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DECEMBER 1, 2008, 4:44 P.M. ET

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

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

Article

Comments

more in Economy
»

By ANDREW
HIGGINS

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.

"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.

Dmitrijs Smirnovs

Now free after two days of questioning, Mr. Smirnovs hasn't been charged. But
he is still under investigation for bad-mouthing the stability of Latvia's banks
and the national currency, the lat. Investigators suspect him of spreading
"untruthful information." They've ordered him not to leave the country and
seized his computer.

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, cellphone 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.

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.

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.

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.

The ingredients of Latvia's troubles are much the same as elsewhere: a credit
crisis, a slump in property prices and a severe economic slowdown. But in a tiny
nation long wary of big neighbors, primarily Russia but also Sweden, economic
woes are never just about money.

"We are a small country, and panic would have very grave consequences," says
Teodors Tverijons, head of the Association of Latvian Commercial Banks.
Preventing uninformed gossip, he says, is a "matter of state economic
security."

"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.

The Security Police don't comment on the specifics of their investigations.
But, says spokeswoman Kristine Apse-Krumina, the agency has a duty to "gather
information" and take "preventive measure...to avoid destabilization of the
financial situation."

Virtually no one here worries that Latvia is reverting to the ways of the
Soviet Union, when the KGB hunted down dissidents and kept the population in
cowed silence. 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. 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.

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.

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.

Authorities responded to the affair by demanding tougher curbs on
finance-related rumors. Human-rights lawyers protested. But a year ago, the
criminal code was amended to outlaw the dissemination of "false information
about the financial system orally, in writing or in any other manner." It
mandated jail terms of up to six years.

In Latvia's Soviet past, officials routinely blamed their problems on
saboteurs or other scapegoats. "This is part of our political culture," says
Sergei Kruks, a media-studies lecturer. "If the state doesn't have a solution,
it has to find someone to blame."

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%.

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."

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

By late October, Swedbank, fortified by guarantees announced by the Swedish
government, started to lure back customers. But Parex, Latvian-owned and
therefore unprotected by the Swedish state, sank deeper into trouble as
depositors continued to flee.

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

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. "Extraordinary times call for extraordinary measures."

Write to Andrew Higgins at [email-masked]

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

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