the second largest private bank in Russia in terms of private deposits and third largest in terms of assets. It played a significant role in financing Russia's foreign trade. Under Vinogradov's direction Inkombank engaged in some high flying financial transactions. Inkombank acquired financial control of some of the businesses that made investments in it, including Sokol in aircraft manufacturing, Transneft, the gas pipeline operator, and Magnitagorsk Steel. In 1996 the Central Bank of Russia cited Inkombank for having inadequate reserves for a bank. This resulted in some loss of deposits but Inkombank survived and Vladimir Vinogradov was made vice president of the Association of Russian Bankers.
Inkombank along with many other Russian banks was severely hurt by the financial turmoil of August 1998 when Russia defaulted on its bonds. Inkombank was insolvent, its assets falling far short of its liabilities. Despite an antagonism between Vinogradov and officials of the Central Bank Inkombank was granted $100 million in credit to allow it to survive, but it only survived temporarily. Ultimately Inkombank was declared insolvent and there were accusations that the management illegally transferred funds from the bank to subsidiaries outside of Russia.
Mikhail Friedman came from the western Ukranian city of Lvov, a formerly Polish city acquired by Soviet troops in the partition of Poland by Stalin and Hitler in 1939. Mikhail Friedman came from a Jewish family, as did four of the six other oligarchs. Mikhail Friedman enter a Moscow institution of higher learning in Moscow. In the 1980's, the declining years of the Communist system, the necessities of life were available without much effort. The living standard was low but, and perhaps because of this, people did not have to exert much effort. This was the era characterized by an anonymous Soviet citizen who said,
They pretend to pay us and we pretend to work.
This period of a low level of responsibility combined with the assurance of the necessities for survival is one that some look back on nostalgically. While the luxuries of life were unavailable there was the leisure to read and discuss literature and the arts. In the Soviet system there was support for theatre, dance and so forth, but the tickets were distributed on a political basis rather than through the market. People who wanted tickets had to have contact with someone who could obtain them or who could wait in line to acquire them from the official sources. Some students were making money by acquiring tickets and reselling them or waiting in line for other people. The students engaged in this black market ticket business were known as the Theatre Mafia. Mikhail Friedman saw the opportunity to systematize these processes. He made the black market ticket operations into a real business.
He not only acquired valuable business experience but he made business partners that joined with him in forming the Alpha Group, a conglomerate dealing in oil, finance, and industrial goods trading. He also learned to payoff the political establishment to get the things he wanted.
The Alfa (Alpha) Group was not formed immediately. Instead Mikhail Friedman was involved in small business ventures in the form of cooperatives. Cooperatives were permitted under Gorbachev's perestroika policy. One of the first major successes was in providing window washing services for state companies. No one had thought to create such a business before. From this success Friedman and his associates moved into importing and exporting. It was very profitable to export oil since the purchase price of oil in the Soviet Union was far below the international price. It was also very lucrative to import computers. Friedman and his associates engaged in both of these activities. But to do that they had to share their profits by paying bribes to the bureaucrats who controlled the system.
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