TIME: Almanac 1995

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<text id=94TT1123> <title> Aug. 08, 1994: Russia:Poof Go the Profits </title> <history> TIME--The Weekly Newsmagazine--1994 Aug. 08, 1994 Everybody's Hip (And That's Not Cool) </history> <article> <source>Time Magazine</source> <hdr> RUSSIA, Page 44 Poof Go the Profits </hdr> <body> A pyramid scheme collapses, infuriating investors and triggering the country's worst free-market crisis By Barbara Rudolph--Reported by Sally B. Donnelly/Moscow Elsewhere, savvy investors might have smelled a rat earlier. But this was postcommunist Russia, where capitalism is wild, woolly and new. The come-on, in any event, had been slick and seductive: pervasive TV commercials that wafted visions of apartments in Paris and vacations in California, and preposterous returns of 2,000% annually with no minimum investment. With those tactics, it did not take long for 5 million Russians to pour money into the offices of the MMM investment firm, the country's biggest and best-known stock fund. Then came the painful lesson: things too good to be true usually aren't. Last week investors learned the hard way about the old-fashioned Ponzi scheme. MMM suddenly collapsed. By week's end thousands of investors swarmed around its Moscow offices, trying to redeem their pieces of paper. Many of the shorn had come from the Moscow Commodity Exchange on the other side of town, where windows were broken before they were told to try their luck at the company headquarters instead. On Saturday that market evaporated when the company folded up shop, and shares that had dropped from a high of $62 to 50 cents last week were worthless. A regularly scheduled meeting of the Cabinet was devoted almost entirely to the most dramatic financial scandal since the fall of communism. The debacle had been building for much of the week, as crowds of concerned shareholders camped outside MMM's building, waiting, mostly in vain, for the company to redeem their certificates. Police and Interior Ministry troops stood guard to intimidate potential troublemakers. There weren't many. The few lucky enough to exchange their shares for cash stumbled out of the building, with cardboard boxes and plastic bags bulging with rubles, to shouts from the assembled crowd: "Is there any money left?" A few yelled imprecations on Prime Minister Viktor Chernomyrdin and central bank chairman Viktor Gerashenko, but many were simply philosophical. Mira, a chemistry researcher who earns 60,000 rubles, or $30, a month, stood in line for 24 hours, hoping to redeem 70 shares. "Hey, it's a risky game," she shrugged. And it is still being widely played. MMM is by far the largest investment fund in Russia, but about 600 other funds, along with countless phony companies that sell stock themselves, continue doing business. Economists are worried that some will soon fold. A few have already blazed the way. Last spring, for example, the operators of the Independent Oil Co. simply disappeared after collecting $3.8 million from investors in exchange for promises of fat profits after just three months. MMM is the handiwork of Sergei Mavrodi, who is in his late 30s. Overweight and partial to expensive Italian suits, Mavrodi called himself an entrepreneur--the label covers a lot of ground in Moscow these days--and recently appeared in a newspaper survey as the sixth richest man in the country. He launched the MMM fund in 1992 with 100,000 rubles, worth about $50 today. Like all pyramid-type schemes, his snowballing effort worked well for a time. Shares priced in February at 1,600 rubles (the equivalent then of $1) traded at 105,000 rubles two weeks ago. Mavrodi apparently was paying off old investors with money from new ones. Then the fund could no longer keep up with its promised returns; most of its money was sunk into hard-currency speculation and short-term loans, and it held few assets of any value. The house of cards began to topple on July 22, when the government, belatedly trying to apply limits, announced that MMM would not be allowed to issue new shares. That triggered a selling stampede. At week's end, as he surveyed the wreckage around him, Mavrodi took the offensive and tried to blame excessive regulation for his troubles. "There is every indication that the authorities have little concern for the interests of shareholders," he wrote in a letter to a newspaper. "What is more important to them is to decapitate MMM." Even as the crowds milled in front of the MMM offices, the fund's commercials continued to appear on television. Most Russians were not buying Mavrodi's antigovernment argument: even such opponents of President Boris Yeltsin as Communist Party leader Gennadi Zugyanov and aspiring presidential candidate Alexander Rutskoi remained silent about the debacle and the government's role. The MMM fiasco has already prodded the government into more energetic regulation of the country's unfettered capital markets, but how effective it will be is anyone's guess. The Cabinet announced it would direct the Finance Ministry to move toward establishing regulatory procedures, but that responsibility is shared with the central bank and the State Property Committee. It is far from clear how--or whether--the three agencies will coordinate their efforts. Meanwhile, more Russians are likely to learn capitalism's most painful lesson: rewards and risks are inseparable. In the long run, that may not be the worst thing that could happen in a country where the entire population used to look to the state for everything. </body> </article> </text>