Sigrún Davíðsdóttir's Icelog

Soon after the fall of the Icelandic banks in Oct. 2008, news of questionable practices started seeping out. Much of this reporting related to loans to staff, at the beginning mostly at Kaupthing, but later it’s appeared that probably all the banks practiced this in one way or another. The banks all financed the buying of their own shares – even on a gargantuan scale.

As liquidity dried up in summer 2007 foreign banks made margin calls against the main protagonists of Icelandic companies expanding abroad. Since many of the big players had pledged their Icelandic bank shares against foreign loans it was obvious that as soon as foreign banks would start making margin calls the markets would be awash with Icelandic bank shares – and the shares would go into free fall in an already weak market.

‘Hell is other people’ said Sartre. For the Icelandic banks in winter 2007-08 hell was other banks, foreign banks – and in order to escape this hell the Icelandic banks all cranked up what they were already practicing: lending money to buy their own shares, with only these shares pledged against the loans. The hellish consequence was a massive erosion of own capital. It can be argued that already by summer 2008, months before the FSA intervened the UK operations of Kaupthing and Landsbanki, the banks own capital had evaporated.

All the banks used a variety of investment schemes to lend against their shares and to absorb the flood of shares from late 2007: unrelated loans were increased so there would be a sum for share-buying; bank staff was encouraged to borrow money from their respective bank to buy shares, often way beyond what was reasonable compared to their salaries. Just around the fall of Kaupthing all personal guarantees tied to their loans was cancelled. The legality of this and the tax aspects haven’t yet been settled.

In some cases there was cross-lending for this purpose: one bank lent against shares of another bank. (Cross-lending was also practised for other reasons but that’s another story). Recently, a banker in one of the collapsed banks told me that not later than early 2008 cross-lending and other similar practices had firmly tied the knot between the banks: should one bank collapse it would drag the two others down with it. In his report in March 2008 Kaarlo Jännäri concluded that the collapse of one bank would unavoidably have meant the end of the other two.

However, as the situation did nothing but deteriorate week by week and month by month through 2008 the ghastly side-effect of this diabolic scheme became ever more clear: the banks could neither make margin calls on the share-buying loans nor could they sell the debt off or in any way slash or shrink this part of their balance sheet. This scheme turned into fetters – and it eroded the banks’ own capital, consequently leaving them much weakened.

It’s been suggested that by then the banks had lent ISK1700bn against their own shares but the banks’ combined capital was only 1000bn. – Last year, I asked a banker at one of the major American banks if his bank would lend money to buy its own shares. ‘You know, it’s such an insane idea that I don’t even know if it’s legal,’ he answered flabbergasted.

But was the lending against own shares purely a salvaging policy? One of the three banks seems for certain to have practiced lending against own shares for quite some time before the credit crunch hit. It was part of its business model: when a potential big client walked through the door he would invariably be offered the bank’s shares – and asking for the purchase to be financed by the bank was no hindrance. Most likely, the master plan here was to prevent a hostile takeover and make short-selling less likely. – Since the three banks followed similar practices it’s quite likely that this was also done in the two other banks.

Another side of this scheme might be market manipulation on a grand scale and that’s what the Icelandic Financial Authorities (FME) is now investigating as is the Special Prosecutor. It’s interesting to note that there seems good reason to believe that this scheme didn’t only came into use around and after summer 2007. My sources indicate that this practice can be traced a few years back, even back to 2004 – which would make for some intriguing questions to be asked related to the whole banking sector in Iceland well before the collapse in 2008.

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The pre-fall banking system in Iceland had some intriguing characteristics. One of the more astounding one is how willingly all the three major banks lent a small group of businessmen, tied to the banks through ownership and inter-dealings, beyond all rhyme and reason. This completely reversed the power balance between the banks and their main clients – the clients, not the banks, set the rules of the game. In their game the clients were favoured at the expense and to a great risk for the banks.

Last summer I read a fascinating and scary book, ‘Mafia Pulita’, ‘The Clean Mafia’, by Antonio Laudati (now a prosecutor in Bari where the Mafia is particularly ingrained and vicious) and Elio Veltri, both well known for their fight against organised crime. Through stories of a few Mafiosi they explain how the Mafia infiltrates the ‘clean’ economy (as opposed to the ‘dirty’ or ‘black’ economy of organised crime) – this is the Mafia that buys what it can and only kills when it has to. I interviewed Laudati on a hot August Sunday morning in Naples where we shared the Napolitan pastry ‘sfogliata’ as he told me about corrupt Italian banks that seemed uncannily similar to the Icelandic banks.

In former times, the Mafia would find a bank clerk, often a low level one, to help channel its ill begotten money into the licit economy. Now instead, there have been cases, mostly in small banks in the North of Italy, where the criminals collude with the managers. The criminals get loans that systematically are far above the exposure anyone else gets, putting the bank itself at great risk. These banks also assist the criminals to borrow money from other banks by guaranteeing their loans though the collaterals, mostly shares and property, often financed by loans from the ‘helping’ banks. This effective loan machine generates money for the criminals, their loans are never paid back but serviced with more loans.

I’m not suggesting a Mafia connection or anything Mafia-related regarding the Icelandic banks; not at all. I just find it intriguing that the only banks with business patterns similar to the Icelandic ones turn out to be corrupt Italian banks that have been closed down by the authorities. As in the Italian banks the Icelandic banks loaned money to few chosen individuals beyond all sensible limits. These clients weren’t much bothered with margin calls nor the collaterals sold when loan covenants were breeched; old loans were serviced with new ones and it does indeed seem likely that in some cases the banks did not expect the loans to be repaid.

Icelanders are now following with anger and resentment how the new banks –Islandsbanki and Arion Bank owned by credit holders respectively in Kaupthing and Glitnir respectively, Landsbanki by the Icelandic state – are refinancing companies owned by some of the major before-the-fall players. Here are the latest examples:

There isn’t much left of Baugur, Jon Asgeir Johannesson’s retail empire spanning UK high streets and other places. Both Baugur Iceland and Baugur UK collapsed under its debt. Administrators have contested various last-minute dealings. Landsbanki was evidently the biggest lender but the two other banks were fairly generous too. The most valuable Icelandic assets are now in Hagar, a holding company that runs a myriad of shops in Iceland, most importantly two supermarket chains, Bonus and Hagkaup (interestingly, Hagkaup was founded by the father of Jon Asgeir’s wife – first Jon Asgeir bought Hagkaup, later he married into the Hagkaup family, though long after its founder’s day). Arion Bank had taken over Hagar, apparently against a debt of ISK70bn (£350m).

After continuous headlines of Hagar’s fate – last summer Johannesson i.a. wowed to bring in foreign investors in 2-3 years time – Arion Bank has now decided to float Hagar later this year. Johannes, Jon Asgeir’s father (who in 1989 founded Bonus with his son, the first step towards the Baugur empire), is the chairman of Hagar. Arion will grant him the right to buy 10% of the company, in addition to the management getting 5% – in Iceland, the takeover trigger is 30%. Before the fall the bank would no doubt have lent preferred buyers against Hagar shares but Arion claims that’s not on offer now. Many Icelanders would have liked to see Hagar broken up so as to correct the ca 60% market share that Hagar has in the food market. Arion maintain that it’s obliged to focus on its profit not correcting competition.

Olafur Olafsson’s foreign profile has been much lower than Jon Asgeir’s though he has been living abroad for years, recently swapping Knightsbridge for Lausanne. Olafsson, who spans the gamut of the pre- and post-privatisation period, rose on the tail of the Progressive Party and the co-operative movement and built his empire on the shipping company Samskip. He later became one of the biggest shareholders in Kaupthing and was the main shareholder of Alfesca that sprung from one of the two main fishing companies, operating since after the war. It seems to have been through Olafsson’s networking that the Quatari businessman al-Thani invested in both Kaupthing (Sept. 2008) and Alfesca (summer 2008). The Alfesca investment never materialised; the Kaupthing one is being investigated as an alleged market manipulation. Olafsson and Samskip’s management have now negotiated a financial reorganisation with Arion and Fortis Bank – it is understood that the owners will bring in new capital.

Icelandic Group is the other major Icelandic fishing company that in 2005 was bought by Magnus Thorsteinsson and Björgolfur Gudmundsson. These two, together with Gudmundsson’s son Bjorgolfur Thor Bjorgolfsson, bought 40% as Landsbanki was privatised in 2002. At the time it was understood that the money came from the sale of the Bravo Brewery in St Petersburg to Heineken for $400m (their St Petersburg enterprise gave rise to myriads of stories about Iceland’s ‘Russian connections’ and ‘Russian money’ culminating when Russian authorities seemed to contemplate bailing Iceland out in Oct. 2008 – one of the many untold stories of the fall). It’s now clear that if there was any profit from the Bravo sale it only partly, if at all, financed the Landsbanki deal – the three simply got a loan from Bunadarbanki just like those who bought Bunadarbanki (later merging with Kaupthing), Olafsson being one of them, got a loan from Landsbanki.

Thorsteinsson and Gudmundsson are both bankrupt in Iceland. As most companies touched by the two (and all the other ‘viking’ investors) Icelandic sank under its debt in October 2008 when Landsbanki’s new CEO, put in place just after the bank’s demise, revived it. Icelandic’s present management has been running the company since 2007. In spite of losses since 2005, Landsbanki, now on its second CEO since the fall, still keeps the company afloat, claiming that the company will be able to clear out its debt in due course. Since Icelandic hasn’t published an annual report since 2007 it’s difficult to judge its position.

The latest stories of Hagar, Samskip and Icelandic – all important companies within the major Icelandic business conglomerates during the boom – show that certain relations seem to reach if not beyond the grave then at least beyond bankruptcies. Those who had the greatest hold on the old banks are still flying but some of these financial cliffhangers might still crash as the administrators edge in. In Iceland, the feeling is that it’s happening only very slowly – people find it difficult to understand that billions in debt in companies fallen by the road side do not affect the general standing of those whose financial acrobatics brought down the banks and the krona. Returning to former times when the political parties meted out favours through the banks is not an option – and yet there is a great pressure on the Government to do whatever it takes to prevent what is seen as cementing the unfairness in the unhealthy banking system before the fall.

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‘How could the banks that all appeared in good shape in summer 2008 suddenly all be gone by the first week of October?’ asked a big client of one of the Icelandic banks when I spoke to him last autumn. With greater insight into how the three banks operated it’s becoming less and less surprising that the collapsed – but what exactly happened in autumn 2008? Weirdly enough, neither the Icelandic nor the British side of the story has been clarified. But it’s possible to piece together some known facts.

The three main Icelandic banks, Glitnir, Kaupthing and Landsbanki all operated in the UK. The FSA had little interest in Glitnir since it operated only as an investment bank whereas Landsbanki and Kaupthing offered private depositors high interest savings accounts. Landsbanki opened its IceSave accounts in 2006 to secure funding: the Icelandic banks had experienced a glitch in wholesale funding after negative reports from financial analysts (and if only the financial analysts had stuck with their criticism instead of accepting the banks’ window dressing things would have been different but that’s another story…)

Landsbanki’s CEO called IceSave ‘pure brilliance’ (‘tær snilld’), a phrase now as famous in Iceland as the most famous citations from the Sagas. Kaupthing Edge opened in the UK as late as Februar 2008. That summer, British ministers assured Parliament that the fast-growing deposits in Icelandic banks in the UK were under control. The FSA seemed to agree that the savings accounts were indeed brilliant. Yet, it paid Kaupthing ARROW visits in July August and September. Most likely, the same was done at Landsbanki. The financial tremors after the Lehman collapse, causing private individuals and companies to withdraw money and show other signs of panic, drained both Kaupthing and Landsbanki of liquidity.

After business hours Fri. Oct. 3 the FSA ordered Kaupthing Singer & Friedlander and Heritable Bank, Landsbanki’s subsidiary to place all new deposits from Oct. 2 with the Bank of England. The FSA was clearly getting worried: after all, 170,000 clients had put £2.6bn in Kaupthing Edge and 300,000 clients had put £4bn in Icesave. Kaupthing complied, Heritable didn’t. The following Monday the FSA asked Heritable to sign over money held with Barclays and HSBC.

In Iceland things were also moving fast. Though it should have been clear how intertwined the fates of the country’s three banks were, it was strongly believed at the time that Kaupthing, the biggest, would survive – it procured a €500m (£463m) loan from the Icelandic Central Bank on October 6, the day that the prime minister addressed the nation live on TV, ending with ‘God bless Iceland’. – Here the intriguing point is whether the ICB was at the time informed of the Oct. 3 FSA action against Kaupthing directing all new deposits to the BoE. (I’ve asked around, my feeling is that Kaupthing didn’t mention this but I could be wrong).

Tuesday Oct 7 the Treasury transferred Heritable’s deposits to the Dutch bank ING. The €500m ICB loan to Kaupthing didn’t solve the Kaupthing’s liquidity problems in the UK and by Wednesday Kaupthing Edge was also transferred to ING – and that was the end of Kaupthing.

There are several intriguing questions that the UK Treasury has never answered: why did it transfer the deposits from the Icelandic banks to a Dutch bank – that needed to be saved by the Dutch government only a few days later? Most likely ING was yet another threat to the volatile UK financial sector, it got financial help for sorting out the Icelandic problem and was momentarily strengthened – until the Dutch government bailed it out only days later. By using ING the Treasury cleverly solved two problems with one action.

But the UK Treasury wasn’t fininshed with Iceland: although defaulted in Iceland the Treasury put out a freezing order on Landsbanki by using the Anti-Terrorism, Crime and Security Act 2001. The Treasury believed that “action to the detriment of the UK’s economy (or part of it) has been or is likely to be taken by certain persons who are the government of or resident of a country or territory outside the UK”.

This Delphic utterance meant that suddenly the Anti-Terrorism Act defined Iceland as a whole with serious effect for the country’s companies and individuals. It took weeks for the Treasury to define its target, Landsbanki, more accurately. The Treasury has never clarified why this nuclear option was necessary. What dreadful deeds did the Treasury so fear that only the Anti-Terrorism Act would do? Or was this only an unfortunate sign of nerves?

A puzzling note: although Icelandic politicians have complained – and are still complaining – about this act, neither the Icelandic government nor single politicians have at any time done anything at all to seek clarification as to why the Treasury chose this way. Hopefully, this will be one of the things clarified in the ‘Truth Commission’ report but why we have to wait so long is a complete mystery to me.

Kaupthing’s resolution committee last year asked for a judicial review on the legitimacy of the UK Treasury transferring Kaupthing Edge. The UK High Court decided in favour of the Treasury but the case threw light on events leading up the the action. However, the much more serious action against Landsbanki hasn’t been tested in court and consequently the events surrounding Landsbanki are a lot less clear.

There was, and still is, strong resentment in Iceland against the UK for actions leading to the collapse of the banks – there has always been a strong tendency in Iceland to blame all foreigners for all evil. However, with more insight into the banks’ operations it’s become clear that the banks were already doomed, not only because of the UK actions or by circumstances in international banks. They were doomed because within them there had already been a colossal collapse of common sense.

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“I am going to tell you a story about greed, excessive risk-taking, fraud that we believe was both serious and massive, and the complete economic collapse that befell a remote land.” This is how Gunnar Andersen the director of FME (the Icelandic Financial Services Authority recently described the new Icelandic saga of the collapse of the three Icelandic banks, Glitnir, Kaupthing and Landsbanki, in Oct. 2008. Authorities in Iceland and the UK Serious Fraud Office are now investigating this saga. Just this week, the Luxembourg police, together with Icelandic investigators, altogether almost 50 people, carried out an extensive house search at several premises in Luxembourg, centred on the former Kaupthing Luxembourg, now Banque Havilland (bought in summer 2008 by the English Rowland family through its investment company, Blackfish Capital).

I’m just back in London after three weeks in Iceland, my 6th trip to Iceland since Oct. 2008. As usual, I tried to meet as many people as possible – journalists, academics, civil servants, politicians, bankers or former bankers, investors, clients of the banks and, when possible, some of those closely connected to the collapsed banks through ownership (though most of them are getting less willing to talk, even off-the-record since many of them now face prosecution or know they soon will). The more people I talk to and the more I look into the operations of the banks and their closest circle the better idea I get of what Andersen might mean with ‘both serious and massive’ fraud.

Before the banks collapsed foreigners often asked me if I thought the Icelandic banks were sound institutions. My standard answer was that though the ability of Icelandic regulators might be doubted the banks were no dingy back street shops but operated in the full glare of the authorities in many properly, or so we thought, regulated countries. The three banks and their Icelandic satellite investment companies such as Baugur, Milestone, FL Group, Fons and Samson, now all bankrupt, and Exista, surviving at the mercy of its creditors, made headlines in the international media for years, the tone usually either admiring or tinged with suspicion. As early as 2006 I heard that both the Danish Central Bank and the Danish FSA kept a close eye on the Icelandic banks and businesses buying up Danish assets. Though persistent rumours of foul play tailed them wherever they went the rumours never instigated an investigation – until recently.

I travelled to Iceland for the publication of the long-awaited report by the Parliament’s Investigative Commission, www.rannsoknarnefnd.is, nicknamed in English the ‘Truth Commission’ (in Icelandic it’s just called the Investigative Commission). The report was due at the beginning of Feb. but is now expected at the end of this month. Its chairman has already declared to the Icelandic media that rarely has any commission presented such an ugly story to its nation.

With the foreboding of ‘both serious and massive’ fraud it’s clear that there isn’t much happy tiding in the report. However, the good news is the fact that this report was done and is about to be finished. As far as I can judge, without having seen anything from the report, it will be a thorough job of 2000 pages, part of which is written by a sub-commission focusing on ethical aspects. This will be the only extensive report as to yet in any country on the effect of the banking crisis – most appropriately in the country most dramatically hit so far.

What could the ‘serious and massive’ fraud consist of? I don’t think the Ikaruses in the Icelandic banks and businesses invented anything new but they might have taken things to higher levels than bankers in any major banks would dare. Extensive market manipulation in all the banks, driven by the highest echelons in the banks in conjunction with their major owners and related parties, is already being investigated. Opaque ownership has for years characterised Icelandic companies and might have been used to stay under takeover trigger. Assets were most likely siphoned off through companies related to the banks. There is evidence to suggest that when the banks started to offer mortgages they strategically traded mortgage-related bonds in order to push up interest rates in the market. – There is no lack of possibilities here.

These are only few of the schemes that might have been used and are most likely being investigated. Except for the last one they are all tricks often found in companies facing bankruptcy. The feeling in Iceland is that the 2000 pages will takes us far into this murky story; it won’t be a joyous read for bankers, politicians and regulators. Although I’m going to resist the claim that the report will be an example for others to follow it will for sure tell an interesting story of political vanity, a deep and extensive failure of public control – and fraud.

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