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CHAPTER 8 The Bear's Bear Institutional Developments and the Crash of 1998 On August 17, 1998, Russian Prime Minister Sergei Kirienko announced a de facto devaluation of the ruble, a freeze on payments by the government of its forty billion dollar foreign debt, and a ninety-day moratorium on foreign debt payments by Russian banks. The economic and political consequences of this announcement were swift. Within a week the ruble lost more than 80 percent of its value against the dollar. The Russian equities market accelerated its yearlong decline and lost more than 20 percent of its value. Finally, on August 25 President Yeltsin removed Prime Minister Kirienko and his government and appointed Victor Chernomyrdin as acting prime minister. Within a month the head of the Central Bank resigned, and many of the oligarchs who had grown rich by financing the government were facing economic ruin as international lenders threatened to seize their assets held abroad. Most important, President Yeltsin failed to persuade the Duma to reappoint acting Prime Minister Viktor Chernomyrdin. Faced with the possibility of holding new elections that would likely strengthen his opponents, President Yeltsin nominated a candidate acceptable to his Communist rivals in the Duma to head the government. These moves marked the end ofthe first wave of Russian economic reform begun by President Yeltsin in January 1992. In retrospect, the financial crash of August 1998 seems to have been inevitable. Russia's persistent budget deficits, chronically low tax collection rates, endemic corruption, and failure to enforce hard-budget constraints on loss-making enterprises were common knowledge. In addition, the concentration ofeconomic and political power in the hands ofrickety Russian banks and poorly managed raw material exporters were oft-cited obstacles to stabilization . Yet in 1997 this outcome was far from certain. The Russian government was sufficiently confident to announce in advance a currency reform that promised to drop three zeros from the ruble on January 1, 1998. Given Russia 's recent history of confiscatory monetary reforms, the ability of the Russian government to fulfill this promise suggests considerable optimism. The currency had been relatively stable for several years, and inflation had fallen to only 11 percent in 1997. 193 194 Brokers and Bureaucrats Moreover, after six years of economic decline that had erased roughly 40 percent of GOP, the Russian econolny registered a small (0.4 percent) but positive rate of growth for the first time in 1997. As many believe that the State Statistical Agency understates the size of the informal econonlY, and that punitive tax rates encourage firms to underreport their output, the actual rate of growth was probably higher. In addition, foreign banks and governInents were willing to lend vast sums to Russia in 1997 indicating that they believed that Russia had turned the corner. (Lenders rarely make loans to countries that they expect to collapse unless they believe that the IMF will bail them out, which may have been the case in Russia.) Many governments have muddled through under worse conditions and a case could be made that a financial collapse of the magnitude experienced in the summer of 1998 was far fronl inevitable. What factors drove the crisis? What role did the markets previously depicted in the study play in the crash? Several important elelnents of the crisis were rooted in institutional failures on Russia's capital markets. First, the government's increasing reliance on Russian banks and the RCB for capital depicted in the last chapter proved problematic. In particular, the reliance on short-term financing from domestic and foreign sources and the failure to regulate the foreign currency operations of Russia's banks played significant roles in the crash. Second, the failure of the Federal Commission on the Securities Market, or any other government body, to protect minority shareholder rights on the equities market also accelerated the crash. Chapter 5 demonstrated that brokers could trade shares with confidence that other brokers would abide by the agreement. This chapter however, argues that institutions to protect shareholder rights on the equities markets were weak. Brokers could trade shares with relative ease but rarely had influence on majority shareholders-often the managers of firms issuing the shares. Minority investors who feared that their rights as shareholders would not be respected led the stampede fronl the equities Inarket in 1998. This chapter does not offer a full explanation of the causes of the crisis; instead, it focuses on how institutional factors in Russia contributed to the collapse of the financial systeln...

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