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Andrew Ross Sorkin: High Hopes for Russia Are Fading on Wall St.

Goldman Sachs has an office in Moscow. So do Citigroup and Morgan Stanley. JPMorgan Chase and Bank of America Merrill Lynch, too.

Russia was supposed to be a growth market for Wall Street. It is quickly turning out to be a potential financial nightmare and a political hot potato.

With the deteriorating relationship between the United States and Russia over Ukraine, and a series of punitive sanctions clearly slowing Russia's economy, Wall Street banks are facing a conundrum: Should they stay or go?

Wall Street's involvement with Russia has long been a source of controversy. Some critics contend that Western banks have quietly helped enrich the government of President Vladimir V. Putin while he ran roughshod over the rule of law, often confiscating assets from political opponents.

"Hidden behind economic sanctions against Russia is the role of Wall Street banks in propping up Putin," Robert B. Reich, the former labor secretary, wrote recently. "Morgan Stanley, for example, earned an estimated $360 million in investment banking fees in Russia from 2002 through 2013. The bank led the $10 billion initial public offering for Rosneft, Russia's giant state-controlled oil company, and has helped transform it into the world's largest publicly traded oil producer." He added: "Is there anything Wall Street banks won't do to make more money?"

Over the last decade, Russian companies have produced about $8 billion in banking fees, according to Thomson Reuters' Deals Intelligence unit. Deutsche Bank is the leading beneficiary of Russian fees over the last decade, with 8.3 percent market share, followed by Morgan Stanley with 6.22 percent, Citigroup with 6.16 percent and JPMorgan with 5.9 percent.

Two of Russia's largest state-owned companies have been the biggest generators of fees, Gazprom and Rosneft, paying out nearly $600 million.

When relations between the United States and Russia were friendlier, John J. Mack, Morgan Stanley's former chief executive, was added to Rosneft's board with the personal approval of Mr. Putin, according to Bloomberg News. Mr. Mack stepped down in late May just as tensions between the two countries were heating up. He has insisted that his departure was unrelated to any political issues.

But his departure did come as Morgan Stanley was in the process of selling its oil and commodities business to a unit of Rosneft, a deal that was reached in late 2013 but still needs various government approvals, including from the Committee on Foreign Investment in the United States, whose mission is to "determine the effect of such transactions on the national security of the United States."

Morgan Stanley's deal with Rosneft is a bit of an odd puzzle: The United States government had pushed banks like Morgan Stanley to sell their commodities businesses. The bank, naturally, sought out the most logical buyer, but the deal is in political limbo.

The question for most United States banks is what to do with all of their employees "who are sitting on their hands," according to one senior executive of a large bank. While Russia's economy holds enormous promise if the political tensions ease and the sanctions are lifted, it could take years to capitalize on it and banks will most likely have to spend tens of millions of dollars, if not more, to keep their operations open.

Most United States banks have offices with at least 100 people in Moscow, and in some cases many more. Citigroup has about 50 branches in Russia.

Goldman specifically mentioned in its most recent quarterly filing that "the political situations in Iraq, Russia and Ukraine have negatively affected market sentiment toward those countries," and it pegged its credit and exposure to Russia at about $1 billion.

Up to $100 billion of capital could flee the country just this year, making investments and mergers and acquisitions almost impossible.

The Blackstone Group, the private equity firm, is planning to end its ambition to make investments in Russia this year, according to a person involved in the decision. The Financial Times reported that Blackstone did not plan to renew a consulting contract with a leading financier in the country who had been contracted to scout for Blackstone. The rival Carlyle Group tried to establish an office in Russia twice and ultimately withdrew.

At Bloomberg Markets Most Influential Summit conference in Manhattan on Monday, Patrick J. Healy, deputy chief executive of Hellman & Friedman, a private equity firm, declared, "If you don't have to invest in Russia, why would you?"

Still, that doesn't address the question of what happens if a bank were to leave the country and try to return later. Goldman withdrew from Russia in the late 1990s and then spent nearly a decade re-establishing itself.

Then, of course, there is the political calculus and the public relations issues.

Earlier this year, the White House specifically directed chief executives of United States companies, including the banks, to decline invitations to the annual St. Petersburg International Economic Forum, often known as Russia's Davos. Virtually no major Wall Street chief executive attended the event, after having accepted the invitation. Those declines led an official of Russia's Ministry of Economic Development to publicly criticize the United States government. "We regret the refusals by C.E.O.s of some American companies to participate," the official said, "owing to the unprecedented pressure that the U.S. administration is exerting on business."

At the conference, Mr. Putin was even more forceful: "In the modern, interconnected world, economic sanctions as an instrument of political pressure can have a boomerang effect, and in the end they have an impact on the businesses and economies of the countries that initiated them."

That's exactly what Wall Street is worried about.

Andrew Ross Sorkin is the editor at large of DealBook. Twitter: @andrewrsorkin

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Posted: September 22, 2014 Monday 09:17 PM