This paper tells the story of the Albanian pyramid scheme crisis of 1996–97, analyzes its causes and consequences, and attempts to draw some lessons from it. The pyramid scheme phenomenon in Albania is important because its scale relative to the size of the economy was unprecedented, and because the political and social consequences of the collapse of the pyramid schemes were profound. At their peak, the nominal value of the pyramid schemes’ liabilities amounted to almost half of the country’s GDP. When the schemes collapsed, there was uncontained rioting, the government fell, and the country descended into anarchy and a near civil war in which some 2,000 people were killed. This paper explores the causes of the rise of the pyramid schemes and addresses the question of what could have been done to prevent it. It also examines the handling of the crisis. The paper then discusses the economic effects of the pyramid scheme phenomenon and concludes that despite the tremendous political effects, the economic effects have been surprisingly limited. Finally, it suggests lessons that can be drawn from the crisis by other governments and by the international financial institutions.
Blejer, Mario, and others, 1992, Albania: From Isolation Toward Reform, IMF Occasional Paper No. 98 (Washington: International Monetary Fund).
Muço, Marta, and Drini Salko, 1996, “Some Issues on the Development of the Informal Financial Sector in Albania” (unpublished; Albanian Center for Economic Research).
Chris Jarvis is a Senior Economist in the IMF’s Policy Development and Review Department. He thanks Jacques Artus, Bob Corker, Juha Kähkönen, Sanjay Kalra, Tim Lane, Alfredo Leone, Ranjit Teja, and other colleagues at the IMF for helpful comments and insights, as well as Marie Ricasa and Gordana Rodic for secretarial support and Luzmaria Monasi and Jane Keneshea for valuable research assistance.
In the 1780s Edward Gibbon described Albania as “a country within sight of Italy which is less known than the interior of America.” See Davies, 1996, p. 645.
Economic conditions in Albania before transition are described in detail in Blejer and others, 1992. Hoxha’s hostility to outside influences is illustrated by his breaking successively with the USSR and China on the grounds that they were too moderate, and, more concretely, by his building of about half a million bunkers—one for every six Albanians—for defense against foreign invaders.
The banks’ poor credit evaluation is epitomized by the state-owned Rural Commercial Bank’s making short-term loans to farmers to buy tractors and trucks. At end-1996, the tractor and truck loans still accounted for one-third of the bank’s total lending and 80 percent of its bad loans. The bank was liquidated in December 1997.
In 1995, an IMF consultant posed briefly as a potential investor and was quickly warned that this was not safe.
During discussions between the IMF and the authorities in late 1996, IMF staff suggested that the tax authorities should investigate these companies and close them if they were found to be insolvent. The staff also pointed out that the Russian pyramid scheme, MMM, had initially been prosecuted not for fraud but for tax evasion. However, the authorities were unwilling to pursue this possibility.
Much of the smuggled oil was legally imported into Albania, and hence subject to customs duties and excise taxes.
Interest rates in the formal financial sector also rose during this period (see Figure 1). Political uncertainty and a preelection loosening of fiscal policy caused the lek to depreciate by some 15 percent during the first 5 months of the year, and underlying inflation rose from 10.6 percent to 19.1 percent a year. In response, the Bank of Albania tightened monetary policy, raising minimum interest rates on 12-month deposits from 13.25 percent to 16 percent. However, the increase in annualized interest rates offered by the pyramid scheme companies (from about 100 percent to about 150 percent) cannot be explained by these changes.
In Xhafferi’s case there was a smattering of window dressing. Xhafferi sponsored a football team in one of the most depressed towns in Albania and recruited the former captain of the 1978 World Cup-winning Argentina team to coach it. The football ground was the scene of one of the first pyramid scheme riots.
The phrase was used by a banker who invested in the South Sea Bubble (see Box 3) and is quoted in Kindleberger, 1978. The similarities between the pyramid scheme mania and other financial manias are discussed below.
One of the more bizarre features of the year was that the operators of the schemes did not themselves have a consistent name for their activities, so that many, including those with real investments, simply adopted the name “pyramid schemes” given to them by foreign observers, but stripped it of its pejorative implications. This led to quotes like a government official’s reported assertion that “Our pyramid schemes are the cleanest pyramid schemes in Europe.”
It would have been possible in theory to use the existing bankruptcy law to take over the pyramid scheme companies. However, this would have meant that administrators would be appointed by the courts, which were notoriously corrupt (a survey funded by the World Bank in 1998 found that the judiciary was regarded as the second most corrupt institution in Albania, after the customs service) and open to influence by the pyramid scheme owners.
The government’s lack of confidence in the courts turned out to be well justified. In November 1997, the Constitutional Court, whose members had all been appointed by the previous administration, declared the law under which foreign administrators were appointed an unconstitutional infringement of private property rights. Parliament responded by passing the law again as a constitutional amendment.
As of 1998, there were no national accounts data collected in Albania. GDP estimates are based on firm data on agricultural production and the production of state enterprises and very partial data on the growing private industrial and service sector. Moreover, the government’s figures for the election year of 1996 were particularly suspect, and collection of some data for 1997 was interrupted by the civil disorder.
The anomalous figures for January 1997 in Table 4 reflect a temporary accounting treatment of the asset seizure and should be ignored.
There were certainly some cases of outright theft, and many more of fraud, especially withdrawals of funds to purchase assets at vastly inflated prices from related parties. It is not clear to what extent these could have been prevented if the authorities had seized the financial assets of the other companies at the same time as Xhafferi and Populli. However, it appears that the limit on daily withdrawals was not an effective barrier. It was set at a relatively high level (30 million lek, or about US$300,000 at the time the limit was imposed) and was applied to individual bank accounts rather than companies. Many companies had numerous bank accounts: VEFA, for example, had over 80 accounts.