Sigrún Davíðsdóttir's Icelog

That’s the cards that nature has dealt Iceland recently: first there was a small neat eruption at Fimmvorduhals. As it was residing on Monday out came the report of the Investigative Commission and shook the country, leaving us with 2000 pages to read and learn from on how the banks and their principal shareholders used them to line their own investments watched over by at first enthralled and then bewildered politicians and regulators.

Yesterday, this little neat eruption was declared extinguished – but early this morning water started to flood down from Eyjafjallajokull, a glacier close by. Now it’s clear that there is an eruption under the ice cap; it has already melted a hole the cap, with steam now rising several km up into the air.

The glacier is part of a mountain ridge in the South of Iceland. South of the glacier, down to the Atlantic there are sands, now partly flooded by the melted ice. Floods of this type are called ‘leap’ in Icelandic, the water leaps down from the glacier. Quite a spectacle that you can see here!

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The report of the Investigative Commission, ICR, gives a clear and detailed insight into the running of the three Icelandic banks – Kaupthing, Landsbanki og Glitnir – compareable to the insight into Lehman in Anton Valukas’ recent report. The Icelandic insight is far from flattering. Much of it should have been obvious to the actors in international markets, i.a. also the credit rating agencies, yet again raising questions about the CRAs and their methods.

As Mark Flannery points out in his article in the ICR the banks’ exponential growth and expanding operations abroad drew the attention of the international financial sector. Their growth was remarkable, ‘at least double that of the other Nordic banks. Put another way, in the same markets and under the same world financial conditions, the Icelandic banks had found a way to earn substantially more than their more experienced, overseas com- petitors. Moreover, these higher earnings were attained with a higher cost of funds, because the Icelandic banks relied more heavily on relatively expensive wholesale funding.’

Was there any reason to believe that the newcomers knew something the others didn’t know? That was often the explanation in Iceland: that the Icelandic bankers were far more clever and savvy than their competitors.

Against the apparent success stood two potential warning signs: “surprisingly low reported loan problems and a growing (but uncertain) reliance on shares to collateralize their loans.”

After the rapid expansion in 2003-05 the Icelandic banking success started to attract the attention and curiosity of foreign banks and CRAs. Their reports contained a barrage of criticism. Danske Bank’s report stung the Icelanders’ national pride and Lars Christensen, the bank’s chief economist, became the most unpopular person in Iceland.

These reports identified four problematic aspects of the Icelandic banking system: lending to related entities, questionable credit quality, funding and the expanding banking sector compared to country’s economy and the central bank’s foreign reserves.

How did the Icelandic banks and Icelandic authorities meet this criticism that led to the Icelandic mini-crisis in 2006? In just the same way as criticism was met in 2008: by changes directed toward style instead of substance, flat denial and xenophobic accusations of foreigners’ malign intents.

Kaupthing did i.a., to some degree, severe its incestuous relationship with Exista, the bank’s largest shareholder. In spite of the responses FME, the Icelandic financial services authorities, concluded, among other things, that the banks didn’t properly recognise relationships among entities they lent to. The ICR clearly outlines the banks’ rambling and inexact classification of related entities.

The Icelandic window dressing satisfied the rating companies. In February 2007 Moody’s improved the three banks’ credit rating and was, quite remarkably, widely criticised. Yet, nothing changed for the worse for the Icelandic banks until well into 2008.

The three banks did, like Lehman, direct much of its efforts at appeasing the CRAs, instead of addressing their weaknesses – and the CRAs seem to have been far too easy to fool. The CRAs have had a lot of bashing lately though possibly not enough. The Icelandic banks are just one further inglorious example of the CRAs’ failure.

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Here you see the report, in the box, carried out of the press conference yesterday morning by my colleague Thordis Arnljotsdottir. As you can see it’s a heavy burden, yet carried with a smile!

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Substantial parts of the report of the Investigative Commission will be published in English. Due to technical glitches only a part of the translation is in place so far but more will come tomorrow. On this same page there are also transparencies in English used at the press conference today and the conclusions of the Working Group on Ethics working alongside the Investigative Commission.

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The striking characteristic of the Icelandic banks is that though they were listed companies the banks were run like the private coffers of the principal shareholders. As Sigridur Benediktsdottir, one of the three members of the Investigative Commission, pointed out this morning, shareholders get dividends on the basis of profit. The operation changes fundamentally when people increase their dividends by lending money to themselves – by lending as much as possible the dividend is increased as much as possible. This happened in the Icelandic banks. Clearly, the principal owners completely ignored the interests of small investors.

The Commission concludes that the banks failed because of their rapid growth. In seven years the banks grew 20-fold – growth that was due to poor underwriting, making solvency-related difficulties very likely. The quality of the Icelandic banks loan portfolios eroded successively during this time. One of the Icelandic ways of banking was lending to holding companies with poor assets, often shares in the banks, or even no assets.

After sifting through the banks‘ exposure the Commission concludes that all the banks had an abnormally easy access to loans in these banks, apparently in their capacity as owners. The banks‘ largest clients were the banks‘ principal owners. Was this lending done at arm‘s length? That doesn‘t seem to have been the case. The banks defined ‘related parties‘ in an abnormal way thereby giving a misleading picture of the exposures to the major shareholders.

The abnormal relationship to the principal owners is also clear when it comes to the money market funds: their prime investments included securities and deposits connected to the banks‘ largest owners.

In order to demonstrate the principal shareholders‘s stronghold on the banks two graphs tell a striking story. The graph below shows Landsbanki‘s lending to Bjorgolfur Thor Bjorgolfsson, one of the bank‘s two major shareholders (the other one was his father, with equally gargantuan exposures). Bjorgulfsson also had large exposures in the other two banks. Landsbanki was the bank responsible for the infamous IceSave. In the report, Arni Matthiessen at the time minister of finance claims that all the leading bankers lied to the government just before the collapse – but the worst of the lot, says the minister, was Bjorgolfsson.

(In m of euros; the names above refer to companies owned by BTB).

Another equally striking graph shows Glitnir‘s lending to Fons, a holding company owned by Palmi Haraldsson and a constant companion to Baugur, owned by Jon Asgeir Johannesson. What happened in 2007? Fons and Baugur became the principal shareholders of Glitnir – and Glitnir‘s lending to Fons shot up dramatically. Fons was also a large borrower in the other two banks.

(In m of euros; the names above refer to companies owned by Fons).

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Pall Hreinsson outlined the shortcomings within the government, the Central Bank and the regulators. It’s a tale of staggering lack of coordinated action and share bewilderment. There was a so called ‘coordination group’ but this group didn’t take their task very seriously.

At one point in spring 2008 the government thought that the Central Bank should ‘do something’ – but the Central Bank thought it was up to the government to lead that ‘something’. Not surprisingly, nothing was done. And that’s more or less how things continued.

When the banks failed there was no plan in place how to proceed. However, no matter what, in 2008 the banks were beyond salvation. The necessary measures should have been taken much earlier.

Bank of England was contacted in early spring of 2008. The Icelandic Central Bank wanted to make currency swaps but got a plain ‘no’. However, in a letter Mervyn King offered assistance in terms of advice. His letter wasn’t answered. Instead, Icelandic politicians, like the bankers, continued to claim that Iceland’s problem was a lack of understanding in international markets. The problem was a problem of image.

Leading ministers – the prime minister, minister of finance and minister of trade and bankin – failed in their office. The director of the Icelandic Financial Services, FME, and the three directors of the Central Bank also failed to carry out his duties. It will now be up the Althingi, in case of the ministers, and courts if those mentioned will be brought to court for their failures.

Vilhjalmur Arnason, from the Commission’s Ethical committee, is now pointing out the destructive influence of political appointments of civil servants. That fact that David Oddsson governor of the Central Bank had been a politician had a particularly bad influence of the bank’s trust.

Criticism from abroad was always branded as ‘evil’, a sign of ‘jealousy’ instead of taking it seriously. Banks and wealthy individuals made donations to the political party – no doubt an unhealthy effect on critical thought towards these same individuals and banks within the political parties.

Last but not least: by travelling the world and extolling the Icelandic financial geniuses the president of Iceland didn’t portray the nation in a sensible way as the so called Icelandic success made the standing of the banks in Iceland far too great.

Salvor Nordal, also from the Ethical committee, pointed out the ingrained lack of respect for law and order in Iceland.

Sigridur Benediktsdottir gave a fascinating insight into the banks – will deal with that later…

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After quickly glancing through the report it is clear that it, i.a., gives a thorough overview of the operations of the three Icelandic banks. Their relationship with their largest clients and major shareholders, numbers and all.

Pall Hreinsson is now telling the press that the Commission points out areas where fraud could be found.

In short: whatever its shortcomings will be, at closer inspection the report is dynamite!

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‘Happy festivity’ – ‘gleðilega hátíð’ – one of my colleagues at the radio said as he walked in earlier this morning. His greeting gives a sense of the spirit in Iceland. Even the weather is completely still, not a straw moving, after gales and rain yesterday. Here at Ruv, the Icelandic State Broadcaster, there is tremendous excitement in the air.

Driving through Reykjavik around 7.30 local time (GMT) I could sense the country holding its breath. Yesterday, at a café in Reykjavik a couple and two men all in their forties on the table next to me were discussing the report. They weren’t sure they would read the whole thing but they were going to follow transmissions during the day and have a look at the website. Last night, visiting relatives, we spent most of the evening talking about the situation in Iceland and what we expect from the report.

Yesterday, I talked to the director of a large public institution. At his work place the television will be running in the canteen the whole day. People can gather there to watch the press conference later on and then interviews and reporting. Those who want to read the report during the day can do so. The same is the case all over the country. At the City Theatre, Borgarleikhusid, actors will start reading as soon as the report is published.

Early this morning the Investigative Commission meets the Althingi’s presidium and the MPs get their copies of the report – over 2000 pages in 9 volumes – you need roughly 40cm in your bookshelves to house it. The press conference is due to start at 10 and at 10.40 the report should be available on-line. The on-line version, with additions not in the printed version, will first be available on the Commission’s website but will then be put on the Ruv website and do doubt other websites as well.

In addition to the on-line version the report has been printed in 6000 copies that are now being driven to bookshops, with great care being taken that no one takes an untimely peep. These copies are now sold out, have all been pre-ordered. Consequently, 2,4 km of bookshelves will be filled today all over Iceland.

I’ve just realised that I’ll need a pass to get into the press conference so I better go and see the lady here at Ruv who is in charge of these precious things. She’s expecting me so I better run.

‘With all this excitement I hope there’s something in the report!’ a technician said just now as he greeted me. I’m pretty sure there’s a lot to take in – it will take some time to digest. Whatever its content, the report is the first deep-ploughing report in any country on the crises. Just that is a feat in itself. Now that a lot of things will be clarified the hope is that some of this past can be laid behind – though justice will need to be done in those cases where individuals have allegedly broken the law.

PS Re justice – the Investigative Commission met yesterday with a special prosecutor, from the Office of the Special Prosecutor set up to deal with cases related to the collapse of the banks. The purpose of the meeting was to inform him on issues and areas where the Commission thinks there might be grounds for further investigation.

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How can a bank break all rules to lend ISK6bn, £30m, to a shelf company without any assets – and buy back this company, debt and all, for 1 krona? This might seem to run counter to both business sense and common sense – but welcome to the Icelandic way of banking.

This tale, not a fairy tale but a bank tale, rotates around Fons, a now bankrupt company owned by Palmi Haraldsson and closely connected to Baugur, the now bankrupt company of Jon Asgeir Johannesson. In early 2008 Fons’ debt to Glitnir was so ominous that Glitnir could hardly avoid making margin calls. Johannesson and Haraldsson then rather insistently presented a plan to Glitnir: the bank agrees to finance a deal between two Fons’ subsidiaries that triggers a loan of ISK6bn whereby Fons’ debt of ISK4bn is paid and ISK2bn in cash is released to Fons out of which ISK1bn goes into Johanesson’s private current account.

This is the apparent structure behind charges brought recently by Glitnir’s resolution committee against Jon Asgeir Johannesson who built up the Baugur empire in Iceland, the UK, Denmark and elsewhere, Palmi Haraldsson the present owner of Iceland Express as well as a string of failed companies and a frequent business partner of Johannesson, Larus Welding former CEO of Glitnir, brought in when Johannesson and Haraldsson became the bank’s major shareholders in 2007 and three employees of the bank who, after Glitnir’s collapse, have continued to work at Islandsbanki, the new Glitnir. All six claim innocence. The case will open in late April. The charges clarify news that has been brewing in the Icelandic media over the last few weeks, complete with excerpts from emails of the personae dramatis.

The loan was structured around the sale of a Fons subsidiary to another subsidiary of Fons’ share in Aurum, the holding company of Goldsmiths, a UK jewelry chain, where Baugur and Fons were major shareholders. Glitnir valued the shares at no more than ISK1,5bn but in emails Johannesson and Haraldsson insist on a loan of ISK6bn against the shares. In an email to the bank Johannesson ‘expects’ his plan to be carried out. Welding ordered his employees to ‘prepare a loan agreement’ according to the plan outlined by the two businessmen.

Out of the 6bn 4bn were used to pay up older loans – and 2bn in cash put into Fons’ account. Fons sends 1bn to Kaupthing Luxembourg, allegedly to settle a loan there. Johannesson claims a billion for himself. In an email Johannesson explains that he absolutely doesn’t want to be overdrawn since that doesn’t look good – accordingly, the bank settles the overdraft and puts 750m in ready money into Johannesson’s account. Fixing the overdraft and providing cash of the bank’s major shareholder seems to be enough for the bank to give a helping hand.

According to the charges the only motive for the loan is to the help an already insolvent Fons from Glitnir’s inescapable claims, to dump Baugur’s and Fons’ obligations into an empty shelf company and to provide the two businessmen with cash without any collaterals or obligations. According to the charges all three motives were perfectly clear to the bank.

In an email written as the loan was in the making, a Glitnir employee points out to Welding that he can’t understand why Glitnir needs to go to this length of setting up the Aurum sale – it would have been a lot simpler just to send 2bn directly into Fons’ account in the Cayman Islands.

The emails quoted in the charges give an interesting insight into the minds of the two businessmen and the bankers ordered to prepare the loan. In an email at the end of May Johannesson explains how the loan should be structured, adding that if these requirements won’t be met ‘I should perhaps consider becoming an executive chairman of Glitnir.’ – This has been widely understood as a threat. After the charges became public Johannesson claimed that by deleting a smiley after this sentence the resolution committee had changed its meaning. Apparently, a smiley is no laughing matter to the businessman.

Smiley or not: only three weeks later, this was a threat without any claws. June 5 2008 the Icelandic High Court confirmed an earlier verdict over Johannesson by the Reykjavik County Court Johannesson of three months conditional prison sentence – thereby excluding Johannesson from sitting on any company boards for the next many years.

But there is a further twist to this tale. As the loan agreement was finally in place in July 2008 and FS38, the shelf company, saddled with the loan Fons did a call option with Glitnir obliging the bank to buy FS38 for 1 krona in December 2008 if FS38 so wished. In December, Fons made use of its option and Glitnir, by then taken over by the resolution committee, was forced to buy back its own glorious 6bn debt structure for the agreed 1 krona. In April 2009 Fons went bankrupt. One of Glitnir’s credit claims in Fons is the 6bn loan that then gave rise to the present charges.

According to the charges, Johannesson and Haraldsson were the instigators who commanded the four bankers to fix the loan that was only a make-believe deal, made to provide the two businessmen with 2bn in cash. The businessmen are charged with violations of company law. The bankers are charged with breaking the bank’s internal rules and violating company law.

Bankrupt companies related to Baugur and Fons now come by the dozen and their combined debt amounts to hundreds of billions of kronas that will never be paid. Each of the three Icelandic banks lent tens of billions, in some cases hundreds of billions, to these companies. Around 2000, Kaupthing was instrumental in the making of Baugur as the company started expanding abroad. Landsbanki later lent Baugur astronomical amounts, even when Kaupthing appears to have become more reticent. Baugur and Fons had already done pretty well for themselves when these two became the principal shareholders in Glitnir in summer 2007.

As the credit crunch was slowly crushing the Icelandic banks in the summer of 2008, Glitnir decided on the loan and the call option of 1 krona with the foreseeable final loss shouldered by the bank. The loan of 6bn is not only an offense to all business ethics and to common sense but also runs contrary to good business practice.

It’s an intriguing question why all the three major Icelandic banks went down the same path of lending only a handful of people exorbitant amounts of money on such shaky premises – in deals that time and again run against the interests of the banks, all listed companies.

The Italians have a great expertise when it comes to organised crime – and one of their lessons is that crime propagates in a vacuum beyond the state. The charges against the six haven’t yet been resolved in court – and as long as it hasn’t happened the six are innocent – but these charges and other cases seem to indicate that there was a lawless vacuum in the banks. Hopefully, the report of the Investigative Commission, coming out tomorrow will clarify these issues.

It’s deals like these that have left the Icelanders somewhat perplexed as to what kind of bank system was actually run in Iceland. At the root of this modern amorality tale are bankers prepared to break every rule in the book and major shareholders pulling the strings.

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Next Monday, ‘the report day’, the City Theatre, Borgarleikhusid, known for fabulous productions of classics such as Chekov and Shakespeare (now showing i.a. ‘Faust’ with music by Nick Cave written for Borgarleikhusid’s production), will bring to the stage its hitherto most unique production: the long awaited report of the Investigative Commission.

On ‘report day’, as soon as the report is published, actors will start reading it aloud continuing till the last word is read. It will take theatre’s 45 actors approximately 3-5 days to read the ca 2000 pages. The reading will be divided into shifts of 2-4 hours where two actors take turn reading the text.

During the reading time, day and night, the theatre will remain open and free for all. Those who can’t come can follow the reading via webcast on Borgarleikhusid’s website. According to the theatre’s press release the idea is to create a kind of sanctuary where people can drop in, listen and reflect on the report’s ‘topics, its content and the causes’ of the collapse of the three Icelandic banks in October 2008.

With this public reading Borgarleikhusid is underlining the importance of the report, impatiently awaited by the whole nation and possibly the most important Icelandic event for decades. The report won’t be dramatised – the drama is the text itself – but the theatre’s aim is participating in the national conversation that the report will no doubt create. Borgarleikhusid has already staged two plays reflecting the collapse of the banks one of which will be performed at the theatre-festival in Wiesbaden.

Icelanders are great at turning things into events – I’m sure that next week will be a special week in Iceland. Icelanders will no doubt mark the publication of the report in many ways though Borgarleikhusid’s event might easily be the most spectacular one.

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