Sigrún Davíðsdóttir's Icelog

In 2006 foreign financial analysts began to air their doubts about the Icelandic banks and the Icelandic economy. Pointing at the strength of the pension funds, set up with great foresight in the 60s, quickly became a standard reaction by Icelandic bankers and politicians. Icelanders have a tendency to hyperbole – a politician from a sun-kissed South European country found it most amusing when his Icelandic hosts told him that Icelandic greenhouse tomatoes were the best in the world. The pension system was deemed to be one of the best, if not the best, funded systems in the world (though losses accrued from the bank collapse are still not clear). However, observing the role of the pension funds in the rise of the new Icelandic economy indicates that the strong pension funds can indeed be seen as a mixed blessing: they proved to be a dangerously uncritical investor.

A case in point is Samson, a now bankrupt holding company, leaving behind ISK80bn in debt and only 2bn in assets. Samson was set up by Bjorgolfur Gudmundsson, his son Bjorgolfur Thor and Magnus Thorsteinsson to hold their shares in Landsbanki. Thorsteinsson went his own way in 2005, leaving father and son to expand the holding company into an investment company of sort, fuelled by bonds sold to almost 20 pension funds, almost exclusively the small funds. It didn’t seem to bother the funds that Samson’s investments were all in companies related to father and son. Samson lending followed the same pattern, it lent to father and son.

In more mature markets pension funds almost without an exception never buy bonds from a private holding companies akin to Samson – and foreign companies like highly leveraged Samson would most likely never finance themselves by issuing bonds. Risk-seeking holding companies are normally funded by issuing shares so as not to limit eventual return on capital and then leveraged with investment banks that take collaterals in whatever assets are then bought. – Needless to say, foreign pension funds didn’t buy bonds from Samson.

As bondholders in the now collapsed Icelandic holding companies like Samson are now painfully aware of there is little to be had when these companies go bankrupt. The claims in Samson amount to ISK80bn, the assets are valued at ISK2bn. A bond in a bankrupt bank might fetch 40%. Banks will normally hold more sound collaterals (though that doesn’t always seem to be the case with the Icelandic banks). In Iceland, a company like Baugur could borrow against own shares whereas foreign banks would lend money for its specific projects where tangible assets like property would be used as a collateral.

The relationship of the leading tycoons with the powerful pension funds wasn’t always smooth. In 2006 the owners of Baugur and FL Group (an investment company run by Hannes Smarason, closely linked to Baugur) threatened to set up a pension fund for their staff: they weren’t happy about investments by the pension fund where the majority of their staff had their pension.

It was never a particularly bright idea for the pension funds to buy bonds of highly leveraged private holding companies. When Samson failed, a manager of one of the pension funds that held its bonds said it was shocking to discover that the owners ‘had run the companies in an irresponsible way, either by siphoning off assets or simply by idiotic investments.’ The manager then added that he had never expected that a company belonging to some of the richest men in the world would fail.

One person familiar with the Icelandic banking sector says that the Icelandic bond market has always had its peculiarities. Bond issuers always had good access to money without the buyers being too fussy about their guarantees. The demand on return should have been much higher but the fierce competition between the banks had worked the wrong way. Those who complained were simply be sidelined. The fact that the bond market didn’t distinguish between private holding companies and listed companies unveils the immaturity of this market.

The worrying fact is that after being a rather undiscerning bond-buyer the pension funds are now turning out to be fairly undemanding creditors. They don’t seem to be too interested in getting to the bottom of the muddled affairs in many of the now bankrupt companies they previously did business with. In many of these companies bitter battles are fought as to how to how to deal with assets sold off prior to bankruptcy and how to explain their often very opaque affairs.

One of my sources in one of the ministries recently told me that the lack of interest within the funds to scrutinise the running of the big holding companies that previously almost owned Iceland was worrying. In spite of great losses they didn’t seem to be asking the crucial questions both regarding finance, governance ethical issues.

Lackadaisical investments over the last years weren’t only an Icelandic phenomenon. However, the strong pension funds characterised the Icelandic economy. No doubt that’s a blessing but their uncritical investments were anything but a blessing. They have indicated that they want to be part of the regeneration of the Icelandic economy. Money is certainly needed – but in order to be a credible partner the funds will have to demonstrate a much greater scrutiny.

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