You have probably heard of the Albanian personal-savings pyramid scheme that started a revolution. Or maybe the Odessa municipal-bond pyramid scheme that helped to unseat and damage the reputation of a popular mayor.
In terms of the sum of money involved, and the profits to be made, the pyramid scheme run by the Ukrainian government far surpassed those rivals.
Imagine a pyramid scheme, 'guaranteed' by a government, in which you invest one hryvna and get four hryvna back. It works, for simplicity sake, like this. You double your money after the first year, and quadruple it within two years! Bonanza!
Just such a get-rich-quick scheme has been operating in Ukraine for the past few years. Its sponsor was the Ukrainian government. Its major players were Ukrainian and foreign banks.
Since March 1995, the Finance Ministry has sold treasury bills maturing after three months to one year. Initially the interest rate was 100 percent per annum; it has fluctuated greatly but has never been much less than 50 percent and has usually been much more.
Similar bonds offered by Western governments provide only 6 percent to 8 percent interest. The Ukrainian government, unable to reconcile its weak tax revenues with its subsidy-laden budget, was so desperate for money that it was offering what could only be described as astronomical rates.
For the past three years, the Finance Ministry has been continually paying off T-bills as they mature. But since the government had used the money initially received to keep the state budget at least somewhere near solvent, the only way the Finance Ministry could pay off the bills was to sell more and more.
By June 26, 1998, the ministry had paid out Hr 12 billion for maturing T-bills and had another Hr 9.7 billion to pay by summer 1999. Horribly complex math is involved in calculating how much of that 21.7 billion was original principal (channeled to the state budget) and how much is mere interest (sometimes recycled many times over), but clearly the bulk of the Hr 21.7 billion falls into the latter category.
By the end of August, the Finance Ministry's outstanding T-bill debt had grown to almost Hr 11 billion, and it was clear the ministry could not continue to service the pyramid scheme by selling off more T-bills. Investors saw the end coming and stopped buying bills.
By that time, payments to the banks to service the T-bills were literally draining the national treasury dry. The only way to keep the scheme rolling along was to have the National Bank buy the T-bills itself.
In August the government asked resident banks to voluntarily convert their T-bills into bonds maturing in 2001-2004. The government wanted a reprieve, a time-out from the mess it had gotten itself into. The resident banks held about Hr 2 billion worth of T-bills, and the government hoped they would cooperate in the national interest.
However, for many of the Ukrainian banks, T-bills were their primary source of income. They stood or fell from the profits they made from T-bills. Unlike in the West, where banks make money by making loans and investments, Ukrainian banks had very few customers for loans as interest rates were over 100 percent.
By late August, the government, surprisingly, had succeeded in convincing 16 resident banks to voluntarily convert T-bills maturing in 1998-1999 into bonds maturing in 2001-2004. But that only amounted to Hr 803 million or 35 percent of the T-bills held by resident banks.
The majority of resident banks refused to go along with the conversion. They felt they could not be solvent without the profits made from the T-bills.
For non-resident investors, who are owed Hr 1.7 billion, the government offered a superior deal. They have been asked to agree to swap their T-bills for new bonds with minimum interest calculated in dollars to mat-ure in the year 2000. Three foreign investors, Merrill Lynch (Hr 739 milion), ING Bank (Hr 327 million) and Credit Suisse First Boston (Hr 104 million) hold most of the non-resident T-bills.
They are expected to agree to the government terms because they fear that if they don't the government might not pay them any money at all. But what guarantees are there that the government will have the money to pay in the future for the converted bonds?
The Russian crisis came as a golden opportunity for the Ukrainian government to find its way out of the pyramid scheme it created for its investors. It could use the crisis as an excuse to force the banks to accept a postponement of money due for the maturing T-bills.
In secret, on Sept. 10, the Cabinet of Ministers adopted a resolution stipulating that T-bills held by resident banks were subject to conversion without the holders' consent. On Sept. 12, the Finance Ministry and the National Bank faxed resident banks with the news that T-bills held by them had been converted into bonds maturing in 2001-2004.
Most of the banks were outraged. The bankers regarded the government decision as a default and some saw their banks going bankrupt. However, nothing of this appeared in the mass media, as the government and the bankers created a wall of silence so as not to create a run on the banks as had happened in Russia.
The affected bankers were not about to accept the terms forced on them.
On Sept. 14, bank representatives met with National Bank head Viktor Yushchenko and Deputy Finance Minister Andry Lytvyn to demand cancelation of the government's unilateral decision to restructure T-bills. They came away from the meeting with hope that the Cabinet of Ministers resolution might be changed.
On Sept. 15, the bankers met Prime Minister Valery Pustovoitenko to once again ask that the government rescind its decision. This time the bankers came out of the meeting claiming that the forced conversion of T-bills would be canceled in the coming days.
Indeed, on the same day, the National Bank informed the bankers that the T-bills were not subject to forced conversion and that the government's obligations to them would be met.
The Finance Ministry informed the banks that the 'main conditions for voluntary conversion, details of which will be sent to banks,' had been set during a Sept. 15 meeting between Prime Minister Valery Pustovoitenko and bankers. However, those details have yet to emerge, and there still has been no announcement of any Cabinet decision to rescind the conversion order.
The joker in the pack in the government T-bill scheme is that more than half of the T-bills were bought by the National Bank. Out of the Hr 11 billion owed by the Finance Ministry, Hr 7 billion or 63 percent of the total is owed to the National Bank.
In that part of the scheme, there was not any gain or loss for the government; the money just revolved from one office to another. The enormous amount of interest received by the National Bank was returned to the Finance Ministry to buy more T-bills.
What was the point of the government buying its own T-bills? To create the impression that there was a great demand for T-bills? What will the result be?
It's hard to imagine the government collecting enough taxes to pay off the bills held by the National Bank. Most likely, the National Bank will have to create the money with which to pay itself back. The hryvna may still have a long way to slide before it bottoms out.
