Affordable Housing Institute : US

“Don’t shoot the messenger,” we say when we speak truth to power – but what if they did shoot the messenger?

 

Always printed on the back of my business cards!

 

As described in this Wall Street Journal article, Dmitrijs Smirnovs is about to find out:

 

How to Combat a Banking Crisis: First, Round Up the Pessimists

Latvian Agents Detain a Gloomy Economist; ‘It Is a Form of Deterrence’

 

Get that economist out of his coffin

 

RIGA, Latvia — Hammered by economic woe, this former Soviet republic recently took a novel step to contain the crisis. Its counterespionage agency busted an economist for being too downbeat.

 

Could I get arrested for posting this image?

 

“All I did was say what everyone knows,” says Dmitrijs Smirnovs, a 32-year-old university lecturer detained by Latvia’s Security Police. The force is responsible for hunting down spies, terrorists and other threats to this Baltic nation of 2.3 million people and 26 banks.

 

To function, markets need bad news as well as good.

 

Dangerous for his advice?

 

Finance is a highly touchy subject in Latvia, one that the state tries, with unusual zeal, to shield from loose tongues. It is a criminal offense here to spread “untrue data or information” about the country’s financial system. Undermining it is outlawed as subversion.

 

So, when the global financial system began to buckle this autumn, Latvia’s Security Police mobilized to combat destabilizing chatter about banks and exchange rates. Agents directed their attention to Internet chat rooms, newspaper articles, cell phone text messages and even rock concerts. A popular musician was taken in for questioning after he cracked a joke about unstable Latvian banks at a performance.

 

Just one problem: Much of the speculative buzz now turns out to ring true.

 

That’s the problem with slander and defamation, isn’t it?  What if it’s true?

 

When you take the I out of slander, what have you got?

 

After insisting its banking sector was healthy, Latvia last month took over the largest locally owned bank, Parex, to save it from collapse. After denying it needed aid from the International Monetary Fund, the government is now in talks with the IMF.

 

I can deny it because you can’t see me

 

Markets thrive on information. 

 

Finance Ministry officials acknowledge that secret police won’t save the country from economic crises. But they do believe Security Police vigilance makes the public think twice before spreading uninformed gossip about banks.

 

“It is a form of deterrence,” says Martins Bicevskis, Finance Ministry state secretary.

 

Restrict information and you distort markets.  Mr. Ponzi would have loved Latvia.

 

And then they don’t look so good …

 

What then about the problem of false information?  Can the market sort through that by itself?

 

“We are a small country, and panic would have very grave consequences,” says Teodors Tverijons, head of the Association of Latvian Commercial Banks.

 

Same latitude as Aberdeen

 

One of the Baltics

 

Preventing uninformed gossip, he says, is a “matter of state economic security.”

 

Is informed gossip any better?

 

 

“It is regarded as unpatriotic to criticize,” says Alf Vanags, director of the Baltic International Centre for Economic Policy Studies.

Early last year, Mr. Vanags held a news conference and sounded the alarm over Latvia’s ballooning current-account deficit. Soon after, he says, he got a call from the Security Police. “Within an hour they were on the phone asking to see my materials,” he recalls. Mr. Vanags says he handed over his data and never heard anything more.

 

Mr. Vanags, the Security Police are here to see you

 

It sounds like a joke, doesn’t it?  Thank goodness for the First Amendment!

 

The Security Police don’t comment on the specifics of their investigations.

 

Have you been shorting stocks?

 

Lest the world guffaw too much.

 

Unlike Russia, where state-controlled media largely ignore bad news, Latvia has a vibrant free press. Mr. Smirnovs’s detention was front-page news and created an uproar.

 

Free Smirnovs!

 

This, says the economist, “shows that we are still living in a democracy.”

 

Latvians have good reason to be jumpy about their banks. In 1995, depositors lost upwards of $800 million when the country’s biggest bank, Bank Baltija, collapsed and nearly felled the entire banking sector. Its senior executives went to jail.

 

Okay, now we get to a legitimate concern.  Banks fail, and because they have depositors, a bank failure is much more impactful than an automaker’s failure.  Because the herd is observant, panics can ensue.

 

But authorities also have cause to be wary of unfounded gossip. Latvia last year was suddenly awash with rumors of an imminent devaluation of the lat, which is pegged to the euro. Citizens, ignoring government reassurances, rushed to convert their cash into euros. The central bank spent heavily to sustain the currency peg. There was no devaluation.

 

Ever since there were stock markets, there have been speculators who create panics.  We’ve seen this in the US credit crunch.  The antidote, however, is not no information, but better information, a reverse Gresham’s Law.

 

Sir Thomas Gresham: bad portraits drive out good?

 

Suspecting foul play, the Security Police launched a hunt for the source of the devaluation talk. It eventually found the culprit but quickly let him go. “He was in a drunk condition when he spread the rumor,” says the Security Police’s Ms. Apse-Krumina.

 

I love that formality: in a drunk condition.

 

Don’t spread rumors

 

Latvia’s economy took a nose dive this year. After enjoying the highest growth rate in the European Union, which it joined in 2004, the country is now in deep recession. Its economy shrank 4.2% in the third quarter.

 

In late September, the nation was gripped by feverish talk of a banking crisis. Much of the initial worry focused on Sweden’s Swedbank, the biggest bank in Latvia in terms of assets. Maris Avotins, the head of Swedbank’s Latvia operations, found himself under siege. “Customers big and small were going into our branches and asking: ‘Are you in trouble?‘ ”  Deposits, he says, slipped by about 3%.

 

One of the many reasons the US has long had deposit insurance.

 

Parex, a big locally owned rival, started to lose customers, too. It lost more than 5% of its deposits in October. Anxiety then spread to the solvency of the country as a whole.

 

It was at this point that Mr. Smirnovs, the economist, took part in a discussion organized by a small local newspaper, Ventas Balss. Predicting serious trouble ahead for Latvia, he said: “All I can advise is this: First, don’t keep money in banks. Second, don’t keep money in lats.”

 

They said.

 

Is this the financial equivalent of shouting fire in a crowded theater?

 

Shortly afterwards, on Oct. 6, the Security Police opened a criminal investigation into people who “spread rumor and untruthful information.”

 

Since when is advice ‘rumor and untruthful information’?

 

By late October, Swedbank, fortified by guarantees announced by the Swedish government, started to lure back customers.  

 

The cure for panic is credit enhancement – in this case, from the sovereign itself.

 

But Parex, Latvian-owned and therefore unprotected by the Swedish state, sank deeper into trouble as depositors continued to flee.

 

Alert AHI blog readers will recognize this is the same dynamic that led to widening spreads between Fannie Mae securities and Treasuries earlier this year, which eventually forced Hank Paulson’s hand into taking the GSEs into conservatorship.

 

Fearing the worst, Latvia’s government took a 51% stake in Parex last month.  

 

So those panicking were right – they had reason to be worried, and the government acted. 

 

It then asked both the European Union and the IMF for help. A few days later, Mr. Smirnovs was picked up outside his home by two plainclothes officers from the Security Police.

 

Mr. Smirnovs sounds like a financial Paul Revere.

 

In silver we trust … and not in the British

 

Gene Zolotarev, an American financial manager who has lived in Latvia for years, says that he’s “not generally a fan of totalitarianism,” but doesn’t mind the probes.

 

I wouldn’t mind these at all … would you?

 

“Extraordinary times call for extraordinary measures.”

 

Mr. Smirnovs says he will certainly be “more careful” about voicing his opinions in the future. But he scoffs at the use of security agents “as a medicine that only makes people more worried.” Until his detention, his bleak view of Latvia’s financial prospects was known only to his students and readers of small newspapers in his hometown of Ventspils.

 

“Now everybody knows who I am and what I think,” he says.

 

Bloggers of the world unite!  Information wants to be free!

 

Blogging!

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