Brokers Ponder Lessons of 1998

Any investor who dared to put his money into UES shares amid the 1998 financial crisis would have seen his portfolio skyrocket 15-fold by now.

But few did.

In October 1998, 102 companies that had failed to pay quarterly fees lost their membership on the benchmark RTS stock index. Many brokerages were killed in action shortly thereafter.

Among the casualties were Deutsche Morgan Grenfell, Flemings-UCB, Rinaco, Yukos-Invest, Raiffeisen Bank Austria and Regent European Securities. Credit Suisse, which accounted for 80 percent of equity trading with foreigners in the mid-1990s, quickly downsized and transferred the remains of its brokerage business to London. The bank made its last deal on the RTS in January this year.

Amid the turmoil, Adam Elstein, the head of Bankers Trust in Moscow, coined the immortal phrase, "After this, Western investors would rather eat nuclear waste than buy Russian debt," in an interview with The Wall Street Journal.

Now, five years after the start of the Aug. 17, 1998, crisis, two key questions remain: Why were brokers and bankers so blissfully unaware of the dangers looming on the horizon, and could they end up on the wrong side of the judgment call again?

"People underestimated the nature of dysfunction in the government and they were making a great deal of money," Alfa Bank chief strategist Chris Weafer said. "There was no reason to rock the boat."

Weafer arrived in Moscow three weeks before the crisis, which was sparked by economic turmoil in Southeast Asia. He had observed the fall of the Thai baht as the head of research for NatWest's regional office.

At that time, Russian margins were thick -- a broker easily made a profit of 1 percent to 2 percent selling second-tier stocks in 1997 and even more before that.

Apart from a failure to understand the macroeconomic risks and greed, a lack of experience also weighed in.

"I was just a kid out of college at the time," said Nick Betsky, 35, senior equity sales manager at the Aton brokerage.

Betsky, who was then selling equities for Pioneer Securities, said since then he has started looking at the numbers much more closely and become a better adviser.

"I had never experienced a bear market before, only the bull market," he said.

Betsky moved to Canada in 1998 before deciding to come back to Moscow in 2001 to participate in another bull run on the RTS.

Bankers said the crisis changed the face of the industry forever.

"Before the crisis, there was a great deal of guesswork," Weafer said. "It was a momentum investment."

Before August 1998, foreigners accounted for three-quarters of the average brokerage's client list, whereas now they represent about a quarter of the market, said Dan Rapoport, who recently returned to become chief executive of a revamped CentreInvest Securities after a two-year break from Russia in the south of France.

"People are very much aware of the Russian risk now," said Richard Hainsworth, head of the RusRating agency and a banking analyst with Renaissance Capital.

Hainsworth, who in 1998 was the local representative for Thomson BankWatch, said he advised a friend to take his money out of Inkombank on Aug. 10, just two days before the bank stopped processing payments.

"It was clear that something was happening," Hainsworth said.

Thomson BankWatch saw its money frozen in Dialog Bank in 1998 but later used it to offset taxes.

This August, brokers and bankers are once again bullish on the market -- and they have good reason. The RTS, which hit the floor at 37 after the crisis, ended at 510.84 on Friday, up 8 percent on the week. Unified Energy Systems, which fell below 2 cents per share in October 1998, was trading at 29.5 cents.

"We are talking about macroeconomic risks -- inflation, rates of growth and other normal issues," Weafer said. "But it is a question of whether the RTS index goes to 400 or 600, not whether it goes to 37."

Coast Sullenger, who manages two funds for Lombard Odier Bank in Geneva and who was head of sales at Pioneer Securities in 1998, is also upbeat.

"Resource stocks are gaining momentum after years of underinvestment and neglect," Sullenger said. "Russia is perfectly positioned to benefit from this."

Pioneer sold its brokerage business in the wake of the crisis.

Market insiders say that no matter what happens, there will be no return to the pre-1998 stone age.

"Before the RTS was introduced in 1995, prices were written in chalk on the blackboard, and traders went back and forth to put fresh quotes when the market moved," Sullenger recalled. "When you look at it in retrospective, it is like going from the abacus to using a calculator."

In 1994, about half of all trades were never closed because sellers refused to deliver securities when prices increased after the deal was made.

"I decided to retire in 2001, but I could not resist the temptation to come back," Rapoport said. "This is why I want to build an investment boutique focusing on second-tier stocks. There is no way one can make money in blue chips unless you have large turnovers."

He said that when foreign money starts pouring in from mutual funds, local brokers will not be in position to serve them.

"They will deal with brokers from the top 10 approved list," he said, referring to lists drawn up by mutual funds themselves.

He added that the industry remains oversaturated with brokers, as it was in 1997.