Segment 1 Of 2 Next Hearing Segment(2)
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RUSSIAN MONEY LAUNDERING
TUESDAY, SEPTEMBER 21, 1999
U.S. House of Representatives,
Committee on Banking and Financial Services,
The committee met, pursuant to call, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach; Representatives Roukema, Bereuter, Lazio, Bachus, Royce, D. Weldon of Florida, Ryan, Biggert, Terry, LaFalce, Vento, Frank, Waters, Velazquez, Bentsen, Sandlin, Inslee, Moore, Jones, and C. Weldon of Pennsylvania.
Chairman LEACH. The hearing will come to order.
The committee meets today for its fifth hearing on international financial issues this year and the third on Russia and corruption over the last twelve months. The hearings today and tomorrow will be followed this fall by others dealing specifically with Western financial assistance strategy, including the International Monetary Fund, regulatory issues attendant to preventing financial crimes, the depth of the crime and corruption problem in Russia, Russian use of offshore financial institutions and the intertwining of those institutions with the United States and other Western banks, the role of public and private United States advisers in Russia's transition to free markets, the role of the U.S. intelligence community in monitoring Russia's Central Bank and other monetary and banking matters, as well as other concerns.
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Today, we will begin with an examination of recent allegations that corrupt Russian groups and individuals have infiltrated Western financial institutions. In this regard, we invited several witnesses who, according to various reports, have material knowledge of these matters, but who have declined to appear voluntarily before the committee, including Natasha Kagalovsky, former head of the Eastern European Division, Bank of New York; Lucy Edwards, formerly with the London office of the Bank of New York; Bruce Rappaport, Chairman and CEO of the Bank of New York Inter-Maritime; Mikhail Khodorkovsky, Russian oil industry executive; as well as the chairmen of several Western money center banks.
As the hearing process continues, it will be my intention to seek witness subpoenas where appropriate. We also invited Carla del Ponte, the former Chief Swiss Prosecutor. She could not come, because she took up new functions at The Hague yesterday, but she sent a statement outlining a new aggressive Swiss policy toward the scourge of money laundering which involves a hard look at Russian corruption. I invite the committee's attention to her statement and would ask unanimous consent it be placed in the record.
I also invite the committee's attention to a letter from the Honorable Yuri Skuratov, the Prosecutor General of Russia, who also was invited to testify. Mr. Skuratov notes that he is ''unfortunately'' unable to come this week, but observed that he is ''deeply convinced that the forthcoming hearings will allow him to develop valuable recommendations to the financial and law enforcement structure of Russia and the United States of America in counteracting infiltration of dirty money into our financial systems.''
Mr. Skuratov has offered his personal cooperation with the committee's work. Significantly, two days after receiving the committee's invitation to testify, his apartment in Moscow was ransacked.
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It is my intention that the first of our subsequent committee hearings on Russia will focus on Western assistance strategy for Russia and the possible diversion or misappropriation of those funds. Last month, Mr. LaFalce and I commissioned a GAO study to examine the effectiveness of the $90 billion in Western assistance for Russia, particularly in light of problems of corruption and the power of the so-called ''oligarchs.'' But recent developments warrant an additional in-depth investigation of allegations of diversion or misuse of Western assistance.
In this context, I would advise in the strongest possible terms that the Department of the Treasury insist on a full and complete audit of the relationship between the Central Bank of Russia and the IMF, particularly the activities of the CBR in the foreign exchange and treasury markets in the period of July to August 1998. Failure to do so would undercut any remaining credibility of international financial institutions dealing with Russia. Likewise, I will request this week a full GAO audit of U.S. bilateral assistance to Russia, as well as a review of multilateral assistance efforts.
The global payment system is opaque and anonymous by design, and has been made more so by the technological advances of the past decade. The same technology that has produced such great benefits for the financial services industry and the world economy as a whole has also made it enormously difficult to trace the proceeds of illegal activity once a criminal succeeds in gaining entry to the payment system. In an era where funds can be transferred among multiple accounts on multiple continents in the blink of an eye, the challenges faced by law enforcement agencies, regulators and financial institutions in trying to track dirty money through the system are enormous.
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In this regard, one of the issues brought forth by recent reports of large money flows of questionable origin through Western financial institutions is the legal obligation of U.S. banks to report such activity to appropriate authorities. Under current law, depository institutions are required to file so-called ''Suspicious Activity Reports,'' or SARs, with the Treasury Department whenever they become aware of suspicious account activity or possible violations of law. According to press reports, it was the filing of a SAR by one of the banks that will be represented at this hearing, Republic National Bank of New York, that helped alert law enforcement authorities to the massive funds flow from Russia into other New York money center banks.
Let me just conclude by stressing that this is a hearing designed to help Russia and the Russian people. It is not a hearing designed to embarrass anyone. We want to look to Russia as a country with a great future, not as a country that appears to be imploding from within, and for this reason, I would like to take a moment to speak directly to the Russian people.
[Statement from Chairman Leach in Russian.]
At this point, I would like to introduce a group of Russian parliamentarians who are visiting us this morning. I would like them to stand.
You are very welcome. Thank you.
Chairman LEACH. Mr. LaFalce.
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Mr. LAFALCE. Mr. Chairman, I don't know whether to say that I agree or disagree with those latest remarks of yours, but I am sure that I agree in large part.
Mr. FRANK. Would the gentleman yield?
I would like to just say that some of us are glad now that we didn't vote for the English-only bill, because it would have gotten the Chairman in trouble.
Mr. LAFALCE. Mr. Chairman, thank you very much for holding these extremely important hearings. We have all become aware of the recent press reports revealing major problems in the areas of money laundering, diversion of funds, the crime and corruption in Russia that appear to have reached into the United States banking system. The situation has called into question the efficacy of our money laundering statutes and the monitoring capabilities of our international financial institutions.
I have long been concerned with the serious allegations of crime and corruption in Russia and the alleged infiltration of the country's government institutions by organized crime. Indeed, as Chairman of the Small Business Committee, I held hearings on this issue the last year I was Chairman, April 14, 1994, and then on May 12, 1994, where I had the pleasure of having the then-Assistant Secretary of the Treasury for International Policy and Financial Institutions, Dr. Summers, and we discussed this issue at considerable length at that time.
With your permission, Mr. Chairman, I would like to put into the record the opening statements that I gave at those two hearings in April and May of 1994.
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Chairman LEACH. Without objection.
Mr. LAFALCE. While we are not in any position to dictate how a country should run its internal affairs, we are fully entitled to an accounting of whether the funds provided by international financial institutions are to be used for their intended purposes. These funds involve significant United States taxpayer resources, and it is our duty to ensure that they are not misused.
At the same time, our National Security Adviser and the stability of the world's financial system demand our continued constructive involvement with Russia. As a democracy experiencing growing pains and still purging itself of the political and economic ghosts of its Soviet past, Russia continues to need our help. Isolating Russia and isolating ourselves from Russia would not be the solution. It would be counterproductive.
And so I see little to gain in the simplistic options some have suggested of abandoning as substantial and as troubled an economy as Russia's. I recognize there are challenges to continued engagement, and the memorable words of Sir Winston Churchill more than a half a century ago still ring true. ''I cannot forecast to you the actions of Russia; it is a riddle wrapped in a mystery inside an enigma.''
However, as painful and frustrating as the process might be, I know that the ultimate payoffs of our continued engagement with Russia are far, far greater than the risks. But it is time to ask some tough questions and to get answers that we need to make our policy of engagement work much better. We should continue to encourage economic and political reform in Russia, but we should also impose tough conditions on the assistance we give and find better mechanisms, if at all possible, for monitoring that compliance, and unless we can obtain the necessary cooperation from Russia to make that possible, our long-term involvement would be put at risk.
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I think there is one area of our policy that deserves particular scrutiny and hopefully will teach us some important lessons. I personally believe that a major part of what went wrong in Russia was the manner of the privatization program in Russia. This is not a new refrain for me. I had hearings on the privatization program. I have discussed this at length; I wrote to the President on this, and so forth.
Privatization can be very important, and it can first help achieve greater equity and new opportunity in the distribution of a society's wealth and assets; and second, can restructure key resources such as utilities, transportation, banks and trade companies to permit them to respond to market forces rather than government dictates. It can build up a small business and medium-size business class that can build up a middle-income structure within a country, that is, if it is done right.
But there is another approach to privatization, what I refer to in my letters to the President and in my hearings in 1994 as Mexican ''patron'' privatization and Russian ''nomenklatura'' privatization, and that, in considerable part, is unfortunately the road that Russia took. Russian privatization has most often come to mean the wholesale transfer of valuable state assets to a small group of tycoons who are more interested in taking value out of the country than investing in it. This type of privatization concentrates wealth and puts an economy at risk.
Dr. Summers, who testified on this before my Small Business Committee in 1994, I would appreciate at some point in your presentation today your analysis of what went wrong, what went right, what we can learn about managing such situations in the future and dealing with such situations.
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Let me now turn to the specific issue of money laundering. Of the many public policy challenges facing lawmakers, the law enforcement community and regulators today, none may represent as significant a threat to our financial system as money laundering does. You want to get at the root of crime, follow the money, follow the money, follow the money.
And the wholesale ''cleansing'' of illegitimate profits derived from criminal activities reaches staggering proportions, by some estimates, between $100 and $300 billion in the United States alone and perhaps one-half trillion worldwide. By comparison, this figure dwarfs the GDP of many, many nations.
Press reports have now alleged that up to $10 billion of possible illicit Russian money passed through one bank. That may or may not be accurate. That may or may not involve appropriate accountingdouble, triple accounting. It remains to be seen. The facts of the case are very sketchy. The criminal authorities are investigating. It would be most premature for us to pass judgment on any aspect of this case without a full accounting of the facts, and since there is a criminal investigation taking place, it might be some time before we have that.
Our Banking Committee did take a good look at money laundering in 1994 when we passed the Money Laundering Suppression Act. Up until recently, the emphasis on financial institutions' compliance with cumbersome paperwork requirements worked against the effective enforcement of money laundering laws. The 1994 Act made the reporting requirements part of the Bank Secrecy Act more meaningful and more useful to law enforcement.
But even with these targeted changes, we still learn of egregious cases that our regulatory system is supposed to catch, but misses. And often they occur in vulnerable emerging democracies like Mexico and Russia, places where the rule of law is still, unfortunately, not fully consolidated; and when the big cases strike, we begin to wonder whether the regulatory system, our first line of defense, truly works.
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I do believe, Mr. Chairman, that it would have been productive for us to examine regulatory issues in this hearing, which are ripe for revisiting, and I hope that in the very near future the bank regulators, who are not going to be here either today or tomorrow, will come before our committee to explain to us what may or may not be wrong with our current regulatory system. I would like to hear, for example, from the Federal Reserve, the regulator with respect to one bank that received a tremendous amount of publicity, the Bank of New York, for example.
With that, I thank the Chair very much.
Chairman LEACH. Well, thank you, John, and let me say that will be the subject of future hearings, which I outlined at the beginning of my statement.
Does anyone else have an opening statement?
Mr. BEREUTER. Thank you, Mr. Chairman. While I certainly do commend you for the obvious need to have the hearings on Russian money laundering, I appreciate the fact that you and Ranking Member LaFalce have apparently solicited the assistance of the General Accounting Office. Like the Banking and Financial Services Committee, we share a role in reviewing these issues with the International Relations Committee. I think that the bilateral assistance programs of the United States also need to be examined.
Page 10 PREV PAGE TOP OF DOC Segment 1 Of 2 While this hearing is on Russian money laundering, the Treasury Department, of course, has the major role for our Government's participation in making decisions on multilateral development banks. One of the most important, obviously, is the International Monetary Fund. I served as the Ranking Member for many years on the subcommittee responsible for oversight of the multilateral development banks, including the IMF, and I would urge the Chairman and Subcommittee Chairman Bachus that this is an appropriate time to examine the performance of the International Monetary Fund.
In my history here I have never failed to support authorizations and appropriations for the International Monetary Fund, but in light of what has happened, I do believe that it is time to hold in abeyance any further assistance from the International Monetary Fund to Russia. I also think I would have to cast a vote of no confidence on the International Monetary Fund in their activities.
It is clear to me that they gave bad advice to Korea and Thailand in the early stages of their financial problems, and thus they complicated the situation in those countries. It is clear to me that bilateral and multilateral funds were used to shore up the election opportunities of President Yeltsin to the disadvantage of the Russian people.
I believe that we certainly need to continue bilateral assistance programs for rule of law, for democracy building, and for Nunn-Lugar, working with a variety of governors and local officials that have managed to escape the ravages of corruption in that country.
All you have to do today is to go to Cyprus to see the impact of money laundering on its economy. It has become a center of money laundering for money coming out of the former Soviet Union, including Russia. Distinguished former members of Democrat and Republican Administrations in the past have told us here on Capitol Hill in the last several months that they estimate at least 30 percent of the financial assistance going to Russia has been outright stolennot just misused, but outright stolenand unlike the money stolen by the robber barons of the previous century in the United States, that money was not reinvested in Russia. We are looking at one track of money laundering activities these new barons moved out of Russia today.
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I do believe it is appropriate for us to examine the IMF and its role, and certainly to examine the bilateral assistance programs of the United States aimed at the central government of Russia today. For the past two years, Russian economists have been telling those of us involved in the Aspen Institute study seminars for some fifteen years, that financial assistance to the Russian central government has, in fact, been counterproductive. I urge my colleagues to think beyond money laundering, where we will focus today, on how the funds of the International Monetary Fund may have been used by false accounting, by false reports, by failed promises on the part of the Russian central government.
Thank you, Mr. Chairman.
Mr. FRANK. Mr. Chairman.
Chairman LEACH. Mr. Frank.
Mr. FRANK. Thank you, Mr. Chairman. There are two levels at which we have to proceed. One is the very specific inquiry into what was obviously serious wrongdoing on the part of people within the Russian government and the failure of some oversight mechanisms, and I think that is very important that we do that; but there is a second level, and I think it is important that we balance them.
The second level is recognition that we are dealing with a major nuclear armed power and the fact is that there is a tendency, I believe, not just here, but elsewhere, for Americans to exaggerate the extent to which we here in Washington can solve all the problems in the world. We confronted a situation in post-Communist Russia of grave danger and uncertainty. Indeed, we all do tend to focus on worst cases, and clearly the degree of theft and the consequent denial of resources to the Russian people is outrageous and should be focused on.
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What we ought also to remember, I remember some of the predictions that there would be mass starvation, that democracy would fall, that forces of the old Communist regime would take over, that a new kind of fascism would take over. There was also a more serious threat of nuclear proliferation. The second most heavily armed nuclear power in the history of the world was in this terrible state, and I say that, because when we come to the question of better oversight and better mechanisms, I think we should be very stringent.
When it comes to the question of American policy in general, I will be particularly interested to hear people tell me what the alternatives were. Obviously, we faced a very difficult situationthe world's other superpower, adjusting to not being a superpower, but still being superpowerful in terms of its nuclear weapons; a nation which had no tradition of democracy entering democracy; a nation that had no tradition of a market economy being led to a market economyand I don't doubt we should have done better. But there has to be a consideration of what our alternatives were. There has to be a consideration of what else we should have done.
I also think we are going to greet our old friend hindsight here today. Maybe I was absent that day, but I don't remember the day a motion was made on the floor of the House to cut off all aid to Russia. I might have been there; I don't remember it. I know many of us gritted our teeth and regretted some of the things that were happening, but the notion ofI guess there were two other alternatives to what we did in the grand scheme. One was to threaten the Russians with a cutoff and hope that that would produce better results. The other would have been to cut them off.
Page 13 PREV PAGE TOP OF DOC Segment 1 Of 2 I would like to hear all of those alternatives considered, because we have both technical and specific function of oversight of the IMF, but we are also Members of the Congress of the United States, talking about the broadest, most important strategic foreign policy questions we have. And I fear that there will be a temptation to offer no alternatives and simply to be critical of what has happened.
And, yes, we need to look at how we get better from here, but the notion that there was some clear-cut and obvious alternative to what we did, other than trying harder to be clear.
And with regard to the Yeltsin election, obviously I don't think people should be improperly influencing elections, but I have got to be honest with you, as I looked at that cast of characters that were running in Russia, I was rooting hard for Yeltsin. Things, as they said, have gotten a little bit better. I am under no temptation to return to the land of my grandparents. I have talked to my Aunt Frannie. She is happy she is still here and not back in Minsk or in Moscow.
So I am not suggesting everything is wonderful. I am suggesting that this policy has not been an unmitigated disaster, that there has, in fact, been a forestalling of much of the most negative suggestions about what might happen in Russia, and that the perspective we should take is that in a situation of great difficulty with very serious constraints on what we could do both bilaterally and through the IMF, let us look at how we could have done what we did better. And if someone has some grand alternative that they were advocating at the time and we didn't follow, I will be glad to hear about it.
Page 14 PREV PAGE TOP OF DOC Segment 1 Of 2 Chairman LEACH. Thank you, Mr. Frank.
Mr. BACHUS. Thank you. Welcome, Secretary Summers.
I would submit to my colleagues on the Banking Committee and to you that what Russia needs is a Moses, and I will say that again. What Russia needs is a Moses. They are coming from communism to democracy. They need leadership. They need a leader.
If you look at India, you had Gandhi. If you look at Czechoslovakia, which is a wonderful example of a country that in 1989 had Havel step forward. You have got Walesa in Poland; even some might say, Nelson Mandela. But what Russia needs is a leader.
I think a lot of us thought that Yeltsin was that leader and maybe it is the obstacles he has faced, but until we have that strong leadership in Russia, what we have seen is predictable. We have been having hearings for three years. We have heard about the mafia. We have heard about the oligarchs. We have heard about money laundering. We have heard about generals selling weapons, lack of effective government.
There is a lot of consternation. There is a lot of concern. There is a lot of the wringing of the hands here. There is a lot of questioning, a lot of groping for answers and solutions, what I would call ''chasing of rabbits,'' because there is just so much we can do, what Mr. Frank said. If there is not strong leadership in Russia, our options are limited.
Page 15 PREV PAGE TOP OF DOC Segment 1 Of 2 We met in June and we talked about Russia and the economic situation there, and I said at that time what Russia needed was time, and that is when I first compared their situation to the children of Israel wandering in the desert for forty years, trying to get ready to govern themselves; and saying thatand I introduced at that time a junior high schoolgirl's dissertation in Russia where she compared the Russian people to the children of Israel and the fact that they needed time. And she said that ''they had forty years, and we may need forty years.''
They need time, but they also need strong leadership. There was an article recently that said, ''Who Lost Russia?'' and I think that was inappropriate. But I do think it is appropriate for us to ask about who is leading Russia, who are we dealing with, who is calling the shots behind the scene and the IMF. If we continue to pump money into this country and the leadership is not there, we are going to continue to lose. So I would simply say that I am not sure we can have an accounting or an explanation from Russia.
How valid is it going to be? Can we rely on it? They have been giving us explanations. They have been accounting for what they have been doing, and we found out that a lot of it wasn't true. I would say this. I think what we need to do at this time is to focus on their leadership and not intervene, but until there is leadership in place in Russia, I am not sure what we can do.
So that would be at least another angle.
Chairman LEACH. Thank you. Does anyone else wish to make a statement?
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Ms. VELAZQUEZ. I ask unanimous consent to enter my entire statement into the record.
Chairman LEACH. Without objection, so ordered.
Ms. VELAZQUEZ. I would like to applaud you for holding this hearing in such a timely manner. While it is important that we explore the effect of Russian organized crime and money laundering, I would like to take this time to stress another aspect of the money laundering equation that seems to have been lost in this discussion so far, money laundering's close relationship to drug dealers.
In the United States alone, estimates put the amount of drug profits moving through our financial system as high as $100 billion. Money laundering provides the life of the drug trade, allowing dealers and other criminals to thrive and have devastating social and economic consequences in our communities. That is why some of my colleagues on this committee, including Chairman Leach, Ranking Member LaFalce, Representatives Roukema, Bachus and King, joined with me in passing the Money Laundering and Financial Strategy Act which was signed into law last year.
This Act takes three important steps in combining money laundering. First, it authorizes funding to help State and local officials combat money laundering. Second, it establishes high-intensity financial crime areas which will help concentrate the law enforcement resources in the areas where they are most needed. Finally, the Act mandates the Treasury Secretary to develop the first comprehensive national strategy to combat money laundering.
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All three of these initiatives are important in our fight against money laundering, but from a Federal standpoint the most important initiative is the strategy. Tracking down these criminals is all about following the money. The money laundering strategy, for the first time, provides law enforcement officials a road map to follow the money.
The money laundering strategy was due in February of this year. Although it took a while to complete, we have a good basis to continue our fight against money laundering, and I want to commend Secretary Summers for completing the first comprehensive anti-money laundering strategy in our Nation's history. The Treasury Department was ready to deliver the strategy to Congress at the end of last week, but I asked that it be postponed, because Members were out of town as a result of Hurricane Floyd. It is my understanding that the strategy will be unveiled later this week.
Since becoming Treasury Secretary, Mr. Summers has shown that this strategy is a priority for his administration. I thank him, as well as Deputy Secretary Eizenstat, Under Secretary Jim Johnson, Deputy Assistant Secretary Medina and Chief Counsel Stephen McHale. For those who have questioned our need for a national money laundering strategy, the developments of the Bank of New York case demonstrate the critical need.
One of the weaknesses in the current system is the lack of cooperation between financial institutions and law enforcement officials. In the case before us today, the Bank of New York did not file a suspicious activity report until after the Justice Department had subpoenaed account records. Had there been better cooperation between bank officials and Federal law enforcement, steps could have been taken sooner. In order for money laundering detection to work in the United States, there must be cooperation between banks and law enforcement officials.
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In most money laundering cases, the banks are in the best position to know if illegal activities are taking place. The anti-money laundering strategy addresses these issues and lists among its priorities enhancing the regulatory and combative efforts between financial institutions and law enforcement officials.
The most important aspect of this strategy may simply be that it is the first comprehensive national strategy. It puts in writing the goal for our fight against money laundering and how the various Federal agencies charged with fighting money laundering should work together. The strategy is a blueprint for building a coherent and effective anti-money laundering force, something clearly lacking now.
Thank you again, Mr. Chairman, for holding this important hearing, and I look forward to hearing from our witnesses.
Chairman LEACH. Thank you.
Mr. ROYCE. Mr. Chairman.
Chairman LEACH. One second. The Chair would like to suggest that if we can we hold opening statements to be as brief as possibleand let me say that we have a long day of hearings; and I recognize, as Chair, I started out with a long statement, but I am going to ask two minutes only, please.
The gentleman from California.
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Mr. ROYCE. I will be brief, Mr. Chairman. Thank you.
What we are examining today is a very serious issue, one that goes to the heart of U.S.-Russia relations, and it is worth noting, I think, that Russian corruption and the Administration's response to that challenge is not a new issue.
Three years ago this committee held a hearing on organized crime in Russia and the threat to international banking systems. We heard from representatives of the FBI, the financial crimes enforcement network, the Department of Justice, and we heard from recognized authorities on Russia; and during that hearing, I brought up questions of extreme capital flight and, most importantly, of accountability with respect to International Monetary Fund loans. Specifically, I raised concerns about the lack of money laundering laws in Russia and our own inability to impose standards on foreign banking institutions, and I questioned what guarantees we had that billions of dollars in IMF and international loans to Russia reached their intended recipients and were not, instead, diverted outside the country by organized crime.
Two years prior to that, in 1994, I said our aid to Russia should be conditioned on assurances from Russia's government, and our own, that all is being done that can be done with respect to monitoring and countering the growing threat of these crime syndicates before they can choke off the infant democratic experiment in the former Soviet Union. This is about countering a real threat to the chances for a successful transition in the former Soviet Union, and it is about stopping an international crime wave before it crests on our own shores.
Here we are five years and billions of dollars later and these questions may have risen to the level of a scandal. Unfortunately, not much has been done in the last five years. IMF Managing Director Michael Camdessus recently said it is impossible to determine whether specific capital flows from Russia, whether legal or illegal, come from a particular in-flow, such as IMF loans or export earnings. Apparently, once the IMF funds are released to the Central Bank there is no tracking where the moneyin this case, $10 billiongoes.
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American taxpayers deserve better. However, the New York Times recently reported that Clinton Administration officials learned of allegations of Russian money laundering at the Bank of New York five months earlier than they acknowledged, yet the Administration continued to rally for more aid to Russia, even though they were fully aware that these funds were not reaching the intended recipients and the intended recipients were the Russian people.
Instead of making a genuine effort on critically needed structural reform, the emphasis was placed on touting feel-good stories about dubious successes in the Russian economy. So, in the end, funds flowed to a Russia where corruption ran rampant. Anti-money laundering laws were actually vetoed by Boris Yeltsin, and politicians did little but throw up their hands and say, ''Well, that is the way things are in Russia.''
What I am interested in finding out today is whether the Administration has acquiesced to the cycle of corruption in Russia so it could claim reform in name only. Policies that turn a blind eye to real reform do irreparable damage to the process of democracy building. This does a tremendous disservice to the people of this country and to the people of Russia, and I look forward to hearing from our witnesses today.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you very much for that very thoughtful statement.
Ms. Waters, who was helping this committee on money laundering matters. Ms. Waters.
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Ms. WATERS. Thank you very much, Mr. Chairman and Members.
While there needs to be much said about the IMF and the way they have handled Russia, I am not going to concentrate my few minutes talking about the IMF's role in what appears to be the laundering of money by our banks, except to say it is obvious that there is a policy that Russia is too important to fail and that we did turn a blind eye while the IMF shuttled about $11 billion into Russia and ignored the fact that corruption and money laundering was going on.
I am going to concentrate my remarks on what we do here in this country about the laundering of drug money, because I do believe that we should have advanced a lot further than we have advanced in dealing with the laundering of drug money right here in our own country. We have had great opportunities to do so, and we are all to blame that we haven't done a better job. So I am not at all shocked that we have to convene once again to address the most serious issue of money laundering in the United States financial institutions.
As many of you know, I have worked very hard on the money laundering issue, particularly as it relates to drug trafficking. I was an original cosponsor of H.R. 405, the Money Laundering Deterrence Act of 1988, and had four amendments which were included in the bill. I spoke in opposition to the Citicorp/Travelers merger due to the ongoing Department of Justice investigation into money laundering and other potential financial crimes involving Raul Salinas and Citibank. I have held press conferences and sent numerous letters to the Department of Justice, the United States President and Members of the House Banking and Financial Services Committee. I have appeared on television shows and spoken on radio programs to discuss money laundering, drug trafficking and their devastating impact on America's communities.
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Last year, I introduced legislation to include money laundering as a priority when the Federal Reserve considers bank applications for mergers or acquisitions, and I have recently introduced the Integrity in Banking and Money Laundering Prevention Act of 1999 to help eliminate money laundering in the banking industry.
The House Banking and Financial Services Committee can do more to ensure that our financial institutions are free from abuse by alleged drug traffickers such as Semoin Mogilevitch, one of the leading figures in the investigation of money laundering at the Bank of New York.
My remarks today will focus on three problems with our current anti-money laundering laws and legislative solutions to each. Law enforcement officials have stated that one of the biggest problems they encounter in money laundering investigations, particularly where there is an international flow of funds such as in the case where money flows from Russia to offshore accounts and then into accounts in the United States, is the inability to reconstruct an audit trail for prosecution purposes. This was a major obstacle in the case of Raul Salinas and is an obstacle for law enforcement in the present money laundering scandal.
I have identified two areas that should be addressed to aid law enforcement in money laundering investigations. The first is proper maintenance of something known as ''concentration accounts,'' and the second is adequate documentation of the beneficial owner of offshore accounts. Concentration accounts are business accounts maintained by a financial institution in which funds from various sources are commingled.
Page 23 PREV PAGE TOP OF DOC Segment 1 Of 2 In July 1997, the Federal Reserve Bank of New York issued, and I quote: ''sound practice guidelines'' that highlighted concentration accounts as a weakness in money laundering controls. The Federal Reserve reported that concentration accounts could, I quote: ''mask unusual transaction and flows,'' making it nearly impossible to establish the ownership of all funds in a single account.
During last year's money laundering hearings on H.R. 405, I asked Herbert A. Biern, a witness from the Federal Reserve's Board of Governors, Division of Banking Supervision, about the potential for money laundering through concentration accounts. He stated that banking organizations should make sure that they have clear records about fund transfers, and if banks want to use a concentration account, also called a ''suspense'' or ''omnibus account,'' then they should keep proper records.
My legislative proposal would require that banks who use concentration accounts maintain all accounts in such a way as to ensure that the name of the account holder and the number of the account are associated with all account activity of the account holder. This requirement will aid law enforcement and help to protect banks from money laundering abuses.
Similar attention must be paid to offshore accounts. Offshore accounts are havens for money laundering and drug trafficker. In the case of Raul Salinas, a phony offshore company named Troika was set up which allowed Salinas to hide the flow of illegal drug money.
In the present case, one of the key accounts through which money is suspected of being laundered belongs to a company called Benex, which investigators believe filtered money from Semoin Mogilevitch, the alleged kingpin of Russian organized crime.
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According to investigators, it is likely to take months before they can sift through the documents and penetrate the complex web of offshore companies and holding companies to determine precisely where the money came from and where it went. My legislation would aid law enforcement efforts by requiring enhanced recordkeeping of beneficial owners of such offshore accounts.
Finally, I want to address the penalties assessed against banks convicted of money laundering. We know that they laundered money. During an April 15, 1999, hearing on trends in money laundering, I asked a Department of Justice witness how many United States or foreign depository institutions had lost their charter as a result of a conviction or a civil penalty imposed for money laundering. The response I received from the U.S. Department of Justice is that no U.S. or foreign depository institution has lost its license as a result of money laundering activities in the United States.
Well, my legislation would give courts the ability to double the sentence against persons and institutions that violate United States anti-money laundering laws with respect to foreign high-intensity money laundering areas. If we do not have the courage to address the practice in our own financial institutions, the money laundering abuses will only get worse.
I have the greatest respect for you, Mr. Chairman, but I don't have any confidence that we are going to do anything about the laundering of drug money in our banks. They are too big to touch, such as in the case of Citibank, and Russia is too big to fail. So I am going to go through this, but I want to tell you, we have not shown that we have the courage or the desire or the will to do anything about the laundering of drug money, and we have known for a long time about the Russian mafia, what they were doing on Wall Street, and we have simply turned a blind eye. I am disappointed, and at the point that it is now revealed, we have another hearing. Well, I will sit through it.
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With that, I yield back the balance of my time.
Chairman LEACH. The gentlelady has no time to yield back.
The Chair would like to ask unanimous consent that his earlier statement be revised and extendedI had quite a lot that I didn't add to the recordand that the statements of all other Members be placed in the record at this point.
I would also like to note that we have prepared a rather comprehensive new approach to strengthening our money laundering laws. I am prepared to introduce today and ask that any Members interested in cosponsoring contact me or my staff.
At this point I would like to ask unanimous consent Mrs. Biggert, you had a statement to place in the record. Is it all right to do so?
Chairman LEACH. And let me just stress as strongly as I can that money laundering may seem to be a modest crime to some people, but it is a window looking at far graver crimes. It is for that reason that it is of such significance.
At this point, I would like to welcome for his first appearance before this committee as the Secretary of the United States Treasury, Mr. Lawrence Summers.
Mr. Summers, please proceed as you see fit.
Page 26 PREV PAGE TOP OF DOC Segment 1 Of 2 STATEMENT OF HON. LAWRENCE H. SUMMERS, SECRETARY, DEPARTMENT OF THE TREASURY
Mr. SUMMERS. Thank you very much, Mr. Chairman, Ranking Member LaFalce, Members of the committee. I have a rather lengthy statement that I prepared for the record which I will just attempt to summarize here and would ask you to include the entirety of the statement.
Chairman LEACH. Without objection, that will occur.
Mr. SUMMERS. I am grateful for this opportunity to discuss financial policies toward Russia and the issue of money laundering more generally in light of recent reports and allegations regarding corruption, capital flight and money laundering.
Let my say at the outset, in the wake of recent allegations of money laundering through a U.S. bank, that we are fully committed to the full investigation of these allegations, to the prosecution of any crimes uncovered and to strengthening our capacity to combat future abuses.
I want to focus on four issues in my testimony: the broad context of U.S. financial policy toward Russia; the capital flight, money laundering and corruption in Russia; the very different financial policy toward Russia that we have had in place since the traumatic events of August, 1998; and our broader efforts to combat corruption and money laundering worldwide.
Turning to our policy toward Russia, it would be difficult to overestimate the seriousness of the problems facing Russia today. At the same time, the American people have an enormous national security, economic and law enforcement stake in a peaceful and successful transition to a law-based democratic market economy in Russia.
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The United States has pursued these interests, both bilaterally and multilaterally, in a number of ways. We have sought to do so in a fashion that is both hard-headed and clear-eyed and puts America's interests at the forefront.
The crucial multilateral tool to support economic reform in Russia has been conditional finance from the international financial institutions. Our support for official financing for Russia has been grounded on the recognition that we cannot want successful market reform in Russia more than Russia's government and its people do.
We have sought, in supporting the conditionality of the international financial institutions, to balance what would be best economically with what is politically realistic in the Russia context; between the desire to effect meaningful reform and the need to avoid taking decisions ourselves that Russia must ultimately embrace for itself; between the goal of dismantling the apparatus of communism and the need to cushion the impact of the process of change.
A review of the record of lending to Russia by the IMF and World Bank shows that these institutions have withheld financing when previously agreed-upon conditions have not been met, including twice in the context of the presidential election year of 1996 and including for nearly a year following the events of August, 1998.
No one here in the United States, and certainly not in Russia, can be satisfied with economic developments in Russia during the past decade. But I think it is also fair to say, Mr. Chairman, that if not all our goals or Russia's goals have been fulfilled, it is certainly equally true that not all of the fears for Russia that were common a decade ago have materialized. Russia is a very different country than it was a decade ago, with nuclear weapons no longer targeted at our cities; 1,500 nuclear weapons deactivated; with military spending one-tenth the level that it had reached in 1988. With 70 percent of Russia's economy output now generated by the private sector, the Communist system has essentially been dismantled and the state's tentacles of central control have been largely dislodged. Economic distortions created by energy prices that were held far below world prices and the easy availability of subsidized credits have been greatly reduced.
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Let me turn to the specific and interrelated questions of corruption, capital flight and international money laundering in Russia.
Russia inherited huge corruption problems from the distorted economic system of the Soviet era. Since then, it has failed to establish a rule of law and a credible law enforcement system, and corruption is a continuing and serious problem. It is one that we have recognized in the policies that we have supported and urged, both in terms of structural and institutional reform, to bring about the rule of law and, as I described in more detail in my written testimony, the placing of specific conditions aimed at reducing opportunities for corruption made possible by Russia's economic and legal system.
Let me give an example that comes from the Soviet expert, Anders Aslund. In 1992, a barrel of oil cost in Russia the same amount as a pack of Marlboros. In that economic environment, the pervasive purchase of oil at a low domestic price and sale at a large international price was a major source of profiteering. Along with subsidized credits, in one estimate it represented corruption equal to 80 percent of GDP in that year.
The international financial institutions have worked to bring about more open markets, prices approaching international levels, limitations on the supply of subsidized credit. The creation of a functioningof a working tax systemhas been centrally directed at combatting the opportunities for corruption that those distortions have permitted.
If corruption is often indicative of a vote of no confidence in a state's capacity to enforce the rule of law, capital flight is a vote of no confidence in a country's economic policies. Capital flight drains perhaps $15 billion a year from the Russian economy. It will only be effectively addressed when an environment is created in which there are economic opportunities in Russia that make Russians want to keep their money at home.
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These issues, capital flight and corruption, come together in the serious crime of money laundering. The current allegations involving money laundering through major American financial institutions only reinforce our recognition that widespread corruption in Russia can pose a significant danger to our interests.
In a telephone conversation earlier this month, President Clinton stressed to President Yeltsin the importance of swiftly designing and enacting a strong anti-money laundering law. President Yeltsin assured President Clinton that this was indeed his intent. In the context of ongoing IMF engagement with Russia, the United States and other major IMF shareholders will be monitoring Russian developments in this area closely.
Let me turn to the current stance of policy on the part of the IMF and the other international financial institutions toward Russia.
Following the economic and financial collapse of August, 1998, the International Monetary Fund ceased lending to Russia and did not provide any financial assistance for a year. The financial approach going forward had shifted in a major way from providing new loans, new net funds to Russia in order to promote economic reform to instead partially refinancing debt coming due to the IMF as a part of an attempt to support economic stability in Russia. We have insisted that any support from the international financial institutions be based on an adequate accounting and adequate safeguards.
The new IMF program is in that way very different from all of Russia's prior programs. The funds were provided in the form of Special Drawing Rights and paid into an account at the IMF that can be used only to repay Russian obligations to the fund. Under the new IMF agreement, Russia is to repay about $2 billion to the IMF over the next eighteen months and refinance the remaining funds coming due, thereby reducing Russia's net indebtedness to the IMF.
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Our continued support for IMF or World Bank engagement, even with these safeguards in Russia, is predicated on Russia's compliance with crucial conditions to ensure financial integrity and to safeguard any assistance provided in refinancing.
The nature of the audits with respect to subsidiaries of the Russian Central Bank and with respect to the procedures of the Russian Central Bank in granting credits and so forth are described in some detail in my testimony.
Going forward, we in the G7 will be calling for authoritative reviews by the IMF and World Bank to identify ways more generally around the world to strengthen safeguards on the use of IMF and World Bank funds, especially in cases where there is a heightened risk of diversion or misappropriations.
Let me just say, in response to the Chairman's inquiry, that we are fully prepared to cooperate in investigations with respect to what is taking place with respect to IMF funds in Russia; though I would caution that some of the assertions that one encounters go beyond what has yet been established by evidence, although this is something that is obviously the subject of continuing close attention.
As we work to promote the adoption of sound economic reforms in Russia and around the world, combatting corruption and pursuing policies to reduce crime will be essential components of these efforts, including through our national and bilateral programs.
This Thursday, as has been mentioned, in line with the legislation in which Congresswoman Velazquez played such a crucial role, the Treasury and Justice Departments will release the Administration's first National Money Laundering Strategy report. It contains several dozen recommendations to combat the types of criminal activity that we are discussing here today. And based on what I have been able to learn this morning, Mr. Chairman, I would say that it covers quite similar ground to your own legislation. This is an area where we certainly look forward to working together.
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During the past six-and-a-half years, we have faced very difficult questions of balance and very difficult choices in managing the United States relationship with Russia and in combatting corruption and money laundering globally. It has always been clear that Russia's transformation from a centrally-planned Communist empire, ruled by the law of force, to a democratic, market-based economy, based on the force of law, would take a great deal of time. We have sought, while always recognizing that Russia will shape its own destiny, to pursue what is the very great American interests in Russia's outcome in a hard-headed and prudent way, as we will continue to do going forward.
I welcome the opportunity for dialogue that this hearing presents on how we can all address this very crucial U.S. foreign policy and financial policy issue.
Thank you, Mr. Chairman.
Chairman LEACH. I thank you, Mr. Secretary.
Let me say that I think the premise of the American policy of wanting to help Russia has always been correct. The effect of American policy is somewhat more in doubt. One of the great questions is, when one sees that efforts are counter-productive, does one shift gears? That is a profound question.
A further witness of ours, an expert on Russia, Ann Williamson, has taped a series of interviews with former Russian officials. One Russian official, a finance minister named Boris Feodorov, reported that he asked Treasury not to include an IMF loanthis would be five or six years agoof $1.5 billion, since he argued the loan would undermine his attempts to discipline the finance ministry. He suggested that corruption might be an issue.
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Other Russians, namely Sokolov, the chief auditor of the Russian Federation of Chamber of Accounts, which is an institution roughly equivalent to the GAO, has argued that he believed that virtually all of the funds coming into Russia would be diverted for less-than-perfect purposes.
And so the question is, what do you, as a Secretary of the Treasury, believe should be the United States' policy in terms of a circumstance where a foreign government appears to be entwined in a culture of corruption? Do we continue to aid it, because Russia is too big to fail, because a potential leader, as flawed as he may be, seems less flawed than others? Or do we say, ''enough is enough,'' that no taxpayer anywhere can sustain the kind of ''beltway'' investments where taxpayer funds are revolved in foreign bank accounts and then returned to this country in the hands of foreign corrupt officials or entrepreneurs? What does our Government do at this point?
Mr. SUMMERS. Mr. Chairman, let me distinguish the issues of policy going forward from the retrospective issues that were implicit in a portion of your question.
Going forward in my testimony I laid out the approach that is in place, which is an approach that does not provide new funds to Russia, but that refinances a portion of the debt of Russia that is coming due to the IMF so that Russia is on net making repayments in this period. Because, given the pervasive problems in the rule of law in Russia, we do not believe at this point that the provision of new funds would be constructive and indeed could run into some of the risks that you described in your question.
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With respect to the earlier period, a balance was always struck recognizing that the provision of funds, which, as in the case of all IMF programs, goes to Central Bank reserves which are used in the currency markets to support stability, would advance the cause of creating an economic environment in Russia in which capital flight would be limited. And indeed, if one looks to the period from 1993 to 1996 to 1997, what one sees is that Russia went from a country that was experiencing massive capital flight to a country that for several years was experiencing net capital inflows, reflecting the fact that there had been some improvements in the economic environment.
In light of the policy errors that took place in 1997, the change in international conditions toward emerging markets with the Asian financial crisis, the fall in price of oil and the unwillingness of the Russian Duma to support reforms that would bring the budget under control, Russia was ultimately unable to maintain stability, and one saw the economic and financial collapse of August, 1998. That collapse, as serious as it was, should not obscure the fact that during this period one saw quite substantial economic change, from inflation rates in the thousands of percents, from markets that were largely closed to the outside world, from state-directed plans to a market-based system. Those changes, which operated to reduce capital flight, were part of what these international financial institution programs were about. We certainly supported them in a way that was mindful of the risks, but also mindful of the alternatives that could not have materialized without the engagement between the international financial institutions and Russia.
Chairman LEACH. I appreciate that perspective, but I think there needs to be a bit of an add-on, which is that, for the last decade, Russia has lost 40 percent of its GNP value. So one can hardly define this as success. When we look at the last IMF funding, over $600 million went for the repayment of loans, which is an implicit acknowledgment, I believe, that prior loans had failed, and that it strikes me that it is pretty hard to defend that particular policy.
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Let me just end with the notion that somehow, as we look at this ''beltway'' of fundsand they are stunning. When you have a 40 percent drop in GNP it is because capital flight has exceeded Western investment, which has been significant. And there does not appear to be a concerted effort to put an end to that capital flight.
There alsoin a Western sense, we have always believed that public service involves some sort of idealisticyou have what appears to be a self-serving nature of some in the Russia oligarchy elite that is very troubling. I don't think that it can be simply looked at, because some alternatives look worse over a period of time. It looks as if we have been ensconcing a system that maybe deserves a little more discipline. On retrospective, do you think that is the case or not?
Mr. SUMMERS. Let me say, first, Mr. Chairman, that with respect to the question of capital flight, it is best to think of capital flight in Russia or in another country not so much as a cause of economic problems, but as a symptom of economic problems. Because Russia's economy wasn't working, because property rights weren't secure, because people could not have confidence in the value of the ruble, they chose to leave their money offshore or to take their money offshore. So capital flight was much less the cause of Russia's economic problems in this period than it was a consequence of an economy that, as I think we have all recognized, wasn't working in a satisfactory way.
Now, there will be debates forever, I suspect, about what economic policies Russia could best have pursued. There would be those who argue that, had they moved more rapidly with the steps of reform, the results would have been better. There would be others that will argue had they moved more slowly the results would have been better. I am not sure that we will ever know the answer to that counterfactual question, but I certainly tried to make clear that no one here or in Russia can be satisfied with the performance of Russia's economy.
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Equally, I think it has to be recognized that the historically unprecedented magnitude of the four transitions, from empire to state, from dictatorship to democracy, from a criminal state to a law-based state, and from a Communist economy without private property to a private market economy, almost certainly made it inevitable that there would be very, very substantial economic disruptions and problems during the transition, and the attempt of the international financial institutions was to influence that process in as constructive a way as possible.
Chairman LEACH. I appreciate that.
My time has expired. There are many other Members who want to ask questions, and we may come back.
I am compelled to note that what may be a system also causes a problem. That is fairly undeniable.
Second, there is an analogy, and this is something that Ms. Waters has been working on, some of the Mexico issues. I remember years ago, after being visited by a number of very extraordinary Mexican officials, hearing the observations from the Mexican experts, they are extraordinarily well educated, but more than a few are crooks.
Top Treasury officials have described some of the Russian team as a ''dream team'', but the evidence is emerging that part of their dream is self-serving. That is why I stress that public service is not about self-serving aggrandizement. It must be about idealism. It appears in this country that idealism as an element has elapsed, and that is one of the reasons there is such cynicism and hopelessness appearing in Russia today. And that is the single most important issue in many regards for American national security and foreign policy.
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Mr. LAFALCE. Thank you very much, Mr. Chairman.
It is extremely difficult to fashion a policy and implement a policy when you are taking the former Soviet Republic, see it disintegrate into its several component states, and then watch and try to assist in the transition from what has been a centrally-planned economy to some form of market-based economy. The world does not have much experience with that, so it was difficult.
Of course, we knew it was difficult at the time, and we knew what those difficulties were, too. We knew that crime was running rampant. We knew that they did not have adequate laws or any laws or enforcement with respect to privacy rights, property rights, bankruptcy laws, a transparency with respect to its banking system, enforcement mechanisms, adherence to international norms and standards, and so forth.
It also seems to me, though, that one of our underlying premises should have been, let's not make this situation worse. There is going to be economic dislocations. Let's mitigate the dislocations, though, so that we do not see people going with less bread. We do not see people going with less heat. We do not see a decline in GDP if at all possible.
So I think this argues for a more gradual transition rather than for an immediate transition. So it is damn the torpedoes, full speed ahead. So long as we can get rid of the state-owned industries, they ultimately will be better off, and ultimately it might be a long timeframe. You have to look at the difficulties that come in between.
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That is history. We have seen some good, and we have seen some bad. What are we doing today, though, within the present context? What are our imperatives? As one country, the United States, what are our imperatives as a country within the international forum that exists with respect to conditioning future involvement with Russia and countries such as Russia? By involvement, I mean a broad spectrum of activities including financial assistance.
What are we demanding with respect to reforms of their central bank, with respect to not just passage of legislation, but enforcement of that legislation with respect to property rights, with respect to the bankruptcy laws so there could not be precipitous withdrawal of monies. I guess we can't impose our will on another country, but we can refrain from certain types of involvement with a country unless it is done in the right way.
Do you care to respond?
Mr. SUMMERS. Congressman, let me answer your question in three ways. First, we are insisting on absolute safeguards with respect to our own money, namely the United States' own money, the IMF's money which is in part our money, in the insistence that that money not get to Russia, that it move from one IMF account to another account and that is all the money that is provided.
Mr. LAFALCE. What do you mean, from one IMF account to another? For what purpose then?
Mr. SUMMERS. For the purpose of repaying the IMF.
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Mr. LAFALCE. So we are giving loans to finance pre-existing
Mr. SUMMERS. In effect, we are extending the portion of the debt that is coming due from Russia to the IMF. The remainder will be paid back directly from Russia to the IMF, and a portion is being refinanced, is being extended. Other than that, from the IMF, there is no new
Mr. LAFALCE. So you are saying that the United States' policy and the international financial institution's policy is no new money to Russia? The only thing that we will do is engage in some paper transactions for the refinancing or at least scheduling the existing indebtedness?
Mr. SUMMERS. That is the situation of the IMF.
With respect to the development banks, there are a limited number of loans that are directed at specific projects and specific purposes with closely monitored accounting for the use of the funds. The safety net for coal workers would be one example of such a program for the World Bank. EBRD assistance to funds for small businesses would be another example of such a program. So it is bottom-up.
Mr. LAFALCE. The total scheme of things, how much assistance would be given respectively through the IMF, which is exclusively for the refinancing of existing debt, and how much new money for these discrete purposes through the other international financial institutionsthe World Bank, the European Bankfor reconstruction, development, and so forth?
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Mr. SUMMERS. Over the next year, I would expect it to be in the range ofsomeone behind me may correct mea billion dollars over the next year. In toto, if you add all of the international financial institutions together, Russia would be making a net repayment to all of the international financial institutions taken together over the next year. And then, of course, U.S. bilateral assistance and, more generally, the international financial community bilateral assistance on questions like building a functioning tax system, establishing a bankruptcy law, establishing protections for minority shareholders at the Russian SAC and so forth will be conducted in a continuing and active way, because that is part of what I think we would all agree is the long-run imperative here, which is the establishment of the rule of law.
Mr. LAFALCE. Which comes first, the chicken or the egg? In other words, are we going to establish some of these actions as preconditions to the future assistance? That is the first questionor conditions subsequent.
The second question is, you referred to the absolute safeguards. At least with respect to the IMF future assistance, do we have either absolute or some form of safeguards with respect to non-IMF or other, either bilateral or international, financial institutions' assistance?
Mr. SUMMERS. With respect to the other international financial institutions' assistance, there are very strong safeguards with respect to the accounting. Certainly with respect to U.S. bilateral assistance there are as well.
Mr. LAFALCE. What is the nature of those safeguards?
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Mr. SUMMERS. The nature of those safeguards, for example, in the bilateral assistance is that, rather than providing money, what you are doing is providing services and relying on a whole set of U.S. contracting procedures and so forth.
Mr. LAFALCE. What about when money is provided?
Mr. SUMMERS. I would be happy to give you an answer in writing of the detailed procedures at USAID, but the essence of those procedures is that the money is provided only on the basis of a clear receipt for specific services rendered. There is no money provided to Russian institutions for their general use as they see fit. It is specific funds for specific services.
Chairman LEACH. Thank you, Mr. LaFalce.
The Chair has not set a perfect model, but he is at this point going to insist on maintaining the five-minute rule. We have a number of witnesses today.
Mr. BEREUTER. Thank you, Mr. Chairman.
With regard to the comments about the drop in GDP, just to put that in perspective for the American people, Russia is still the fifth most populous country, with a GDP less than the Netherlands or Denmark, and the GDP is still going down.
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Mr. Secretary, congratulations on your assumption of the secretaryship. I regret that it is this subject that brings you here, but we wish you well as you pursue that job.
I have three questions that I think you could address briefly. You mentioned we were looking for adequate accounting, of course, for the IMF funds. Given the size of that highly paid bureaucracysome would say a bloated bureaucracy at IMFdo we have a systemic auditing that you would regard as adequate at the IMF? You also may wish to enlarge that to the World Bank.
Second, has the Treasury Department or anyone in the Administration spoken to the Russian prosecutor general, Mr. Skuratov, to try to confirm his accusation of Kremlin officials receiving kickbacks and improper market speculation on high-yield treasuries?
And, third, Mr. E. Waymarry, head of the political section of the U.S. Embassy in Moscow from 1991 to 1994, claimed in a recent article that he, ''Personally saw dozens of draft reports on economic problems that were never transmitted while the Treasury representative blocked the negative assessment of Russia's capacity to introducing a market economy rapidly by arguing that would give Larry Summers a heart attack.''
Have you looked into whether or not there was an effort by Treasury people not to report what the real situation was in Russia to you when you were an Under Secretary and your boss was Secretary Rubin?
Mr. SUMMERS. Let me, if I could, Congressman Bereuter, answer the questions in the reverse of the order that you asked them.
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With respect to that report, it is the first that I have heard of anything like that. While we in the Treasury like to think that we have a lot of influence in the U.S. Government, I assure you that we do not have the capacity to censor the reporting from U.S. Embassies. And certainly of all possible rationales for limiting reporting, the fact that it would shake the preconceptions of a policy official in Washington is the best reason for a report to be sent and certainly not for it not to be sent.
Mr. BEREUTER. Mr. Secretary, I am talking about self-censor. I am not suggesting that anyone told them not to say it.
Mr. SUMMERS. I am not awareit would be a very serious problem during a period when I am Secretary, as it would have been during the period when Secretary Rubin was Secretary, as it would have been during the period when Secretary Bentsen was Secretary, if anyone sought to prevent bad news from reaching Washington. That is the opposite of everything that we stand for as we try to work with our staffs. I don't know where that report came from.
With respect to the prosecutor general in Russia, I have not had any conversations with him. We have sought, I think appropriately, to compartmentalize the law enforcement channel with respect to ongoing investigations from the policy channel as these things are pursued. I think that is a question that would be best directed toward the officials with direct investigative responsibility. It may be a question that is better addressed in closed session.
Page 43 PREV PAGE TOP OF DOC Segment 1 Of 2 With respect to our satisfaction with respect to the reports that we have received, let me first say that we have strongly supported the idea that these audits are not to be done by IMF staff, but done by independent international accounting firms for some of the reasons that you cite. There have been reports that have come in that have provided clarity with respect to some issues, but there are important outstanding issues. That is why my testimony is clear that there is a set of further conditions that have to be satisfied, not just in the economic policy area, but in the integrity area, before we would be in a position to support any further disbursements of this refinancing kind to Russia.
Chairman LEACH. Thank you, Mr. Bereuter.
Mr. FRANK. Mr. Secretary, I noticed in the testimony that we are going to be getting later that one of the witnesses noted that American pressure did have an impact on Russian behavior elsewhere. He mentions the cooperation in Bosnia and Kosovo. He mentions dealing with Iran, some macro-economic policy. Obviously, we have the relative quiescence in the expansion of NATO.
I raise those because this argues the fact that pressures succeeded thereand most recently many of us were enormously grateful for the Russian position with regard to Kosovo, because I think that helped get America out of an extraordinarily excruciating moral, as well as political, dilemma. He argues that the fact that pressure succeeded there means that pressure would have succeeded here.
Page 44 PREV PAGE TOP OF DOC Segment 1 Of 2 My question is whether to some extent the opposite might be the case. That is, if you simply accumulate pressure in all fronts without any tradeoffs that you are less likely to win. I don't say this critically. I say this critically of our structure. I wish you were here with Mr. Berger and Ms. Albright. Anybody who thinks we should have made policy toward Russia abstractly, solely on these kinds of economic and technical monetary problems, is wrong. Clearly, we have a whole complex of issues with Russia.
So the question is, was thereI think it would be perfectly good, but my own sense is, yeah, people may have said, ''Boy, this Yeltsin is no day at the beach, but on the other hand he is better than a week out in the snow'' and we have some other things on the fire here. To what extent are tradeoffs and these other kinds of considerations involved? To what extentwhen you talk about, for instance, cutting off Russia, if we got to the point where on these grounds that have been advanced that you thought Russia should be cut off from some of your areas, would you instruct your representative of the IMF to so vote without first checking or without talking to Secretary Albright or National Security Advisor Berger, not to mention the President?
Mr. SUMMERS. I think your very thoughtful question, Congressman Frank, really points out why making policy in this area and other related areas is so difficult. One has to distinguish, if you like, between degrees of unsatisfactoriness.
As I referenced in my testimony, you have to make a balance between what would be economically best and what is politically realistic. I think, on the one hand, as we manage a relationship, a financial relationship with any country, it is not possible to do so outside of the context of the overall issues that that country poses. On the other hand, we have also sought to remember that the international financial institutions have a basic core mission and have a basic responsibility with respect to the management of moneies.
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So, no, we would not under any circumstance tolerate money being provided without conditions or under circumstances in which the expectation was that it would simply be diverted and not be used for its intended purpose. That is a basic question of financial integrity.
At the same time, certainly, in carrying on policy, one has to be mindful of the broad context. I think, as your comments suggest, the broad context is one where, if we had not gotten everything that we wanted in terms of Russia policy choices, it is also true that many of the things that were feared not very long agohyper-inflation, collapse of the Russian state or return to communism and so forth, major nationalist revival in the anti-American faction have also not materialized. It is that balance that we have tried to keep in mind as we carried on the policy on an Administration-wide basis.
Mr. FRANK. I think that part of what you are saying is one way to deal with this is to move toward more project-specific funding of the World Bank, Nunn-Lugar specific funding to deal with non-proliferation, so that to some extent the future orientation is less general budgetary support, more very specific and strings attached targeted aid. I think that is a reasonable direction to go in and may be the way to deal with this dilemma.
The second question I have is just an abstract one. The Chairman mentioned the drop in Russian GDP, and I realize it is a very significant drop. I would be interestedthis is more of an abstract than an academic question, to retrogress you for a minute.
Page 46 PREV PAGE TOP OF DOC Segment 1 Of 2 One of the things we used to hearand I will finish up in 30 seconds, Mr. Chairmanone of the things that we used to hear was that much of what the Russians produced in the old days, nobody wanted. Now, some of that obviously was military, but there were other goods. Do we have an analysisobviously, there has been a drop in the production. But do we have an analysis of how much of that is a real drop in the quality of life?
Everything that I ever read when I was studying the Soviet Union beforehand said there should have been a drop in the production of a lot of things which were produced and nobody wanted them. So do we have an estimate of what the real economic situation is in Russia today as it was in the last days of the overture?
Mr. SUMMERS. I will get you a more precise answer in writing than I can give here.
In general, in approaching your question, I would just emphasize these points: 25 percent of GNP previously on some estimates was military spending, and the loss of that presumably doesn't have a direct impact on Russian living standards.
Mr. FRANK. And a positive impact on ours.
Mr. SUMMERS. It is difficult to know how to think about wages that were higher relative to the price of meat than they are today, but you couldn't get meat at the store even after you waited in line for several hours. So what you see is the wage goes less far in terms of meat, but the reality is that you couldn't get the meat at the posted price before, and, if you could, it was with hours of waiting.
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All of that said, I don't think anyone can escape the conclusion that there has been a distinct reduction in living standards for at least large parts of the Russian population since 1989. I would take issue with the easy inference that has been drawn by some that that somehow economic reform took place too rapidly.
If one looks at other countries, Ukraine, Belarus, other of the former Soviet republics where reform has taken place even less rapidly than in Russia, in many cases the fall in living standards has actually been significantly greater. And if one looks at some of the places in the Baltics or in the northern parts of Central Europe where reform has taken place more rapidly, what has happened to living standards has been somewhat more favorable.
I think the core reason why the decline has been so great has been the combination of how militarized it was and how fundamentally distorted the composition of industrial production by military need, and by industry that was based on oil at a very small fraction of the world's prices.
Chairman LEACH. Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman.
Mr. Secretary, I think we all know that it has been stated here that Russia is too big, it is too nuclear, it is too inflational for us to ignore. I don't think there is really any serious doubt that we are going to continue to help Russia, we are going to continue to assist Russia. And despite what we hear from time to time within the Congress, the IMF and the World Bank, other organizations to do that, because there is really no one else that can play that role. Do you agree with that?
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Mr. SUMMERS. I would agree with that, although I would caution, as I have tried to articulate, that the terms of their engagement and the approaches that they pursue have to change with conditions on the ground. And then, under current conditions, much more of a bottom-up approach and much less direct support to the foreign exchange market are appropriate.
Mr. BACHUS. I guess what I am saying is the IMF and the World Bank and the United States, we are going to continue to cooperate with Russia, we are going to continue to assist Russia. I think the questions that are helpful or not, whether we do that or not, because we are going to do itI am going to say it is a fact that that is going to be the IMF and the World Bank. I am going to approach my questioning from that standpoint, because I am going to assume those as given.
In that regard, in many of the previous IMF loans to crisis countries such as Korea, the Federal Reserve was brought in to help monitor and assist the IMF loan program. I am not aware that the Fed was asked to help implement the IMF Russia loan program. This is particularly disturbing, because there were and still are serious concerns about the effectiveness of Russia's Central Bank. Federal Reserve oversight would have been very useful since it appears that the Russian Central Bank is plagued with conflicts of interest.
I read an interview by the chairman of the federal commission for the security market. So this is Russians that are saying that it is engaged in conflicts of interest and, in effect, iffor instance, Russia's Central Bank was acting as a regulator for the commercial banks and at the same time they were speculating in Russia's short-term government debt market, the GKO. So my question to you is this: Why didn't you or Treasury ask the Federal Reserve to help implement the Russian loan program and were you aware of the serious problems of Russia's Central Bank?
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Mr. SUMMERS. With respect to the second question first, certainly we have been aware for quite some time and most especially following the collapse in August of 1998 of integrity problems of the Russian Central Bank, and that is a crucial part of why in the current approach none of the IMF funds will actually reach the Russian Central Bank and why, even for that refinancing, there are a whole set of conditions appended.
With respect to the Korean case that you referenced, the Fed was not involved in the direct enforcement of the IMF conditions. The Fed was, of course, involved in deliberations about U.S. policy in this area and particularly with respect to the use of the Exchange Stabilization Fund. There were officials from the Fed who, in response to the Korean government's request, provided technical assistance. Certainly, we in Treasury would be very supportive of any technical assistance efforts that the Russian Central Bank and the Fed could agree on. That is really a policy call for the Fed to make. But it would not in my judgment be appropriate, and it has not, to my knowledge, been the practice for the Fed to be involved in any case in the enforcement of conditionality.
Mr. BACHUS. Thank you.
My second question is this: What we have seen in Russia with the organized criminal enterprises, the so-called mafia there, and also with government officials who may have been taking money out of the country, that is not something that we are not seeing in other countries. We have seenliterally forever we have been seeing countries looted by corrupt leaders.
Page 50 PREV PAGE TOP OF DOC Segment 1 Of 2 I am particularly encouraged by the legislation that Chairman Leach is introducing and which I am cosponsoring, which is going to move, reallyas long as we have thesewe are going to have these organized criminal enterprises. Mexico, Colombia, and Russia are probably the three best known. We are going to continue to have corrupt government leaders, and others are going to launder money. It leads to terrorism, racketeering, tax evasion, drug smuggling, all of this.
There is one common denominator in all of this. That is that you have these offshore financial centers that are cloaked in secrecy and are poorly regulated and have almost no reporting. The legislation that we are introducing would move to begin to take action to stop this. It is something that we have put up with too long. It is something that is going to need the G7, action by the G7.
Can you comment on that? Is the world community, the G7we are in a world economy. Isn't it time to shut down some of these operations or demand that they be regulated and that they report?
Mr. SUMMERS. Yes is the answer to that question. Without being in a position here to discuss the precise provisions of the legislation that you are introducing, which I haven't had a chance to fully study, and without getting into the full details of what is in the national money laundering strategy, I think this is clearly an issue that has to be addressed; and I think it has to be addressed, frankly, for two interrelated reasons. One is the abuse that is made possible by these offshore centers. The second is the pressure these offshore centers put on the ability to regulate in our country and other major countries where satisfactory regulation becomes more difficult if there is the threat that it will simply produce recourse to offshore centers.
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But my own view, and this is something that I have stressed since I became Secretary as we worked on the development of the national money laundering strategy, is that a proper approach to offshore centers is overdue. I might just say that, as part of the work on the financial architecture, there is a kind of high-level steering group in the financial regulation area, the forum that has been set up, which has three projects underway with the strong encouragement of the United States. One of those projects is directed at the set of issues surrounding offshore centers.
Mr. BACHUS. I know your proposals. They are probably eight months late coming out, but I would hope that they are going to address this issue. Because as long as we have these offshore financial centers, as long as they are poorly regulated, as long as you have the veil of secrecy, we are going to continue to give opportunity to both these criminal enterprises and to corrupt government officials. The arms trade is going to continue to flourish. Terrorism is going to continue to operate wide open. And so I would certainly hope that that is in your proposal, too, and that the United States show leadership on that issue.
Mr. SUMMERS. This is a concern that we share.
Chairman LEACH. I thank the gentleman.
At the risk of presumption, let me just add quickly to that. Our concern is American law, also international negotiations. The degree that we give advice to othersin economics there is a question of whether you should ever place controls on capital. But I don't see how any developing country should not absolutely preclude by law the movement of capital to poorly regulated financial centers supervised by offshore institutions, because the only reason for doing that is for corrupt purposes, to not track capital. I think that is a bit of advice that the international community led by the United States ought to be giving to every country in the world, and we ought to take some of it ourselves.
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Ms. WATERS. Thank you, Mr. Chairman and Members.
While we all are confessing, we know that American policy allows for criminal activity if we feel it is in the best interests of our country. That is rather bluntly stated, but that is about what we are all saying.
I must admit I am not naive about policies that we turn a blind eye to, countries that are sometimes acting in ways that we may not necessarily agree with, but we let it happen. I am aware of Zaire and Mobutu and the fact that we let him steal the money and on and on and on.
How long have you knownTreasury knownabout the money laundering, of this Russian problem?
Mr. SUMMERS. We have been aware of the seriousness of corruption and capital flight from Russia and the likelihood that there were instances of money laundering since the beginning of the time that we were involved in Russian policy. With respect to the specific investigation that has gotten a lot of attention very recently, Treasury officials learned of it in April.
Ms. WATERS. Just this past April?
Page 53 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. SUMMERS. The specific investigation referencing the bank, referencing
Ms. WATERS. Was Treasury involved with the Justice Department in any way in the investigation of the Russian mafia before April?
Mr. SUMMERS. The Treasury investigative arms have cooperated with Justice on a number of different investigations and certainly some specific investigations involving particular Russian targets, substantially priorsignificantly prior to last April, yes.
Ms. WATERS. Did the Russian banks offshore, like in Antigua, play any role in this money laundering and drug money laundering? There are eight Russian banks in Antigua, a place that has 60,000 people and 50 banks. Eight banks are Russian.
Mr. SUMMERS. To the extent that it is possible with respect to an ongoing investigation, we can provide a written answer with respect to what is in the public record regarding Antigua.
With respect to offshore centers generally
Ms. WATERS. I want to know about Russian banks in Antigua, the eight Russian banks.
Mr. SUMMERS. To the extent that it is possible to respond to that inquiry, the investigative authorities are able to respond to that inquiry, I will ask them to do so promptly.
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Ms. WATERS. Let me follow up on what the Chairman asked. One of my pet peeves is the fact that our respectable banks wire transfer money to the banking centers in Antigua and other places, and we know why they are establishing them and what they are doing. What leadership are you going to provide to stop that practice?
Mr. SUMMERS. With respect to the general issue of offshore financial centers, sometimes referred to as havens, I expect us to provide in the context of the national money laundering strategy a set of proposals. I think it will also indicate
Ms. WATERS. Do you want to see it stopped?
Mr. SUMMERS. Yes.
Ms. WATERS. Do you want to see the practice of wire transfers to money laundering centers that we know about stopped, period?
Mr. SUMMERS. Congresswoman, we want to see abuses stopped. We want to see abuses stopped, period. I think our challenge will be to craft rules that stop it, that stop abuses.
Ms. WATERS. Let me just say this. Given that we are not naive and we know that we have to work with countries even if they are not doing what we want them to do and they have practices that we would frown on, and Russia is important for all of the reasons stated, can you separate out drug money laundering in order for us to put our feet down and say we will not tolerate the laundering of drug money? That is my pet peeve. Let them steal IMF's money or our bilateral support, but how tough will you be on the laundering of drug money?
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Mr. SUMMERS. We will in every feasible way that we can seek to combat money laundering of all kinds that you described, including drug money. The qualification that I made with respect to our determination to do everything we could to stop abuses was simply intended to indicate that as serious as these problems are, it would be, I think, a mistake at this juncture to conclude that all financial transactions, period, that involve certain institutions and offshore centers, are transactions of questionable legality.
Ms. WATERS. I am not concerned about trying to wrap this around everybody. I am only concerned about the laundering of drug money.
Mr. SUMMERS. We totally share your concern, Congresswoman.
Ms. WATERS. What will you do about it?
Mr. SUMMERS. In the national money laundering strategy and in the national reviews we propose legislation and administrative steps that will take all feasible steps that we can envision to go after this problem, and I might just say that we would be very grateful for any assistance and suggestions that can be provided to us as to how we can more effectively go after this, because I think this is a very clear issue.
Ms. WATERS. I would like to co-opt the legislation and work with you. Ms. Velazquez has been working so hard on this, and others, and we want some cooperation to help us on the question of the laundering of drug money. Thank you.
Page 56 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. SUMMERS. Let me just, if I could, note that we have acted and have issued an advisory with respect to U.S. banks specifically with regard to transactions involving Antigua, because of a set of concerns that have arisen and have been in touch with the authorities in Antigua as well regarding those concerns.
Ms. WATERS. Mr. Chairman, I have a list of every bank that has been convicted of the laundering of drug money. Not one has lost its charter. We haveeven American Express International that was fined $25 million. I want to tell you these fines and asset forfeitures are simply the cost of doing business for these banks. You have got to put somebody out of business.
Chairman LEACH. The gentlewoman's time has expired.
In this regard a law passed on a bipartisan basis, initiated by Ms. Velazquez, is calling for the Treasury to put forth a strategy. That is eight months in abeyance over a congressional law, and you are coming out with it this week and we are appreciative of that, but the timing is imperfect.
Secondly on the timing front, the Financial Times reported in the last few days that British authorities told the FBI about the issue of the Bank of New York in September. A great congressional concern has been interagency cooperation, who tells what to whom.
If Treasury did not learn about this until April, that is a rather significant time line. And so unrelated to legislation, but also involving legislation, the Congress does expect to have substantially greater coordination within the Executive Branch.
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The gentleman from California.
Mr. ROYCE. Thank you, Mr. Chairman.
Mr. Secretary, I understand there is typically a due diligence standard set in order to contain risks associated with a transaction to an acceptable level. According to the New York Times, you and Secretary Rubin knew of the investigation into allegations of Russian money laundering and the Bank of New York before the latest round of IMF loans to Russia, but these allegations were not taken into account in setting conditions for the loans. Chairman Leach mentioned earlier the former Russian Finance Minister Boris Feodorov in 1993, did an interview with Ann Williamson, in which he reported that he asked you to not approve an IMF loan of $1.5 billion since the loan would undermine his attempts to discipline the finance ministry. He further remarked we came to a modus operandi in Washington with the IMF which was essentially a carrot-donkey process. In this sense, the IMF's role was gamesmanship, because they never required any conditions for loans.
In April 1993, the IMF decided to give $1.5 billion and on the 26th of April, the former Russian finance minister reported: ''I discovered that the budget deficit had grown, because once the money was promised, it was consumed immediately, mostly through graft on government importing schemes. I always told Larry Summers, 'You have the money and the wish to spend it, come and spend. Of course, this money will ultimately be deposited somewhere in Zurich.' I told Summers that.'' And he goes on to say, ''Once the money is given, there is no motivation to reform. That is one of the reasons why I left the government,'' says the former Russian finance minister.
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My first question would be, what information did the Treasury Department and the IMF take into consideration in order to formulate the due diligence standard as it applied to loans to Russia? Why did the allegations of money laundering not factor into these formulations, and in light of this, what specific due diligence standards have been applied to the loans to Russia?
Mr. SUMMERS. With respect to the loans that were made subsequent to our learning of the money laundering investigation in April of 1999, those reports only reinforced what were our extraordinarily great concerns about the integrity and the handling of funds following what took place in August of 1998. Our judgment at that time was that the appropriate form of new finance was one which would be provided in the form of special drawing rights to an account at the IMF which would not be eligible for use by the Russian authorities at their discretion, but could be used only to repay the IMF. In effect they could not get their hands on the funds for a use of their choice. That was a response to concerns about integrity which were reinforced by the reports that you have described.
Mr. ROYCE. Of course Finance Minister Feodorov's statements were from 1993.
Mr. SUMMERS. Perhaps I could just respond with respect to those statements.
It is correct that at certain stages during his time as finance minister, it was Mr. Feodorov's view that it would be better to delay the provision of support. And indeed at a number of those points the provision of support was delayed until specific accomplishments were achieved, until there were certain specific steps taken.
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I would just caution that if one looks at the period from 1993, 1994, 1995, one saw a period in which inflation rates in Russia fell from the thousands of percent to much lower levels.
One saw in those years that much of the apparatus of the Communist state was dismantled. Clearly there was always a balance that needed to be struck between the risks of inhibiting the tendency to reform with the benefits of engagement and pushing the process of reform along.
I would just caution that in making judgments I think it is appropriate to remember that in 1993 it was widely expected that there would be starvation in the cities, that hyper-inflation would break out, that there would be a return to communism and that the Soviet state would collapse. Those fears did not materialize. Certainly, not everything that was hoped for or all the goals that were set were achieved either.
Mr. ROYCE. Of course he also brings up his concerns about not having conditions on the loans, graft on government importing schemes and ultimately the money being deposited somewhere in Zurich. That being brought up in 1993 should have been a heads-up.
Mr. SUMMERS. I think there were a set of controls that were in place. Of course, IMF funds go into a central bank reserve and a central bank's reserves are used in part to intervene in a currency market. There is a large volume in the currency market. The vast majority includes the proceeds of exports, and so it is very difficult to identify where a particular dollar that comes into one side of a market that is only a small portion of that side ultimately ends up.
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The concern about capital flight was something that was always uppermost on everyone's mind in the design of these policies and that was why there was a strong effort to address its roots, inadequate tax collection, in subsidized credits, in inflationary policies that caused the ruble to lose its value.
I think it is very difficult to know what the counter-factual would be if different policies had been pursued. But the attempt was to strike a balance very mindful of the dangers of capital flight and dangers of corruption.
Mr. ROYCE. Thank you, Secretary Summers.
Thank you, Mr. Chairman.
Chairman LEACH. Ms. Velazquez.
Ms. VELAZQUEZ. Mr. Summers, you said that the Treasury Department learned in April about the money laundering activities through the Bank of New York. Can you tell me what was the Treasury Department's response?
Mr. SUMMERS. Upon learning of that information, our international colleagues in our international area notified Secretary Rubin and myself of their intention to go back to the Federal Reserve System, where they had learned of it, to see if there was any information that pointed to the diversion of IMF funds that was contained in those reports. They did that, and they learned that there was no such information.
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What we did with this information was have it to serve to reinforce our large concerns about corruption and capital flight from Russia, which helped to shape the different approach to IMF engagement that is in place at this point.
Ms. VELAZQUEZ. At the time were bank regulators notified so that those organizations which most frequently access bank records and money through bank records could track any suspicious account through the Bank of New York?
Mr. SUMMERS. It was a bank regulator that notified us; namely, the Federal Reserve. And so it was presumptively aware of the situation. I might say that through this whole period there have been what I understand to be close working relationships at the investigative level between Treasury's Financial Crimes Enforcement Network and the relevant authorities in the Department of Justice.
Ms. VELAZQUEZ. In 1998, the General Accounting Office conducted a study that found that 24 percent of Federal field agents did not know about any anti-money laundering problems or services offered by FinCEN. Would you tell me that under your leadership will the Treasury Department ensure that every law enforcement agency, whether State, Federal or local, would be aware of the resources that are available by the agencies?
Mr. SUMMERS. I can tell you that Secretary Rubin and I appointed a new director of FinCEN a few months ago and that he sees as one of his central mandates with our very strong support is assuring that there is full knowledge with respect to FinCEN's services in this area and we are more generally making sure that financial crime is something that is very much a focus throughout the law enforcement community.
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And I might say that, within Treasury, FinCEN is, of course, very involved in these issues and, just so I am very clear, FinCEN has been involved in analysis of this issue through a law enforcement channel prior to notification to policy officials in April. The IRS anti-crime unit and the Customs Service both also have had substantial roles with respect to money laundering investigations.
Ms. VELAZQUEZ. My final question, Mr. Summers, how do you think the money laundering strategies focus on intergovernmental cooperation could have assisted U.S. efforts in the early stages of the Bank of New York case?
Mr. SUMMERS. I think there will need to be a careful examination of the approaches for sharing information both within the law enforcement compartment and between the law enforcement compartment and the more general policy area. There are a very difficult set of balances in this area, because of the importance of protecting the integrity of ongoing investigations.
Ms. VELAZQUEZ. Thank you.
Chairman LEACH. Thank you, Ms. Velazquez.
Dr. WELDON OF FLORIDA. Secretary Summers, I represent the East Central coast of Florida, it is called the Space Coast. About a year-and-a-half ago we had to lay off about 600 people at Kennedy Space Center partly because the Space Shuttle wasn't flying. You may have heard on some of the reports on Hurricane Floyd there was concern about $10 billion worth of Space Station hardware stacked up at the Space Center waiting to fly, and the reason that the Shuttle is not flying is we are waiting on a Russian component to the Space Station, something that the President had negotiated with the Russians about six years ago. This element, it is about a $300 million element, a lot of money. I have personally met with Yuriy Koptev, the head of the Russian Space Agency, who tells me that he is not getting any money and that is why this thing is delayed. It is very frustrating to hear that some of the billions of dollars that the IMF has sent to Russia has been siphoned off for illegal purposes, and that their economy continues to spiral downward, because of this huge flight of capital.
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Now, I am very pleased to hear you come before us today and say that we are not going to send them any more money and we are just going to refinance their existing debt, but I have a serious concern that maybe we should not even be doing that. By not applying the necessary pressure by asking them to repay the debt, are we in effect going to not fulfill our fiduciary responsibilities and cause the current problems that we have over there to continue?
In my follow-up question to that, do you really look at these IMF transfers in a true fiduciary way, the same way that a bank is responsible when it lends money to an individual or a corporation?
Mr. SUMMERS. Dr. Weldon, let me try to respond to both parts of your question, if I could.
With respect to the current level IMF approach, it attempts to strike a balance between being appropriately hard-headed, maintaining the pressure for the necessary change, and at the same time recognizing that our involvement or the IMF's involvement does provide the opportunity for influence on questions like integrity of accounting. The current approach also avoids what I think otherwise would be the danger if all of these loans were called at the same moment, creating a very difficult financial situation and allowing the international community to become scapegoats for very real problems in Russia. In sizing the engagement, in timing the engagement, this is exactly the kind of balance that has to be struck. It has to be struck in a hard-headed way.
With respect to the fiduciary question, if I can call it that, I think it is perhaps helpful for me to state what the nature and purpose of IMF support in a situation like Russia is.
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It goes to augment the reserves of the Russia Central Bank. Those reserves are then used in an effort to help stabilize the foreign exchange market. There is a lot of trade in the foreign exchange market. Most of trading in the foreign exchange market doesn't involve the IMF money on either side. It involves buying and selling based on people's judgments as to a price and where they want to have their money, so that it is difficult or really impossible to identify what in some sense the ultimate use of a particular dollar is. What can be audited and what has been audited is that the dollars that were provided by the IMF went for their intended use: Augmentation of Russian reserves and use in the foreign exchange market. That doesn't go to address a whole set of concerns about the selected provision of credits within Russia, about the flows of information that took place within Russia that go to the integrity of the Russian financial system where there are obviously pervasive problems.
But I think it iswithout minimizing what are enormous problems of corruption and establishing financial integrity and the rule of lawmisleading to suggest on the basis of the evidence that is available at this point that there have been direct diversions of IMF dollars that should have been used for reserves in the foreign exchange market to some entirely different purpose.
Dr. WELDON. Thank you, Secretary Summers.
Chairman LEACH. Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
Page 65 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. Secretary, I have a number of questions, some of which you have already answered. The Treasury Department learned about the Bank of New York situation in April of 1999. Is the Bank of New York, is that a national bank or is it a State-chartered bank or is it a bank holding company? My question is who is the primary regulator?
Mr. SUMMERS. The Federal Reserve. Just to be strictly accurate with the committee, the policy officials at the Treasury learned in April. There had been some cooperation at the law enforcement investigative level between Treasury and law enforcement prior to April. But Treasury learned at the policy level in April, and the primary regulator is the Federal Reserve.
Mr. BENTSEN. Do you think that it would have been appropriate once the policy level was aware of this in April 1999, do you think it would have been appropriate to then notify up the line? I guess my point is that some have made the allegation that perhaps once Treasury became aware of this ongoing criminal investigation, that perhaps even higher levels within the Administration should have been notified of this and that they should have gone as far as perhaps to notify high levels in the Russian administration that there was a criminal investigation going on involving a U.S. bank, and by not doing so, that there is some culpability or political culpability on the part of the U.S. Administration. Don't you think that would have been inappropriate behavior on the part of the Treasury Department to interfere with an ongoing investigation, and the appropriate course of action was to allow the investigation to carry out at the appropriate levels, rather than tip off the Russians and say, ''We are investigating some of your activities involving your banks''?
Mr. SUMMERS. The practice and guidelines within which department officials operate, Congressman Bentsen, are to be very, very careful with respect to the discussion of or spread of information with respect to ongoing law enforcement investigations, and I think that history amply demonstrates the prudence of those guidelines, and that is why the approach that was taken when this information was brought to policy officials was to go back on the specific policy relevant question to the Federal Reserve through general counsel channels. But the policy practices under which department officials operate dictate that with respect to an ongoing investigation being conducted by the Justice Department, it was a decision for the Justice Department to make in terms of broader notifications.
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Mr. BENTSEN. In response to a previous question asked you stated that there is currently no evidence that multilateral development fund or international financial assistance funds, IMF, World Bank, have been misused or stolen or anything to the like based upon the audits provided to the international financial institutions and what Treasury has looked at.
There is the case of Fimaco with the offshore transfer. Was the case there that the Central Bank transferred it to their offshore entity and then turned around and purchased government bonds presumably to bolstertransferred funds in the general revenueto bolster the government bond market, but otherwise there is no evidence at this point in time that any funds have been siphoned off for non-governmental activity?
Mr. SUMMERS. I want to make sure that we distinguish the Bank of New York situation from the Fimaco situation.
Mr. BENTSEN. Yes.
Mr. SUMMERS. With respect to Bank of New York there is no evidence that there were any IMF funds diverted.
On the other question, there is ample evidence of integrity and corruption issues that have arisen in the Russian government and in the Russian Central Bank. But the report and the evidence at this point do not point to their having involved in the diversion of IMF funds to inappropriate uses. The concerns go more to the provision of ruble credits, and they go to misreporting of the underlying situation through the use of the Fimaco subsidiary.
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But there are underway, as conditions for the ongoing IMF financing, further audits with respect to the ongoing activities of the Central Bank and there are further issues involving other subsidiaries of the Central Bank that have to be cleared up.
Mr. BENTSEN. Thank you. Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Bentsen.
Mr. RYAN. Thank you for coming today, Mr. Secretary. I regret that I did not hear your opening testimony. I just flew in from Wisconsin.
I want to read you from an editorial from The Economist a couple of weeks ago in describing the culture of corruption within Russia and our relationship with Russia. ''Far from civilizing the wreckage of the Soviet economy, economic transactions between Russia and the West are running the risk of corrupting the Western side, if only by forcing it to wink at practices which would be outlawed in more established economies. There is a particular irony in the fact that one Western party is the IMF, whose stated purpose is to propagate virtues of sound economic policy and good governance. But if the IMF's integrity has been compromised, the cause does not lie in its own sloppy controls, it lies in the collusion of the American and Russian governments to cover up failures and press the Fund into treating Russia with greater generosity than its economic performance would warrant.''
Page 68 PREV PAGE TOP OF DOC Segment 1 Of 2 It seems with news reports, with academia coming to Congress telling us that the Administration has kind of adopted a policy toward this Russian culture of corruption of ''hear no evil, see no evil, know no evil,'' we need a new system to help the Russian people. It is my hope that this does not relegate into some kind of a partisan issue, but that we keep our eye on the ball. That is that we help the Russian people get a healthy growing economy with currency that has a solid store of value.
Have you considered, given the fact that the IMF themselves now will not send money into Russia, because they are unsure of the misuse of the funds, have you considered encouraging Russia to establish a currency board? And would a currency board be one solution which would help stabilize the currency regime in Russia, a central banking system which has been in turmoil since 1914, they have not been in full convertibility. Wouldn't a currency board be one solution that the U.S. and the IMF could encourage on Russia which would be one way to thwart the escalating corruption, and I would ask you to look at the Estonia situation with the currency board and hasn't that helped stem corruption and helped stabilize the currency market there?
Mr. SUMMERS. Congressman, it is something that has been discussed and Mr. Feodorov, whom Congressman Royce was quoting earlier, has actually advocated a currency board in Russia.
To be workable, a currency board system requires a set of prerequisites. It requires, because it denies the government access to the printing press, a budget that is balanced. It requires that a banking system is functioning since one loses the ability for the Central Bank to provide direct credits to banks. And it requires a substantial external component of reserves and that the external component of reserves be readily accessible by anyone wishing to take money out of the country.
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I think while the experience of a number of countries, including Estonia, suggest that currency boards can make very substantial positive contributions to economic stability, at this point the fiscal requisite, the stability in the banking system requisite, and the requisite that requires basic integrity in the economic environment so one is prepared to make an external financing of any capital withdrawal desired by any Russian, I think those three requisites certainly are not in place at this point.
Mr. RYAN. With all due respect, that sounds like an endorsement for the status quo. It sounds like you are putting the cart in front of the horse. Isn't a currency board and a sound banking system the prerequisite for sound fiscal policy? Isn't a currency board and a sound monetary regime basically putting the cart in front of the horse, meaning that is how we can get a good fiscal situation cleaned up in Russia?
Mr. SUMMERS. Congressman, let me say that the status quo is very different than the policy that was in place a year ago prior to the economic and financial collapse, and it is very different in ways that are directly responsive to the concerns about corruption.
There is no question that, as you suggest in your question, a currency board can contribute to maintenance of stability. But if the appetite to spend is not commensurate with the appetite to tax, if there is no capacity to regulate wildcat banks, if the banking system is being used as an adjunct to subsidize industry, those are not things that would be solved by the imposition of a currency board.
Page 70 PREV PAGE TOP OF DOC Segment 1 Of 2 So I think almost all economists, including many of those who are most enthusiastic about a currency board as an ultimate objective, would agree that there are very substantial steps that would have to be taken in the Russian context before a currency board can be considered.
Mr. RYAN. Let me ask you this, and just looking at some of Stanley Fisher's articles, what if you set up a currency board and allowed foreign Western banks to go into Russia and to have sort of a banking holiday, for Russian banks in Russia to allow access to Western banks in Russia, to give us a better, transparent, incorruptible banking system. And a currency boardcould that not be one solution as a way of getting monetary stability in the country without waiting for the fiscal side to develop, before then going on to the monetary side?
Mr. SUMMERS. I think that we have stressed in all of our policy dialogue over the last few years with Russia and other countries that quite apart from the question of capital controls which involves a different set of issues, there are enormous advantages to allowing foreign banks to take an active role in a country's financial system as you propose, and we would be very supportive of that.
Even if you had a major foreign banking presence, the basic challenge of the fiscal year of commensurate taxes and spending is an area that would also need to be addressed as a requisite to a currency board.
I think at this point in Russia's political cycle with the political calendar that we are all aware of, the initiative for such a major imminent change in Russia is not there. So I think what is important is to focus on the more incremental issues of maintaining integrity and addressing banking and addressing banking problems as the issues of this moment.
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But I think the impulse behind your question that a stable money is crucial to a stable economy is exactly right.
Mr. RYAN. So you are basically saying that you have to have the fiscal house in order before you can implement strong monetary changes?
Mr. SUMMERS. I think you would need to have a fiscal house much more in order than Russia's fiscal houses and banking systems are in order today.
Chairman LEACH. The gentleman's time has expired. At the risk of presumption, putting the currency board aside, which is a credible alternative, the United States of America encourages foreign banks. About 20 percent of our assets are controlled by foreign banks and we find it very healthy for the United States. Of modest advice to other societies, including Russia, would be to encourage the existence of foreign banks which operate under the rule of law, and I think it would be very helpful to Russian society if they were to open up to law-based banks as contrasted to a current system where many banks are money laundering centers for insiders.
Mr. VENTO. Thank you, Mr. Chairman. I regret that I arrived late on my flight, but I did look at your testimony, Mr. Secretary.
On the issue of the IMF tranches and the new agreement that is in effect, the fact of the matter is that once the credit is extended, we have a very difficult time trying to extrapolate how that credit may be used. In a sense, these dollars really go to keep the economy and the current circumstances that are in place, the good and the bad, functioning; don't they?
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Mr. SUMMERS. Under the arrangements in place going forward, the funds will only be used to repay the IMF.
Mr. VENTO. Let me interrupt, Mr. Secretary. I understand that there will be a net payback of IMF loans, but in essence the economy of Russia, with whatever the inadequate amounts going for space in some people's view, and whatever other enterprises are taking place, and some of it the corruption and the crime that is prevalent, there will in fact be sustained by this type of credit activity. These dollars are fungible. Some suggest that the efficiency is about 79 cents on $1 in terms of what is spent.
So the fundamental decision here, I guess, is obviously in terms of new conditions, new requirements that are placed; and I read some of the list of conditions and I concur with them. I am not for a currency exchange board. I think a floating ruble is good. Even when the IMF guessed wrong last August, I think they had good intentions, but they made a mistake.
But the issue here is one of whether or not we are going to sustain these conditions. Some have suggested that Russia and other countries that have the potential problems that they facesuch as I suppose you can put China and Indonesiaare too large and they are too important to let slip away. I think that is a realization has been expressed here, perhaps not as bluntly as I am expressing, but it is a factor. We hope that gradually that they are going to grow from a Socialist, centrally controlled economy to a free market state. There are a lot of bumps in the road and there may be some big holes. Maybe there is a black hole, I don't know. Do you want to respond to that?
Page 73 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. SUMMERS. Your question describes very well the kind of balances that are involved in making policy in this area trying to balance what is economically best, and what is realistically achievable in the context.
I think we need to always insist, as a base, on financial integrity with respect to the handling of assistance funds. At the same time, we need to recognize the broad political context in which we are trying to operate. We need to recognize the need for speed in dismantling the apparatus of communism. We need to recognize the unsatisfactory characteristics and the difficulties of integrity that many who come to positions of power have in many countries, and at the same time the fact that they are the representatives of the countries with whom we deal.
So I think there are a difficult set of balances that need to be struck here. Our policy has been to try, in pursuit of American interests, to strike them in as appropriate a way as possible.
Mr. VENTO. As you pointed out, we have $15 billion a year of capital flight from Russia and there is an $80 billion export market. A lot of dollars are coming out and going back. We talked about the IMF tried to take on PricewaterhouseCoopers' audit to provide some air of security. Are there auditors and auditing systems in Russia? Are there regulators? I know free market countries that don't have adequate regulators. It is sort of begging the question. They do not have. Can we really in effect audit and know where $80 billion goes a year or try to prevent a $15 billion loss? All of us would like to see the rubles remain in the country so they can achieve the type of economic success that we would like to see.
Page 74 PREV PAGE TOP OF DOC Segment 1 Of 2 What is the answer? These requirements here, lack of auditing capacity, lack of regulatory capacity in the banking and financial system, to say nothing of the civil justice system, the rule of law, these fundamentally are uneven at best, are they not?
Mr. SUMMERS. Congressman Vento, I would agree with everything that you have said about there being very substantial inadequacies in the accounting and regulatory frameworks in Russia. If you look at our own country where the problems were much, much simpler, the development of those frameworks took us a very long time.
What I think is prudent and appropriate for us is to insist on very specific auditing with respect to the specific funds that the IMF provides and rigorous safeguards with respect to those funds from the international financial institutions.
With respect to the problem of capital flight, there is I think something that we can learn from the broad economic history, and that is that it is a King Canute-like task to try to stop capital flight by measuring every flow and puttingand erecting appropriate barriers and having satisfactory regulation.
Capital flight stops when a broad economic environment changes to one in which a country's citizens decide that it is in their interest to make investments in their country. Until that change has been brought about, no set of administrative procedures will stop capital flight. And once that change is brought about, the administrative procedures become less important and that is why support for the broad direction of Russian economic reform and stability in Russia has to be a component of a prudent policy.
Page 75 PREV PAGE TOP OF DOC Segment 1 Of 2 But I think that the important thing for us to keep in mind is that this is a long-standing task that we will be with for a long time.
Mr. VENTO. Just stating a parameter, the $15 billion in capital flight does not all come to the United States. The $80 billion in exports does not come here. The mistakes made by the IMF in terms of the floating ruble and the devaluation of it and the sort of uncontrolled nature, not the lack of recognition, these are fundamental mistakes. I disagree and I think most of us in hindsight could do well in terms of this interpretation, but I understand that the answers to that are not easy to come to as we look ahead.
Chairman LEACH. Mrs. Biggert.
Mrs. BIGGERT. Thank you, Mr. Chairman and thank you, Mr. Secretary for participating today. Last week Secretary of State Albright was quoted in the New York Times, criticizing Russian leaders for failing to combat corruption. Secretary Albright said that the Administration would no longer support further multilateral assistance to Russia unless fully adequate safeguards are in place. Additionally, I think it was in another paper, she said that a close eye is always kept on bilateral aid as well.
Do Secretary Albright's comments reflect the position of the Administration? Does that reflect what will happen with agreements that are already in the pipeline, that are already in the works?
Mr. SUMMERS. Yes, it does reflect the Administration position. And yes, with respect to all future bilateral assistance and with respect to the IMF and the international financial institutions support, we will only support disbursements based on adequate safeguards and adequate accounting.
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Mrs. BIGGERT. What about those that are just about to be forthcoming, would it be prudent to delay or cancel those as well?
Mr. SUMMERS. It would be prudent for them not to take place until adequate accounting and adequate safeguards are in place.
Mrs. BIGGERT. So that there would be concrete evidence that those safeguards are in place?
Mr. SUMMERS. Absolutely.
Mrs. BIGGERT. Thank you. Thank you very much.
Chairman LEACH. Thank you.
Mr. INSLEE. I just want to make a comment and then I have a couple of questions.
I read from our friends in the press who sort of suggested that these hearings are to answer the question ''Who lost Russia?'' and I want to say that nobody ''lost'' Russia, Russia was not ours to lose. And if Russia loses this opportunity to go to a law-based free enterprise system, it will be Russian failure, not American, and I think it is important to say that when we think about what we can or cannot do with regard to Russia.
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But if there is a new shift, when and if we ever get back to try to help them financially, and I appreciate the Administration's decision to essentially just refinance existing loans, if we ever do get back to that position, the first question: Should we consider rethinking how we offer assistance to Russia, to go to a system of maybe more micro-credit in the sense that we make individual lending decisions on our end of the pond, so to speak, rather than central banking decisions in Russia?
Should we simply accept the fact that we are going to have to make those lending decisions here to have credibility and integrity, at least for some period of time? And we have had, as you know, some real success in a lot of developing nations with some of our micro-lending policies with specific entrepreneurs. Should we be thinking more on those lines rather than just sort of supporting the central banking system?
Mr. SUMMERS. Certainly I think doing as much as we possibly can in a micro-enterprise area should be very much a priority and should be something that we and the international financial institutions should strongly support.
In general over the last number of years in Russia, the constraint has frankly been less the availability of external finance for micro-enterprise than the ability to put institutions in place on the ground that can identify enough loans. Not even all the money that has been allocated for this purpose has moved, because of the need for satisfactory control.
I think that, Congressman Inslee, in light of the substantial debts that Russia has coming due, and in light of the fact that the conditions of stability in which micro-enterprise can function does depend somewhat on the macro-economic framework, it wouldn't be a good idea for us to make a blanket judgment about moving away from macro-economic support for change in Russia, although as our current policy limited to refinancing illustrates, that is an area on which we will have to be very hard-headed going forward.
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Mr. INSLEE. Is there a way, if the American taxpayer is going to be providing some financial assistance or guarantees, if you will, should we be more rigorous in directing it to things that we may have a self-interest in; for instance, the command and control system of their nuclear force? Should we be trying to tie some of our assistance and say we want to see a targeting toward some specific concern? Should we be thinking in those terms?
Mr. SUMMERS. Yes. My discussions here today reflecting what are the responsibilities of the Treasury Department have concentrated on the work of the international financial institutions, which I think covers primarily the areas that we have been discussing.
If one looks at the broad portfolio of U.S. policy, and particularly our bilateral assistance program, I think there is no question that a crucial aspect has to be the area that the Nunn-Lugar program represented in terms of supporting targeting of nuclear materials. I think there are questions in which Senator Domenici and many others have been active involving enriched uranium and plutonium fuels from Russia.
I think there are a broader set of issues involved in defense conversion and housing for Russian military who are brought back to Russian soil. It seems to me that one of the great transformations is the defense conversion effort, and that is something that we have very large, very direct security interests in cooperating with the Russians on, and it is an area that is somewhat separate from the set of issues that we have been focused on today.
Mr. INSLEE. Thank you.
Page 79 PREV PAGE TOP OF DOC Segment 1 Of 2 Chairman LEACH. Thank you. That concludes the last Member from our committee, but we have a guest, Mr. Weldon.
Mr. WELDON OF PENNSYLVANIA. Thank you, Mr. Chairman. I appreciate the opportunity to sit through this provocative hearing and the comments made.
I am here because I co-chair, with Congressman Steny Hoyer, the Duma-Congress Initiative, and we are very active with members of the Duma. Mr. Secretary, I was very much interested in your testimony, but before I get to that, I would like to, Mr. Chairman, introduce members of the Duma who have been invited here to witness these hearings.
I invited, and he is here, the Chairman of the Corruption Commission of the State Duma, Alexander Kotenkov. Would you please rise? The Deputy Chairman of the State Duma Committee on Budget, Taxation, Banks and Finance, Mr. Gitin. Mr. Gitin, would you please rise? Mr. Andrei is due to arrive along with Viktor Gitin. You will have a Duma deputy testifying tomorrow in one of your panels.
In the twelve-page statement that you made, Mr. Secretary, which was very thorough and comprehensive, and for the record I have supported every initiative the Administration has had with regard to Russia, I have lobbied for the Nunn-Lugar program and have been trying to support the engagement with Russia. But in your statement there is no mention of the Parliament in Russia. There is no mention of the word Duma or Federation Council. In fact, the only time you referred to it was after you asked a question, and this was your statement: ''that things were not moving forward because of the unwillingness of the Russian Duma to bring the budget under control.''
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In fact, if you look at all of the concerns raised by our Government and the IMF, the budget and the privatization of land, the reforms, all of those require action by the state Duma. My contention is that has been the failure. Our policy for the past seven years, in my opinion, has been so preoccupied with our two Presidents and our Vice President and the Prime Minister that we have forgotten that Russia also lives under a Constitution and that Constitution includes a Parliament, and that Parliament has a legitimate role to play.
My concern is when the IMF goes in and attempts to ask the Duma to make tough reforms, like imposing new taxes on people for the water that they drink, for the electricity, for the housing which in the past they got for free, if I were a Duma deputy, I would say to the IMF and the U.S. Government: Go pound sand. Why didn't you come to us when you were spending all of this money in our country? Why didn't you come to us when policies were being developed as to where the IMF were putting dollars? Why didn't you come to us when we suggested that the regions should be benefiting where they are making reforms? Why didn't you come to us all along? Do not come at the eleventh hour and expect us to do the right thing simply because Russia's back is against the wall.
In my opinion, that has been the failure of our Government, and I include the Congress and the White House. We have not done enough to strengthen the institution of the Parliament in Washington.
I was in Moscow a year ago in September when this Congress would not approve IMF funding to let the most recent tranche at that time, and at the same time the Duma was opposed to the tranche of IMF funding. Why would the Duma be opposed to more money coming into Russia? Because the Duma deputies from all the factions look at this as a bailout of the corrupt policies of the Yeltsin government, of the cronies and the oligarchs who run the seven banks, the cronies who benefited from the billions of dollars that we put into Russia, and I would disagree that all of it is totally accounted for.
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I would make the statement that there are some cases where we have not been able to account for even the taxpayer money going into Russia. That is why the Duma was opposed to the IMF tranche.
I came up with a set of eight principles. This follows up on Mr. Frank's suggestion that if we have some ideas, bring them forward. These ideas are two years ago, Mr. Secretary. Let me read them to you in summary form and ask which ones you disagree with.
Number one: to establish a joint U.S.-Russian legislative oversight commission to monitor every dime of Western money going into Russia. Not to dictate where it goes, but to make sure it is going to where it is supposed to go.
Focus Russian resources on programs like housing that will help develop a Russian middle class; to make Western resources available to reform-minded regional governments instead of running everything through the central government in Moscow. Deny corrupt Moscow-based institutions access to any further Western resources.
Number five, reform the International Monetary Fund was a suggestion to me by George Soros the week I left for Moscow. He said the one thing that needs to be done is to put pressure on the IMF to establish an international blue ribbon task force to make recommendations on how to deal with an emerging economy like Russia's.
And number six, Mr. Secretary, the Duma leaders agreed to this, and listen to this, to put the horse in front of the cart, make reforms precede and not follow the resources. So something the IMF couldn't get Russia to do, that our Government couldn't get it to do, the Duma agreed to because we were tying it into these other changes focusing on the regions, making sure focusing on programs that create middle classes, to make sure there was an oversight process where the Duma could monitor inside of Russia where the dollars were going.
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The last two were to develop a joint action plan to engage CEOs of American companies with Russian enterprises and a mentoring relationship, some of which is being done now.
And the last one was to bring over 15,000 young Russian students within three years to have them attend undergrad and graduate degree programs at American business, finance and economic schools with the stipulation they must go back to Russia to live to help create the next generation of free market leaders in Russia.
We presented this plan to the President, and the White House told Speaker Gingrich, ''we don't support it,'' and so Speaker Gingrich, to his fault, was not willing to stand up and have the Congress vote on it, yet the Duma agreed to it.
My question, Mr. Chairman, if we are ever going to get Russia straightened out, we have to understand that Russia lives under a constitution, and as much as I want Yeltsin to succeed, and I did all the way through, you have to engage the parliamentary bodies, the Duma and the Federation Council, because if you don't, you will never have the reforms codified that you and the IMF feel are so necessary.
Mr. SUMMERS. Let me just say, Congressman Weldon, how much we appreciate the work that you have done for a number of years with the Duma, and I think you are right in your central point that engaging with any country, you have to engage with the whole of its government and not just its president; and that should be, and I think will be, a priority policy going forward.
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There is obviously a balance that has to be struck, just as foreign governments in dealing with our country, there is a role for them in dealing with Congress, and there is a role for them in dealing with the Executive Branch, and a balance has to be struck. But I think there is no question that our approaches, going forward in Russia, will have to increasingly be from the ground up, and that is a theme that, if you like, connects Congressman Inslee's concern with micro-enterprise lending, some of the concerns that were expressed about making assistance felt directly by the people.
And I think it also goes to your suggestion for a political strategy in terms of a greater degree of engagement with the Duma. Of course, we are at a particularly complex moment in Russia's political calendar right now, and that is something the United States needs to be mindful of as it sets policy toward Russia, but I think that the central point of your eight principles, the need to engage more deeply with Russian society and not simply from the top down, is entirely correct.
Chairman LEACH. I thank you, Mr. Weldon, for your extremely thoughtful contribution.
Just in conclusion, let me say that from the American perspective, the principal issue isn't who lost Russia, but how we can help save Russian democracy; and I believe it would be an exaggeration to suggest that Russia is an economic Vietnam, but it would not be to note that any sense of history requires that the United States take all credible steps to ensure that the Cold War isn't revisited.
Page 84 PREV PAGE TOP OF DOC Segment 1 Of 2 In this context, corruption problems have a capacity to destabilize Russia and, therefore, the international political system. Issues of corruption and public service ethics have a National Security Adviser dimension. In this sense, our committee's basic jurisdiction is over banking, and banks are intermediaries for good or for evil, and it is a challenge to all of us to ensure that financial systems are designed to serve people and not insiders, and that is an extraordinary circumstance that will reflect on, I believe, the future of not only U.S.-Russia relations, but much of Western stability.
Anyway, we thank you very much for your testimony, Mr. Secretary, and we wish you well. And I would say I am particularly supportive of your last theme, and that is to begin from the bottom up, which is implicitly looking at the concerns of people first, recognizing that governments are to be accountable to people and if governments aren't accountable to people, other governments ought to be, and this Government ought to lead the way.
Thank you very much.
Mr. SUMMERS. Mr. Chairman, Ranking Member LaFalce, thank you very much for having provided me with this opportunity for discussing both the crucial issues involved in U.S.-Russia policy and the crucial issues involved in making sure that the United States takes an adequately vigorous approach to financial crime. We in the Administration look forward to consulting with Members of this committee and other Members of Congress on these very important issues as we go forward.
Chairman LEACH. Thank you, Mr. Secretary. The committee will now ask that the second panel come forward, and I will introduce them.
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Our second panel is composed of the Honorable James Woolsey, who is the former Director of the Central Intelligence Agency; Mr. Fritz Ermarth, who is the former CIA Chief Russian Analyst and National Security Council official; Mr. Paul Saunders, who is Director of the Nixon Center; and Mr. Vladimir Brovkin, who is a Professor at the American University Transnational Crime and Corruption Center.
We will begin in the order of introductions and begin with Director Woolsey. Mr. Woolsey, please proceed.
Mr. FRANK. Mr. Chairman, could you ask people who are doing business to clear the room. I think we are going to have trouble hearing. There are various conversations going on.
Chairman LEACH. The Chair would ask that there be order and that it is disconcerting for conversations to take place when our speakers are proceeding.
STATEMENT OF HON. R. JAMES WOOLSEY, SHEA & GARDNER, FORMER DIRECTOR, CENTRAL INTELLIGENCE AGENCY
Mr. WOOLSEY. Thank you, Mr. Chairman. If it is all right, I would submit this three-page statement and then just speak informally from it for a few minutes, not reading it.
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Chairman LEACH. Without objection, and I will say I am somewhat disappointed, because I considered it to be an exceptional three-page statement, but please proceed as you see it fit, and your full statement will be placed in the record.
Mr. WOOLSEY. Thank you, Mr. Chairman.
It is an honor to be asked to testify today on this important subject. I should begin by ensuring that you realize that my detailed knowledge of this particular issuethat is, Russian money launderingis dated, is limited in scope and was highly classified at the time I was working on it several years ago, because of the sources and methods that we used in learning about it.
My involvement arose because during 1993, when I was Director of Central Intelligence, some very able CIA analysts came to me with an excellent briefing on some aspects of Russian organized crime. I moved promptly to ensure that very senior officials at Justice, the FBI, the National Security Council and elsewhere in the Government received this briefing. I commissioned a special National Intelligence Estimate on Russian organized crime that had limited circulation because of the sensitivity of the sources and methods. I also put the issue on the agenda of some of our meetings with our allies at very senior levels working on this issue; and I think that through this, the U.S. intelligence community and the CIA in particular, performed a very valuable service in putting the issue squarely before those in our country and in some of our allies' governments who needed to know about it in order to take appropriate action.
I believe that this is one of the most important issues facing the United States, that is, the issue of large corruption in Russia, of which money laundering is one aspect, really for three reasons.
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First, organized crime and corruption together have the potential to destabilize the Russian state and Russia can still destroy the United States within the 30-minute flight time of an ICBM. Thus, its political instability and the unpredictability of any who command and control its strategic systems are of course extremely important to us.
Second, there is the real possibility that Russian organized crime groups may become involved with the sale of technology or the material for weapons of mass destruction, and such sales could be profitable in the right quarters, for example in the Mideast, to terrorist groups or governments such as Iraq; and this, of course, is a major issue for the United States.
Third, Russian organized crime can use its resources to corrupt institutions in the United States, and the recent case involving the Bank of New York may prove to be one such example.
I have been particularly concerned for some time, Mr. Chairman, at the inter-penetration of Russian organized crime, Russian intelligence and law enforcement, and Russian business. I sometimes illustrate this point with the following hypothetical: If you should chance to strike up a conversation with an articulate English-speaking Russian in, say, the restaurant of one of the luxury hotels along Lake Geneva, and he is wearing a $3,000 suit and Gucci loafers and he tells you he is an executive of a Russian trading company and he wants to talk to you about a joint venture, he may be what he says he is. He may be a Russian intelligence officer under commercial cover. He may be part of a Russian organized crime group. But the really interesting possibility is that he may be all three, and that none of those three institutions have any problem with that arrangement.
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In addition to the above points, I have said publicly, Mr. Chairman, that during the time we were working on this issue of organized crime in Russia, Mr. Louchansky and his company, Nordex, were a focus of our attention.
I would point out that since the second week of January of 1995 I have been a private citizen. So let me turn now from what I know to what I just have judgments about, based on public sources.
I have no reason to dispute the Russian government's estimate that criminal syndicates now control around 40 percent of the Russian economy, and as you pointed out in your piece in the New York Times, Mr. Chairman, there are higher estimates as well. Former Interior Minister Kulikov said to me last week that the Duma has passed anticorruption legislation on five occasions that has either been vetoed by President Yeltsin or sidetracked by him and his staff in some fashion.
The heart of the matter seems to me to be the difficulty that we have today in finding an institution or group of individuals with whom we can work on a long-term basis. I might contrast the current Russian situation with that in Italy some years ago, when organized crime was an extremely serious matter. But by working with Italian magistrates, who by law and by custom are the ''untouchables,'' in a sense, in the Italian system, we were able to help those magistrates make a substantial dent in the problem of organized crime in Italy.
In Russia, there are individuals with whom from time to time we can work, but there does not seem to be a critical mass at the national level of honest magistrates of this sort, or any other arrangement which gives us a partner on a long-term basis. Perhaps the presidential election in Russia will bring some developments that will be positive; I hope so. But it is important for us to do what we can, even if we operate alone.
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Let me conclude with the following point. I have been asked frequently, since the story began to break a few weeks ago concerning money laundering through the Bank of New York, whether during my tenure I detected any lack of willingness at the senior levels of the U.S. Government to hear information about this subject. My answer to that specific question is, no, I detected no such lack of willingness as of January, 1995; but during the last several years, as a policy matter now, we have seen that to an extraordinary degree the United States has become identified with President Yeltsin and his senior people, the circulating list of senior people, and we have been quite generous financially, particularly through the IMF, with sending funds to Russia, and we have pushed for increased tax collections and tight budgets.
Each of these approaches at one time or another had some defensible aspects to it, but if you step back from them and look at the overall pattern, it is very easy to see, as Congressman Weldon has pointed out, why ordinary Russians who saw us just a few years ago in very idealized terms have turned sour on the United States. In their eyes, we are the supporters of those who have stolen much of their national patrimony, through a highly corrupt privatization process particularly, and at the same time we are the ones who insist that the ordinary people of Russia bend their backs even harder. We are seen, in short, by average Russians as supporting the system and the individuals who are exploiting them.
To them, America won the Cold War and then helped to give them a capitalist economic system that is modeled not on Silicon Valley, but on the Chicago liquor market of the 1920's. Something is badly wrong here, but the roots of the problem don't lie solely in our knowledge about, or our approach toward dealing with, Russian organized crime. There are deeper, I think fundamental, issues in the approach toward Russia that we have, perhaps in a fit of absent-mindedness, adopted as American policy.
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I conclude with one final point, Mr. Chairman. Congressman Weldon was kind enough earlier this year to have me and former Secretary of Defense Rumsfeld and several others join him and other Members of the House in Moscow, meeting with some members of the Russian Duma, and I became familiar then with the program which he described a few minutes ago.
I think that his statement, and some of the questions by Congressman Inslee, as well as your closing remarks and some of the things that Secretary Summers said, could point the direction toward a rather middle way between the current policy and the withdrawal from engagement with Russia. In pursuit of such a withdrawal, some have even proposed cutting Nunn-Lugar funds, which I think would be extremely shortsighted.
I would characterize Congressman Weldon's overall approach as a form of ''tough love'' in dealing with Russia. It has often been said that the Morrill Act, establishing land grant colleges, and mortgage interest deductability may be two of the most important things that the Congress has ever done in terms of building an educated middle class, and a homeowning middle class, in the United States.
Many of the analogs that exist to those types of measures and others in Congressman Weldon's program seem to me to present a positive approach. Perhaps not every detail ought to be implemented precisely the way it is drafted now, but I believe if those in the Administration who have fostered the approach that I believe has not succeeded and has brought us to this point, as well as those in the Congress who are proposing more or less a complete withdrawal from dealing with Russia, would get together and focus on some of the points and issues that Congressman Weldon and others here have raised, I think there is a way out of this. It will not be easy, but it does present the possibility of a positive approach toward engagement with the Russian people in way that we have not been engaged to date.
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Thank you, Mr. Chairman.
Mr. LEACH. Thank you, Mr. Woolsey.
STATEMENT OF FRITZ W. ERMARTH, FORMER CIA CHIEF RUSSIAN ANALYST, NATIONAL SECURITY COUNCIL OFFICIAL
Mr. ERMARTH. Mr. Chairman, I am deeply grateful to you and the other Members of the committee for offering me the opportunity to testify today on this extremely important agenda.
Staff asked me to say just a word about my background. I retired a year ago from a 35-year career in serving the national security, twenty of it working for CIA, and in those years I was a national intelligence officer for the U.S.S.R., now Russia. I was the Chairman of the National Intelligence Council, which prepares national intelligence estimates. I had two tours on the NSC staff, one under President Carter, one under President Reagan, and I also served in private industry.
Throughout that period, I was primarily focused on things having to do with the Soviet Union one way or another, and of course, I continued my keen interest in Russian affairs after the collapse of the Soviet Union.
Page 92 PREV PAGE TOP OF DOC Segment 1 Of 2 I would like to focus my testimony on the larger context of Russian developments that have posed the challenge before this committee, the challenge of organized crime and its various threatening practices like money laundering. We can probably need to have little doubt that our law enforcement agencies and regulators will come to grip with this challenge. This committee will no doubt help in that endeavor, but we must keep the most important issues in the forefront, as the Chairman has done in his public statements and in his very gracious and, I thought, very timely statement in the Russian language to the Russian people here today.
We must consider how our country's future security and well-being will be threatened if, once again, Russia fails in its historic mission to find a way to an authentic, stable democracy in a just, prosperous society with a market economy.
My bottom line is that Russia is not lost. That is a strongman statement, as a matter of fact; we ought to ban it from the debate from now on since everybody's attention has been got anyhow. Russia is stuck, stuck in a swamp, between the Soviet past and several alternative future possibilities, some of them bright and some of them ominously dark.
The larger purpose of these hearings in this committee and in other committees at the Congress and in the debate now finally taking place in our political arena and in our press is to understand Russia's condition and prospects better and to inform better American policies for encouraging the brighter prospects of democracy and Russian capitalism.
The threat from Russian organized crime springs from two fundamental and interrelated realities: first, the grave weakness of the rule of law in Russia and, second, the perversions of what we have called ''economic reform.''
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The Communist system was itself a kind of structured lawlessness. The Soviet Union had lots of laws. They were really tools in the hands of those who wielded power to use, abuse or ignore, and they left plenty of room for ordinary crime, organized crime and official crime or what I called authorized crime. And these possibilities of course expanded massively and rapidly with the collapse of the Soviet order.
The collapse of Communist rule gave free rein to these phenomena in a completely new setting. Now, that new setting, which we have labeled The Emerging Capitalist Economy of Russia is something for which I have not found a good definition. It has important features of democracy and capitalism, but it is not authentic democracy or complete democracy, and certainly not authentic capitalism. Focusing on the business and economic side, I would use the term ''crony capitalism'' without capitalism or at least much capitalism.
By ''capitalism,'' we mean investment for the building of wealth; that is not what was going on there. We see a lack of firm property rights and good corporate governance. We see a system that is more about the distribution and especially the concentration of wealth than it is about investment and the creation of wealth, and above all, we see a system that is about the extraction and the expatriation of wealth.
We have used the term ''capital flight'' here. I think we have got to have another term for most of this because capital flight ain't what it is. It is the flight of loot rather than the flight of capital in many cases. That is not just the criminal loot, but the plundered wealth out of the natural resource base. It isn't the same as a businessman in Brazil making a profit on a business and then sending that money abroad, because it isn't safe or profitable at home.
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Now, this came about in large measure because of the manner in which the reformers of the post-Communist regime tried to create capitalism amidst the wreckage of the Soviet order. As one analyst I have read put it, they proceeded in good Communist fashion to create a new capitalist class. By basically appointing them, relying largely on privileged insider relationships, vast resources and enterprises were placed into private hands, often the old Communist hands, at less than fire sale prices. Enterprises were sold off at less than the cash value of their annual revenues. Export and import privileges were handed out to cronies like the sports funds. Even the church profited from this, alas.
Thus, the process of privatization was, from the outset, a rip-off at the expense of the state and the society. This, along with the destruction, the unnecessary destruction of people's savings through inflation in the early 1990's deeply blighted the public's view of capitalism from the outset. The reformers took a course certain to alienate society. They almost deliberately ignored the task of building public understanding and support, a theme to which Congressman Weldon spoke when he referred to the importance of engaging the Duma.
Dimitri Simes, known I am sure to all of you who follow Russian affairs, tells a story of how on his last trip to Moscow, former President Nixon visited with President Yeltsin and urged President Yeltsin and the reform team to pay more attention to building public and Duma support, at least a dialogue in the face of mounting opposition. President Yeltsin said, ''Well, that is not what we are hearing from Washington. We are told we ought to just ignore them, the Duma and the opposition.'' This was in 1993. So the politicalor naivete is not too good a word for it, but whatever it is on our part started very early.
Page 95 PREV PAGE TOP OF DOC Segment 1 Of 2 Now, this style might have worked out had the new owners, however privileged and unfair their access to this wealth, had they proceeded to manage their new wealth as real capitalists, as real entrepreneurs, by investing, building and creating as our robber barons did, so-called; but far too often they did not do this. Lacking confidence that their new wealth could be profitably invested in Russia, even if they could hold on to it and not knowing in most cases how to turn resources into new wealth through investment and entrepreneurship, they all too often simply extracted it, stripped it, plundered it out of Russia and sent it abroad where it could be safe and productive, with little work by themselves other than financial and other kinds of bureaucratic machinations.
In this matter, a country rich in natural resources and productive potential saw its state and its society impoverished. The society and domestic economy reacted with various coping strategiesbarter, trade, moonlighting work. The state had its coping strategies like not paying its bills and then very creative financing called the short-term capital bond market at high interest rates which aptly turned into a no-lose casino that eventually had to go bust despite the lavish spending of the IMF to keep it up.
What we have seen here is not so much organized crime as authorized crime, intertwined with corrupt government and politics at all levels. It has been abetted and has abetted itself by organized crime with its money laundering, its protection rackets and the like.
The fundamental misdemeanor of Western, including American, policy was that it bought into this phony, crony capitalism too uncritically and for too long, and against obvious evidence you could have shut down all of Mr. Woolsey's colleagues on this front and it still would have been obvious. Intelligence brought its own very special contribution sources and methods of a sensitive nature, but you didn't need intelligence to see this. You needed an absence of intelligencesmall ''i''to ignore it, but the government wasn't alone. The mainstream media, the mainstream foreign policy establishment up and down Mass Avenue ignored it as well. The protests of Western and Russian observers who knew what was going on went unheeded.
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One of the sad consequences of IMF lending, while aiming to stabilize and grow the economy, it actually lubricated, legitimized this plundering; at least that was the way a lot of Russians viewed the political meaning of IMF lending. I think it was more a perversion, than diversion, of IMF lending. Although I think there was some diversion, especially in July-August 1998.
If one includes the period of the late 1980's, when much of this activity was begun under the aegis of the CPSU and the KGB, the representatives of the Soviet state itself, one might guess from $200 to $500 billion of ''capital flight,'' ''capital loot,'' has left Russia.
Now, some of it derives from crime. Some of it was completely legitimate, although it was trying to escape taxes, but most of it was in this gray zone derived from phony, crony, insider access to natural and other resources. Now, some of it comes out to be laundered, because it needs to be disguised, but a lot of it just gets deposited, just comes out where it is safe and productive and it doesn't stay in Cyprus. It goes to the biggest, most productive, most successful economy in the world, the United States of America.
Here, it goes in several directions. Some stays and takes a nap, as I say, waiting for future opportunities. Some goes back to Russia for business, crime, for politics. A lot of it gets invested in portfolios and real estate and businesses, and I am sure that some of it goes into political contributions.
Now, that might seem like an inflammatory statement, but I can make it with confidence for three reasons. First, the logic of the situation. That is what this kind of money does. It is bipartisan. It won't go to just one side of the aisle, but that doesn't make sense. These people don't care about the issues or the values or the politics. They care about influence.
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The second reason, I think, I can make this statement is because there are some examples in the press over the years; and third, because FBI people who follow Russian organized crime in this country have said it is so, it goes on. They don't know quite what to do about it if it doesn't involve direct violation of law, but they have told me that it does.
I would assign even greater weight, however, to a more general problem or threat. Money on this scale acquires friends, and those friends have leverage. How much leverage and with what effects on Government policies, I do not know, but that is a proper subject for inquiry by this committee.
Did Americans heavily invested in the GKO market, this casino, this no-lose casino that eventually became a plundering of the Russian state budget for the benefit of Russia and Western speculatorsvast profits extracted, vast losses riskeddid the stakeholders in that enterprise have influence over U.S. Government policy to encourage IMF lending last summer? Mr. Soros and others have strongly implied exactly that.
Let me state that the picture, Mr. Chairman, that I have painted here is deliberately unfair, because it doesn't afford enough attention to the positive. There is real capitalism and democracy in Russia. There are decent businesses, honest policemen, clean politicians.
Back to our first point, Russia is stuck, not lost. If the Russians can somehow get through these elections, the crisis of terrorism, create a somewhat stable and legitimate government, I believe there is a possibility that a real window for reform will reopen, that it could be done right. Certainly it can be done better. I hope that we shall be ready with supportive policies that are more perceptive, more honest and more constructive than they have been in the past. At least we have got to quit committing the errors of the past.
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Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
STATEMENT OF PAUL J. SAUNDERS, DIRECTOR, THE NIXON CENTER
Mr. SAUNDERS. Thank you very much, Mr. Chairman. Thank you also to the Ranking Member and other Members of the committee for the opportunity to be here today.
Before I start, I wanted to make two minor bureaucratic points. First, my written testimony was prepared jointly with Dimitri Simes, the President of The Nixon Center, who unfortunately was unable to be here today; and second, that despite our respective positions at The Nixon Center, our testimony does not represent an institutional position by the center as an entity and expresses solely our private views. Moreover, to the extent that I drift from the testimony, I am expressing my views alone.
I will discuss my prepared remarks only very briefly, because I would like to address some of the issues that came up in the discussion this morning in a little greater detail.
I think from the discussion this morning, it is clear that the Clinton Administration has been aware of the scope and scale of Russia's corruption problem for some time, and that, for a variety of reasons, it has chosen either not to act or to take limited, ineffective action.
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In my view, this is a result of the Administration's overall approach toward Russia and its division of Russian politicians into ''good'' and ''bad.'' This was a gross oversimplification of the situation in Russia. It led to the Parliament being put into ''bad'' the category with some of the consequences that Mr. Weldon outlined earlier.
It also allowed the Administration to ignore the inappropriate or questionable actions of the so-called ''good people'' with consequences that we have heard about today.
Turning to the question of who lost Russia, I don't think that it is an appropriate debate. Secretary of State Madeline Albright said last week that it was ''arrogant to argue that we could have lost Russia, because only Russia could lose Russia.'' I agree wholeheartedly with that sentiment; but I would take it one step farther and say that is it arrogant not only to say that we could lose Russia, but also to pursue the policy that we have pursued in recent years, believing that we know better than Russia's government and people what budget deficit level they should have, what inflation level is appropriate, or which specific people should be part of any given Russian government. That is one of the major problems of our policy toward Russia. There was a sense that we somehow knew more than the Russians did, that we could come up with the right answer for Russia out of the dizzying array of economic possibilities in the world.
This led us to focus on macro-economic issues, the budget deficit, inflation rate, and others I mentioned earlier.
Page 100 PREV PAGE TOP OF DOC Segment 1 Of 2 These policies were advanced at the expense of other priorities that would have been much more desirable in the long term, such as the rule of law.
I believe that if the Administration had pressured Russia and President Yeltsin more heavily on the rule of law, rather than on these economic issues, which ended up spoiling relations between the Russian executive and legislative branches and prevented the passage of legislation that would have encouraged investment and limited opportunities for corruption in Russia, we would be in a much better position than we are today.
On that point, it is essential in thinking about Russia to decide what our priorities really are. Whether Russia's budget deficit is 3 percent or 4 percent or 5 percent is not going to keep anybody awake at night in Washington, but if there is a return to some kind of authoritarian government, or if there is chaos in Russia resulting from popular frustration with corruption and other problems, I think a lot of us could be awake at night.
I would like to make one final point about the debate over our policy toward Russia. The Administration and its defenders have frequently tried to cast opponents to their policy as ''cold warriors'' opposed to engagement with Russia. I don't think that is really the correct way to frame the argument.
There are many ways to engage with Russia that will allow us to have a very productive and mutually beneficial relationship. If we give more attention to the things that really matter in Russia, such as creating a rule of law system, we will be much better served in the long run.
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Chairman LEACH. Thank you, Mr. Saunders.
STATEMENT OF PROF. VLADIMIR BROVKIN, PROFESSOR, AMERICAN UNIVERSITY TRANSNATIONAL CRIME AND CORRUPTION CENTER, ACCOMPANIED BY PROF. LOUISE SHELLEY
Mr. BROVKIN. Thank you very much for the opportunity to speak before this committee. I also should say that I am particularly honored to be here, as I am a Russian-American. I spent half of my life in Leningrad, U.S.S.R., and the other half in the United States, having been educated in this country, but devoting my professional life to the study of Russia; and I am particularly grateful to my colleague and friend, Louise Shelley, the Director of the Transnational Crime and Corruption Center, with whom we have been working for the last two years on the problem of organized crime and corruption in Russia.
The written part of our remarks has been developed by the three of usthe two Directors and I, Keith Henderson and Louise Shelley. I will summarize briefly our major points, and also as we go along, give a couple of examples about the issues that we have developed in these remarks.
First of all, I should say that in the two years that we have been working on this project, actually funded in large part by a Department of Justice grant, we have come in contact with many, many Russiansjournalists, politicians, prosecutors, street copsand we have developed very good relations with many of them. In July 1998, we held a money laundering conference at the Federation Council in Moscow which was extremely useful and very revealing in terms of the processes and mechanisms of how money laundering works; and a lot of debate was going on about the formulation of the money laundering law in Russia, which still hasn't been passed. It also showed that the term ''money laundering'' is understood in quite a variety of ways and certainly very different from what we understand here in the United States, which also needs to be addressed in a future discussion.
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We have just returned from Moscow, where we had a conference on corruption, sponsored by us and our partners in Russia with the Institute of State Law and the Russian Academy of Sciences, and I am not going to spend time summarizing it. It is all going to be on our Website. But what I would say is, I was struck with the degree of openness, the degree of frankness when the Russian prosecutors and officials were talking about their problems in front of Americans. This was totally inconceivable five or six years ago, let alone in the Soviet period.
Moreover, what I also think you all will be pleased to hear is, the kinds of proposals they have developed are very much in the American spirit. They were talking about the conflict of interest law that they would like to introduce, about the statement of income for the relatives of civil servants, about the ethical code of behavior for the civil servants and many, many other interesting initiatives. So it is one more time to emphasize that when we do speak about corruption and organized crime in Russia, that should not mean that there are no serious attempts made by many honest Russians to combat this problem.
But now to our comments, and essentially what we are arguing in this paper, in this presentation, is that the scandals that have been filling the pages of the world press recently are a wake-up call that reveal several fundamental problems that have been plaguing the Russian and American financial communities. It should be a wake-up call to the Congress, to the White House, to multilateral institutions such as the IMF and the World Bank, financial institutions and regulators, and the public at large.
We do have extensive analysis of the mechanisms of the phenomenon of money laundering and capital flight, and in a nutshell, we are convinced that it is not just a Russian problem. It is not just a Russian organized crime issue, because respectable American and multinational companies, financial institutions in many countriesin U.S., Swiss, Russian, United Kingdom, Cyprus, and many other offshore zoneshave been involved in this, and therefore, if money was flowing through all these places, it is not just a Russian problem. There is a serious problem on this side. Some of my Russian colleagues tell us, ''You''meaning Americans''benefit from this; you make all the money and we lose all the money.'' So this, of course, is something that should be of concern to this committee, that Russia is losing capital it badly needs, that is, of course, leaving Russia for a variety of reasons.
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What we have done in our TraCCC Institute is reconstruct some of the models of illicit capital flight and try to develop typologies to distinguish what is a capital flight, as opposed to theft of natural resources, as opposed to illicit proceeds that would be criminal under one system and not criminal under another system.
We have a term, such as ''skimming,'' which is double accounting, which is a part of the resources are exported, and if the revenue stays in the West, if they had to pay taxes, it would be totally legitimate parking of your capital abroad. If they have done that, then there is no crime of any kind; but if they not paid taxes to the Russian authorities, then it is tax evasion. But again, it depends on which law and in which country the money is parked.
We are also developing typologies of how front companies, or what the British call ''shell companies'' operate, and that concerns mostly the Russian export sector. And that, of course, directly involves money laundering, but again it depends which laws have been broken and in which country and whether that would qualify as money laundering or not.
Our estimate is that of the total figure, $15 billion, that is leaving Russia, probably about a third is what you could call hard-core criminal proceeds; the rest of it is either semi-legitimate or simply money parked abroad since the ruble is undesirable currency.
We believe, and we do state in this statement, that these processes represent a national security threat to the United States, to the financial stability of the Free World and also to Russia, and of course, many other countries such as Mexico, Indonesia, and Brazil. We do think that it is essential to rethink the financial structure and the national security aspects of it; and it is my term that I add, that we need to think about containing the threat of global organized crime with the same seriousness as we thought about containing communism, because in today's world the transnational organized crime networks represent just about an equal danger to the financial stability of the United States and the world as did the Communist threat, if not more so.
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We also believe that if left unchecked, these processes of corruption and organized crime will lead to serious social damage to Russia and CIS countries and many other developing countries, because dirty money feeds the caucus of criminal networks involved in a number of activities we studied, such as nuclear and weapons smuggling, narcotics trade, and trafficking in human beings, especially exploitation of women and children. So there is a component of human rights here that is extremely important.
As far as the loans are concerned, much has been said today about this, the IMF and the World Bank. We are convinced that new policies and procedures for dispensing and monitoring aid and loans must be developed. As Keith Henderson put it, ''Know your donee'' rules, conditionality, sanctions, independent audits and civil society monitoring and oversight mechanisms must be developed and enforced. For diplomatic and political reasons, government and multilateral companies may have to sometimes deal with corrupt public officials. However, they should not do so with a blind eye to accountability.
And here I should add in view of the discussion this morning that I myself was in Russia, as a matter of fact, attending the money laundering conference in June 1998, exactly June 1998, and this is in regard to Congressman Weldon's comments. And that is that this is the time, if you recall, that Mr. Chubais, who was appointed as the negotiator on the Russian side with the IMF, and the way it was presented when finally the news broke that the IMF released the tranche was that the Duma would have to accept an anticrisis program. But nobody knew, and it was never publicized or said anywhere what exactly IMF wanted Russia to do. So the Duma perceived this as a kind of a hidden deal behind closed doors between Mr. Chubais and the American Government.
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Now, to make their fears worse, Chubais appeared on national TVand I saw it myselfand he said if the Duma does not pass an anticrisis program, the administration, meaning President Yeltsin, would find other means to implement the program which was, of course, a clear threat in regard to the Duma. Now, of course, the Duma would not be very happy with operating under such conditions.
What we are suggesting is that there should be more transparency in the interest of the IMF and accountability in the way that deals are concluded and adopted.
And finally, one more point on this subject that Secretary Larry Summers was talking about this morning, and that is that there is an open revolving door. Where is the money of the IMF? And when it goes into the budget, you would never know whether that is the budget or not. But let me give you an example of the situation at that time, June-July 1998.
Suppose that you know from the inside of the government that $4 billion is coming to the Russian budget. Now, what does that piece of information mean? It means that immediately the GKO rates go up, because everybody knows the government will have more money. So that means that from 60 percent, in two weeks, the Russian GKO market rates went to 123 percent, which means that if you are buying up the GKO, you are making a lot of money in full confidence that the government will support the ruble, that is, will support its financial system.
In other words, what is happening is that the IMF money is coming into the budget and the state is giving it away essentially to privileged banks through the mechanism of high interest rates on GKO.
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In other words, you don't really need to siphon off or channel any of the IMF money on the side. You do it by buying GKO at 123 percent a year, and conversely, if you do know that the ruble is going to fall, you sell the GKO and that is how several of the Russian privileged banks made a lot of money in August.
Mr. LEACH. Thank you, Mr. Brovkin.
Can you summarize very quickly your statement? You are going on a little bit longer than the other panelists. Can you summarize?
Mr. BROVKIN. Yes.
Finally, I go to our recommendations in one minute. I think that it is essential to rethink the regulation of the financial market mechanisms as was spoken today, before. We believe it is essential to be more vigilant in addressing grand corruption and no looking the other way, regardless of how high ranking the government officials are. The lawyers, investment bankers, accountants, were involved in facilitating corruption in organized crime, and it must be subject to great scrutiny and appropriate sanctions.
We believe that it is essential to foster interagency cooperation both in drug-related and in non-drug-related money laundering between the intelligence community, law enforcement, political and financial analysis between the United States and Russia.
We also believe that it essential not to politicize the issue of corruption in Russia, but rather present it in a way that the Russian people will be the beneficiaries if they have a clean government, if they have transparency and if they have banks that keep their money rather than expropriate it every several years.
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Next point, we believe that it is essential to restructure the Russian banking system. Much was talked about it this morning, to abolish the privileged banks that handle the state budget and are a source of corruption and money laundering. It is essential to work together with the Russian financial institutions in trying to implement the kind of ideas we heard this morning.
It is also important to bring money from the shadow economy into the real economy and institute a number of measures with international support that would make repatriation of Russian capital into Russia. If things go the way they do, Russia will have serious economic and political upheavals. The country cannot sustain a loss of $15 billion a year.
Russia needs to enact legislation and adopt effective enforcement strategies in the judicial and taxation sector. Great oversight is needed in the international loan policy. More attention must be paid to preventing diversion of money by corruption and organized crime.
And finally, the tenth point, great attention must be paid to developing policies to seize and repatriate assets and to promote development in public policy goals.
Chairman LEACH. Thank you, Professor.
Let me turn first to Mr. Woolsey. In your statement you indicated that in 1993 you approached high levels of the Government, the IG and Justice Department, and so forth, about information your agency received related to corruption. Can you tell us, did this information that you relayed involve government officials and official resources, Western or Russian?
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Mr. WOOLSEY. This did not really focus on the senior individuals in the Russian government at that time, Mr. Chairman. It was basically, as I recalland I haven't read it now in over five yearsconcentrated on how organized crime was working in Russia, what areas they were getting into, how successful some Russian organized crime groups had been, and it was basically sort of an introduction to the seriousness of the problem. But at that point in 1993-1994, I don't recall that any of our focus was that there were really any indications of corruption at very senior levels of the Russian government.
Chairman LEACH. You referenced in your testimony a concurrence with some of the statements of one of your successors, Mr. Deutch, about the Louchansky-Nordex matter.
Mr. WOOLSEY. Yes.
Chairman LEACH. I wonder if you could provide the committee some perspective. Who was Mr. Louchansky? Who was Nordex? What is the relevance of this, particularly to Mr. Ermath's assertion that perhaps there are political monies that have entered into the American process.
Mr. WOOLSEY. Mr. Chairman, my recollection of the details of that analysis, as I say, are over five years old. I haven't read any of that material since then.
At the time, the reason it was so highly classified was because of the sources and methods, and I am a bit afraid to start trying to speculate about what I remember from them and what might still be classified or not.
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I am sure the Intelligence Committees have copies of that estimate, and I would really prefer if in some executive session or in some way, hopefully with the cooperation of the Director of Central Intelligence, they, or I in some fashion, could go over this in executive session. I would need to refresh my recollection and also find out exactly what is classified in what way.
Chairman LEACH. Fair enough.
Mr. ERMATH. Mr. Chairman.
Chairman LEACH. One second, Mr. Ermath.
One of the concerns as a committee is, we look at the problem of corruption abroad, how do you present shields to your own country and have those shields work? And Mr. Ermath has asserted that he believes that there may have been monies that have seeped into the American political process.
And I would like to ask you, Mr. Ermath, if you could elaborate on that assertion.
Mr. ERMARTH. The Louchansky case is one of the more prominent that I know about in the public domain. It has just been referred to in the press. In fact, most of the Louchansky story is in the public domain, because of press coverage in Europe and in the United States over the years.
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He was one of those operations that was set up in business by the KGB in the late 1980's that semiprivatized himself after the collapse of the Soviet order. The political contribution arose in 1993 when he attended a fund-raiser in New York with an American friend, and the allegation was, he just wouldn't have been there if he hadn't made a contribution.
Another case is Golden Ada, a company in San Francisco since dissolved and defunct, set up in the early 1990's to cut, polish and market Russian diamonds and other precious metals and stones, receiving hundreds of millions of dollars of diamonds and gold, platinum, which they just pocketed the proceeds; and they are known to have made political contributions in the San Francisco area.
I simply cite those as attention-getting public cases. I would rest more on the direct assertions admittedly in private settings by colleagues and the FBI who say, yes, it is happening at the Federal or at the State and local and probably at the Federal level as well, at least in the States where there is a substantial Russian business influence from offshore. There is no attempt here to impugn the honesty or patriotism of Russian-Americans who now live in this country in fairly substantial numbers, but it is money coming from offshore.
Chairman LEACH. Thank you. Does anyone else wish to comment on this subject?
Mr. LAFALCE. Mr. Brovkin, I just want to find out a bit more about the Transnational Crime and Corruption Center. Are you affiliated with American University in some way?
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Mr. BROVKIN. Yes.
Mr. LAFALCE. When did it come into existence?
Mr. BROVKIN. In the current form, it was founded in 1997. Before that it was a smaller program, a grant program funded by the MacArthur Foundation. But the founding person is right here; it is Louise Shelley. I joined the crew in the fall of 1997. Before that, I taught at Harvard University in the Russian Research Center.
Mr. LAFALCE. Well, either of you can respond to my questions. You made reference to the studies that you did which were enabled by a Department of Justice grant.
Can you expand upon this Department of Justice grant, please?
Mr. BROVKIN. Could I ask Louise Shelley to answer?
Mr. LAFALCE. Surely.
Chairman LEACH. If you would introduce yourself for the record.
Ms. SHELLEY. I am Professor Shelley of American University. I am the Director of the Center for the Study of Transnational Crime and Corruption. The reason Professor Brovkin has asked me to comment on this is that I was the principal investigator on these proposals before Professor Brovkin arrived on the scene, and we have been running projects in Russia and now in Ukraine with Russian colleagues and Ukrainian colleaguesin four cities in Russia and one in Ukraineto study problems of organized crime and corruption.
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With them we have worked with members of the Russian Parliament and produced publications and seminars and training for law enforcement.
Mr. LAFALCE. Can we focus in on the Department of Justice grant, Ms. Shelley?
Ms. SHELLEY. That is the Department of Justice grant.
We also have a second grant
Mr. LAFALCE. You say that is. What is?
Ms. SHELLEY. We have two grants from the Department of Justice out of the Coordinator's Office administered by the Department of Justice on organized crime studies.
Mr. LAFALCE. Did they put out solicitations for these grants, requests for proposals?
Ms. SHELLEY. Yes.
Mr. LAFALCE. When did they do this?
Ms. SHELLEY. When this project first startedit was in 1995we received initial funding from the McArthur Foundation and some additional money from AID. That funding ran a total of a year. After that point, the FBI and the anti-corruption working group within the U.S. Embassy in Moscow began to participate in our programs and asked us to make a formal application for funding to the Coordinator's Office at the Department of State for assistance to the former Soviet Union for a full-scale program in Russia, at which point I developed such a proposal that went through appropriate committees, and it was then given to the Department of Justice to administer. So we have been receiving Department of Justice funding since 1997.
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Mr. LAFALCE. 1997? How much is that for?
Ms. SHELLEY. In this year, our fundingwe are still operating our 1998 moneyis approximately $300,000. We submitted all of these reports with our testimony.
We also received fundingDr. Brovkin and I wrote last year a proposal to international law enforcement at their request to study money laundering and front companies. That money from international law enforcement at the State Department was transferred to the Department of Justice to administer, and we started working on that this spring.
Mr. LAFALCE. I am just wondering to what extent the Justice Department was involved in investigating whatever money laundering problems may have been in existence in connection with Russia, or corruption problems, at the time of their request for proposals and whether your work was enabling to them in carrying out and enforcing the United States law?
Ms. SHELLEY. We would certainly hope so.
At other points, Professor Brovkin and I have given lectures in 1999, to the strike forces on organized crime to help them understand these issues. We have sat with prosecutors and tried to bring the results of our research to bear.
Mr. LAFALCE. And you work with officials from the Treasury Department? Did you work at all with officials from the national regulatory agencies, whether it is the Federal Reserve or the OCC or the superintendent's office from the State of New York?
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Ms. SHELLEY. We have met on just one occasion with the Department of the Treasury. We have also met with top officials at the World Bank on these issues in the last year. But we have not had other contact than those. Our contacts have been primarily with the Justice Department on these issues.
Mr. LAFALCE. Did your studies investigate the nature of the privatization process within Russia and the tremendous potential for either good or bad or exploitation of that process?
Ms. SHELLEY. I have even testified before Congress many times on the misuse of privatization and the abuses that were committed in this process and gave lectures to the State Department and AID on this issue already four years ago.
Mr. LAFALCE. Would you give me the list of each of the occasions that you testified before Congress and each of the United States or international financial institutional entities that you have spoken before on this subject, please?
Ms. SHELLEY. Yes.
Mr. LAFALCE. Thank you.
Chairman LEACH. Thank you, Mr. LaFalce.
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Mr. BEREUTER. Thank you, Mr. Chairman.
I want to say to the witnesses that I regret not hearing your oral testimony. To the extent that you have submitted written statements, I have read them in advance.
I simply wanted to ask all of you, in order, if you can respond as directly as possible about what is, in your judgment, the primary thing that we in the Congress, or the Government generally, can do to reduce money laundering activities from Russia that take place in this country, and including those that involve American financial institutions?
Could I start with you, Director Woolsey?
Mr. WOOLSEY. Yes, Congressman Bereuter.
The money laundering itself is, from my point of view, a problem in two ways. One is what you mentioned, that it runs the risk with large deposits in this country of corrupting American institutions. And about that I have no specific learning or expertise. It is obviously a very important issue and important to this committee.
But from my background and perspective, one second very troubling aspect of it is that it is evidence of corruption in Russia which undermines the structure of the state. Sometimes it is hard to tell money that is simply being deposited here from money that is being laundered. And although capital flight is a problem from Russia, the real problem, in the second sense that I was describing, seems to me to be that the laundering of it is evidence that particularly the privatization process in Russia was so corruptly handled that individual Russians have lost confidence with the stability of their state and of our involvement with it.
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I really think that the primary effort on that second problem ought to be best dealt with by a program something along the lines of what Congressman Weldon has proposed, which moves us in the direction of working with those honest institutions in Russiaand there are definitely some at the oblast and krai levelin the direction of working together with proper Russian financial institutions on mortgages for home-owning and the like, so that ordinary Russians see that American efforts are going to help them, rather than to being diverted into corrupt channels. That seems to me to be, again from the perspective of my background and interests and focus, a very, very major problem. It is the major difficulty that over the course of the last several years our policies have not fostered that.
So I guess I will close with those two points.
Mr. BEREUTER. Thank you.
Mr. Ermarth, would you comment on what is the most important thing we can do to stop money laundering in this country, whether or not it involves American institutions?
Mr. ERMARTH. Two things, sir. First, the mandate of this committee directly to craft laws and regulations and institutional change that causes the regulation of our financial institutions to catch up with the globalization of everything. It is not just Russian money laundering.
Second, to contribute to the larger debate in the Congress and in the public about Russian policy so that when and if a new window of opportunity for reform in Russia opens up we have the policies, the perspectives, the strategies ready to go, as it were, that can respond. Congressman Weldon has a list. Others have lists. In effect, it is an answer to Congressman Frank's question, what could we have done better?
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The alternatives were there in the past: more honesty, more transparency, more rigorous and thoughtful conditionality. It does not necessarily mean tighter, but about things that really matter like law and order, the courts, the civil code. And, finally, not so close in identification with certain individuals and a certain clan of politicians.
Mr. BEREUTER. Thank you.
Mr. Saunders, would you respond, if you wish?
Mr. SAUNDERS. I don't have anything to add. I endorse the comments of both of the previous witnesses.
Mr. BEREUTER. Let me then get Professor Brovkin an opportunity in my five-minute period.
Mr. BROVKIN. In addition to what has been said already, which I completely agree, I just simply want you to keep in mind when developing these transparency and honesty systems and legislation, to keep in mind that it is in the national interest of the United States to keep the goodwill of the Russian people which is now turning sour, and that Russian people, because of the failed reforms, increasingly perceive the United States as the country that is partly responsible or guilty of the misery that they are in. They identify misery with capitalism, capitalism with failed democracy.
I think it is extremely important to realize, before it is too lateand it could be too late at some time down the roadthat you have got to change course and make sure that the Russian people understand that U.S. policy is for them, and not necessarily for whatever political leader happens to be there at the top.
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Mr. BEREUTER. I understand. That is good advice.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Doug.
Mr. FRANK. Mr. Brovkin, I, like Mr. Bereuter, have read the statements. I wasn't able to be here for them.
You made reference to a fund-raiser in 1992 that a Mr. Louchansky gave money to.
Did I hear that correctly?
Mr. ERMARTH. That is what has been reported.
Mr. FRANK. Whose fund-raiser? Who was the beneficiary?
Mr. ERMARTH. Democratic National Committee.
Mr. FRANK. In 1993?
Page 119 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. ERMARTH. The man's name is spelled in a somewhat Frenchified, Frankified manner. L-O-U
Mr. FRANK. Let's stick with Frenchified. You can give that off of my minute. You can give that to the reporter off of my time.
Mr. ERMARTH. If you do an Internet run, you will get it all.
Mr. FRANK. Mr. Saunders, first, your criticisms of some of the kind of macro- and micro-economic policy I was pleased to hear, because I think what we get here are the common themesto some extent these are not Russian-specific, but IMF-specific. There is an underlying problem that many of us have had with an IMF imposition, one of too much specificity and too much austerity. Professor Brovkin, you have summed what I have found to be the problem with that.
We get this identification, because very often we are simultaneously implementing IMF policies in newly democratizing countries, and we give people this notion that austerity and democracy go together and that paying more for your food and paying more for necessities is somehow a consequence of democracy.
I would say, Mr. Chairman, I said this to Mr. Summers before, it has relevance to a piece of legislation that we are going to deal with. I believe morally there is nothing more important for us than to pass the legislation dealing with the heavily indebted poor countries. But I don't believe the votes are here in this House, nor should there be, to put that to the ESAF, to put that through the economic structural adjustment fund of the IMF for some of the kinds of reasons we have had here.
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But back now, if I could, to Mr. Saunders. As I said, I appreciate that, because I did want to say that in context. It is a problem of our Treasury and IMF and other treasuries in general. Part of the problem isand maybe we ought to look at this, Mr. Chairman. We ought to maybe get the State Department and open entities into this.
The problem is that increasingly in the world today foreign policy is heavily influenced by the World Bank and the IMFI think the Bank has been much better than the IMFand they are run by treasuries. There is a structural problem. The political element, the people who appreciate democracy, the people who appreciate some of these kinds of considerations are literally out of that loop. We have only the treasuries to the IMF and other financial institutions, and I think that should be looked at.
Mr. Saunders, let me ask you just one question. You said that we made a mistake when we divided the Russians into the good guys and the bad guys. None of us have trouble thinking of good guys who aren't such good guys, but I am wondering, who did we inappropriately characterize as bad guys to whom we should have been more neutral? Because I have a harder time coming up with that list.
Mr. SAUNDERS. I tried to answer that question earlier in my opening statement. I think one of the groups that was inappropriately characterized as ''bad guys'' was clearly the Russian Parliament. They obtained this label, ''Communist dominated,'' which ended up in virtually every speech or piece of press reporting on Russian political developments. I think that had a very negative impact.
Page 121 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FRANK. I think those two tie in, because that would be true of other parliaments in other countries, which is parliaments are necessarily, understandably, less inclined to raise food prices and cut unemployment benefits and throw people out of work.
What we are really talking about is a conflict between financial orthodoxy and democracy. I guess those who have been unable to get the American Congress to do some of those things should not be surprised when the IMF is unable to get other parliaments to do it.
The only other thing that I would have to sayand I must say, Mr. Saunders, in the statement, that I did read the statement, my guess is the State Department probably would be pointing with pride to your giving credit for successfully influencing Russian policy with regards to Bosnia, Kosovo, Iran, and I would throw in NATO. I was wondering before about where the tradeoff would come, because you can't obviouslyone other areaand I was wondering if I read you correctly, because you also throw in here macro-economic policy.
I gather your tradeoff would have been more sort of stricter legal regularity and less concern with both macro- and micro-economic policy, less fiscal regularity?
Mr. SAUNDERS. That is correct. I would also consider tradeoffs on some of the foreign policy issues, but that is probably not germane to this.
Mr. FRANK. Oh, yes, it is. Go ahead.
Mr. SAUNDERS. I think if we had tried to work earlier and more cooperatively with Russia and Yugoslavia, we might not have ended up having to lean quite so hard on them toward the end.
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Mr. FRANK. I guess I didn'tI need more elaboration on that. I must say you could hear an enormous sigh of relief that almost raised the Capitol dome when the Russians threw in with us and helped bring about an end to the terrible time that we faced in Kosovo. Certainly any suggestion that that tradeoff should have been made we wouldn't argue. You are saying we could avoided that earlier on, but I would have to, since I have run out of time, close with just a skepticism about that without a chance to discuss it.
Chairman LEACH. Thank you.
Mr. ROYCE. Mr. Woolsey, thanks for being here today.
Five-and-a-half years ago, you appeared before the International Relations Committee. At that time, I asked you about the extent of the former Soviet KGB involvement in organized criminal activity in Russia, which was then becoming evident. Today, that problem has mushroomed beyond Russia, becoming a transnational and international issue.
The question that I would ask is, what is the extent of Russian internal security, electronics intelligence, and foreign intelligence agency operations against American banking interests, American banking and in business? One of the reasons that I ask that question is because a Russian external intelligence spokesman has said that they are focussing less on foreign ministries and defense and now more on foreign ministries of finance. If so, that means that the United States Treasury Department, the Federal Reserve, and the banking and financial systems are targets of Russian espionage.
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My question is, how much does the FBI know about Russian intelligence against American banking and business and what is being done to alert those agencies and businesses to the problem, to help them counteract the problem and take countermeasures?
The second question that I would ask is, if there were violations of U.S. and international law on the part of U.S. Government officials with regard to U.S. financial aid to Russia, what is the appropriate agency to investigate those violations? Would it be the General Accounting Office, the FBI, the Justice Department, the Federal Reserve? Which agencies would investigate the IMF?
Should international investigating and forensic auditing companies be used more aggressively to get to the bottom of the Russian corruption is another question, and how can we ensure against future looting of U.S. assistance?
Mr. WOOLSEY. I will give a try to those, Congressman.
First of all, let me say I am four-and-a-half years out of date with respect to any classified information on this, so what you are really getting from me is essentially the reactions of a rather careful newspaper reader.
Also, with respect to the law enforcement questions, of course, our responsibility out at the CIA was, whenever any indication of a violation of law by an American citizen might have come across the screen as a result of foreign intelligence collection, to refer that to the Department of Justice and then get as far away from it as possible. The CIA doesn't look into matters that might involve lawbreaking by Americans.
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So for two reasons my knowledge is limited here.
I have spent some time over the course of the last several years on a panel with Arnaud de Borchgrave and Frank Ciluffo, who will be testifying next, at the Center for Strategic and International Studies where we have looked into both Russian organized crime and cybercrime as well as a number of related issues.
My judgment is that, with respect to your first question, the implication is quite correct that there has come to be a good deal of focus by combined efforts of Russian intelligence and Russian organized crime interests on Western, and particularly American, financial institutions. But with respect to the scope as distinct from the direction, I don't have any specialized knowledge or judgment.
I think that, as far as violations of the law by international financial institutions are concerned, in the first instance, if American citizens have been involved in any such violations of law, that should immediately go to the Justice Department and presumably the FBI.
The international financial institution itself in its official capacity presents, of course, a very complicated question. Most of these institutions have immunity from prosecution or lawsuits in the United States for one reason or another. I have been involved in arbitrations against the United Nations as an institution, and certainly we could handle something by arbitration there, because of the arbitration clause in the contract, but we could never have brought them into court.
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I think I will have to stop at that and suggest that, with respect to what the FBI knows or the violations of law by American citizens, that you need more specialized counsel on those subjects than my background is able to give you.
Mr. ROYCE. I thank you, Mr. Woolsey, Mr. Chairman.
Chairman LEACH. Mr. Royce.
Mr. RYAN. Thank you.
Dr. Brovkin, I was very taken by what you had said about the Russian people are losing faith in America and in American policy toward them, because their version of capitalism is this crony capitalism that we talk about.
Mr. Saunders, you mentioned that our American policyour Federal Government's policy has been, pick the good guys, pick the bad guys, and stick with the good guys regardless of whether or not we find out or determine that they are bad guys.
This leads me to a question for you, Mr. Ermarth. In a recent article, I think it was in Insight magazine this week, you said that you felt pressure to whitewash intelligence reports about corruption in Russia. And, further, career diplomats at the U.S. Embassy in Russia confirmed your statements; and the article discussed a top secret 1995 CIA report on Chernomyrdin and other Russian leaders that elaborated on their affiliation with corrupt activities and organized criminal figures.
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How did the White House and the Vice President's office receive this report? What was the reaction to the allegations of corrupt activities to the so-called good guys?
Mr. ERMARTH. Mr. Congressman, I have never written anything for Insight magazine, so they must have been quoting me from something else.
Mr. RYAN. It was a quotelet meit may have been from that
Mr. ERMARTH.in the national interests.
In the article that I did write, I alluded to a variety of problems we had in dealing with Russian organized crime, corruption and official corruption, high-level kind of corruption.
There was some pressure because, in a variety of mostly subtle ways the people who made policy on Russia, the Administration made it clear they didn't want to hear much about that, at least allegations of high-level corruption.
I wasn't in the line of fire directly. I got most of this from the analysts who were. They came back from the meetings and told me about it because I was taking an interest in this almost as a case study in post-Cold War problems. We have had so many faces to it, nuclear proliferation, almostit was crime. It was KGB intelligence. It was politics. It was business. It was banking. It is foreign affairs, even, because it affected our diplomacy. A lot of these people had Israeli citizenship and so forth.
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So I was watching how this evolved. And the analysts had a lot of problems, because of the political distaste for what they had to say, partly because they couldn't bring all of the different pictures and pieces of the picture together, partly because economists didn't know how to deal with corruption and crime as an analytical problem. So there was a lot of problems.
It was in this context that a story arose and a report went down to the White House to Vice President Gore's office, and he came back with the so-called barnyard epithet.
I will tell you, as an intelligence officer, you have got to make judgments about the truth or falsity of what you hear. I heard it from so many people that I think it is true. I never saw it, however. And now they can't find it.
Mr. RYAN. Are you saying
Mr. ERMARTH. It is a bit of a symbol of the problem for which there is a lot more
Mr. WELDON. If the gentleman would yield, I would not necessarily put you in the position of stating that barnyard epithet, but would you characterize the tone of the barnyard epithet in terms of what it meant to the report?
Mr. ERMARTH. Yes. It was quite clearly dismissive of what was in the report. But there again, I just heard it so often that I believed it was true. But that was not the basis for my belief that there was a resistance to this from policymakers.
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Mr. RYAN. So what you saw in the intelligence community was a shift from the White House and policymakers from deep analysis, objective analysis to one of more agenda-driven analysis on intelligence reports?
Mr. ERMARTH. I found that to be the case across the board. Remember, this was a period in which two contradictory things were happening. On the one hand, the topic, the agenda of intelligence was spreading out over a lot of issues, not anew, but new priorities, and all of them quite difficult and demanding of manpower in the field for collection and at home for analysis. At the same time, there was downsizing of the work force. And you throw on top of that the fact that Russia was kind of unfashionable in the early 1990's because it was redolent of the Cold War, and there were all of these other things to put people onto. Yes, there was a shrinkage of the resources for deep analysis. Some people pretended the in-box
Mr. RYAN. I guess my final question, seeing that the red light is about to go on, is whyI would like to ask all of the panelists thiswhy this shift in intelligence attitude?
It is understandable that we don't want to do things that drive nationalization in Russia, that we don't want to push them away from freedom and democracy and capitalism, that we want to go down the road. But it seems as though the attitude from the Administration has been one of receiving intelligence reports that are more preferable to the political agenda than receiving intelligence reports that are more factual or accurate. Why is that? I would just like to see if anybody would care to answer that question, what your opinion would be.
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Mr. WOOLSEY. Congressman, I will take a stab at that.
I have always said that the principal qualification of Director of Central Intelligence is that you don't want anyone on the job who wants too much to be liked, because you are always, if you are doing your job right, the skunk at the garden party. You are not a participant in the policy process directly. I think you should not be if you are doing the job right. You should not be making policy recommendations, because then the other players, State, Defense, and so forth, will believe that you are skewing what you estimate in the direction of supporting your own policies. You are the only person at the table who should, I think, have no stake in the policy outcome. Just call it like you see it. Sometimes you are right. Sometimes you are wrong.
During the first two years of the Administration when I was the DCI, we did have the phenomenon that Fritz describes of declining resources and a need to focus a great deal on the newer issues. But I felt one of the newer issues we were focusing on and, as I said in my testimony, I did not detect any lack of interest in it or subtle signals to turn away from it, was Russian organized crime.
I would not say the same of some other questions. There were, for example, a number of times which I forwarded or made assessments about what was going on in Haiti, that I felt there was a great deal of body language in other parts of the Administration showing a not wanting to hear what the CIA had to say, or I had to say. I did not feel that way as of early January, 1995, about Russian organized crime.
Page 130 PREV PAGE TOP OF DOC Segment 1 Of 2 But Fritz was in the agency longer than I. I have known him a long time and value his judgments and views very highly. I would certainly not dispute his judgments about what things looked like during the entire time he was there.
Mr. ERMARTH. I would only add that while there were problems, and I described them in that article and tried to summarize, I think it is very important for people like the Members of this committee and other committees to understand that intelligence problems attending to all of thisand it had less to do, by the way, of organized crime where there were no political pressures than the high end, the authorized crime, the big shots who were corrupt and the notion that maybe these reforms were not all they were cranked up to be. That our leadership did have a problem with.
But this was secondary because, like I said earlier, the facts and very sophisticated interpretations of what was going on in Russia, the truth was amply in the public domain, in the Russian press, in Western analysis. In fact, I would say that after 1996 when he founded this little news service, David Johnson calledhis product is Johnson's Russia List. If you are interested in Russia and you are prepared to spend half-an-hour a day and only read English, you have absolutely no excuse, from 1996, to be in the dark about any of this.
Mr. WOOLSEY. Mr. Chairman, could I add one more point? It is important to get the sequence of events straight here.
The privatization of the program with the vouchers was taking place, I think, for instance, in 1994. So that did result in a number of institutions and old-line Communist managers of factories and the like being able to buy up people's vouchers very cheaply and to get control of things. That was understood and reported very clearly.
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The now highly discredited loans-for-shares program, which Mr. Chubais operated, was really after that. I think it took place in 1995 or 1996. That probably began the time in which you began to see, at least from my reading of the press during the time after I left the Government, strong suspicions of involvement of very high-level people in what would be in this country corrupt behavior and was morally corrupt in Russia, even if it perhaps didn't violate the laws that were on the books.
So there is a time sequence here. I would say 1995-1996 was probably the period in whichagain, from my reading of the pressit looks as if people's attention started to turn to high-level corruption and may well coincide with some of the reactions that Fritz is describing.
Mr. RYAN. Any others wish to comment on that?
Mr. BROVKIN. I would just say, in addition to what has been said, is that Secretary Summers referred this morning about a too fast or too slow approach. The fact is, it is not a matter of too slow or too fast, but differently.
What we have just heard is exactly the process. They first vouch organizations, they then fake elections, and then the rise of the oligarchs who finance the ultimate selection campaign. Then the reports that some violations may have been committed during the elections campaign. The United States Administration looks the other way. Then there are more and more examples, both from the political and economics sphere, that the Administration looks the other way. As a result, things get bigger.
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If companies make more and more money on GTOs, you look at the progress of the banks. It is public information on the Internet. You look from year to year after year how the twelve major Russian banks were expanding at the time when the economy was collapsing. That is amazing, that is an absolute miracle that Russian banks were expanding in 1996, 1997, 1998. How could they possibly be making so much money when the economy was shrinking? That is the question that needs to be answered by this committee.
Mr. RYAN. Very insightful, thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Mrs. Jones.
Mrs. JONES. Thank you, Mr. Chairman.
Would you pronounce your name for me, sir, in the burgundy jacket, please?
Mr. BROVKIN. Professor Brovkin.
Mrs. JONES. Let's continue that. How could they grow? How could those banks grow when the economy was falling apart? Speculate for me.
Mr. BROVKIN. Primarily due to the high-interest GTO market. GTO stands for government short-term obligation. It is a domestic debt. So the way it was functioning was that the Russian government had a deficit in the budget. They couldn't pay the wages. They couldn't pay the pensioners. They couldn't pay their soldiers. The reason they couldn't pay that was nothing was working.
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So the correct approach, not the one we had this morning, would have been to start by getting Russian people to work. Even if it is not profitable, get them to work. Get small businesses going. I call it in one of my articles the same approach that was taken in Germany in 1946. You don't start with privatizing the banks. You start with getting local bakeries and local businesses going and making sure that the local mafia does not control them, that there is law enforcement, that there is observance at least of the Soviet laws.
None of that was done. Instead, the Administration encouraged Mr. Chubais and others to create the securities markets. How can there be a securities market when there is no industry?
Mrs. JONES. Thank you. Let me ask another question. Thank you.
Now, this is, from your perspective, not being a part of the Administration; is that correct?
Mr. BROVKIN. That is correct.
Mrs. JONES. And not knowing all that the Administration knew; is that correct?
Mr. BROVKIN. That is correct.
Mrs. JONES. So you sit here on this panel, based on your experience outside of a responsibility as administrator of a Government like the United States. And you are not alleging in your statement any wrongdoing, criminal wrongdoing on the part of the Administration based on this situation, correct?
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Mr. BROVKIN. No.
Mrs. JONES. Thank you. I want to ask someone else another question. Thank you very much.
It is kind of hard when you are a less senior person on the committee, you get way in the corner over here.
Mr. Ermarth, I want to ask you a question. Thanks.
You were saying there was a shift and a deep analysis, and that shift and deep analysis arose, am I correct, as a result of a lack of enough people or staffing to be able to do a deep analysis? Is that what you said?
Mr. ERMARTH. No, ma'am. That is not the only cause.
Mrs. JONES. But you did say that earlier?
Mr. ERMARTH. It appeared in this article, ''Why Did We Underachieve Out at the CIA?'' I wrote a little article about that. That was one of the factors.
Mrs. JONES. So was it a minor or major factor?
Mr. ERMARTH. This lack of deep analysis? It was a major factor in our
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Mrs. JONES. It was a lack of deep analysis that arose as a result of a lack of staff.
Mr. ERMARTH. That was part of it. Also, it got unfashionable.
Mrs. JONES. Now, when you say ''unfashionable,'' would you be a little more clear with that for me, please?
Mr. ERMARTH. The management of the agency in which I was a part for a good many years found, particularly in the 1980's, that a lot of our old products, big heavy analyses of what the Russian military forces, the Soviet military forces, they did not help the customer very much, the policymaker very much. He wanted more operational near term: What do I do tomorrow? How do I handle
Mrs. JONES. When you say ''he'', would you be more clear on who ''he'' is?
Mr. ERMARTH. The customer for intelligence throughout the Executive Branch.
Mr. RYAN. If the gentlewoman would yield.
Mrs. JONES. I don't know if I want to, but I will.
Page 136 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. RYAN. Thank you, Stephanie.
I just wanted tobecause I brought this up with Mr. Ermarth's quoteI just want to read you a quote and see if you still agree.
Mrs. JONES. Why don't you let me finish and then can you deal with that? Go ahead.
Mr. ERMARTH. So there was an effort made to encourage analysts in all areas, Latin America, Africa, Middle East and Russia, to write things that are more current, that have a more immediate relevance to what the policymakers are doing.
OK, please the customer. So the business got more retail, if you will, to the point where sometimes we began to say, ''Well, we are just Kentucky-fried intelligence.'' Where is the depth? There was a sacrifice there, because it takes a lot of deep investment to, for example, meet military intelligence requirements, make sure your maps are up to date, for example.
Mrs. JONES. But as a policymaker, you are an analyst. As a policymaker, sometimes you have to make that decision, where are you going to put the most, the best of your troops, right?
Mr. ERMARTH. That is right.
Mrs. JONES. Sometimes you make the decision based on all that is in front of you at that juncture. As an analyst, not being the policymaker, you could not necessarily say that that was a bad decision to be made based on all of that you had in front of you in light of the fact that you didn't know everything? Yes or no?
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Mr. ERMARTH. No. The analysts usually know more than the policymakers.
Mrs. JONES. That is because you are an analyst.
Mr. ERMARTH. I have been both.
Mrs. JONES. Based on what we are talking about, it was your opinion after the analysis that you knew more than the policymakers and that is why you make the statements that you made today.
Mr. ERMARTH. Yes.
Mrs. JONES. OK. I am done.
Mr. RYAN. I just wanted to clear this up, because it is a very worthwhile point. I think it goes beyond whether there were staffing cutbacks or something like that, the shift in intelligence. I just wanted to read one of your quotes and see if you could just confirm this.
That, ''deep analysisintelligence reports with regard to Russia deteriorated from deep analysis toward an agenda,'' where you described, ''supportive of daily business, our policymakers did not want, and our intelligence analysts had little incentive to provide, a big picture of long-term assessment of Russian realities. They mainly wanted to get to the next Chernomyrdin meeting or the next quarrel about Russian missile dealings with Iran.''
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It sounds as if there was a shift in attitude for what you were sending them. Is that correct?
Do you still agree with these quotes?
Mr. ERMARTH. I agree with them, but I would not say it is a shift in attitude. If you will, it is a shift in business style. It had consequences, and they were costly.
And, by the way, management at the agency has recognized that and tried to counteract that within the resource constraints that they have. You can't have current intelligence that is meaningful unless you do deep analysis to back it up. That applies to very mundane things like maps and order of battle and economic data.
Mr. RYAN. Very fair point.
Mr. WOOLSEY. I have one sentence on this, if I may.
That tension existedexists all the time. I agree with the concerns that Fritz expressed about the direction and the pressure. But in 1993, 1994, we felt that the work that we were doing on Russian organized crime was precisely a good example of the in-depth, long-term analysis. This was a very fine piece of work by young analysts out of the agency that I took around to very senior people in the U.S. Government and in other governments, because it was so thorough and in-depth.
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So it is not a simple picture, but I don't dispute what Fritz said about what happened in 1995 and 1996.
Chairman LEACH. Thank you.
Mr. LAZIO. Thank you, Mr. Chairman.
I think that we are left with a fairly sobering picture here of a strategic relationship, a bilateral, strategic relationship that has largely deteriorated since 1993, no progress really in terms of arms control, divestment estimates from $100 billion to $150 billion to maybe twice that amount in terms of net numbers. You have a political leap in Russia that seems to seek to undermine American interests, and then you have, as Professor Brovkin has noted, popular sentiment turning against America as the so-called reforms have had sort of a perverse impact on the quality of life and purchasing power for people.
I want to get back to sort of these turning points, because it seems as though around this 1993 point that we began this downward spiral, and it coincides to some extentI would like to hear from the panelistswith the Chubais loans-for-shares program, and the relationship between the Treasury Department, the Administration, the Harvard Institute, and this privatization issue, how we went about it, bypassing public bidding proposals. And it seems as though the net result was a concentration of great wealth in the hands of the few, a sort of economic oligarchy.
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I want to begin with Professor Brovkin, if he could respond to that assessment and whether he agrees with that or not and respond to it and any of the other panelists that would like to add in.
Mr. BROVKIN. Yes, I do agree with what you just said.
I should add that in the next issue of the journal Demokratizatsiya we are runningand we are showing the editorswe are running an article by Janine Wedel exactly on this subject, on the kind of nexus political between the Chubais clan, as she calls it, and several people in Washington, and the way they have shaped U.S. policy to Russia and designed the privatization program which in many waysit is not only her opinion, but mine and many, many other people believe set in motion the process of crooked privatization, the rise of the oligarchs, the rise of the organized crime and, of course, money laundering.
So, in many ways, the crucial decisions were indeed made in 1994, 1995, and the loans-for-shares scandal was the first actual scandal. It was the first time it became apparent that something terribly wrong was happening.
I do believe and I do support the view that a large share of the responsibility lies with those on this side who either didn't understandI grant them the benefit of the doubt. They just made a mistake or they knew that something was happening and they just looked the other way or, even worse, benefited from the kind of processes that went further.
Mr. LAZIO. Anybody else want to respond?
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Mr. WOOLSEY. I will add, Congressman Lazio, I do think the loans-for-shares program was something of a tipping point. Clearly, many of the problems that Russia was facing in all of the ways that we were describing were incipient up until that point. But the extraordinary buy-off of the companies for very small amounts of money and the aggrandizement of some of these individuals through that loans-for-shares program was the point at which I think it all sort of came together, and it has been downhill ever since.
If there is no single event, there is no single thing that was absolutely decisive. But if you are looking for a point in which I think everybody who was watching this either said or should have said, this is all starting to go really bad now, it would have been
Mr. LAZIO. Sort of a national pilfering.
Could you comment on the Harvard Management Company's participation in that?
Mr. WOOLSEY. That all occurred after I left Government. I just read the newspapers on that. I don't really have any substantial views on that.
Mr. LAZIO. That raises some fairly extraordinary questions in terms of insider dealings and who was profiting from this.
Let me ask you, if I can, Director, about Louchansky and his relationship with the DNC. And if there were Republicans involved, I would like to hear about that as well.
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Mr. WOOLSEY. The only thing that I can think that I can say publicly about thisand just about all I remember from this assessment of several years agois the sequence of events I believe was that Mr. Louchansky was invited to a fund-raiser in New York by an American citizen. He apparently had his picture taken with President Clinton. That picture appeared in a Russian publication. When we first saw it, we thought it was a forgery. But it turned out it was not.
Mr. LAZIO. There is much that we find out that we think is unbelievable.
Mr. WOOLSEY. Lots of people get their hands shaken at fund-raisers and apparently his was.
Then a couple of years later, even though there had been a good deal of attention paid to Mr. Louchansky at the top levels of the Government as a result of our reports, he was apparently invited by the DNC to another fund-raiser in his own right, and then the State Department did not give him a visa. Somehow it had filtered through the system. I don't know exactly what happened. That was after I left the Government, but those are the bare facts as I believe them to be the case based on public reports and what we knew at the time. More than that, what money went from anyone to anyone, if any money went from anyone to anyone, I don't know.
Mr. LAZIO. Does anybody have any information on this?
Mr. ERMARTH. If you are interested in Mr. Louchansky, including, by the way, his denials of any wrongdoing, any organized crime, any smuggling, money laundering, just get one of your staffers to do a search on the Web and you will get more than you ever want to read about Mr. Louchansky.
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Mr. LAZIO. Thank you, Mr. Chairman.
Chairman LEACH. Mr. LaFalce.
Mr. LAFALCE. I really can't address the specifics of any particular fund-raiser or any particular photo. It is just interesting to note that I have received invitations to fund-raisers for Governor Bush, Senator Dole. Somehow I got on some list. I can't begin to count the number of people that I have had my pictures taken with, with a handshake, and I am unaware of who they are. I just wanted to point that out. This is a fact of life, and the more prominent you become the more frequently this happens.
Mr. Woolsey, when did you leave the CIA?
Mr. WOOLSEY. The second week of January of 1995.
Mr. LAFALCE. So you were there until January of 1995.
Mr. Ermarth, when did you leave the CIA?
Mr. ERMARTH. I retired on October 1, 1998.
Mr. LAFALCE. OK. Now, in my prior life when I was Chairman of the Small Business Committee, I did a lot of things. For example, when I went to some of the Central European countries in January of 1990, I came back and we created legislatively the Central European Small Business Commission. The whole purpose of that was to develop a small business sector in those formerly centrally planned economies.
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I think it was very successful for the funding that we were able to achieve. Unfortunately, OMB came in and said we were just going to have to eliminate that. That was very unfortunate, because I saw the importance of it.
I also saw what I thought was the most important phenomenon in the world at that time and that was the phenomenon of privatization and that we were in this critical juncture in the world where we would either do it right or do it wrong and we would have far reaching consequences on account of that. So I had hearings in my Small Business Committee, a number of them in early 1994.
I said it would be terrible if we measured the success of the privatization program by the number of privatizations similar to the areasavings and loan subsequent to FIREA. We measured the success of the approach to deal with this problem by the number of institutions that we closed, which was the worst possible measure. I said the success of privatization should be measured by the way in which societal wealth is being distributed and whether or not we were building up a small or medium-sized sector.
Were there any studies within CIA, any reports within CIA about the phenomenon of privatization, about the pitfalls of privatization, about the potential of privatization, either in the abstract or in the concrete? In the concrete more specifically with respect to Russia, either by the end of 1995 orin your case, Mr. Woolseyor, in your case, Mr. Ermarth, by the end of October of 1998?
Mr. WOOLSEY. Again, Congressman, I resigned in early January of 1995.
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Mr. LAFALCE. That is what I was referring to.
Mr. WOOLSEY. I recall more than one assessment, critical assessments of the way that the voucher privatization program had been going and the problems with it. I don't recall a single long study or detailed study of the sort that I described about the 1993 work on Russian organized crime.
Mr. LAFALCE. The difficulty that I had was I couldn't get anybody to pay attention to the quality of privatization, and I am talking about with any international financial institution. I went to London to talk with the head of the European bank and reconstruction development about Russia and other programs and whether or not we were doing it right, and so forth. I was unaware the CIA really was that concerned at all.
Mr. WOOLSEY. I recall several items that the voucher program was notitems that said the voucher program was producing a much greater concentration of wealth. People's assets were being bought up very cheaply. It was not being spread around in society, the ownership shares
Mr. LAFALCE. I had testimony in my early 1994 hearings that privatization was the way for the wealth to be stolen from the State into the hands of either the patrons or no one was sure. This was notand there was article after article. This was not something that was secret.
Mr. WOOLSEY. I think that we are starting to see that with respect to those vouchers in 1994 and by early 1995 when I left. And I think if I can just say, I think your concern about the procedures and the fairness and the quality is exactly on the mark. One of the things that has gone badly wrong here is that all of us in different professions have our blinders. Certainly, my profession of the law has its. But sometimes economists and financial people assume that a rule of law is going to apply and all they really need to do is look at the economics in some theoretical way.
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That was, I think, the wrong approach in our attitude toward Russian privatization. I think that what you suggested about the quality of the privatization was exactly the approach that people should have been focussed on.
Mr. LAFALCE. That is hindsight. I was wondering if at the time the CIA was making any reports on this to the Administration, to anybody else, with a call for action, with a call for remedial policy and strategy, and so forth?
Mr. WOOLSEY. Reports to some extent I do recall. The Intelligence Committees would be able to tell you in more detail. I don't recall a single major detailed study, as I said, of the sort we had on Russian organized crime. But as far as a call to action, no, we would not have done that. We would not make a policy recommendation. We would not have done that.
Mr. LAFALCE. Mr. Ermarth.
Mr. ERMARTH. I had the same reaction in the early 1990's as you had, Mr. LaFalce. I don't recall a specific report on privatization, per se, but there were many reports on how the economic reforms were going, and they all contained observations, data assertions about the extent of privatization. Thirty percent of industry
Mr. LAFALCE. I was wondering about the utility of the work that the CIA does, if I could just explain what I mean by that statement.
Page 147 PREV PAGE TOP OF DOC Segment 1 Of 2 It is one thing to come up with a fact. It is another thing to come up with an interpretation of those facts and recommendations based upon those interpretations. I am just wondering if you saw, knew what was going on, but you didn't pull it all together and press the case, make specific recommendations.
Mr. WOOLSEY. Recommendations we would have not done, would not press the case, would not call for action.
Mr. LAFALCE. Was that inappropriate for CIA?
Mr. WOOLSEY. I believe so. That was my understanding with President Clinton, when I took the job, that I would not make policy recommendations. We resolutely refrained from making policy recommendations while I was there.
Mr. LAFALCE. What about some overall study, exposition of the nature of the problem?
Mr. ERMARTH. I found the same problem you did. The quality of the privatization was not being assessed and challenged properly.
When they said, ''OK, 40 percent are privatized,'' I would go around to the analyst and say, ''Look, we know that privatization is a strange thing in Russia. Some state industries act like private ones.'' In other words, they are looking for new customers, they are looking for revenue, they are looking to improve their product.
Page 148 PREV PAGE TOP OF DOC Segment 1 Of 2 On the other hand, some privatized ones are acting like state ones. They are looking for subsidies, they are looking for protection. Don't you go out and try to tell the difference, the quality of privatization, exactly as you put it, the quality of management and the broader impact on the economy of that quality.
They said, ''No, we haven't got the resources.'' You have got to do that almost door-to-door.
Mr. LAFALCE. Thank you, Mr. Chairman.
Chairman LEACH. Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman. I apologize first of all to the witnesses for not being here for your testimony. I had to take care of some meetings in my office.
I have had a chance to go through some of the testimony, and I guess what I would ask is while Russia has progressed far less than any of us would like to have seen, it seems to me that it is hard to determine what would have been a more appropriate strategy going forward. Mr. Woolsey in his testimony states that if you are engaged in dealing with Russia at the time, both from Administration and IMF policy, at each instance you would probably have taken the steps. When you stand back you might say why are we doing this? But the problemweren't we in a period, one, where you see the collapse of the Soviet Union; the new Russian federation under Yeltsin with a government that we don't know whether or not is going to survive for a day, a week, or a year just from a force standpoint, let alone an economic standpoint. We don't know what direction they are going to go in. We have numerous strategic concerns, not to mention economic concerns. You go from that period forward to where you are trying to build some stability in the mid-1990's, and that carries you up to 1998 where you have a complete collapse, a near complete collapse of the Russian economy, just as we had seen in other emerging markets, and I would argue that there is not a lot of difference between the problems that we have seen in other emerging markets. Even if we could step back now and in hindsight say we would have done things differently, I am not sure that I see or have heard today what we would have done differently. I don't think anyone here has advocated that we would not have engaged the Russians and I don't think that the Administration has also explicitly advocated that yes we know that there is corruption, but that is the only choice we have. I don't know that I have seen anywhere where the Administration has explicitly said that corruption in Russia is acceptable in order to get to the end. Has anybody been able to document that?
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Mr. WOOLSEY. No, I don't recall hearing an Administration witness say that, Congressman. I will try to deal with the question, if you want.
Mr. BENTSEN. Sure.
Mr. WOOLSEY. I think it is unfair to look back with 20/20 hindsight and engage in complete Monday morning quarterbacking and say that the Bush Administration in its last year or the Clinton Administration right at the beginning of the Administration should have done all of the things that some of us up here now are suggesting would have been good ideas. I don't think that is fair. Policy-making is an uncertain situation and this was a highly complicated and difficult set of circumstances that both the Bush Administration in its last year and the Clinton Administration, when it came in, met.
I would say this. That by the time of the loans-for-shares program in 1995, there should have been, I think, a good deal more alarm bells going off than appeared to have gone off. And second, by around the time of 1996-1997, I think that a different approach somewhat along the line of what Congressman Weldon has suggested should have commended itself to many of the decision-makers involved. That would not have been a disengagement from Russia. It would have been far more focused on working with individual Russians, on monitoring the money and the like. Just a little over a year ago, the IMF granted over a $22 billion loan to the Russian government on Mr. Chubais' assurances, and he later said publicly that he connedthe thrust was that he connedthe U.S. Government into moving this way. At some point in there, the 1996-1997-1998 timeframe, it seems to me, even as I try to avoid being hypercritical with 20/20 hindsight, that some different shift in emphasis in the way we engaged with Russia should have commended itself to people.
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Mr. BENTSEN. For the record, of the $22 billion the outstanding IMF debt to Russia is not that high at this point in time. I think it is in the range of $17 billion and the tranches were stopped over that period of time and in fact new IMF policy, as has been stated today, is quite severe in terms of both the type of currency that is lent and how the funding is done.
Let me ask you this and particularly Mr. Saunders and Mr. Brovkin.
I am a graduate of American University and so I am glad to see that you are here today, perhaps not well trained, but nonetheless, can you tell me of a similar situation in history where you have had a country that is trying to make the transition the same as Russia is? It seems to me that you cannot compare Russia with other former Eastern Bloc nations. There is not the history or the economic history as you would have, say in Poland, or the Czech Republic? Is it fairer to state that Russia in many respects went from almost a near feudal system into its experimentfailed experiment I would addin Marxism and a centralist planned economy, and then is thrown into capitalism. Is there a similar situation in economic history and are there any parallels?
Mr. SAUNDERS. There is no question that the transformation underway now in Russia is historically unprecedented. I would return to a theme that I was discussing earlier, however, and add that precisely because it is a historically unprecedented transformation, it was remarkably arrogant of the United States to believe that we could go to Russia with a set of very specific policy prescriptions and recommendations, telling them what the budget deficit should be or the inflation level should be. In the context of this amazing transformation, I can't understand how people felt that we knew enough ourselves in this country to try to give that kind of advice. So I agree that it was an unprecedented situation, but I would say that it was all the more reason to be very cautious in our approach.
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Mr. BENTSEN. Do you not concursome of my colleagues argue that the U.S. through the IMF was not requesting a sufficient level of conditionality in terms of making loans. You argue the reverse, that the U.S. was trying to impose too much structure?
Mr. SAUNDERS. I think the conditionality should have taken a different form. In the early 1990's, some people, including former President Richard Nixon, proposed that assistance to Russia be organized not through the IMF, but through G7 precisely to avoid the problem of the IMF and financial bureaucrats coming up with these various economic targets and ignoring the broader political issues in Russia. There definitely should have been very strict conditionality, but it should have been conditionality based on the rule of law and the development of a legal system that would promote investment. This could have prevented much of the corruption and capital flight we now see.
Mr. BENTSEN. Do you think that U.S. policy, which is fairly dominant in IMF activities I would argue with respect to Russiahas been silent with respect to establishing a rule of law or civil justice system?
Mr. SAUNDERS. Certainly not. But, at the same time, the Administration has clearly given greater priority to privatization, for example, to privatizing 70 percent of enterprises or some other number, than it has given to getting laws through the Duma. And, because the Administration and the IMF were pushing President Yeltsin to implement these economic policies, he was not able to work with the Duma to get other things. That is where our policy fell apart.
Page 152 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. BROVKIN. Your question implies that since Russia had this unique historic situation, nothing could have been done and only in retrospect we could speculate what could have been done better. I want to remind you of a historical fact. In 1991 when communism collapsed, there was tremendous upsurge in entrepreneurship in Russia. Farmers were appearing. Small businesses set up. Instead of supporting the small businesses, and Russia had this experience in NEP, New Epidemic Policy, and I wrote a book about it, and I referred to Germany in 1946. Instead of that, there was this focus on achieving targets of privatization. That was the stated policy. Instead of supporting privatization, competition, rule of law and guarantee from local mafias so they don't grow up to become transnational mafias, none of this was done. Instead, there were targets on privatization and lectures here in Washington all over town how privatized Russian economy was, how great the capital society has been created. This was a wrong approach. Not too fast, not too slow, wrong approach.
Mr. BENTSEN. Thank you.
Chairman LEACH. Mr. Weldon.
Mr. WELDON OF PENNSYLVANIA. Thank you, Mr. Chairman. I have two points that I want to make, and thank the witnesses for their excellent testimony.
First of all here is the problem. If you are a Russian citizen who for seventy years was dominated by centrally controlled communism, you were looking forward to the day when communism was thrown off and a democracy would give you the benefits of what we have in America. That day came and went.
Page 153 PREV PAGE TOP OF DOC Segment 1 Of 2 I was in Moscow a year ago in January with the Duma at a conference on the Western nations to find out why more Western investment wasn't going into Russia, and I had to give the sad statistic, from 1991 until 1997, U.S. businesses invested $10 billion in the Russian economy. A free democracy, a free market economy. During that same period of time, U.S. businesses invested $350 billion in the Chinese economy.
For those that say that our policy should have been based strictly on dealing with President Yeltsin, because the Duma was dominated by Communists, they have to justify in my mind how they can go hog wild in dealing with the Chinese Communists, who never were elected. And these, the Communists in Russia, were elected in free and fair elections.
Our problem with Russia has been for the past seven years we have been so preoccupied with the Clinton-Yeltsin relationship that anything that would disturb that relationship, anything that would cast a negative impression on our relationship with President Yeltsin or Russia in fact was denigrated, was denied or basically was cast aside, and that is not just in IMF funding. I did a floor speech a year ago where I documented seventeen violations of international arms control regimes by Russia. How many times did we impose the required sanctions? Zero. We had the evidence. In fact, Gordon Eyler had to resign his job. Why, because as the head of the non-proliferation center for the CIA, he made the mistake of telling Congress that Koptev's agency was working with the Iranians on the Shahab 3 and the Shahab 4. What was his reward? Forced out of his position.
Mr. Woolsey left the agency in January 1995 and did an outstanding job. At the end of that year, the CIA completed an intelligence report that he wasn't a part of, called NI9519, which understated the threat that was being caused by Russia proliferating technology around the world, and it was the Rumsfeld Commission two years later that caused the CIA to reverse itself and acknowledge that they made a fundamental mistake, they underestimated the Russian threat.
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When I got that brief in the Intelligence Committee hearing on the day after it was released, I asked the CIA briefer, David Osias, ''How can you make these conclusions that Russia is no greater a threat today than it was back in 1991.'' He said ''That is our information. If you don't like it, that is the way it goes.'' Two years later the CIA reverses itself and says that they made a fundamental mistake. And yet we based much of our discussions with Russia on strategic issues on that report.
Or look at the Russian fission program, which is a program run by the Department of Energy up through the beginning of this Administration. That program was ended in 1994. The material was shredded because it looked to the insecure relationship and the control of Russian fission material.
My position is that we were so preoccupied with bolstering up Boris Yeltsin that we didn't want anything to surface in any area that would undermine Yeltsin. Look at the letter that Bill Gertz revealed for the first time in his book ''Betrayal'', which just came out this summer.
For the first time, Mr. Chairman, the memo that Bill Clinton sent to Boris Yeltsin during the Presidential reelection in Russia, he is saying, ''Don't worry, we will not let anything happen that undermines your leadership. We won't let anything happen to embarrass you.'' That was sent by our President to Boris Yeltsin the year that Yeltsin was running for president.
My position, Mr. Chairman, is that this is a pattern that goes far beyond IMF funding. We didn't want to hear the bad news. That does not mean that we should withdraw from Russia. I support all of the Administration's initiatives, but you have to deal from a position of strength, consistency and candor and when you don't follow those three principles, Russians will not respect you, and I agree with Mr. Brovkin today, the Russian people don't respect us. And to be honest if I were sitting in their shoes, I would think the same thing. Why should I trust America?
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You reinforce the corrupt administration. You saw the oligarch siphoning off this money that was supposed to reform the coal industry, and you denied when reality was occurring that we knew things were wrong, and now you want us to believe that you care about our stability. We have a real problem on our hands.
Mr. Chairman, unlike some of my colleagues I do believe that we are at fault as a Nation. In fact, five years ago General Alexander Levitt testified before the Congress twice, and following his testimony, Alexey Yablokov, the leading Russian economist, testified before Congress twice, and five years ago they told this Congress that it was corrupt, the leaders were siphoning off money and that policies had to be changed, and we did nothing about it. That is our fault.
Chairman LEACH. Well, thank you very much, Mr. Weldon.
Let me just conclude by making one comment that is a little afield, but I think is very important. We have two representatives of the Central Intelligence Agency of the United States, former representatives. In America we sometimes argue that the CIA has done an inadequate job. We argue that it has been too intrusive or not intrusive enough. But when you contrast the CIA with the KGB, the contrast is rather severe. There is something that stands out today that I think is really important. We take for granted the fact that the United States intelligence community is basically as corruptionless and as conflict-of-interest-less of any institutions of any kind anywhere in the world. And if it were any other circumstance, this country would be in grave difficulty.
Page 156 PREV PAGE TOP OF DOC Segment 1 Of 2 Of all the comparative lessons when we look at Russia today and we see the infiltration of former KGB into the financial system, into the economy, and we wonder what is unique about Russia, because there are other kleptocracies in the world, but one of the unique aspects of Russia today is: A, that it is so large and extraordinary; and B, it is a backward economy in many ways, but it is immensely sophisticated in many other ways, for example, intelligence and military hardware.
So the combination of kleptocratic greed, coupled with centralized controls and bureaucratic expertise and coercion of a historical nature is something that the world has never seen before. So we are looking at a situation that is absolutely novel, as well as a situation that has precedents in other societies. But the combination of situations is novel.
So A, I want to thank two particular witnesses for their distinguished public service and I would like to thank three others for distinctive analysis, and thank you for your testimony today and we will commence with the third panel.
Mr. WOOLSEY. Thank you, Mr. Chairman.
Mr. ERMATH. Thank you, Mr. Chairman.
Chairman LEACH. Our third and final panel will be composed of Mr. Yuri Shvets, who is a former KGB agent; Ms. Ann Williamson, who is an author of a forthcoming book entitled ''Contagion: The Betrayal of Liberty; Russia and the United States in the 1990's''; Mr. Arnaud de Borchgrave, who is currently at the Center for Strategic and International Studies; and finally, Mr. Richard Palmer, who is a former CIA station chief.
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We will begin in the order of introductions and let me just say I apologize partly on the lateness of the day, but all statements will be placed in the record and I would like you to do your best to not be as lengthy as possibly you might have intended. We will begin with Mr. Shvets.
STATEMENT OF YURI SHVETS, CONSULTANT, FORMER KGB AGENT
Mr. SHVETS. Thank you, Mr. Chairman and Members of the committee, for extending an invitation to appear before the distinguished committee. This is a unique experience and privilege for me to appear before a committee of the United States Congress.
Chairman LEACH. Excuse me, if I can ask you to bring the microphone a little closer.
Mr. SHVETS. From 1980 to 1990, I worked for the KGB intelligence service. Starting from 1988, the KGB intelligence service focused primarily on following domestic developments in the Soviet Union. It was also preparing for future market reforms in the Soviet Union. The number one priority of any KGB officer was to work on establishing new businesses or penetrating existing businesses, including the banks. I was a senior analyst, and my responsibility included analyzing the information provided by the field officers and composing reports to the top leadership of the country.
Page 158 PREV PAGE TOP OF DOC Segment 1 Of 2 In September 1990, I resigned from the KGB intelligence service on political grounds. At that point it was clear to me and to many of my colleagues that the leadership of the KGB and the Soviet Communist Party were ruining the country. Later I published my book about my experience with the agency, which was published by Simon and Schuster in New York in 1995. The same year I was granted political asylum in the United States.
Widescale infiltration of the Western financial system by Russian organized crime started right on the eve of collapse of the Soviet Union. The main players of the game were high ranking officials of the Soviet Communist Party, top KGB leadership and top bosses of the criminal world. They joined forces by the end of the 1980's on the initiative of the Communist Party, and this unique formation is called today by the Russian people the Russian mafia. The primary objective of this brotherhood was to accumulate maximum personal wealth and build safe havens abroad before Russia plummeted into financial chaos. There was little doubt among them that the collapse was more likely than not in the near future.
The first full-scale money laundering in Russia to the best of my knowledge is associated with the All-Russia Exchange Bank. It was established in Moscow on April 24, 1991, but the concept of this operation had been formulated in the mid-1980's. The bank was established under the full KGB control and one was under its total operational control. As a front of the operation, the KGB used a 24-year-old Russian citizen, Alexander Konanykhine, appointing him the president of the bank. The full corresponding account of the All-Russia Exchange Bank was opened in the Central European International Bank, Bupapest, Hungary, in November 1991. From November 1991 to May 1992, the bank channeled from Russia hundreds of millions of dollars which are still missing. The total amount of the theft is not clear yet. High ranking officials of law enforcement agencies speaking before the closed door in Russian Duma acknowledged the theft of $300 million. The former president of the bank recently publicly acknowledged the theft of $1 billion. It is remarkable that the money was being taken out of Russia during the first months of Boris Yeltsin assuming the presidency of independent Russia. The newly appointed democratic government, chaired by Yegor Gaydar, declared that the state reserves of hard currency were totally depleted and asked the West for humanitarian aid. At the same time humanitarian aid was coming in, the former KGB was taking hundreds of millions of U.S. dollars out of Russia. It is even more remarkable that the theft was committed by the former KGB in 1992, but after this date the Russian military prosecutor's office has been going out of its way to cover the theft up. Several governments and prime ministers and prosecutors were appointed and dismissed, but military prosecutors kept covering this crime up.
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The Russian government went as far as misinforming the U.S. Administration on this case. It demonstrates better than any declarations of the Russian officials that the former KGB leadership is as powerful today as it was in the Soviet Union and is as well connected at the top Yeltsin regime and that this regime is corrupt.
I would add also that this bank, while executing this money laundering operation, contributed significantly to the Yeltsin electoral campaign in 1992.
As a result, I am not very much optimistic when the Russian law enforcement agency pledges to cooperate with the American counterparts on investigating allegations of money laundering in the Bank of New York or other American financial institutions. When the All-Russia Exchange Bank completed money laundering operations, the president, Alexander Konanykhine, moved to the United States and was granted political asylum in this country. I believe it was a mistake. I believe granting him political asylum was a mistake. There are strong indications that Konanykhine was a willing accomplice of the KGB in the operation, in stealing the money from Russia and laundering the money through Western financial institutions.
A recent high-ranking delegation of the Russian law enforcement agency visited the United States and about two days ago they returned back to Moscow. Their position is there are no corroborating facts of Russian money laundering and the infiltration of Western financial systems by Russian criminals.
I would respectfully direct attention of the distinguished Members of this committee to the All-Russia Exchange Bank case. This case has it all. Large scale money theft from Russia, money laundering through the international financial system, coverup and deception of a foreign government.
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As for the situation being discussed today on what to do next concerning Russian corruption and money laundering, I believe it is a complicated issue, but there is a solution, and it may not be as complicated and as difficult to achieve as it may seem. We have to realize that the so-called Russian ''elite'', the people who have the real money in Russia, have the real power. They keep their personal savings in the West. They steal in Russia, they transfer money to the West and this is where they build their safe havens. They realize that what they are doing right now in Russia sooner or later may break the country apart, and then they will flee the country and come over to the West and enjoy their life here.
It is my understanding and it is the understanding of an average Russian citizen, if the people are totally dependent on the West, the West has the right to tell them loud and clear that the West will not tolerate corruption, outrageous corruption and money laundering involving Western financial institutions. I believe that this message alone sent loud and clear to the Russian elite will make a big difference. Thank you very much for your attention.
Chairman LEACH. Well, thank you, Mr. Shvets.
STATEMENT OF ANNE WILLIAMSON, AUTHOR
Ms. WILLIAMSON. Before I begin my testimony, I want to take a moment to thank you, Chairman Leach, and Ranking Member LaFalce for the opportunity to share with the House Committee on Banking some of the things I have learned over eight years of watching our Russian assistance program unfold. Chairman Leach, I particularly want to commend your efforts to lead the Congress on this very timely investigation of the true nature and unhappy consequences of our Russian policies.
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I should just like to add a few words about myself. I am the author of ''Contagion: The Betrayal of Liberty; Russia and the United States in the 1990's'', which will be available to committee Members and the American public in time for the Nation's Thanksgiving holiday.
Chairman LEACH. Who is the publisher?
Ms. WILLIAMSON. They will find out in November. It is a surprise. Prior to beginning my work on the book, I covered just about all things Russian for a broad range of publications, including the Wall Street Journal, the New York Times, Mother Jones, Art and Antiques, Premiere, Film Comment and Spy Magazine. From the late 1980's until 1997, I maintained homes in both Moscow and the United States, and therefore I can say that for much of the last decade I had the privilege of being a witness to the dramatic history unfolding in Russia and the pleasure and excitement of sharing with the Russian people their remarkable land, language and culture, and it is with a profound gratitude to them and a deep respect for that noble, heroic and too-long suffering people that I speak to you today.
In the matter before usmany billions churning through Western banks, we should look at this as an opportunity, because it throws open a window on what sort of financial arrangements a country without property rights, a country without banks, a country without certainty of contract, a country without an accountable government or a leadership decent enough to be concerned with the national interest or its own citizens' well-being looks like. It is not a very pretty picture, but let there be no mistake, in Russia the West has truly been the author of our own misery. And there are two victims to this story: The first, U.S. taxpayers along with other Western taxpayers, and Russian citizens whose national legacy was stolen only to be squandered and/or invested in Western real estate and equities markets.
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The failure to understand where communism ended and Russia began insured that the Clinton Administration's policies toward Russia would be riddled with error and ultimately ineffective. Two mistakes are key to understanding what went wrong and why. The first mistake was the West's perception of the elected Russian president, Boris Yeltsin; where American triumphalists saw a great democrat determined to destroy the Communist system for freedom's sake, Soviet history will record a usurper. A usurper's first task is to transform a thin layer of the self-interested rabble into a constituency. Western assistance, IMF lending and the targeted division of national assets are what provided Boris Yeltsin the initial wherewithal to purchase his constituency of ex-Komsomol bank chiefs, who were given the freedom and the mechanisms to plunder their own country in tandem with the resurgent and more economically competent criminal class. The new elite learned everything about the confiscation of wealth, but nothing about its creation. Worse yet, this elite thrives in the condition of chaos and eschews the very stability for which the United States so fervently hopes, knowing full well as they do that stability will severely hamper their ability to obtain outrageous profits. Consequently, Yeltsin's reform government was and is doomed to sustain their parasitic political base composed of the banking oligarchy.
The second mistake lay in a profound misunderstanding of the Russian culture and in the Harvard Institute of International Development's advisers' disregard for the very basis of their own country's success; property rights. It was a very grave error. Private property is not only the most effective instrument of economic organization, it is also the organizational mechanism of an independent civil society. The protection of property, both of individuals and that of a nation, has justified the existence of and a population's acceptance of the modern state and its public levies.
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Without private property, Russians will never pay taxes nor will any other population that I know of in the world. Russian property rights are tricky. Property has never been distributed, but only confiscated and awarded on a cyclical basis. For the big players, property exists as it always has, where there is power. For the common man, the property right hasn't advanced much beyond custom, which prevents the taking of any man's shelter, clothes or tools so long as a continuous usage is demonstrable. An additional purely Slavic feature of the Russian's concept of property is the shared belief that each has a claim upon some part of the whole.
The whole is known as the votchina, or the estate, and was held by all members of a particular clan. This understanding of property still informs the culture; Westerners bemoan Moscow Mayor Yuri Lyuzhkov's retention of the system of the residential permit, or propiska, as an impediment to a more flexible labor force, but this policy is one of Lyuzhkov's most popular. Moscovites are well satisfied with a mayor who polices outsiders as they believe any proprietor of such a great estate as Moscow should.
The Russians' failure to accept the Roman concept of private property has compelled them to suffer the coercive powers of the state so that at the very least a civil order, if not a civil society, might be established and sustained. The hackneyed idea that Russians have some special longing for tyranny is a pernicious myth. Rather, they share the common human need for predictable event undergirded by civil and state institutions, and their difficult history is the result of their struggle to achieve both in the absence of private property.
We are running short on time and so I will just briefly add that the real problem with our privatization program was in its conception. It wasn't a bad idea, a share holding society. In fact it was rather good, because a share holding society would have addressed the central flaw in the Russian concept of property, which was that it was non-transferable. It is a very great shame that the Harvard Institute of International Development, along with advisers from the multilateral institutions, thought that they could simply override this concept and target particular players with the property. It is a very great mistake to think that all of the injustice began with loans-for-shares. You simply need to examine closely the privatization program, voucher privatization, which American citizens paid for with $325 million. It was a tremendous swindle and the Russians knew it. They knew it at the time and so did the advisers in Moscow. I spoke with them in real time. I have many interviews and quotes from these people, and this is something of a myth that they are attempting to create today by saying that the problems began with loans-for-shares. It simply isn't true.
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Second, the idea of freezing prices in a monopolistic economy is simply mad. All that happened is that the monopoly producers raised prices without penalty. In turn, the Russian people were robbed of their national savings. That is why they had a 2500 percent inflation in 1992. By the time the property auctions began in 1993, the only money available to participate was criminal money and foreign money. In other words, the money coming into Russia, that is when it is laundered. It is going out as capital flight. It is going out as capital flight, because there are no banks, because no rational person can possibly work within this system.
Today when we hear very much criticism about the national character and the nature of Russian business, I would remind everyone in this room if any of us were living in such a society with so many distortions and disincentives, we would behave in exactly the same way. There is nothing wrong with the character of the Russian people, their energy, their resourcefulness, their ability to produce, but they are extremely hampered by the government and by the lack of a judicial system and by the West continuing to fund a criminal government.
Now since the party had the property, no individual Russian could ever be sure of anything upon which to build wealth. And let us not forget that the property right is the poor man's ticket into the game of wealth. The rich have their friends and money. The poor must rely upon the law. And it was in the absence of property, and it was access, the opportunity to seek opportunity and favor in which the Russians began to traffic. This is what colors their behavior and culture to this day. The connections achieved in turn became the most essential tools a human being could grasp, employ and over time in which he might trade. Where relationships, not laws, are used to define society's boundaries, attribute must be paid. Bribery, extortion and subterfuge have been the inevitable result. And what marks the Russian condition in particular is the scale of these activities, which is colossal, as is her wealth. Russia is a negotiated culture, the opposite of what an openly competitive productive market requires.
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There was an alternative in Russia in 1992. A woman by the name of Larisa Piasheva was appointed privatization chief by Moscow Mayor Popov. She had devised a true free market program, an actual one based upon the principles of Werner Erhard, his reform in Germany. Essentially she was going to pursue Lenin's revolutionary dictum of property to the people, factory to the workers in a rapid and fearless plunge into the market which would have distributed property widely into Russia's many eager hands. Her program did not rely upon Western lending, but instead tailored itself to maximize direct Western investment with a particular emphasis on the development and the protection of property rights. After robbing the Russian people of the only capital they had to participate in the new market, the nation's household savings, America's advisers signed on with the brave young Russian reformers who had ginned up a development theory of big capitalism based on Karl Marx's mistaken edict that capitalism requires the accumulation of capital. The big capitalists would appear instantly, they said, and a broadly based market economy shortly thereafter. If only the pocket of preselected members of their own ex-Komsomol circle were properly stopped. Those who hankered for a public reputation were to secure the government purchases from which they would pass state assets to their brethren in the nascent business community happy in the knowledge that they too would be kicked back a significant cut of the swag. The U.S.-led West accommodated the reformers' cockeyed theory by designating a rapid and easily manipulated voucher privatization program that was really only a transfer of title. Voucher privatizations receipts were compounded by a grevious insult, unregulated voucher investment funds which the privatizers encouraged the uncertain Russian citizenry to patronize. Hundreds and hundreds of investment funds simply walked with their clients' vouchers, reselling them to domestic criminals, red directors, Western investment banks and international money launderers.
When the eighteen-month long bank voucher privatization that the bank represented was concluded in July 1994, the program whose very design left the controlling share-holding of any single enterprise in the hands of the state, had actually institutionalized the state as the determinant owner of all that had formerly belonged to the people. And that was the rationale for the loans-for-share program, that they had to break up the state ownership, yet the voucher privatization is what created it and institutionalized the state, because according to the Soviet Union constitution, the nation's assets belonged to all of the people undivided, not to the state. That was the legal arrangement that our program changed. Of course we then went on to establish a bond market. That was an initiative from the Bush Administration. Their yields were improbable. They drew all investment to bonds to the support of the state just as Tsarism and communism had done previously.
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Today when the Clinton Administration says that someone had to keep the Communists at bay, this too is a deceit. There were no Communists in Russia by late 1991, only nascent investment bankers looking to nail down a stake any which way. Communism had evaporated by late 1987, a year in which the Russian people were allowed to hold convertible currency. Overnight the power of money replaced the power of ideology.
We also protected the banks, we allowed Russia to protect her banks and opened her producers to competition with the West. It should have been the other way around. Her industry should have been protected and banking should have had to suffer the competition of the West. At any rate after the loans-for-shares program, the predatory privatization continued. Directors stashed profits abroad, withheld employees' wages and after cash famine set in, used those wages, confiscated profits and state subsidies to buy the workers' shares from them. But until the Russian people decide how property is to be held and secured, their decision de jure, all of the destructive economic arrangements and cultural behaviors crowding Russian history will continue. Wealth will not be created without private property. Without transferable property legally secure to protect, no Russian will pay taxes. Without revenues, no Russian government can endure without falling back on what is every state's final reserve, coercion. The best way to understand Russia, the Russia we must cope with, is through her most common souvenir, the Matreshka doll, because each doll as you examine it is trapped within the larger one until finally the largest doll consumes them all. It is a perfect demonstration of Russia's universe.
Chairman LEACH. Thank you very much.
Mr. de Borchgrave.
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STATEMENT OF ARNAUD DE BORCHGRAVE, DIRECTOR, THE GLOBAL ORGANIZED CRIME PROJECT, THE CENTER FOR STRATEGIC AND INTERNATIONAL STUDIES
Mr. DE BORCHGRAVE. Thank you, Mr. Chairman, for the opportunity to assist you in trying to illuminate this critically important subject. I speak to you today as Director of the Global Organized Crime Project at the Center for Strategic and International Studies, which is chaired, as I think you know, by Judge William Webster, the former FBI director and director of central intelligence. Our project is divided into seven task forces for all matters of transnational crime. One of them is Russian organized crime, which is chaired by my Deputy Director behind me, Frank Cilluffo.
We published our first report on Russian Organized Crime and its Global Implications for U.S. National Security on September 29, 1997. Four days before its release, President Yeltsin told the upper house of parliament, known as the Federal Council, that ''criminal elements have entered our political arena and are dictating our laws with the help of corrupt bureaucrats.''
The Russian organized crime task force is in the process of completing a companion report updating the situation since the August 17, 1998 meltdown. The report will be released before the end of the year. The key findings of the 1997 report are still very relevant today. They are two years old. A few of them, and I quote: Left unchecked, Russia is in danger of becoming a criminal syndicalist state under the control of corrupt government bureaucrats, politicians, businessmen and criminals with which normal relations would be impossible.
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Russian organized crime, ROC, constitutes a direct threat to the national security interests of the United States by fostering instability in a nuclear armed major power. Equally ominous is the challenge to national security and law enforcement posed by the transnational operations and alliances of ROC groups. Overall, some 200 large, sophisticated ROC groups are now operating in 58 countries, which is up from 29 countries four years ago according to the FBI.
The processes of democratization and economic liberalization in Russia are being seriously undermined by ROC. ROC has extended its tentacles throughout Russia's economy, which confers an aura of legitimacy to myriad illicit activities, including the manipulation of Russia's banking system and financial markets.
In the absence of effective courts, a working judicial system, and consistent enforcement of established commercial and contract law, criminal elements have become de facto adjudicators. Protection rackets in effect have usurped the government's traditional legal functions and safeguards.
So what was a threat two years ago is a reality today.
The CSIS report on ROC was quickly endorsed by FBI Director Louis Freeh, but just as quickly dismissed by high ranking Administration officials, even though the intelligence community was well aware of the facts, as you have already heard today.
The genesis of the Global Organized Crime Project at CSIS goes back to 1994, when a wealthy friend of mine with high level contacts in Moscow was called by one of his contacts who said ''Could you please take care of five Russians coming over to New York next week?'' He said ''no problem.'' He quickly discovered that what they really wanted was an introduction to his banker in Nassau in the Bahamas, where he also kept a house. Two days later he got a call from this banker saying, ''Do you realize what your Russian friends wanted?'' He said, ''Yes, I assume that they wanted to open a bank account.'' He said, ''Do you realize for how much?'' He said, ''Well, I thought it might be a few million. Why, what is the problem?''
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And the Swiss banker said, ''The amount was $2.5 billion, which they wanted to put in untraceable accounts through a variety of offshore tax havens.'' Zurich turned down the business.
Three weeks later I was in the south of France on vacation sitting next to another Swiss banker based in Monte Carlo. I recounted the anecdote and he said, ''What a coincidence, I had a Russian walk in two days ago with no introductions who wanted to deposit $400 million through six different countries as well.''
1994, as you may recall, Mr. Chairman, was also the year the late Claire Sterling, a much honored investigative reporter, published a book titled ''Thieves World,'' which documented chapter and verse on the global tentacles of ROC. Ms. Sterling had traveled the world, including several trips to Russia, to investigate the connections between Russian intelligence and security agencies, organized crime syndicates and the so-called oligarchs who plundered Russia systematically under the guise of various privatization schemes. There was no doubt in Ms. Sterling's mind that this lethal mix enjoyed the protection of the powers that be in the Kremlin. I also traveled extensively on behalf of CSIS's Global Organized Crime Project without using any of Ms. Sterling's contacts. We deliberately avoided duplication. From Buenos Aires to Berlin, from London to Lugano, from Bogota to Beirut, the pattern was identicalcountless billions of dollars siphoned out of Russia that were laundered before buying commercial properties or being used to pay cash for lavish private residences in Europe's capitals and in the Mediterranean's luxury resorts, as well as to purchase yachts and private planes. I personally discovered scores of examples of properties ranging in price from $5 million to $75 million, paid for by Russians in cash.
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Little known outside the intelligence community is the fact that the clandestine stripping of Russia's assets began as early as 1985 and 1986 when key members of the Soviet Communist Party's Central Committee concluded that President Gorbachev's glasnost and perestroika policies would lead to the collapse of communism. This is when these Central Committee members turned to the KGB for assistance in moving abroad precious metals and stones and liquid assets. The KGB was the only organization familiar with Western conduits willing to handle this clandestine traffic.
When the Soviet empire began to implode in 1989, many of these Communist apparatchiks and their KGB associates became instant businessmen.
I saw that the red light went on, so don't want to be longer than I am allowed to be.
Chairman LEACH. Mr. de Borchgrave, please continue if you like. Your statement is excellent.
Mr. DE BORCHGRAVE. I was trying to respect the red light. I'm sorry.
Russia's much touted instant market economics and democratic politics were little more than a sham, Mr. Chairman. In 1997 Prosecutor-General Yuri Skuratov ridiculed President Yeltsin's seven major crackdowns on organized crime and corruption as a Potemkin Village. ''It is a charade'', Mr. Skuratov said in an interview. There is neither the will at the top nor the resources to do much about it. After three years of investigative work, Mr. Skuratov started prosecuting the first of 780 top officials. Not for long. Skuratov was framed in a sex scandal by the security services earlier this year and then suspended by Mr. Yeltsin for poking around the Kremlin's immensely complicated financial structure. But the Russian parliament twice declined to endorse the suspension and Mr. Skuratov continues to speak out in interviews. He now says that $3.9 billion of the IMF's $4.8 billion loaned last year never reached Russia, but was sold by the Russian Central Bank directly to eighteen commercial banks controlled by the oligarchs.
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You've heard Jim Woolsey this afternoon quoting former Deputy Prime Minister and former Interior Minister Anatoly Kulikov. He was at a ROC task force in Washington a week ago. He estimates that about half the Russian economy is controlled by shadow systems that run illegal operations.
Kulikov also estimates the amount of capital flight since 1992 is close to $300 billion. Some 55 offshore secrecy jurisdictions from Vanuatu in the Pacific to island nations in the Carribean and a dozen countries from Bahrain to the Bahamas were eager to take in Russia's dirty laundry. In 1995 and 1996 about $1 billion a month came into Cyprus from Russia and another $1 billion a month went in and out of Israel. The money laundering activities uncovered recently by the FBI at the Bank of New York are not unusual. They have been duplicated by scores of banks the world over. Wealthy individuals have parked an estimated $8 trillion in offshore tax shelters that guarantee secrecy. There are also approximately one million corporations anonymously chartered in these secrecy jurisdictions that sell naturalization and a new passport for $50,000. Dominica charges $75,000, but that includes passports for a spouse and two children. This is not to say that this is the Russian organized crime trillions of dollars winding up in these places, but the facilities are extraordinary and widely used by tax dodgers all over the world.
Russians have been very bitter about how what they perceive as American capitalism made them poor. 40 percent of the population is now living below the poverty line of $38 a month. Now they are bitter about being weak and this plays right into the hands of anti-American ultra nationalists.
The totalitarian temptation, as we know, has existed in Russia for the past one-thousand years. It is now rearing its ugly head again after a decade-long taste of gangster capitalism. Last week Secretary of State Madeleine Albright called on President Yeltsin to make fighting corruption a top priority. ''The problem is real, and must be taken seriously,'' said Mrs. Albright. Well, the problem has been real and glaringly obvious since 1991, and repeated warnings that it was undermining U.S. foreign policy objectives as well as diverting U.S. financial assistance and IMF loans were repeatedly dismissed as exaggerations.
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It is hardly surprising, therefore, that Russian nationalists have convinced themselves that the United States, not content with its Cold War victory, was also bent on wrecking the Russian economy.
The Administration has invariably invoked the need to give priority to strategic arms control and economic reforms, rejecting the notion that the emergence of a criminal state was in direct contradiction with U.S. objectives. General Boris Gromov, Chairman of the Subcommittee on Arms Control and International Security of the Duma's Committee on International Affairs, said this week that the lamentable state of the Russian military was a direct result of Western indifference to the way the Kremlin robbed the armed forces of the resources needed to maintain cohesion. Yeltsin's so-called reforms, General Gromov said, have brought nothing to the majority of the Russian population but disappointment.
By way of conclusion, Saul Bellow once said that ''a great deal of intelligence can be invested in ignorance when the need for illusion runs deep.'' The Administration's need for illusion in its Russian policies has been an evergreen commodity since the collapse of the Soviet Union.
So where do we go from here? I think it is essential, Mr. Chairman, and very urgent to weave Russia, in close cooperation with the Duma, into an ever tighter web of mutual interest with the United States with a view to encouraging transparency, the rule of law and the emergence of a Russian middle class. A back-to-the-drawing-board blueprint is provided by Congressman Weldon's eight-point recommendations that have been partly incorporated in the 1989 Russian Economic Restoration and Justice Act.
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Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. de Borchgrave.
STATEMENT OF RICHARD L. PALMER, PRESIDENT, CACHET INTERNATIONAL, INC., FORMER CIA STATION CHIEF
Mr. PALMER. Thank you, Mr. Chairman, and other honored Members of the committee.
First of all, I am very glad to be here today.
Chairman LEACH. Before you commence, could you give us one second of your background, your employment background.
Mr. PALMER. Very quickly, I spent 5 1/2 years in the military, first as an infantry officer in Vietnam, then as an intelligence officer.
I then spent twenty years as a CIA operations officer, eleven years of that as a senior manager, eighteen years of that time was overseas.
I have nine years' experience in researching the subject of money laundering. I finished my career with a posting in the former Soviet Union. I then remained in the former Soviet Union for an additional three years, worked with a Russian bank for a while, and also was a consultant on business and security.
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I then returned to the United States, thinking that the research that I have been able to do during this period on Russian organized crime would be of great interest, and I must say that before appearing before this committee today, it has been somewhat disappointing. I am glad to see that someone is finally addressing the subject.
Mr. LEACH. Please proceed.
Mr. PALMER. I now work in asset recovery and due diligence primarily in Russia.
I am particularly glad to be here today, because the BBC Moscow is carrying a story that I was removed from the witness list because I was the person who sent Matrokin down the street to the British. This is the former KGB officer who has recently written a book with a lot of details. I cannot discuss my CIA employment in detail, but I can tell you that the first time I ever heard or saw of Mr. Matrokin was in reading a local newspaper, and my closest contact to him is that I ordered his book over the Internet.
I also know nothing about Mr. Penkovsky.
This is a subject that presents serious threats to Western nations as well as involves the use of U.S. taxpayers' funds to continue the looting of Russia and its former republics. I feel reasonably well qualified on the subject as a result of my former Government service, personal research and professional duties. I devoted much of my time, energy and money to Central and Eastern Europe and the former Soviet Union in the last seven years, because I believe that the collapse of the Soviet system was an historic, revolutionary event and that the outcome would shape the course of history. Unfortunately, we have thus far squandered our opportunity to help shape the outcome of this event in the positive directions that benefit the majority of the people in this region rather than just a few persons at the top.
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We have little time left to avoid the permanent denigration of the term democracy in this region and the return of totalitarian regimes which may not necessarily be Communist. This would lead to instability in a region that spans ten time zones and still remains the second ranking nuclear power.
Several knowledgeable, respected speakers have preceded me today. Indeed, Mr. Chairman, your article in the September 10th issue of the New York Times lays out the issues very well. Therefore, I would still like to preface my comments by noting a few points I consider givens.
Russia is too important to us and to the world to simply abandon. Second, despite the incredible, severe obstacles and forces that confront them, there are honest and courageous Russian officials, law enforcement personnel and businessmen. Regrettably that currently represents a small minority.
Third, most Western bankers and businesspersons have been more interested in making usurious profits quickly than building long-term investments. They have also sought to obey neither the law, the spirit of the U.S. laws, nor the letter of the U.S. laws concerning money laundering in their recordkeeping. Further, U.S. laws regarding money laundering and the conduct of due diligence on customers who move large sums of money are inadequate.
We are willing to conduct stings against Mexican banks for money laundering for drug lords. We conduct classes not only in the U.S., but in foreign countries, to advise them about the U.S. laws on money laundering and how this can be avoided. On the other hand, the U.S. Government has not been particularly aggressive in looking at one of the major sources of laundered funds, Russia; and second, I have been told by several foreign countries that they have been, as they put it, ''stiff-armed'' by the U.S. Government when it comes to asking for our help in looking at the provenance of funds. This is something where we give the image that basically we are going after this for competitive advantage instead of actually trying to stop the looting of states.
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And finally, the U.S. Government continued to seek only good news about events in Russia, strenuously overlooking even the most poignant cases of theft and criminal activity at the highest levels. This is self-defeating and dangerous.
The purpose of my rather long and detailed written testimony is to document that the looting of the Russian state was part of an elaborate plan that was created in the mid-1980's. Further, current political leaders such as Prime Minister Vladimir Putin and President Boris Yeltsin continue this program. Any objective observer must be swayed by the multitude of published evidence of the corruption regarding President Yeltsin, his family members, and a circle of financial supporters.
The three appendices to my testimony are simply a small example of the documentation that are publicly available. One of those in Appendix A shows the documents on Mr. Borodin's Swiss bank account. Appendix B is a document that shows that Mr. Borodin bequeathed two apartments to members of the Russian government illegally. One was to the acting prosecutor who replaced Mr. Skuratov, and the other is to the chief military prosecutor for Russia. Apparently this is to ensure that there won't be any prosecution of the Yeltsin group.
We must move away from the personalization of Russian policy. We must be able to talk to all sides. Russia is too big for narrow relationships. We must stop the growing popular perception in Russia that the U.S. and democracy are simply allies of their own corrupt society and government. We must move away from channelling our support solely to the most corrupt elements of the state. We need to recognize that the most corrupt elements include the most senior politicians, bankers, businessmen and even law enforcement officials of Russia. We must come to grips with the concept that the Russian government is riddled with corruption and there is no rule of law. To pretend otherwise is a recipe for disaster.
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Large amounts of money encourage corruption. Russian organized crime is unique in that it is willing to spend up to 50 percent of its profits on corruption, including bribes to officials. That, if left unchecked, will corrode America's political, economic and legal system. Make no mistake about it, the traditional mafia hoodlums who steal cars, run prostitution rings and collect protection money comprise only about 10 to 15 percent of Russian organized crime. Russian officials, politicians, bankers, businessmen, industrial managers and even some law enforcement officials comprise the other 85 to 90 percent. Both components work together to subvert the law. Both engage in typical racketeering activities. Some just have better educations and dress better than others.
Regarding the amount of money that has been stolen from Russia, we must also include the cost of the Russian resources such as oil and copper in these calculations, which were sold at extremely undervalued prices to Russian organized crime intermediary firms. One frequently cited example is the fact that in 1990 one package of Marlboro cigarettes had the same free market cost as one ton of crude oil, about $3. The only problem was to have the connections to obtain a permit to obtain and sell the oil abroad.
Current Russian Prime Minister Vladimir Putin provided such permits as part of his duties when he worked for the former mayor of St. Petersburg before the latter was forced to flee to France when charged with wholesale corruption.
Both Interpol and the Russian Ministry of Interior estimated in 1998 that at least $300 billion had been looted from Russia. The most optimistic estimates say $1 to $2 billion a month were removed, which would put the total between a very optimistic $90 billion and a more reasonable $180 billion. Other, more realistic estimates went as high as $500 billion.
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While no one knows for sure, consider the fact that Benex accounts allegedly moved up to $10 billion through one series of accounts within one year, and that was certainly only one of these accounts.
The key point to remember is that the exodus of this money from Russia is to the West and that it uses the Western banking system for these movements. Combining Russian organized crime members, as well as simply those who do not want to pay taxes, these billions exit Russia leaving it to the Western countries and the IMF to make up the difference. In other words, even if money laundering is not considered a crime in Russia or cannot be prosecuted in the West, we are still helping them avoid paying taxes. The difference is made up by our taxpayers in loans that will never be paid back. This means that what is considered good business for Western banks is forcing Western, particularly U.S. taxpayers, to continue to subsidize corrupt regimes and Russian organized crime.
The phenomenon of large-scale looting or kleptocracy is not and will not be restricted to Russia. We can expect that other autocratic states who encounter similar problems as they attempt to transition to free market societyCuba, Vietnam, North Korea and even Chinahave already begun to register striking growth in organized crime groups, all with ties to the top of their governments. However, this model will also provide a preview of problems to come in countries such as Mexico when they begin to decentralize and privatize their resources.
How to solve these problems? We have to come up with a foreign policy that is bipartisan and has long-term goals. We have to decide what is manageable in Russia. Certainly, we cannot walk away; we must work with them. But we must also tie our aid not to one government, not to a group of politicians on either side, but to cooperation between the governments. We also have to tie our aid to discernible, measurable goals. That means before we allow more investment, we should have a Russian-U.S. investment treaty to protect American investors.
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The European Union was successful on this. Why not us? How can we encourage U.S. investors to invest when we don't even have a treaty to protect their rights?
Second, we must make due diligence a requirement at several levels of our dealings with Russia in its former republics. The argument that effective due diligence is not possible in Russia is specious. It is being done every day and not just in a perfunctory manner. For example, USAID and assistance programs to businesses should include a mandatory section that confirms that this business and its principals have been investigated and found to have no ties to Russian organized crime. These investigations should be overseen and conducted by U.S. or Western firms which can be disciplined if they are found to be negligent or fraudulent in their work. Official Russian assurances or investigation by security firms with ties to Russian organized crime which comprise the majority cannot be taken seriously.
Effective due diligence will encourage that honest firms stay that way. It will reduce cash flows to corrupt or Russian-organized controlled firms. It will give honest businesspersons some incentive to either stay that way or become that way. This isn't pie in the sky. It won't happen overnight, but we have to take a long view.
Western banks must insist on knowing the provenance of the money that they accept. Accepting billions of dollars from firms that don't exist or consist of a small office, telephone and computer are not acceptable. There should be strong penalties for failure to exercise due diligence by any Western bank, particularly in the U.S., because it is the largest banking system in the world.
Page 180 PREV PAGE TOP OF DOC Segment 1 Of 2 And finally, banks must be held responsible for the actions of their employees. It strains credulity to listen to explanations that ''we didn't notice that the billions of dollars were flowing through a bank, because of the actions of one or two corrupt employees.''
Finally, think of the impression we make on other countries when many of our banks that we use here in the Washington area, for example, have the letters N.A. after the name. It means they are based in the Dutch Antilles to minimize taxes and maximize profits, or I recently read that the State of Colorado has passed a law providing for offshore companies for foreigners. Apparently they want to join the ranks of Delaware and similar States that want to attract deposits by foreigners maintaining shell companies in the United States. At what cost?
I am hoping that this committee will be able to follow through on their plans to introduce new legislation.
I want to thank you for your time, sir.
Chairman LEACH. Thank you, Mr. Palmer.
Let me just begin, because you have something unique to the panel, in fact, unique virtually to any American, and that is, you have worked in a Russian bank. The impression that I have is that most Russian banks aren't deserving of the term of art ''bank''; that is, that they aren't deposit-taking institutions that revolve funds to make loans to a community, that they are more simply money laundering platforms or places where government funds come in and high levels are siphoned off by commanders of the banks.
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Now, is that a valid observation or is that a false image?
Mr. PALMER. I would say that that, based on my experience and my research, is at least 85 to 90 percent correct, sir.
Chairman LEACH. The reason I want to press you a little bit on this, let us say you are an American bank, and a Russian bank comes and says, ''We want to do business with you.''
It would be inconceivable, if you are a thoughtful, reasonable American bank, that you would not know that that bank is not a traditional bank, that there is, by definition, a potential problem. Is that valid or not?
Mr. PALMER. That is certainly my view, sir. The bank that I worked with, as many of them did, went bankrupt. It was a Russian-owned bank in Latvia, and one of the largest American brokerages deposited several million dollars with that bank one week before it went bankrupt.
Chairman LEACH. For what reason?
Mr. PALMER. Well, that is a question many people asked afterwards, because it was in the newspapers that the bank was in difficulty. The audit papers from one of the big six audit firms said that the bank was quite solid, but most people don't put much trust in that. But what I am saying is you could ask a taxi driver and learn that people were concerned about the bank.
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Frankly, the thing that I have seen most often in American companies and firms that have been defrauded, from Russia, is that normally the Russian groups, or Eastern European groups in some cases, find someone in the American corporation that they can work with.
Chairman LEACH. I am going to get to that in just one second.
First, I want to ask a very specific question. One of the financial institutions that has come under a great deal of attention is one called Menatep, and I know Ms. Williamson is familiar with it. Is there anyone on this panel that doesn't almost instantly understand that this is an institution of doubtful integrity?
How would you describe it, Mr. Shvets?
Mr. SHVETS. Yes, Mr. Chairman, Menatep was one of the largest Russian banks, the most heavily penetrated by the KGB, starting with the former KGB Chairman, Ivanenko. There were different factions within the KGB before the collapse of the Soviet Union, after collapse of the Soviet Union. So Menatep apparently worked more closer with the faction of the KGB which supported Boris Yeltsin in his fight against so-called ''Gigashipa'' in August 1991, and it basically fits the pattern of the KGB-penetrated financial institution.
Chairman LEACH. Finish your sentence, please.
Page 183 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. SHVETS. This bank particularly, specifically was involved in, let us say, the American leg of the all-Russian exchange bank operation where the Russian exchange bank former President, together as a representativeactually he was then vice president of Menatep Bankcame to this country to work on establishment of a bank with initial capitalization of $1.7 billion, and this mission was financed by Bank Menatep.
Chairman LEACH. Do you have any comments on Menatep, Ms. Williamson?
Ms. WILLIAMSON. Well, it was known as a gangster bank in Moscow. And one thing about the KGB involvement, though, is that the CPSU banked at the Vnesheconomobank, which in the trade is known as V-Bank; and account number one belonged to CPSU, and it was actually KGB that handled the money transfers and so forth for the Communist Party under the Soviet Union. So their moving into Menatep was also a certain capturing of professionalism. But I do know that Income Bank employees used to complain vociferously, because they said there is no end to the money Menatep can get; they constantly were refilled, they told me.
Chairman LEACH. Yes, I know.
Mr. DE BORCHGRAVE. Mr. Chairman, just to show you how the old conduits continued to be useful to latter day Russia, you have read about the FIMACO in the Island of Jersey, where the Russian Central Bank transferred several billion dollars. That particular offshore bank in Jersey belongs to the now-called European Union Bank in Paris, which used to be the Banc Commerciale de Neu in Paris, which was used to move funds from the Soviet Union to the French Communist Party.
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Chairman LEACH. One final question, and I turn to other questioners, particularly Mr. Palmer and Mr. Shvets, but the other two panelists may have knowledge, too: Do you believe that Russian organized crime and/or KGB has infiltrated personnel in aspects of the American financial system?
Mr. PALMER. I would say absolutely.
Chairman LEACH. And can you give examples, if not of named institutions, of kinds of personnel? Do you mean in like management, in computers? How do you mean?
Mr. PALMER. The British Service has published something in their newspapers about two years ago that they had found, ''plants from the KGB, or moles,'' who were involved in providing information on currency exchange rates and bank operations.
Chairman LEACH. Are these in Moscow, London, New York?
Mr. PALMER. These are Russians who were brought into the banks, but these are also British citizens who are then hired by, now, the SVR to provide banking information. That this happens is absolutely true. Banking and financial information is now one of the highest priorities of the SVR. The British have found some of these people, they publicized it.
In the United StatesI have been out of the Government since 1994, so I can't speak for the U.S. Governmentbut it seems to me it begs logic to think that they would avoid the largest banking system in the world.
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I would also say, when you look at this case we are looking at in New York, you have a woman who was a teller in a bank, OK, first of all; and she met an Americanand I know nothing about the case and I am not disparaging her, but in 1976 you didn't meet Americans on the street, strike up a long relationship with them and get them an exit permit to leave married. Mr. Shvets can speak to that.
But someone goes out to the West and is recontacted perhaps. Suddenly they are moved from being a teller to a vice president of a bank to going to an offshore banking haven for RussiaRiga. In Latvia, the second largest industry is money launderingand giving a class on money laundering. I would think in any bank the alarms would go off on that. What I am saying is these things must be happening.
I can say this: Following my retirement, I still met a lot of people from the KGB who were quite willing to come up and tell me where they used to work, about their backgrounds, and they would tell me one of the first things they did was contact the agent they had sent to North America and Western Europe when they were spies and now recontacted them for business. That doesn't mean that these are necessarily on behalf of the KGB, now the SVR, but it can mean that this group that stole the money, that controls the money, has contacted people they used to work with, and now they have economic relations with them as well.
Chairman LEACH. Mr. Shvets, do you want to comment on this?
Mr. SHVETS. Mr. Chairman, as far as to my knowledge
Page 186 PREV PAGE TOP OF DOC Segment 1 Of 2 Chairman LEACH. This is an interesting contrast, a former CIA agent and a former KGB agent.
Mr. SHVETS. We have been knowing each other for quite a while.
Chairman LEACH. I am not going to get into your background, please.
Mr. DE BORCHGRAVE. Neither side could have fought me, Mr. Chairman.
Mr. SHVETS. Basically, minutes after collapse of the Soviet Union, the KGB made an attempt to directly penetrate the American banking system by establishing a KGB-controlled bank in the United States, and they sent their human asset, so-called human asset, to Washington, DC., and he was trying to negotiate the conditions for opening the bank here. Eventually, he was told that there would be no Russian bank on American soil in the foreseeable future. So this attempt was stopped.
However, for some time, I was following very interesting developments in the policy of the Russian embassy toward the Russian citizens living in the United States. The problem now that such countries as China, Israel have citizens in large quantities living in other countries, and the KGB perfectly knew that Chinese intelligence was working very closely with Chinese citizens living in other countries, specifically in the United States, because, as Chinese, they were considered potential assets of the intelligence service.
Page 187 PREV PAGE TOP OF DOC Segment 1 Of 2 The same was known about Mossad, Israel intelligence, and about a year ago the Russian embassy introduced special procedures for officially renewing foreign passports for Russian citizens living in the United States, and in order to renew this passport, each applicant should fill out the form which for me, as a former KGB agent, reminds me very much of the 1970's when the committee had files on all formal Russian citizens. In this document and this application, what is important again for me from a professional point of view, is that a Russian citizen living here as an American resident needs to show where they work, their employment, their telephone numbers and their street address.
Chairman LEACH. As well as their family in Russia.
Mr. SHVETS. And the whereabouts of their family in Russia.
So it was my experience, I take it for granted this information will be used by the KGB for operational needs. They can approach, first, this Russian in the United States who has an offer or demand, and they can put pressure on him or on her through their relatives living in Russia; and lots of Russians living here as residents, they were so scared by this new form that they decided not to fill it out even though they couldn't return to Russia to see their relatives anymore.
Chairman LEACH. Thank you.
Mr. BENTSEN. Thank you, Mr. Chairman.
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Let me just follow up on the Chairman, Mr. Shvets. I have to ask you, did you ever imagine in your wildest dreams that you would be testifying before the U.S. House of Representatives Banking Committee as a former KGB agent?
Mr. SHVETS. It was absolutely incredible. I had a tour of duty in Washington, DC., in the mid-1980's, and I did visit the United States Congress when I worked here under cover as a Tass correspondent, but I never imagined that some day I would be testifying here before a committee of the U.S. Congress.
Mr. BENTSEN. This is an extraordinary time for everything that has gone on.
Ms. Williamson, I haven't read any of your stuff and I want to apologize that there are not many of us here. I think they are all the Members who ever had a subscription to Spy Magazine who are left here today, but are youin your testimony, are you asserting that perhaps the United States backed the wrong force in Yeltsin and, in fact, we should have walked away from Yeltsin some time ago?
Ms. WILLIAMSON. Well, yes. I think we certainly got far too close to him as a personal relationship and put too many hopes on this man.
You know, in 1991, we went along with the idea that what was triumphing was democracy, but in fact what was happening was that Boris Yeltsin had chosen to seize power and the obstacle in his way was a man named Mikhail Gorbachev and an entity, the U.S.S.R.; and a group of them decided, we are in the U.S.S.R. and will take power and take assets of the U.S.S.R. So there was this misunderstanding of the two sides, though the Russians, particularly Mr. Yeltsin, were very clever at leading this notion along amongst Western participants in this drama.
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Mr. BENTSEN. So you are asserting that while there was an attempted coup d'etat with respect to Mikhail Gorbachev and then Yeltsin and his backers seized the parliamentary building, that that was really subterfuge, that this was all a coup d'etat, nonetheless, that was a transfer of power to oust Gorbachev; and whether it was the military or the old Communist regime, that Yeltsin was one and the same.
Ms. WILLIAMSON. No, no.
Mr. BENTSEN. Or were there two coups d'etat going on simultaneously?
Ms. WILLIAMSON. It is my understanding Yeltsin was aware of the intent, that there would be an attempt against Gorbachev and the participants, but there are so many strange things about those days. I am still not entirely convinced whether Mr. Gorbachev knew about it or not. Why wasn't Mr. Yeltsin arrested that morning?
Just lots of anomalies in this story, but I don't necessarily believe at all that Mr. Yeltsin was part of that, but he exploited the situation brilliantly; and then after Mr. Gorbachev's return from Four Oaks and the new day dawned, they moved very quickly to get him completely out of the way, and part of what led to that momentum was, Westerners flooded into Moscow and actors who really wanted to move this forward from Harvard University became involved, and they worked with the media to create this image and to move the situation along. And that is a separate effort, I am saying, from what occurred in August of 1991.
Page 190 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. BENTSEN. I don't know about Harvard, but let me ask, but then you had subsequent elections in Russia, this newly constituted Russian Federation, and you had elections, you had the Presidential election, you had the Duma election, you have effectively a split government, I guess, now with the Communist-controlled Duma versus Yeltsin's being in the opposition, or vice versa.
Those elections, you feltwere those substantial elections, were those rigged elections, oryour observation. And is Russia a democratic country today? Would it be a democratic country?
Ms. WILLIAMSON. I do not believe the constitution of the Russian Federation passed the qualifications to be truly accepted by the electorate. There was not a majority of the electorate that passed it. The elections are dubious.
But, yes, they do have elections. And I will tell you, sir, that the Russian people vote in great numbers. I have witnessed them. They are a population that likes to vote, that likes to make their opinion known and select their leaders, that is true.
Mr. BENTSEN. My time is up, but I have another question. I have been waitingand I am also late for a meeting I have got to make a presentation at, but I do want to ask two things very quickly.
Mr. de Borchgrave, in your testimony, you cite comments by Mr. Skuratov that he has continued to say that $3.9 billion of the IMF $4.8 billion loan, made last year subsequent to August, never reached the Russian shores, never reached the borders of Russia, that that money was siphoned off.
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Mr. DE BORCHGRAVE. It was sold directly, Congressman, to eighteen banks that were on their list of favorites by the Russian Central Bank; and Mr. Skuratov has given six interviews, to my knowledge, in the past fifteen days.
Mr. BENTSEN. And this is contrary to what the IMF has toldcertainly contrary to what the Secretary of the Treasury told us this morning.
Mr. DE BORCHGRAVE. That is correct, sir.
Mr. BENTSEN. And contrary to what the IMF has publicly stated and what Price Waterhouse and others have found.
Mr. DE BORCHGRAVE. That is correct.
Mr. BENTSEN. Have you reviewed the evidence or has Mr. Skuratov provide any evidence to your committee?
Mr. DE BORCHGRAVE. No. Mr. Skuratov, last time I saw him was about a year ago. What I am referring to now is the interviews he has been giving in Moscow.
Mr. BENTSEN. I only say that because I would be interested in it. I, like the Chairman, have been supportive of the IMF when we think they are doing a right job. I, you may know, raised objections with respect to our ongoing loan facility with Indonesia vis-a-vis the East Timor situation. I don't think that is a credit we should want to underwrite under these circumstances, and I would find the same to be true if, in fact, there is credible evidence which can be produced that would indicate that IMF funds are being siphoned off. And I would encourage you, if you have the ability to bring that forward, because no one else seems to have brought that forward.
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Mr. DE BORCHGRAVE. What I would respectfully suggest, Congressman, is that a staffer from this committee or several staffers go to Moscow and talk to Mr. Skuratov on or off the record.
Mr. BENTSEN. I defer to the Chairman, since he controls the pursestrings of the staff.
Finally, let me just restate, Mr. Palmer, you are saying that all of this comes downa vast majority of what is going on, this sort of organized corruption, Russian-style crony capitalism, if you will, the origin of it really goes back to the Communist Party under the old Soviet Union back in the late 1980's and early 1990's when they foresaw the breakup; am I interpreting your comments correctly?
Mr. PALMER. Absolutely correct, Congressman.
Mr. BENTSEN. This is not happenstance or coincidental or what happens, as we have seen in other countries, where you go break up and decentralize and oligarchs appear without basic structures in place. This was a planned event, in many respects?
Mr. PALMER. Exactly right, sir, and I tried to document that in my testimony.
Mr. BENTSEN. Thank you, Mr. Chairman.
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Mr. LAZIO. Thank you, Mr. Chairman. I welcome the panel.
I would like to begin with a question for you, Mr. Shvets, and I want to thank you for your testimony, and I was interested in your testimony concerning the KGB attempt to set up a bank here in the States, and I am wondering what subsequently happened in terms of a strategy. Were there human resources, KGB resources, that were used to infiltrate U.S. banks subsequent to that? Is that your knowledge of part of the strategy?
Mr. SHVETS. It is my understanding that attempts of establishing a KGB-controlled financial institution on American soil is not in the cards anymore, because they were refused this opportunity in 19941993, I am sorry. So from this point on, their attempts, they concentratefocus their attempts on penetrating Western financial institutions through the countries of the Third World.
It is easier to penetrate a banking institution in the Caribbean, for instance, even though there are other problems. It is very difficult to launder $10 billion through a bank in Costa Rica, because the whole budget of the country is $9 billion.
Mr. LAZIO. I can understand that.
Mr. SHVETS. On the other hand, they are working on it.
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The last information I got was that in April this year several Ambassadors of small Central American countries in Moscow were approached byfrom what they describe to me, they were people connected with intelligence service and organized crime, and the offer was thatthe message, the Russian message, was that there is a huge amount of IMF money stashed in European banks and this money is being handled by a small Russian financial company. This Russian company would finance any commercial project, any business project of this small Central American country with the understanding that the small country gets 10 percent, and 90 percent goes to Russia. And the total amount of loan they were considering lending this way was around half-a-billion dollars.
Several Ambassadors were approached and their governments took this offer very seriously, so seriously that the finance minister of Guatemala went to Moscow to conduct specific negotiations.
Mr. LAZIO. Let me follow up on that. If anyone else has any other information, I would like for them to join in. But my question is, subsequent to any possible KGB placement, was there any attempt, do you thinkyou know, this is to the rest of the panelfor there to be organized crime placement? And I noted when you talked about organized crime and KGB, you mentioned them in the same breath in terms of this approach.
Is there any infiltration of organized crime in U.S. banks? How broad is it? Do you think they were placement in key banks? Is that part of an enterprise that reaches, I am sure, to all parts of the world?
Page 195 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. SHVETS. I think that American law enforcement agencies should focus their attention on the banks that have Russian-speaking employees in the areas with a concentration of Russian-speaking population. I don't want to change Russian citizens living in United States; however, I do know that Russian organized crime groups living in such areas as New York, New Jersey and California and Florida, they keep an eye on Russian-speaking citizens who have their jobs with financial institutions in this country.
Mr. LAZIO. Mr. Palmer.
Mr. PALMER. I would just like to add one thing to this. The Russian's organized crime, this society lives by corruption. They are excellent at corrupting. They also, organized crime, inherited a lot of former KGB officers, unemployed, so you see a lot of the techniques used. If you are a small business, you might have someone come up and say, ''We are your new partner, we want 50 percent of your bottling plant or store or whatever.'' If you are a bank, it works a little differently.
I have looked at eleven major cases of U.S. firms who were defrauded by Russian organized crime. These are firms, I am sure the technique is the same, and it would make sense to you. They find someone in the institution who isn't adverse to making more money. I will give you an example.
There is a major U.S. firm. They started a project with Russia. They never looked to see who they were doing business with. It was such a great deal, they had to hurry and get it done before they lost it. Four years down the road they found out they were short $32 million.
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Mr. LAZIO. They lost it?
Mr. PALMER. Yes. So they said, ''Well, actually this is serious money. We have to look at it.'' So what they found was it was a vice president who had pushed this thing the whole time, and we were able to trace in the neighborhood of $2 million had gone to a Caribbean island and appeared to be his.
The company approached him and said, ''Look, the money is missing'', and he said, ''I can't tell you anything about it.'' They said, ''Well, we would like you to leave.'' He said, ''Well, gee, I would like to go, but you know I have a contract. I would like more money.'' Basically to get him to leave without a scandal they had to almost double his golden parachute. It cost them $32 million.
What I am saying is, they find people within the organization that work. It is not just Russians. They can find anyone in the bank who can help them move the money. I think you may be looking at an example of that right now.
Mr. LAZIO. Could I ask just one question? I am sorry. I just want to know if anyone here at the panel can tell me anything about Bruce Rappaport.
Mr. DE BORCHGRAVE. I have known Bruce Rappaport since I was based in Geneva, when I was Chief Foreign Correspondent of Newsweek Magazine for seventeen years. I had opted to live in Geneva, base myself there, and that is how I got to know Mr. Rappaport. And what I know is that he was always involved in the days of the Cold War on business with the Soviet Union. That is all I know about him.
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Mr. LAZIO. Do you know anything about his involvement with the Bank of New York?
Mr. DE BORCHGRAVE. No, sir.
Ms. WILLIAMSON. Representative Lazio, I would add that they were rather open about this. I interviewed Yuri Kovalovki in early autumn 1991; and he is a well-known gentleman with the KGB until just several days ago, Mr. Shvets has informed me. But at any rate, there was a lot of talk about reorganizing the KGB at that time, and they split the agency into a domestic and an external serviceso forth, so onbut we were discovering thatand he was very frank.
He said, ''We are going to use our agents for economic purposes, for economic development''; and I said, ''Well, gee, wouldn't that be more appropriate for someone in the finance ministry or other areas?'' ''Oh, no, these people, that is what our job is going to be is economic development.''
It was quite clear what he meant. So you could get this information very early.
Mr. SHVETS. If I may add, Congressman, after collapse of the Soviet Union the Russian government had problems paying salaries, even to intelligence service employees. So what Mr. Primakov did, when he was appointed director of the Russian intelligence service, he allowed intelligence services employees to do private business on the basis of information, intelligence information, and intelligence contacts that they had, so basically to make their own living using their official positions; and that is exactly what happened. They went out, using different compromising materials, intelligence information, and they penetrated a huge amount of businesses. This is not all of them. If you have a successful Russian business, they give them three or four monthswhich have business with foreign partners, they give this company three or four months to see how it works. If the company looks successful, two visitors from the Russian intelligence service visit the boss of this company, and they offer a deal, if you don't want to have problem, if instead you want to be helped, we want two positions in the administration of your company, second from the top, and we wantthis is a subject of negotiationfrom 30 up to 60 percent of profit of this company, and I was told that in most cases this offer is accepted.
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Mr. LAZIO. Official extortion. Thank you very much, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Lazio.
Mr. ROYCE. Yes.
Mr. de Borchgrave, in your capacity as director of the global organized crime project, how would you evaluate the Administration's policy toward senior level reformers in the Russian government and reformers outside the government? Have these reformers received the support that they needed to implement actual changes; and absent United States support, were their efforts doomed to fail? In other words, were we the only ones that could have affected this?
And the second question I would ask you is, to what degree has the IMF policy of distributing funds without any condition for loans aggravated the problem of capital flight? Are there specific legal or economic reforms that would address the capital flight problem and provide incentives for Russians to keep their money in the country or are the problems so deeply rooted that nothing short of financialjust complete, fundamental cultural change could remedy this situation?
Mr. DE BORCHGRAVE. Well, sir, to pick up again on what I said at the end of my testimony, where do we go from here? I said, as I recall, we should weave Russia, in close cooperation with the Duma, into a very tight web of mutual interest with the United States with a view to encouraging transparency, the rule of law and the emergence of a Russian middle class.
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I don't think it is too late for that. We have to just get on with it; and clearly we have to bypass the family in the Kremlin, and that can be done in my judgment. As for the reformers that you asked me about, there were no reformers.
Mr. ROYCE. Back to the issue of IMF distribution of funds without conditions on those funds and whether or not that aggravated capital flight.
Mr. DE BORCHGRAVE. Of course, it did, Congressman. And clearly, new rules and regulations are required; and that is, I assume, the assignment of the Banking Committee.
Mr. ROYCE. Let me ask another question to any of the witnesses, and that is, several of you today noted that corruption is now kind of an inherent part of the system there, and the Russian Duma has passed anti-money laundering legislation, I think, twice; somebody said five times. President Yeltsin has vetoed it each time, which suggests lack of commitment to addressing the problem created by the thriving criminal element in Russia.
What are the prospects for meaningful anti-money laundering legislation being enacted now? I mean, has the attitude changed there in the executive branch?
Mr. DE BORCHGRAVE. I go back, sir, to what happened with PDD 42I believe the number was number 42in 1995, President Clinton decided to crack down severely on money laundering centers the world over, and if we could not persuade them to curtail these activities, we would then take them out of the American financial loop. The problem with that PDD is that there is no such animal as the American financial loop. There is a seamless global electronic web in which money can be laundered through six different countries in one day.
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Mr. ROYCE. And what about the prospects nowfor any of the panelistsof getting the Russian president to change his attitude about constantly vetoing these bills passed by the Duma?
Ms. WILLIAMSON. I would just say you could probably get that legislation signed, but it doesn't mean it is going to be enforced.
Mr. ROYCE. Only a month ago he vetoed it, right?
Ms. WILLIAMSON. Right. But again, even as a PR move, he might do that, but it isn't relevant to whether it will be enforced. And another element to the capital flight as well as the looting, the state-sponsored looting of Russia, is the draconian taxation which the IMF encourages and asked the Duma to raise taxes even further, and if these taxes were imposed upon our population, we would have similar problems, quite frankly.
So, again, I go back instead to of lots of forms and regulations; let us get serious about the property rights and taxation and rational economics.
Mr. ROYCE. I see.
Mr. SHVETS. The problem right now in Russia is that the system, legal system and law enforcement practice, is such that it is impossible to do successful business following the law. If you strictly follow the law, if you pay all taxes, if you pay all import, export dues, you are broke. So basically any successful businessman has just committed a sort of crime.
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So, if you even pass the law, it will again be up to a bureaucrat in a law enforcement agency to make a decision. This businessman will be prosecuted, and this one will not be prosecuted; and again, you have a problem of corruption.
So I don't think thateven if the legislation is passed, I don't think that it will be a solution.
Mr. ROYCE. I see. OK. Thank you.
Mr. PALMER. I would think the chances are still rather slim, because the Yeltsin family is still very concerned about maintaining their economic, financial support coming into the elections, where they hope to put up their own candidate; and they are worried about their futures.
But I agree with everyone here. If they passed it, it would never be enforced anyhow. I have lived in these countries and seen that their laws have no relationship to what the courts do. Unfortunately, it is a fact that most judges can be bought. I mentioned in my testimony that a company has a decision by the Russian supreme court, and in two years hasn't been able to enforce it, regarding one building, and the courts have no effect.
On the other hand, it would be effective, at least if we had some document, through which we could say, ''Aha, at least to us it looks like money laundering in Russia.''
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Mr. ROYCE. Let me make a point and that is, from my standpointI understand the points you have made, but from my standpoint, for the Duma, if the Duma wanted to do an investigation, at least if there was a law on the books, they would have the right to access the information. But currently they cannot trace money laundering, because there isn't even a law to point to, because it has been repeatedly vetoed; and that is why I raised the point. But would you concur with my analysis on that point?
Mr. PALMER. I think it is absolutely an essential first step, and I couldn't agree more, sir. I think it is absolutely critical that we press for this. What type of success we will have is another matter.
Mr. ROYCE. I understand your wider point on the front in terms of the rule of law being inoperable. Well, thank you again.
Chairman LEACH. Thank you, Mr. Royce.
Mr. Weldon, do you want
Mr. WELDON OF PENNSYLVANIA. I just think the testimony from all three panels has reinforced the notion that we can't impose requirements on Russia unless we have a viable process that works within Russia. We have not done enough, I think, to solidify the nature of democratic institutions in Russia. We have been so preoccupied with bolstering up what is now a floundering presidency that we have ignored the institution of parliament, which could to some degree have the ability to provide a check and balance inside of Russia, and therefore, I think that should be a top priority.
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In closing, I would just like to ask if they could give us some of their own views on, one, are the major potential candidates for succeeding Yeltsin, namely, Luzhkov, Primakov, Putin? Do they have any ties to corruption that perhaps Yeltsin and Chernomyrdin have had?
Number two, who is really running Russia today? I am firmly convinced it is not Yeltsin. Is it Tatyana? Is it Barazovsky? Who is in charge?
And number three, do the tentacles of the corruption effort invade MINATOM, the Ministry of Atomic Energy and the nuclear stockpile of Russia, and are they also intertwined with the Ministry of Defense and agencies like Rosvooruzheniye who does the arms marketing for much of Russia's conventional arms?
Chairman LEACH. I apologize to my colleague. This is a treatise he is asking for, and I am going to ask for all of this to be summed up in about a minute-and-a-half. We have a timing constraint.
Mr. WELDON OF PENNSYLVANIA. If they can put it in the record, also.
Chairman LEACH. Those are tremendous questions.
Mr. DE BORCHGRAVE. Very quickly, Congressman.
Page 204 PREV PAGE TOP OF DOC Segment 1 Of 2 Chairman LEACH. I know you will speak for the panel.
Mr. DE BORCHGRAVE. I can't, because I have learned from long experience, as you know, Mr. Chairman, that political forecasting has made astrology look respectable in recent years. But I would say they are all connected in one way or another with the people we consider bad guys.
The Luzhkov-Primakov combination, no question that they won't be much of a change from what we see today. The only one that I think is totally clean is Mr. Yavlinsky of the Yabloko party.
Chairman LEACH. You have 30 seconds.
Mr. PALMER. There is credible evidence that Mayor Luzhkov is head of one of the largest crime families in Russia. If we look at Mr. Putin, he, as I showed in my testimony, was part and parcel of looting the state; and he was involved in it for years, and then he was involved with Navatex.
Mr. Primakov oversaw the use of the KGB to move the money out of the country, rebuffed attempts by the Duma to investigate it and then later said, oh, well, maybe we should form a committee to see where it went. I really don't see any honest faces on the horizon.
Chairman LEACH. Let me conclude then with a comment.
Mr. Shvets concluded his original testimony in terms of arguing what we might do with the observation that if we strengthened our money laundering laws, that would be a great service to Russia, because strengthening laws in the West becomes a deterrent for Russians to bring their money out. In addition, it serves as a basis for future prosecutions by future governments, or even conceivably by current prosecutors.
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Now, I stress this because money laundering might seem to many as a modest legal dilemma, but underlining, money laundering is someone's accumulation of resources that may involve a very spectacular criminal activity, and so from money laundering you get a lens to see things. You also get the prospect of looking at other laws that might be violated.
And finally, let me just observe that in terms of kleptocracy, we had a modest model on the world stage fifteen years ago in the Philippines where Ferdinand Marcos and his wife appeared to garner a fortune in the several billion and possibly larger range. Upon their demise, the government of the Philippines had a basis to lay claim in some circumstances, and Western governments were willing to assist, including the Swiss. And I only stress this because, from a Russian perspective, I would go back to the point, if they are going to allow capital to leave the country, they ought to make very strict restrictions that it only go into Western financial institutions that may come under Western law, and there must be an end placed to these money center havens that are created for one singular purpose, and that is for illegal funds to be deposited and no other purpose that I can gather, other than lack of regulation and avoidance of scrutiny.
And, therefore, it is incumbent upon the United States to lead in cracking down on money laundering as a technique to crack down on much more significant crime, and crime that has enormous implications for the national interest of the United States and world security.
Let me thank all of you for your extraordinary testimony and I appreciate it very much. The hearing is adjourned, and we will meet tomorrow with another series of panelists.
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[Whereupon, at 5 p.m., the hearing adjourned.]
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