Russia's Big Bang

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Given how rapidly Russia moved from near-bankruptcy in 1998 to what seemed like unprecedented prosperity in 2007 and early 2008, perhaps we should not be surprised that Russian financial markets have been hit even harder than those in the United States, Europe and Asia.

In addition, the original oligarchs, along with the new ones who rose to wealth with former President Vladimir Putin's help, have suffered especially large reversals. Billionaires from Oleg Deripaska to Roman Abramovich have lost more than $230 billion as the combined wealth of Forbes magazine's 25 richest Russians tumbled 62 percent from May 19 to Oct. 6, Bloomberg reported. How did all of this happen?

Several factors have come into play. First, banks around the world traditionally compete to lend money to those who are already rich since wealthy debtors are more likely in normal circumstances to be able to repay those loans. They usually have lots of the collateral that the banks require before they will make such loans. In most cases, the collateral is stock in corporations that are listed and traded on exchanges in various parts of the world. What better collateral could there be than stock in oil or gas companies, especially when the price of a barrel of oil rises to as much as $145, as it did this summer.

But why would oligarchs need or want to borrow money? Don't they have enough? More often than not, they borrow so they can become even richer by buying up control of more stock or developing another oil field or building another factory. To a bank lender operating in normal economic times, it is hard to find better borrowers. That explains why banks not only in Russia but around the world fought with each other to see who could offer the most generous terms to those on the Forbes magazine list of billionaires.

But when a few lenders and banks came to realize that too much money had been lent out and that many of the borrowers would not be able to repay their loans, those banks and lenders decided to stop lending. They also demanded repayment of the loans they had already extended. This in turn triggered a general concern among Russians about the health of the country's economy and whether their deposits were safe. This is because banks usually do not keep all their money in cash in the vault; they lend it out. But if the loans cannot be repaid, then the banks may not be able to return the money to their depositors.

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Naturally, this concern can easily cause panic among other depositors. To protect themselves, many lenders decide that it is unwise to lend to other banks, businesses and individuals. They fear that those borrowers will not be able to repay those loans or that banks will not have enough cash for their depositors to withdraw money. This causes even more panic for depositors, risking a full run on the banks.

Although Russia has raised the level of federal insurance to cover the first 700,000 rubles ($26,800) of personal bank deposits in case of a bank failure, this new government guarantee program doesn't have the historical reliability or the scope of coverage that the U.S. Federal Deposit Insurance Corporation offers Americans. Thus, most Russians rightfully remain concerned about their personal savings.

More important, as the price of oil has dipped below $70 a barrel, the price of Russian energy stocks has fallen. This means that the collateral the banks have secured from energy companies may no longer be large enough to protect the banks should there be a default. Companies that produce commodities such as ferrous and nonferrous metals, which combined with energy companies account for almost all of Russia's industrial sector, have also suffered. To salvage what they can, the banks sell the collateral they hold, which of course means that the price of these stocks will fall even farther. That explains why giants such as Gazprom, Rosneft and LUKoil -- Russia's best credit risks before the crisis -- have all found themselves seeking more credit when they were forced to provide more collateral to those Russian and foreign banks. Moreover, Rosneft, the country's largest producer of oil after taking over most of Yukos' assets, had to respond to a margin call with more cash and stock when its own stock price fell and its banks no longer held enough collateral to cover the company's loans.

In the extreme case, the total value of Gazprom's stock, which only a few weeks ago had a value of $359 billion, has fallen to slightly more than $100 billion. Overall, Russia's market capitalization lost about $1 trillion since its peak in May. This wealth simply vaporized. Something similar happened to Deripaska, who until a few weeks ago was Russia's richest man. Because he could not ante up the additional collateral demanded by his lenders, among other losses he was forced to fork over ownership of his $154 million stake in Magna, a Canadian auto parts manufacturer that is a major supplier to General Motors.

Since the Russian stock market has fallen more than 70 percent since May, those who invested in the country have suffered badly. Yes, you could argue that this only directly affects a small group of Russian and foreign investors, but now there are signs that many Russians who do not own stock may also be hurt. For example, because of the sharp drop in automobile sales, Severstal has cut back steel production and employment by 25 percent in Russia and by 30 percent in the subsidiaries it has recently purchased in the United States.

If such unemployment should spread, this will surely lead to political unrest. It may also mean a rough time for Prime Minister Vladimir Putin and especially for Dmitry Medvedev, who had the misfortune to take over the presidency just as the country's economy began what already looks likely to be the country's worst financial collapse since the breakup of the Soviet Union.

Marshall I. Goldman, emeritus professor of economics at Wellesley College and senior scholar at Harvard University's Davis Center, is author of "Petrostate: Putin, Power and the New Russia," which was published in April.