Date: Thu, 26 Feb 2009
Subject: Part 2, 2009 Crisis Attached
From: Paul Backer <pauljbacker@gmail.com>
The 2009 Financial Crisis, Russia and CIS
Part 2. Structural reasons driving the 2009 financial crisis and Cassandra 101.
By Paul Backer (pauljbacker@gmail.com)
There is a profoundly annoying aspect to the 1998 crisis. A few of us expats were around and survived it. Most got knocked down and muddied a bit, but survived. We are the ones who have the right to wear the “Russia had a 1998 crisis and all I got was…” t-shirts. But now, a decade after the events, apparently everyone predicted it. They all saw the 1998 crisis coming. Talking heads confidently declaim on its inevitability.
I was there and didn’t see it coming. So, it’s kind of like my crisis, and now I have to share it. How is that fair? Tragically, even after the fact, I am not sure how much of 1998 was inevitable and how much of it “jumped the shark” like LTCM. You remember them, the folks who went broke after a Nobel economics laureate helped mathematically prove that they couldn’t go broke.
I lack predictive ability, and therefore the Cassandras vex me. My core responses to the self proclaimed successful fortunetellers of 1998 are “if you are so smart why aren’t you rich?” With a little of “why are your kids so ugly?” thrown in if they are rich. Admittedly, it’s not much. Luckily, an advantage of middle age is that some of my friends are gaining weight and others are balding, so there are a number of other intellectually valid points that I can score.
The current crisis profoundly differs from the “all at once” dues ex machine events of 1998. Its start in February - March of 2009 was largely inevitable and predictable, because the 2009 crisis is driven by key structural factors specific to the Russia/CIS region. It’s a crisis of no operating funds, no credit, no investment and no hope. The longer version follows:
1. Structural legal system deficits. The Russian legal system in particular, and CIS and Ukrainian legal systems generally, fail in the timely enforcement of contractual payment obligations. Not “fail” in the “vast conspiracy against us, because they hate our freedoms” way claimed by expat partners of major law firms over drinks at the (not entirely closed yet) GQ Restaurant to explain why they don’t win cases off their U.S./ U.K. home turf.
The legal system fails, because the civil, procedural and notification rules can be managed to put off a court decision by 12-18 months from start of suit. This may have significant tactical utility for individual companies seeking to put off due payments. But, it spells disaster for the system as a whole if court enforcement can be put off for a year or more by anyone with a halfway decent legal team. Once the crisis made reputational concerns irrelevant, the non-payment crisis gained steam. Payments due in November - January 2008/9 were not made and companies began running out of operating funds in February and nowhere to borrow.
2. Lack of meaningful judicial penalties for nonpayment. Not only is it possible to delay judicial reckoning by a year or more, there is very little penalty for doing so. RF courts generally limit damage awards to the RF CB refinance rate, around 13%. CIS and Ukrainian courts routinely fail to award meaningful damages for contractual breach. If a company chooses not to pay, the worst damages they are likely to face is 13% or half of the going commercial lending interest rate in Russia, CIS and Ukraine (in the unlikely case you can get credit) or less than a third of the consumer interest rate on ruble consumer credit (45% credit card rate at VTB24 for example). This may be useful to individual companies seeking to stave off payments due, but it’s disaster for the system as a whole.
3. No more Mr. Nice Guy. Once the nonpayment crisis got going, exacerbated by the global and local factors, the incentive to fight clean went out the window. Virtually no one in Russia or Ukraine or Kazakhstan is seriously planning to IPO or Eurobond Spring or Summer 2009. Foreign investors are largely, a fond memory. As of February, most focus on surviving the next six months. It’s a clever idea to invest in distressed companies. Not so clever, when your local competitors are litigating every issue and looking to win.
Today, every conflict gets litigated out, and it’s no holds barred litigation. What does no holds barred mean? Enjoy your expense accounted dinner at Galleria with your big international law firm, and then get lawyers who can effectively go to the mattresses for you. Do business in central Moscow? Don’t be surprised to be litigated against in a suburb of Kemerovo or Yakutsk by a 0.0001% equity holder (see Telenor). The strangest law suits wind up in Omsk or Yakutsk or Attarau or something. Now is not a great time to pay $800 per hour plus VAT for travel for someone to fly to Yakutsk.
Litigation got metaphysical. The very existence of transactions is being actively litigated, no damages asked for. Why? If one can prove that a transaction wasn’t legally concluded, odds are local courts won’t enforce it. It’s a logic loop that can take a couple years and a few philosophers to resolve. Meanwhile, someone has someone else’s money and the operating cash crunch worsens.
4. Collapse of white collar, upper and middle class finances. Persons legally laid off at the end of 2008 received two months’ severance mandated by law. The subsidy runs out in February March of 2009. Persons working under (the somewhat illegal) term contracts were let go in January and February without any severance, with many of these contracts simply not renewed. Predatory consumer lending rates at 40% to 60% per annum by RF and CIS banks only exacerbate consumers’ problems.
Those with some funds are precipitating a savings crisis through ceasing to consume. Those with a great deal of money lost a great deal of it by… let’s borrow a particularly ugly bit of financespeak: highly leveraged mistargeted investment. The financial losses of the truly wealthy are reputed to run at 70% to 80% of networth. The net result, cessations of personal and investment spending starting February March 2009.
5. Absence of real time accounting at most RF enterprises. Most RF enterprises run 1C, it’s a nice enough piece of accounting software, but it’s not exactly a substitute for real time financial reporting and analysis. Neither is the previously mentioned $800 per hour plus VAT consultants, they are mostly strategy oriented. Strategy like: make more revenue, have fewer expenses, you know… the good stuff. Though maybe, the consultant can use the McKinsey brick to pummel the local $1,000 a month accountants into greater efficiency. Admittedly, it’s not nice to kick folks when they are down, but couldn’t the $800 per hour include VAT?
Majority of RF enterprises only became aware of how bad things were financially in January February of 2009. Making layoffs and other spending cuts much less managed and much more dramatic than they were in the U.S. and Europe.
What does that mean for your business? First, we are at the beginning of the real crisis. Second, while various government incentive programs can and will have some impact, they can’t change the dynamic of a structural crisis. It can be reasonably expected that consumer spending in Russia other than food and core necessities will be at a standstill through Summer of 2009. The key consumers for Western goods and services are entering financial shell shock during this period and Russia may encounter a “savings crisis” with consumers hoarding whatever limited cash is available to them.
Many consumers are entering unemployment without meaningful savings. Many core consumers for Western goods and services are carrying USD denominated vehicle, business and mortgage loans and, if employed, receive ruble salaries, making these obligations roughly 50% more expensive than six months ago. It’s largely the same story for RF companies with USD and Euro denominated debts and acquisition expenses.
Payment obligations are not being met by companies to each other and cannot be compelled in less than 12 to 18 months through the judicial system. Concerns such as public relations and reputation are virtually out of the window. It is a situation where local companies and businesses stop pretending that they are Western companies and use absolutely every tool and combat handhold available.
But, why would anyone do business here if they don’t love a challenge? The crisis is just that, a challenge, it’s not a death sentence. Nothing that happens in a region of a quarter billion people is a death sentence to any one company selling any one type of widget. It’s an opportunity. A chance to roll up your sleeves, man up, fight the good fight and possibly, win. Could predicting disasters ten years after the fact really be a satisfying substitute for being the Happy Warrior, the one still standing during and most importantly, the current one?
It is my sincere hope that there may be some generally useful stuff in last year’s articles, that you may want to take a look, as I want to focus in future Parts on actionable steps going forward.
Next Part, save on Real Estate and use your lawyers to get Moscow real estate at $28 per m2 per year. Seriously.