Economic meltdown to big freeze

James Turnbull, vice-president of Credit Suisse First Boston's legal department, is typical of corporate lawyers working in Moscow. He is young, well-educated, puts in long hours and is at the heart of attempts to rebuild Russia.

We met for lunch at one of the spanking new pizza joints that have sprung up all over the city. The restaurant stands in the shadow of the monolithic Intourist Hotel – a poignant reminder of the changes that have swept the country. In the bad old days, all visiting foreigners had to stay at the Intourist and were not allowed outside without a “guide” – a euphemism for the KGB caretaker assigned to them.

That was then. Russian economics has changed all that. Between the presidential elections of 1996 and the start of the Asian economic meltdown at the end of 1997, Russia went through a period of blistering growth. Then, on 17 August last year, the economy went into a tail-spin (see box).

The government defaulted on its T bills, the stock markets crashed – losing 90 per cent of their value – and businesses buckled as cash fled the country. It has affected everyone, including foreigners.

“It has been depressing. People got carried away when it was not justified,” says Turnbull.

“It is difficult to see how a country could go from being the darling of the markets one day, to an international financial pariah the next.”

But this is just what happened. And it took no more than a week.

It is this pole to pole action that makes Russia such an exciting place to be. Turnbull's daily routine includes two trips to the Reuters screens to see what is going on – the news having an immediate impact on your personal life in the way unheard of in the West.

In the days after the devaluation debacle, things went haywire and nearly all the progress made in the eight years since the fall of the Soviet Union was undone.

But by the beginning of this year, things had more or less settled down, and the process of clearing up the debris began.

Nonetheless, there is still a sense of impending disaster in the air. This year will be one of survival for Russia and it is not clear whether the country will get through it without another bloody nose.

As for his current work, Turnbull stresses the need to be pragmatic: “We are not suing anyone. We are trying to reach agreements with the agreement of the borrower. It is not that the laws are totally unenforcable, but we are taking a more pragmatic approach.”

“If we try to bankrupt a company, it will not help us to get our money back. It will have no income, no cash stream from which to pay us. We need to keep companies afloat, so they retain enough working capital to repay their loans.”

“In some cases, we may have to make an example and go to the courts. But people have tried this in the past. Six months' later they still have no judgment and, quite frankly, even if they do get one, the courts are so corrupt that the locals get to them.”

You need an affinity with Russia and the Russians to spend a considerable time in Moscow. It is not an easy place to be. “I came here when it was a land of opportunity; relatively unregulated and wild. Most people I know came here because they wanted to be a part of the process of turning Russia around and bringing it up to scratch with the rest of the world,” says Turnbull.

“It was an exciting time. I thought the Western financial institutions would help make Russia successful. I felt we were pulling with the Russians towards a common goal.”

But, with all its problems, Russia is far from being a third world country. The Soviet architecture is drab, of course, but it is interspersed with gleaming new office blocks and magnificent pre-revolutionary palaces. The basic infrastructure is in place, and the people are far from backward.

Turnbull is one of two foreigners in an nine-strong legal department, where no one is older than 31. It is the young who are doing the hard work in Russia. Age and experience count for little in a country that changes its nature twice a year.

Most people over 30 still have much of the “Homo Soveticus” mentality and lack the flexibility and optimism of those that have never worked under a centrally planned system.

“The Russians I work with are educated, driven and highly cultured. It is what gives me the most hope. They are the ones who are going to put Russia back on its feet,” says Turnbull.

“There is an amazingly strong sense of culture, and a classicism that you don't find elsewhere.”

The Russian education system remains one of the best in the world, even though it is crippled by a lack of funds. Turnbull works with some of the best talent of the new generation. But even taxi drivers can quote at length from Pushkin, Mayakovsky and Dostoyevsky, and even Shakespeare.

“We try to bring Western methods, financial structures and behaviour [to transactions], and translate all this in terms of legislation which was written without the legal concepts that underpin the law in the West.

“When I explain to my Russian colleagues what I am trying to achieve within the law, they often say 'you can't do that in Russia'.”

There are at least four bodies legislating at any one time, all of which overlap and contradict one another. And with sweeping constitutional powers, President Boris Yeltsin can fire off any number of decrees, while riding between his hospital bed and the Kremlin. Trying to stay on top of these changes is a full-time job in itself.

To add to the problems, business still has a fly-by-night character, with late nights and panicked phone calls being part of a normal working day. “There is an unbelievable pressure at work that you'd never experience in the West.

“The economy is moving so quickly that a deal which suddenly becomes very attractive, may not be attractive next week. The Russians were all brought up to believe that what is good today may not be there tomorrow, so when they act, they act quickly.”

But there are compensations for the harsh environment and long working hours. On the way to have his photograph taken – across Red Square and past the Lenin mausoleum, a stone's throw from the CSFB offices – Turnbull ruminates on why he stays in Russia. “The first thing is that you end up with a lot more responsibility here.”

“Secondly, although life in New York or London is easier in some ways, Moscow has a unique dynamic. Every visitor I have met has come with the notion that it would be drab – the preconceptions of Soviet conditions. They always go back shocked because there is so much 'life experience' to be had and, in some cases, it can get pretty wild.

“There are enormous disparities in wealth, but there are also no social boundaries like there are at home. Rich and poor, famous and notorious – you meet them all on a daily basis.”

He goes on to explode some other myths. There are no more queues outside the many supermarkets (although you still can't find everything you may want). At the last count, you were more likely to be murdered in Washington or New York than Moscow, because the mafia is more concerned with business than individuals. And although Moscow was once the most expensive city in Europe, post-crisis it has fallen to number 88.

Of course, there are other drawbacks. It is extremely cold in winter, when temperatures can fall from -5C to -28C in less than four hours. Then there is the fact that Moscow has not had time to work out what is “normal”, which often makes work erratic and difficult, but also means anything and everything can happen.

Turnbull, like other expats, stay in the country because of the pioneering nature of the work they do.

Russia has been through crises before, and everyone is confident it will eventually recover from this one too. However, given the current economic problems and uncertainties surrounding the presidential elections due in 2000, Russia will remain the “Wild East” for a while yet.

What went wrong in Russia?

Lawyers in Moscow can do little to make up the huge losses suffered by their clients, as Russia's economic collapse looks set to go down in history as causing the largest single credit loss to the banking community -$100bn, according to London-based rating company Fitch IBCA.

Last September, Credit Suisse First Boston (CSFB) announced it had written off more than $250m (£152m). It is a modest sum compared to banks such as Barclays and Dresdner, which have both reported losses of more than $500m.

In reality, CSFB has probably lost more-a lot more. Banking analysts believe CSFB was the largest foreign holder in the T-bill market and may have lost billions of dollars in this area alone.

The T bills, or GKOs, were a favourite with foreign banks as they provided high yields and were apparently the safest thing in the market because they were supposedly backed by the state. When the Russian government reneged and froze GKOs in August, foreigners were left holding more than $20bn of them.

On top of the GKOs were dollar forward contracts. As the GKOs were dollar forward contracts. As the GKOs were denominated in roubles, the banks signed forwards to lock in the exchange rate when the bondds were redeemed-usually three months later.

The Russian commercial banks had been doing great business with forwards, assuming the rouble would stay inside its exchange corridor under the supervision of the Central Bank.

When the government devalued suddenly, they had to pay out on contracts that assumed an exchange rate of, at worst, about seven roubles to the dollar, when the real rate was more than 20. The Russian banks were left owing their counterparties billions of dollars.

Then there was the stock market. Share values increased by more that 160 per cent in a year, only to lose 60 per cent of their value following devaluation.

Everyone got burned, and legally there is nothing anyone can do about it.

Foreign lawyers' jobs are pretty much unaffected. In the normal course of things, the likes of CSFB could sue the commercail banks for reneging on the dollar forwards, but the GKOs can only be taken up at state level. There have been talks in London to determine how to make Russia honour its GKOs, but little progress has been made.

As for the forwards, lawyers cannot do anything. The Russian regulator is unwilling to withdraw the commercial licences of banks that are all well connected politically, despite the fact that they are effectively bankrupt.

Over the past six months banks have been busily stripping themselves of assets-turning them into shells. The largest, Unexim, is blatantly defaulting on its exitsing obigations, and has stopped making its Eurobond payments.

This has sent a shiver through the market. Withour the backing of the Commercial Bank of Russia-the ultimate authority-the laws are meaningless. And this is something that can only be taken up with the UK government.

For in-house lawyers like Turnbull, the office is ticking over on whatever business the firm can drum up, and things will not pick up again until the government unfreezes the GKOs, forces the commercial banks to pay up, or investor confidence returns-which will not happen for at least two years.