Sigrún Davíðsdóttir's Icelog

What did the managers and key bankers really think about the operations they were running? ‘Well, they clearly didn’t trust the banks because it was all about getting as much money out of them, via salaries and bonuses, as possible,’ a source close to one of the collapsed banks said to me recently. Bankers’ bonuses has been an international media topic for the last many years – both the numbers and the inbuilt incentives – but in this, as in so many other fields, the Icelandic bankers were well ahead of their foreign colleagues when it came to unreasonable claims and general lack of stringency. Out of the many, Glitnir offers some striking examples: Glitnir’s ex-CEO Bjarni Armannsson got Glitnir to pay him ISK380m when he left the bank in 2007, based on a contract that expired in 2006. A property company registered in his wife’s name owned a house in London and rented it out to Baugur, already then one of Glitnir’s biggest client.

The report of the Althingi Investigative Commission throws a revealing light on i.a. the lending practices, the financing of the banks and their internal and external auditing and is an endless source of illuminating material. But no chapter gives a more profound insight into the thinking of the managers of the banks than the report’s chapter on salaries and incentive schemes: the top bankers were generous in handing out the banks’ money to the small clique of major shareholders – and they weren’t stingy either when it came to their own salaries. Let’s focus here on Glitnir.*

In 2000 a merger of Islandsbanki and FBA, an investment bank, formed Islandsbanki-FBA. The CEO of FBA Bjarni Armannsson, the ‘golden boy’ of Icelandic banking and already famous for his high salary, was named the CEO of the new bank. As the report points out the management’s salary schemes were frequently changed, always for the benefit of the management but against the interest of the bank and its shareholders.

Armannsson brought with him the ‘Economic Value Added’ scheme from FBA but already in 2003 there was a deviation from that scheme in his own salary. In general, the rules weren’t stringent and changes were frequent. A change in 2004 made an end to deferred bonuses – whatever Armannsson got was his, no matter how the bank did. In 2001 Armannsson had made a contract based on options that then expired in 2006 without him making any use of it. When he was planning to leave the bank early 2007 he insisted that is should be honoured. The remuneration committee didn’t even have a copy of the contract and wasn’t too keen on letting Armannsson exercising his rights according to the expired contract. Armannsson’s suggested solution was a cash payment of 370m, the same as the contract would have given him but that wasn’t accepted.

After a bit of to and fro Armansson did indeed walk away with 380m. He also got premium on other shares – and did in the end leave the bank with just over ISK1bn that could be seen as a golden handshake. After the collapse of the bank Glitnir’s resolution committee claimed the final salary payment was illegal. Facing a threat of being brought to court Armannsson decided to repay in total around ISK1bn and make no further claims.

From 2004-2007 Armannsson’s average monthly salary rose from 9m a month to 50m a month, in other words it rose more than fivefold. In 2004 his bonus amounted to 1,8m a month but had reached 9m a month when he left the bank in 2007. But he also had a lucrative business on the side. When Glitnir ventured into the mortgage market Armannsson’s wife, a nurse, set up a property company, Landsyn, with loans from Glitnir. Amongst the properties in Landsyn’s portfolio was a house in a gated community in Richmond where many Icelandic bankers and businessmen lived. The house, valued at more than £1m, was rented out to Baugur already in 2006 – so while Baugur was one of Glitnir’s biggest clients the CEO’s wife was Baugur’s landlady. The Icelandic media has reported that in spite of Landsyn being registered under the name of Armannsson’s wife he himself ran the business.

When Jon Asgeir Johannesson, Palmi Haraldsson and Hannes Smarason – the FL Group cabal – became the major shareholders in Glitnir in spring 2008 they brought about drastic changes in the bank, also regarding remuneration. In 2004 the 10% of staff with the highest salary got around 30% of salaries paid in total by the bank – in 2007 this group got over 45% of all salaries at Glitnir.

Already from early on key employees got loans from the bank on highly favourable terms to buy shares in the bank. As frequently encountered in the Icelandic banks the loans were made out to be ‘risk free’, i.e. the risk was all on the bank not on the borrowers, the covenants were absurdly lenient, the interest rates outrageously low and the only collaterals were the shares themselves. The new board wowed to put an end the loans but that didn’t turn out to be the case at all. Two key employees were even given loans where part of the loans was paid out as dividends as soon as the shares were bought: one employee got a loan of 480m whereof 150 went directly into his pocket – another got a loan of 1bn with additional 150m paid out.

The employee loans escalated over the years – and it now seems clear that this sale of Glitnir’s shares, planned by the bank’s management, was organised market manipulation, comparable to similar but possibly even more extensive ‘parking of shares’ by Kaupthing. In both banks the aim was to make the banks immune to the swinging mood of the market. At the end of 2007 the loans amounted to 17% of the bank’s own capital.

The new owners of Glitnir brought in Larus Welding who had been the head of Landsbanki’s London office. Compared to Welding’s salary Armannsson turned out to have been poorly paid. Welding’s average monthly salary in 2007, including the golden handshake, was 84m out of which 4m was his salary and 80m bonuses. At that time a senior civil servant, i.a. a permanent secretary could expect to get around ISK700.000 – so Welding, at the time 31 years old, got paid the equivalent of 120(!) senior civil servants.

So what was the job that Welding was so well rewarded for? Emails published in the report and charges brought by Glitnir’s resolution committee show that Welding was essentially a private cashier for the new clique. Johannesson and Haraldsson were continuously on-line with harsh demands. At one point, Welding complained he was being treated like a branch manager, not like a CEO.

Although Armansson had been unrestrained when it came to his own salary the running of Glitnir under his management was more conservative than both Landsbanki and Kaupthing. The major shareholders during Armannsson’s time – one of Iceland’s old families famous for political power and unostentatious wealth joined by the much more aggressive Wernerson’s brothers – didn’t have the bank and its CEO in their pockets as did the FL cabal.

No doubt inspired by the fantastic success of the high-interest Internet accounts of Landsbanki and Kaupthing, Glitnir’s new owners aimed at the same lucrative market that Welding was already familiar with from London. But they entered the game too late, the international wholesale funding was dwindling and with the crisis hitting the Icelandic banks early on plans to set up the Internet accounts didn’t materialise. In addition, the new owners were so aggressive that Glitnir was the first of the three banks to run aground – and swept the two other banks along in the fall.

*The salary and incentive schemes for Kaupthing and Landsbanki offer a different insight and will be dealt with in later logs.

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What does a banker think, who awards himself or big clients of his bank loans with interest rates comparable to a state, lower interest rates than the bank gets in its own finance, continuously rolls over bullet loans for himself and major clients and on the whole constructs the loan covenants in such a way that the bank gets all the downside and the client/he himself gets all the upside? Does he think that this bank has a great future? Or only a limited future so he better hurry up to profit as he can while there is something to profit from?

After the fall of banks I was of the opinion that the banks had been badly governed by people who had, in most cases, never seen anything but an Icelandic bank – that the combination of a lack of experience of international banking, hubris and arrogance had brought them down. Now, I’m less sure. Already in his short and concise report in April last year, Kaarlo Jannari pointed out that most probably the three Icelandic banks would have folded, crisis or not, since their business model was unsustainable. At the time, the possibilities of an extensive fraud were only starting to come to light. With the report of Althingi’s Investigative Commission we know much more – and I don’t think the lack of experience explains the whole demise.

Loan contracts aren’t generally available – breech of bank secrecy. Luckily, the Glitnir resolution committee was forced to make a few contracts public earlier this year in a lawsuit. The contracts offer a fascinating insight into the world of unsustainable banking. The contracts are between Glitnir and Fons, a holding company owned by Palmi Haraldsson. In close association with Jon Asgeir Johannesson and his Baugur empire, Fons became a major shareholder in Glitnir in the summer of 2007 – and the loans shot up like a rocket.

Not only were Glitnir’s coffers wide open to Fons but the rates and covenants were wholly unsustainable. The rates were absurdly low, marginally higher than the rates for the Icelandic states and even lower than the rates available to Glitnir financing itself. The rates reflected no risk.

Was that because the collaterals were so fabuolous? A bank’s criteria for collaterals is that they can be easily sold – not exactly the case with the Fons collaterals that were illiquid shares in Baugur and Fons companies, much less so at the evaluation Glitnir adorned them with.

A well-structured loan comes with covenants that secure the bank the possibility to make a margin call and/or has a personal guarantee. None of this was carefully spelled out in the Fons loans. In addition, Fons could choose which currency the loans were in – at a time, late 2007 and during 2008 when Glitnir itself couldn’t find any finance abroad.

These are the general characteristics of the four loans that Fons got from December 2007 until summer 2008. Let’s look closer at the loan contract for the biggest loan, a ISK10bn bullet loan, from December 2007. The context for the loan is to be found in the Althingi Investigative Report, published earlier this year. According to the minutes of Glitnir’s risk committee Fons was buying shares in FL Group from two of Fons’ and Baugur’s steady business partners, Magnus Armann and Hannes Smarason, now both living in the UK. The two had bought FL Group’s shares with loans from Glitnir and no longer met the covenants. To save everyone, except the bank, Fons borrowed the 10bn to buy the FL shares.

Fons had this minor problem that it didn’t have the necessary collaterals. That problem was resolutely resolved: Glitnir secured Fons it would buy one of its subsidiary that owned Skeljungur, an oil company, in a year’s time and valued Skeljungur at 8,7bn. The sale and the loan seem to be part of the concerted efforts of Glitnir and major shareholders in FL Group to hide that the company was in fact bankrupt. The movements here indicate serious market minipulation. In August Glitnir sold 51% of Skeljungur for 1,5bn – even considering the diminishing share value in many listed companies this price indicates that 8,7bn was a wild over-valuations. Glitnir’s write off is unclear. Even though the collateral was now apparently nowhere near the loan it doesn’t seem that Glitnir did anything to secure its position.

In a newspaper interview earlier this year, before the very revealing report was published, the owner of Fons Palmi Haraldsson said that he was Glitnir’s victim. Emails published in the report tell another story: the loans were made under huge pressure on Glitnir’s management from Haraldsson but most noticeably from Jon Asgeir Johannesson in spite of the frequent smileys. It’s difficult to picture Fons as the victim here but easier to see how seriously the minor shareholders and other clients suffered at the hand of managers who squandered the bank’ money on loans to major shareholders with the covenants so biased against the bank and in favour of these borrowers that the loans didn’t make any business sense.

Scrutinising this loan shows that the covenants went completely against the interest of the bank and minor shareholders. They are in no way comparable to loan covenants in foreign banks that the Icelandic banks liked to compare themselves with.

Another indication of lax or doubtful covenants came forward in a case at the Reykjavik County Court a few days ago where the Landsbanki resolution committee tried to secure a company that the ResCom thought Fons had pledged to Landsbanki. It turned out that although the company in question was on the bank’s book as a collateral it was neither correctly filed with the bank nor was it legal to use it as a collateral – another example of the favours granted to Fons, this time not with Glitnir but with Landsbanki. Other loans in Landsbanki seem to have been used to pay out record dividends from the supermarket chain Iceland – a textbook example of corporate raiders leaving a company struggling to service staggering loans to pay dividends.

In 1993 George Akerlof, who won the Nobel prize in economy in 2001, wrote an article, ‘Looting: The Economic Underworld of Bankruptcy for Profit.’ In many aspects it seems to describe what happened in Iceland. One day, the bankruptcy of the Icelandic banks might be shown to be an extensive case of bankruptcy for profit.

There’s no reason to believe that Glitnir’s loan to Fons were in any way unique. Rather they seem to be the usual kind of loans that the banks gave its biggest clients who in all cases were also among their major shareholders. The loans couldn’t give the necessary returns for the banks to run a viable operation. It means that the banks could only operate if there was a flow of money into them. An operation where new loans are funded by incoming money, not by loans being repaid or other normal financing for banks, looks more like a Ponzi scheme and less like a bank.

I wonder where the accountants were in all this. And what did the bankers when they makes out loans with lower interest rates than the bank got for its own funding or at interests rates comparable to the state? Didn’t the bankers know that the banks were a machinery of favours, not a proper bank? In an email printed in the Investigative Report that a Glitnir employee sent to the bank’s CEO the employee writes that he doesn’t really understand why the bank has to go to all this length of setting up complicated loan structure; surely it would be a lot simpler just to send the money to Haraldsson’s Cayman accounts.

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Part Two (Part one)

By guest contributor Michael Schulz. A social scientist who has worked for 30 years as a humanitarian manager in development, natural disasters and conflict on missions for the Red Cross in Africa, Asia, the Middle East, Russia and Trans-Caucasus and was i.a. based in Ramallah for two years. The last 5 years Michael was a diplomat with a Red Cross delegation in New York, accredited to the UN. – His Icelandic connection is through his partner who gives Michael an ‘Icelandicness’ and the authority to speak of Iceland though seen through his European eyes. Michael takes a keen interest in all aspects of the ‘Kreppa’ (Icelandic for ‘crisis’) in a philosophical, historical, political, socio-economic and cultural context.

As was mentioned, the OSP (Office of the Special Prosecutor) has taken aim at holding Iceland’s “banksters” accountable. But if there were punity for some will there be impunity for others ?

Perhaps in fairness to the OSP one should allow more time to reveal what the prosecution holds in petto. No doubt, again as stated in the Black Report (by SIC, the Special Investigation Commission), there is evidence that members of government and/or Althingi are implicated in the banksters undoings, dating back to the privatization of banks, to oversight, loans et al.

And it remains to be seen if and possibly to what extent organs such as the Central Bank were engaged above and beyond its lawfully mandated functions and supposed independence.

Neo-liberal ideologues of Iceland’s polity served abatement to the financial sector and the economy. Whether there were, and if to what extend, “innocent” political intentions were at play remains to be seen. The privatization of the banking sector, for example, was evidently no act of political innocence but intended to benefit certain circles of the elite. The political and the (private) banking elites interacted closely, and they did reciprocate “favours”.

Politicians seem to be seeking absolution in diplomatic apologies and temporary resignations, mostly not from formal positions and political mandates but subordinate functions, as if political accountability held no lasting consequences. Far too few accept to be held accountable and too few have resigned.

One shouldn’t be surprised if some, many or even most financial transactions between the financial sector and politics were executed for reasons of criminal intent no matter under what the disguise. The interactions were so numerous that they appeared as normalcy, not the exception. Politics was no longer a guarantor of order. It created an environment, a culture of corruption.

Corruption or criminal offenses as well as neglect, on a scale as in Iceland, obviously come along with an extensive break down of political ethical codices and personal moral standards. Unless for associated crimes and corruption, violations of ethics and moral are difficult to qualify and prosecute.

If government and parliament are no longer the standard-bearers of ethics and moral what authority is?

It is difficult enough to bring crimes to their legal resolutions. Even more difficult is it to re-establish the public acceptance of and believe in ethical and moral values because breaches affect not only (passing) officials but also the credibility of the proper functioning of (lasting) institutions they represented, and the offices they held.

Suspects in public offices will seek refuge in immunities or legal waivers. This might apply to instances of professional incompetence or honest mistakes, perhaps even ignorance. But surely no immunities or waivers can lift a culprit above the law .

What then, if punity or impunity could and should not be applied selectively, if not only banksters but also politicians are to be investigated and eventually prosecuted, what then, for example, about academia and the media?

Would it not have been a legitimate expectation by the general public that academia and media would demonstrate the independence of science and research or the freedom of reporting and reflect the facts while critically commenting on and warning of events and developments that drew Iceland into the Kreppa? Were there critics? Where? Were there any warnings? If not why not?

Of course, conspiracy theories are often ridiculed or outright rejected as conspiracies precisely by those suspected of conspiracy But what about motives? Isn’t it in the secretive nature of corruption to seek a match in the secrecy of conspiracy? Doesn’t it make perfect sense for “money” and politics, individually or unisono, to conspire when seeking control over their potentially most qualified critics, by whatever means, for as long as they want to be un-perturbed in their doings?

The objective has to be to undercut the independence of the academia and the media. Their, the conspirators, means would be many, power and money for one, information, mis- and dis-information another, even harassment, intimidation and the like. It has been said that the easiest way to rob a bank was to own one. Wouldn’t it be easiest to own the media?

This is not to say that individuals in academia and the media were or weren’t receptive to material gains. As said, criminal conduct has to be subjected to law.

Scientists and journalists should or couldn’t have stood the ethical/moral grounds of their professions. Could they have stood their grounds in an environment infested by corrupted norms? Who is to investigate? Who is to judge and how to reinstall the independence of academia and media?

In a culture of corruption the methods to control are subtle. One has to conspire for covered control, not open dependency instead of independency. For control to effective it has to become a routine. Control that blankets entire sectors and functions of a society borders on oppression, is invisible but omnipresent.

While writing, the OSP’s actions haven’t lost momentum while suspects gear up their defense. Who would have thought there wouldn’t be fierce arguments back and forth? A quid pro quo, further forcing the pace.

Are there then early conclusions to be drawn on the legacy of Kreppa?

The tentacles of Kreppa reach as far as the undoing of corrupted elites entangling not only the financial, the monetary, fiscal and banking, sector and subsequently the entire economy but also the public sector, politics, academia and media.

Is it not evident that an ideologically calculated policy of laissez faire created an environment that enabled a culture of corruption which was inclusive to elites while exclusive to the public at large? A system that made independence obsolete by imposing dependencies? A system that broke down laws and political rules? A system that broke down societal, ethical and personal moral values?

The justice system will face a tremendous challenge in bringing punity to those that are guilty of breaking the law. Challenge or not, the OSP signals there will be punity.

What is then the authority to decide on punity or impunity for those who did not break the law but who broke all other societal norms, rules, ethical and moral standards? What is the authority to restore those norms that are the key ingredients to statehood and society?

Politicians, academia or the media do not yet appear ready to take a lead. Perhaps they feel too tainted and it takes time to abdicate an ideology of laissez faire and rid oneself from denial, delusion and digression and to regain integrity and respect. It takes time and a sincere process of programmatic self-reflexion.

Perhaps the peoples authority is the only authority remaining intact, the only higher authority?

For certain, the people have spoken out loudly in the meantime, last weekend in May, at the municipal elections. In all major Icelandic municipalities traditional majorities of the old, established four-party system have been voted out. In Reykjavik Besti Flokurinn (The Best Party, founded by comedian Jon Gnarr) became the strongest faction in the City Council. In Akureyri the new Residents’ Movement gained the absolute majority. Not to mention the “silent voices” and the fact that over 6 % of the ballots cast were blank.

The elections were the clearest demonstration yet that punity or impunity are not up for random choice. The votes also voiced the people’s readiness to engage in a public discourse provided they are listened to. Punity or impunity: if the old political parties don’t listen and act people will eclipse them from Iceland’s political future.

Obviously, academia or media were not up for election. One might wonder how people would have voted if their representatives had stood for elections? But people did monitor during election night and the days after what they had to say – if anything.

During election night, admittedly partying, a group watching TV shook their heads in disbelief or outright dismay over the old fashioned reporting, moderators somewhat at a loss for words to grasp a new reality, seconded by a professor analysing statistics. As one observer noted in the early morning hours: they still don’t get it that this is not about them but us!

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The ‘Environmental Performance Index‘ is an index that rates the environmental performance of 163 countries across several policy categories such as climate change, agriculture, fisheries, forestry, biodiversity and habitat, water and environmental burden of disease. When all is counted and added up, Iceland is the top performing country on the index that Yale and Columbia Universities published in January during the World Economic Forum at Davos in January.

As always, it depends on what is being measured. Iceland has long been a top performer on the Transparency International index over corruption though many Icelanders will claim that the Report of the Investigative Commission shows clear signs of corruption. It’s just not the kind of corruption that the TI measures. Corruption in Iceland doesn’t consist in taking a brown envelop to a judge to get a favourable ruling.

Though Iceland scores high on the EPI it doesn’t mean that there is a great sense of urgency among the Icelandic ruling class when it comes to environmental issues. There are many reasons for this, one being that nature is close to Icelanders, it’s there to be used, not just to be looked at as in so many other European country. Icelanders are still trying to conquer nature, overcome it – and often feel quite helpless as when a volcano suddenly starts to erupt (though this time it made a big part of the world feel equally helpless).

Iceland is also trying to harness nature and often the harnessing seems to be more important than protecting it. Recently, a Canadian energy company, Magma Energy, has divided opinions in Iceland by buying into the energy sector. Since only companies form the EU/EEA can own companies in the energy sector in Iceland it would seem to exclude Magma from ownership. But the holding company for Magma’s interests in Iceland is a Swedish Magma that has no other purpose but to own shares in Icelandic energy companies, set up solely as a holding company. – A clever way of avoiding rules or regulations or a sensible solution to attracting foreign investment to Iceland? Depends whom you ask.

The value of Magma’s investment isn’t clear. At first it was thought it would bring much needed currency to Iceland. Then it turned out, according to Icelandic media, that Magma bought Icelandic kronur at knockdown prices abroad on a market created by currency restrictions in Iceland, to pay part of the price and then borrowing the lion share of the price in Iceland.

Topping the EPI is sweet but deals and investments in environmentally friendly sectors like the sale to Magma Energy raises serious questions. The bank crash in October 2008 was a reality check of the Icelandic way of doing business and a bitter lesson. It will turn even more bitter if it turns out that nothing was learnt from it.

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Icelanders seem to be drawn to superlatives: ‘The Best Party’ has won the most seats on the Reykjavik Council in the local council election last Saturday. The new party, one of many new movements all over Iceland in this last election, is led by the comedian Jon Gnarr who rose to meteoric fame with low budget comedy programs, first on independent radio then on tv.

There are four main political parties in Iceland, the Independence Party (conservative), the Alliance (social democrats), the Progressive Party (historically related to Scandinavian centre parties and the farmers’ movement, now some sort of a liberal leanings) and the Left Green (the name is self-explanatory, the roots are the Cold War socialists and communist). Contrary to the Scandinavian countries, with their strong social democratic parties, the conservatives have been the backbone of Icelandic politics since the founding of the Icelandic republic in 1944.

The most remarkable outcome of the local election is the rise of new and independent movements and lists, unattached to the four old parties. In the four biggest constituencies the old four lost between 30 and 40%.

Quite appropriately the journalist and writer Barbara Ehrenreich has been in Iceland and was yesterday interviewed on the political talk show, Silfur Egils, where she i.a. talked about her book on the rise of positive thinking, ‘The Relentless Promotion of Primitive Thinking.’ In view of Ehrenreich message the reactions of the political leaders were rather comic: the leader of the Independent Party in Reykjavik spoke of the party’s ‘surge’ in Reykjavik to a cheering crowd just as it had become clear that the party lost a set in Reykjavik and consequently the possibility to form a majority on its own. (To those familiar with UK politics the sound of her voice reminded me of Labour’s Neil Kinnock before the party lost in 1992). Anything to cheer at?

The power base of the four traditional parties shrunk considerably in this election. No doubt, the fact that the parties have neither owned up to donations from banks and the business powers that were before the crash in 2008 nor faced their responsibility in it plays a big part. The Left Green didn’t have much stake in the boom but they have been sent in to sweep the floor clean and no sooner were they in power than they started to behave like the four other parties: very little transparency, fear of decisions and apparently not doing much to open up the business community and making sure that the old powers are driven out. That’s a great pity because the Left Green seemed to enter government loaded with political capital and trust, having been in opposition for the last decade and being lead by a politician, Steingrimur Sigfusson, who has been both consistent and vocal in his criticism of crony capitalism and bad environmental policies.

Voters not only vote to have influence and to further their own interests but also to confirm their own identity. What identity they were confirming by voting ‘The Best Party’ isn’t easy to gauge since the party programme is muddles, to say the least. It’s however clear that their identity isn’t heavily attached to the four major parties. And that should be very worrying for these four parties. Yet, it was only one politician, Dagur Eggertsson leader of the social democrats in Reykjavik, who unambiguously spelled it out yesterday that the surge of independent movements and candidates underlined the deep distrust of the four parties. The parties had to face up to it because this can’t go on, he said, if these parties are going to have a future.

After the UK election the only Labour politicians who said quite clearly that the party had lost badly were those who intend to run for the party’s leadership in September. Eggertsson was seen as a possible future leader of the party – he is eloquent and respected though apparently not very popular – but since the social democrats in Reykjavik did badly his chances might be damaged. If he now makes a point of being seen as someone who wants to reform his party he might have a chance when Johanna Sigurdardottir, the prime minister and present leader of the social democrats, steps down as everyone expects she will want to sooner rather than later. She never aspired to become a leader of this government, was about to leave politics, but was the only one in her party that had the necessary trust and respect.

If the Icelandic parties keep on touting politicians heavily connected to the boom years they will face independent parties and a major wipe out in the coming election (which doesn’t need to be held until in three years time) – there is talk now that the party leaders should think their position though no doubt no one is keen on election. But the voters have clearly shown that if the politicians of the main parties keep on being mealy mouthed about the boom years and the need to cleaning out in all corners of society the voters will jump at whatever ‘best offers’ there are – even a comedian with no clear agenda.

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(Part I)

By guest contributor Michael Schulz. A social scientist who has worked for 30 years as a humanitarian manager in development, natural disasters and conflict on missions for the Red Cross in Africa, Asia, the Middle East, Russia and Trans-Caucasus and was i.a. based in Ramallah for two years. The last 5 years Michael was a diplomat with a Red Cross delegation in New York, accredited to the UN. – His Icelandic connection is through his partner who gives Michael an ‘Icelandicness’ and the authority to speak of Iceland though seen through his European eyes. Michael takes a keen interest in all aspects of the ‘Kreppa’ (Icelandic for ‘crisis’) in a philosophical, historical, political, socio-economic and cultural context.

Rambling in Iceland these days, physically or virtually, it seems the island is out of space and time, that it is all about speed. Not least this Icelog’s entries are testimony to daily Kreppa news, news breaking at ever shorter intervals. For observers or social commentators it is at times not easy to keep abreast.

The Office of the Special Prosecutor (OSP) has in earnest started to reach out for suspects, those deemed most instrumental in the undoing of Iceland’s financial sector and, subsequently, the entire economy. Individuals are kept in custody while investigations continue, arrest warrants have been issued for others. Court decisions are appealed. Appeals against temporary detention have been turned down by the Supreme Court. Suspects are released from custody but banned from leaving Iceland. Some returned voluntarily to Iceland for interrogation, others are sought after by Interpol while resisting extradition from abroad or have gone into hiding. Elsewhere, voluminous bills of indictment have been brought before courts. And, as is reported convincingly, more of the same is to come. Calls are on for more white-collar-crime prison cells.

Thus the suspects, so to speak, are on the run. This acceleration of actions had been longed for by the public and it came with somewhat a sigh of relief. Not least the recently published Black Report by the Special Investigation Commission (SIC) had delivered the contextual understanding of the deeply intertwined larger issues and details and who the actors were. It has not been the SIC’s mandate to deliver, as if it were, (legalistic) indictments or verdicts. These are matters of the OSP, public prosecutors, lawyers and courts.

As things stand today the SIC and OSP have exercised professional standards to the highest degree. Thus far it appears that irrespective of elite allegiances no actors or facts have been spared and the OSP, very laudably, is exposing the higher echelons of the banking sector not merely the lower ranks or dogs body. In following this path both special organs are making an important, albeit yet small, contribution towards the public’s belief in and the rehabilitation of credibility of public service institutions.

The Kaupthing wind-up Committee takes steps to salvage retroactively some of the loot. And, after long last, it seems even the tax authorities seem to realise that where fabulous wealth had been generated, irrespective of fraudulent means, revenues to the treasury might have been due.

Not to forget, after a new government has taken power in the UK and once by mid June elections are over in The Netherlands we are likely to watch another sequel of the Icesave saga. To be sure, a group of international banks is making legal claims on Landsbanki assets intended to cover roughly 90% of Icesave debts. If those claims succeed, only 25% might be covered ripping open another hole in the government’s vaults. At the same time, perhaps no coincidence, EFTA (the European Free Trade Association) reiterated that Iceland is legally bound to cover the minimum deposit guarantee to the tune of Euro 20000 per Dutch or British account holder.

Lets allow a short breath before events will rush us on and ponder a few questions that might have risen along the way:

The SIC and OSP are special organs. They have been purposefully placed outside the established judicial systems, in parallel or as an independent extension. One might therefore ask: what was the purpose? Was it not (also) a lack of trust and confidence in the established system? A lack of trust especially in those actors who built and governed the system? A lack that springs from the full knowledge of the partisan political patronage that governed the system and compromised and corrupted its independence?

The authorities had no real choice. It was at no point a realistic option to task the established system with the investigation and/or persecution. At the time the public was alert, up in arms (cooking pots and pans) and fully aware of the legal system’s deficiencies.

The repercussions from the onset of Kreppa were reverberating internationally and international scrutiny demanded – if not expressis verbis – transparency and independence of the process.

The authorities could not but meet mounting expectations and, to some surprise, went farther still and recruited internationally respected legal counsel (Eva Joly) also adding much needed extra legal expertise.

Adherence to those demands was, of course, implicit also an admission of systemic dysfunctions in the establishment.

If those system deficits were true would it not be legitimate to wonder how the traditional, established system can now be expected to manage independently and lawfully the impending onslaught of court cases, complex and with multiple international, political and legalistic, implications exposing powerful and well connected representatives of the local elite?

The OSP is scaling up, increasing its staff from 30 to 90, giving an indication that the case load will be quite massive. Reportedly it is not an easy task to find that many qualified persons in a small society of ca. 300.000. And, where to find the personnel to process the legal cases through courts, judges, assistants, prosecutors and defense lawyers, qualified and experienced to steer through a maze of fiercely fought arguments?

Yes, in a most recent appeal case the Supreme Court upheld a judge’s decision for the continued detention of two suspects under investigation. But was that simply a case in practice or a ruling to be subjected to critical scrutiny along political fault lines? Have not past appointments to courts raised eyebrows as selection criteria for judges other than qualification and merit prevailed?

Perhaps it is raising a question in hindsight as impending court cases seem headed for a course through the established system. But as a matter of principle one could wonder whether or not special courts, somewhat in analogy to the succeeding special organs SIC and OSP, seemingly (so far at least) uncompromised and independent, could do justice best to all parties concerned, including the public at large?

In fact, the question had been raised in the past albeit without much of a tangible conclusion. Some argue against, citing the lasting undermining effects on the old system. Precisely for that reason others argue in favour as change was the order of times.

Beyond the numbers of staff, etc.: What if the independence and confidentiality of the legal system doesn’t hold? What if justice will not be done and cases are perpetuated endlessly on technical grounds, appealed time and again?

Not by any measure an easy question to answer. But law, legislature and the judiciary system, including prosecutors and lawyers, are a matter quintessential to the fabric and functioning of any society including Iceland. Perhaps questions should be answered prior to action?

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The four ex-managers of Kaupthing, recently held in custody in Iceland where the office of the Special Prosecutor is investigating Kaupthing, are now free to travel. After Hreidar Mar Sigurdsson, Magnus Gudmundsson, Ingolfur Helgason and Steingrimur Karason were released from custody they weren’t allowed to leave the country. That ban has now been repealed. The four of them have all been living in Luxembourg.

Sigurdsson was the bank’s CEO, Gudmundsson was the manager of Kaupthing Luxembourg, Helgason was the CEO of Kaupthing Iceland and Karason was the head of risk. Gudmundsson was kept as a manager after the Rowland family, owner of Blackfish Capital, took over Kaupthing Luxembourg but after he was remanded in custody Magnusson was dismissed from his job at Banque Havilland. After the collapse of Kaupthing the three other ex-Kaupthing managers set up a company in Luxembourg, Consolium and had i.a. business relations with Gudmundsson.

As I’ve mentioned in earlier Icelogs there are plenty of rumours around the Blackfish acquisition of Kaupthing Luxembourg. The Rowlands have from the first firmly denied any Icelandic connections or that there are any Icelandic owners among them. They claim that since they had already in mind to set up a bank buying a bank, although in a moratorium, was a simpler process than building up one from scratch.

That’s no doubt true in the sense that Kaupthing already had a client basis – but according to sources that I spoke to in Luxembourg when I was there last week it’s no easier, rather the opposite, when taking over an existing bank. Since Kaupthing was in moratorium the new owners will have been thoroughly scrutinised by the CSSF, the Luxembourg financial services authority. Buying will not have been a short-cut to get a banking license in Luxembourg.

The rumours haven’t died down and probably won’t until further light is thrown on Kaupthing’s operation by the OSP and the SFO, also investigating Kaupthing. After the OSP had meetings last week with authorities in Luxembourg, Belgium and representatives from the SFO and Europol it now seems likely that Luxembourg will become a party in these ongoing investigations and that the investigations will possibly be linked through Europol. Clearly, the possibly fraud that Kaupthing is being investigated for has ramifications far beyond Iceland.

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ESA, the Efta Surveillance Authority, has sent a letter of formal notice to Iceland. According to ESA, Iceland is obliged to ensure payment of the minimum compensation to Icesave depositors in the UK and the Netherlands. The letter, in all 15 pages, clarifies ESA standing on these vital issues. ESA monitors non-EU members of the European internal market.

Earlier, the Icelandic Government had argued in a letter to ESA that setting up a guarantee scheme had been enough to fulfill its obligations under the EU Directive on deposit guarantees. Hence, the government seems to be of the opinion that having very little funds in the guarantee scheme didn’t matter; it was enough to set up the scheme. ESA points out that the aim of having a guarantee scheme is to guarantee 20.000 EUR, not just setting up the scheme.

The Icelandic government had also argued that that the Directive might not be applicable if deposits are unavailable because of a major and general banking crisis. ESA argues that this is clearly not the case. – Consequently, ESA counters Iceland principal arguments, actually shreds them to pieces.

More ominously, the letter warns that the Icelandic so-called ‘emergency law’, passed Oct. 6 2008, that declared that Iceland guaranteed all deposits in Iceland but not in foreign branches, runs counter to EU principles of non-discrimination. ESA points out that it’s possible to make exceptions for particular types of deposits but that Iceland didn’t make any use of these possible opt-outs.

ESA points out that since negotiations are ongoing between Iceland, the UK and the Netherlands nothing further will be done for the time being. If however the dispute isn’t resolved the case might be brought to the Efta Court.

Is this good news for Iceland? Hardly – it shreds Iceland’s arguments for not paying the Icesave bill. The official Icelandic stance has been somewhat schizophrenic: that it needn’t pay but was going to, if the right terms were offered. It will be painful to swallow but the Icesave bill is really the price paid for the past sins of omission, omitting to fetter the banks but dreaming of Wall Street on the Atlantic.

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The eruption in Eyjafjallajokull hasn’t officially been declared as ended – but the volcano is still quiet. For the farmers south of the glacier the stillness comes as a huge relief. Now they can start preparing the work they would normally be doing at this time of the year. Geologists who follow the volcano say it’s still too early to say if the eruption has really ended or if this is merely a pause in the volcanic activities. For the time being the only news from Eyjafjallajokull is that there is, happily, no news…

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‘Too big to fail’ is the crux in how to proceed now that the world’s financial system is slowly slowly being weaned off the life support machine of sovereign cash. But the SEC charges against Goldman Sachs indicate that this is only a part of the problem. Size isn’t the only issue: the big banks aren’t only too big to fail – but they are also too complicated to be scrutnised.

When governments all over the world had to pour the tax-payers’ hard earned money into banks there were whispers here and there that these new bank owners should take a long close look at the companies they were now investing in or taking over. But no, it hasn’t really happened – for many reasons. One is, as James Galbraith and William Black pointed out in their statements before the US Senate and the US House of Representatives recently, that white-collar fraud seems to be an embarrassment and lessons from earlier frauds haven’t been learnt.

The Icelandic banks weren’t involved in terribly sophisticated banking. They didn’t develop complicated products, hardly touched sub-prime loans though they were, as one ex-banker in one of the banks recently told me, ‘suckers for other banks,’ meaning that the Icelandic banks bought some mortgage related securities which the sellers, big banks, probably knew weren’t any terrific products but pushed them to buy by using their market power. But on the whole, the Icelandic banks didn’t practice the kind of banking where physicists and mathematicians were the model makers.

The Icelandic way of banking was mostly about constructing loans that the banks would lose money if the markets went down and the favoured clients would go unscathed. However, the markets went further down than anyone had envisaged, the banks collapsed and most of the big clients went bankrupt when they flow of easy money stopped. A recent casualty is Simon Halabi. Other names are house-hold names in Iceland and abroad such as Jon Asgeir Johannesson, Palmi Haraldsson and Bjorgolfur Gudmundsson. Others, like Robert Tchenguiz and Kevin Stanford, have seen their fortune hugely dented.

Even relatively small banks like the Icelandic ones pose substantial problems when it comes to investigating what exactly went on in them. When it comes to truly big banks, the staggering amount of documents spread over hundreds and even thousands of different system is an exorbitant obstacle. It was incredibly uplifting to read how this had been solved by Anton Valukas and his team working on the Lehman report: they found their way through what they aptly call ‘the Lehman Universe’ of 3 petabytes(!) of date, equivalent to 350bn pages, spread over a patchwork of 2600 different datasystems. (The outlines of how this was done are here, p. 28-35.) What they extracted from the 3 petabytes were emails and other illuminating material to throw light on what went on at Lehman.

Now that the activities of these fairly unsophisticated banks are being poured over by the Office of the Special Prosecutor in Iceland and the Serious Fraud Office in the UK it’s become abundantly clear what a painstaking process it is to trace assets over country borders. It’s difficult to do it even from one European country to another – plenty of legal obstacles to overcome – not to mention the towering summits to climb when it comes to countries like Panama, the British Virgin Islands or the Channel Islands (how shameful it is for the UK to have done so little to put pressure on these islands to cooperate in fraud investigations!)

As has so often been pointed out, the interconnected international markets ease the flow of money and the European market is constructed to facilitate the circulation of money and people. But very little, actually next to nothing, has been done to ease cross-border investigations.

When it comes to the big banks they almost without exception have parts of their operations in Luxembourg, Panama, the BVI and the Channel Islands, often running investment funds through these ‘secrecy jurisdictions.’ In order to fully understand how they operate it’s necessary to scrutinise their cross-border operations. The SEC charges against Goldman Sachs are well-defined and targeted – a clever way of striking but there are vast areas of Goldman Sachs and the other major banks that haven’t been scrutinised because it’s an almost insurmountable task.

These major banks aren’t only possibly too big to fail – they are also quite clearly too complicated to scrutinise. Not that it can’t be done – of course it can – but it takes a clever approach and joint forces of multi-lingual international teams and task forces from the individual countries’ regulators and financial services authorities. By joint efforts, possibly under the auspice of Europol, it would be possible to let information on the gigantic money machines that the banks are flow. – The situation with a borderless financial world and a world full of obstacles for investigations by regulators and financial services authorities is unsustainable and horribly skewed against justice.

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