Sigrún Davíðsdóttir's Icelog

Earlier, the EFTA Surveillance Authority had indicated that it would answer Iceland by the end of the May. It now seems that this time will be stretched until after the coming weekend.

In my reporting for Ruv in Iceland, I have indicated that to some ESA experts the Icelandic answer seemed feeble. I find it unlikely that ESA will be convinced by Iceland’s answer, which I found to be short on legal reasoning and long on beside-the-point arguments. In the end, it matters what the ESA lawyers think. We will know next week.

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Icelandic banks grew and expanded abroad and caught attention in countries where they operated but they never got rid of rumours of dodgy dealings, of money laundering and Russian connections. In spring of 2006, the expansion of Icelandic banks and businesses in Denmark attracted attention, causing worries and consternation. According to a Danish source this was even discussed informally on the board of the Danish National Bank. All along, the only people who seemed totally oblivious to these rumours were the financial services authorities in the countries where the Icelandic banks operated.

And so it was in Luxembourg, at the Commission de Surveillance du Secteur Financier, CSSF, the financial services authorities of this tiny state, which builds its wealth on offshore operations at the heart of Europe.

Only a few weeks after the collapse of the Icelandic banks in October 2008 my attention was drawn to the banks’ operations in Luxembourg. I spent months trawling through the Mémorial/Tagesblatt, the official publication that lists information on Luxembourg companies. The banks, especially Kaupthing, had from 1999, set up hundreds of companies for their Icelandic clients. In 2005, Kaupthing started a successful UK operation, which meant that many of the bank’s largest UK clients also had accounts and companies in Luxembourg.

On a visit to Luxembourg last year, I gathered that the CSSF had been completely ignorant of what was going on in the Icelandic banks. It seemed that the CSSF had not had any insight into the fact that the banks breached the limits how much they could lend to each entity/person and the insufficient or no collaterals/guarantees.

However, I have recently learnt that this wasn’t the case at all. The CSSF was indeed very worried about the situation in the Icelandic banks, at least in Kaupthing and Landsbanki (the Glitnir operation in Luxembourg was never big, it came too late to the game). So worried, that following the Q1 result in 2008 CSSF asked the external auditors of the two banks for a thorough report, ia on credit risk.

How Landsbanki responded I do not know but if they met the CSSF as they met demands from the UK FSA it’s safe to conclude that they were neither swift nor forthcoming. Kaupthing Luxembourg managers dragged their feet. The deadline was in June 2008, the report wasn’t finished until the latter half of July. The report was based on Kaupthing’s position at the end of March. The CSSF didn’t like what they saw but in reality the situation, by late summer 2008, was much worse than the report indicated since the underlying numbers had changed much for the worse.

Kaupthing answered in the Kaupthing way, claiming that the CSSF was entirely wrong about essential things. There was, according to the Kaupthing Luxembourg management nothing wrong and the credit risk well managed. However, Kaupthing Luxembourg was in the end forced to sell assets, providing some much needed liquidity. On Friday October 3 Kaupthing Luxembourg manager Magnus Gudmundsson told some employees that the Luxembourg operations were now secured for the coming months.

Evidently, Kaupthing’s management also convinced people at the Central Bank of Iceland that Kaupthing was, contrary to Glitnir and Landsbanki, in a strong position to weather the storm. On Monday 6 October 2008 the CBI agreed to provide Kaupthing a loan of €500m. Considering the fact that Kaupthing, as well as Landsbanki, was from Friday 3 October forced to put all new deposits into Bank of England, meaning that the banks were no longer operating freely, the loan is incomprehensible. I’ve never been able to certify if the CBI knew about the BoE action but my conclusion is that the CBI must have been aware of it.

It’s never been explained what happened to the €500m. Some of it seems to have gone to Sweden, some of it to Luxembourg. But the real mystery is why this money wasn’t used to save Kaupthing by strengthening Kaupthing Singer & Friedlander. Due to cross default clauses it was clear that if KSF collapsed it would trigger a Kaupthing default. KSF and Kaupthing were in a dialogue with the FSA during the last days. FSA set certain conditions for liquidity, Kaupthing claimed it could meet the limits but never did. Not even when it had the €500m.

But back to Luxembourg in October 2008. Although CSSF had been chasing Kaupthing for credit risk and over-exposure to only a few clients it didn’t seem too concerned about the way the Kaupthing managers had run the bank. Kaupthing went into administration, Franz Fayot, a well connected Luxembourg lawyer, was appointed an administrator. But little changed at the bank where Gudmundsson and the other Icelanders kept on running the bank. Apparently, no questions were asked, in spite of CSSF serious doubts.

After JC Flowers and the Libyan Investment Agency had considered buying Kaupthing but decided against it, the English investor, David Rowland finally took Kaupthing over. His bank, Banque Havilland now acts as an administrator for the Kaupthing assets in Pillar Securitisation. The Luxembourg state risked a loan of €320m to facilitate the deal with Rowland, again no questions asked in spite of CSSF’s earlier doubts and worries.

Rowland fired all his Icelandic employees, except one, after the Office of the Special Prosecutor arrested Gudmundsson last year. The message was that Iceland wasn’t important for Havilland any longer. Yet, suddenly Rowland appeared as an investor in an Icelandic bank, the resurrected MP bank. Rowland seems to have an exotic interest in outliers, investing in Iceland and Belarus. MP bank has invested in Ukraine and the Baltic countries. The question is why Rowland, who was called ‘shady’ in the UK Parliament, is suddenly so interested in Iceland and a bank there.

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The ash plume has resided, looks like the eruption in Grímsvötn 2011 is over. There is however some ash floating around in the air, might cause local disruption here and there in the coming hours, over Iceland and elsewhere but that should be the end of it.

Today, there is glorious weather in Reykjavik, sunny and ca 12C. The darkness encroaching on the city and the whole of Southern Iceland has disappeared and the mood of the country improved.

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This morning, the ash from Grímsvötn has again increased. The eruption is steady, apparently it’s ten times bigger, in terms of ash production, than Eyjafjallajökull last year. The fumes rose highest up to 20 km, the best way of measuring and indicating the strength of the eruption. Since yesterday it’s been 10-15 km, falling under 10 km at times.

There is a crater building up, indicating that lava will start running at some point.* Then the ash production will stop. For the time being, it’s impossible to say when and if this happens but normally, ash rises only, at the most, for the first few days.

In terms of disruption, it all depends on winds and air currents as to where the ash will be floating. The outlook for the UK on Wednesday is uncertain. The UK authorities are bracing themselves for possible flight cancellations.

For the time being, there are no flights in and out of Iceland. This might change, later on. Icelandair hopes to be flying later in today but this will be announced in the coming hours.

*As it is now, there is plenty of water, melted glacier, in the crater. It’s the contact of water and lava from the crater that creates the ash. When the water has evaporated ash doesn’t form any more and the lava starts to flow.

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It now seems that the Eyjafjallajökull eruption was, in case you didn’t know, just a tiny eruption. The one now, in Grímsvötn, is producing much more ash. Tomorrow, the ash cloud might reach Reykjavik. The ash is spreading wide and far over Iceland.

According to the weather forecast on Ruv tonight, the air currents over the North Atlantic indicate that by Wednesday, the cloud might be close to the UK and Northern Europe. However, the eruption seems to be residing so we can only hope that by Wednesday, there isn’t much ash rising out of Grímsvötn.

According to geologist Magnus Tumi Gudmundsson, in an interview with Ruv, the normal pattern of a Grímsvötn eruption is ash for the first few days only whereas the eruption could continue for weeks and months. That means that there is only risk of flight cancellations for the first few days. This may seem dramatic right now but most likely only for a few days more, at most 3-4 days.

Here is an Icelandic blogger, Jon Frimann, blogging in English, keeping track of volcanos in Iceland, now covering the Grímsvötn eruption.

Here is a video from Grímsvötn where Matthew Roberts, who works at the Icelandic Meteorological Office, is telling the BBC about the eruption, just after returning from a flight over the glacier.

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I was a bit too quick concluding that the eruption in Grímsvötn this time would be like last time, in 2004, when air traffic wasn’t affected. This morning, the flights out of Iceland were on schedule whereafter the airports were closed. There is a lot of ash, it’s darkness at noon south of Vatnajökull.

The eruption is much stronger than in 2004, more akin to 1873, geologists gather. The fissure that’s opened up seems to be 500-800m long. However, it’s likely that the ash production is at its most forceful right  now but that it will only continue, at most, for a few days. There are already now signs of diminished ash. That, of course, doesn’t help the ca seven thousand passengers now stranded but it might mean that the disruption of flights won’t last.

Also, it seems that the ash isn’t travelling, so international flights will probably not be affected this time around. Or that’s what the experts are saying. Remains to be seen what nature will do.

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There is steam and ash rising up from Vatnajökull, Europe’s largest glacier, in the South East of Iceland. The eruption is in a place called Grímsvötn. Eruption happen at regular intervals under the glacier, the fire from below melts the ice, the water lifts the ice cap and ‘leaps’ onto the sands below the glacier. It’s now expected that the ‘leap,’ the floods, will start tomorrow morning. Usually, the floods start 10-12 hours after the eruption starts.

The world, in particular the air companies, doesn’t need to hyper ventilate in fear of the eruption endangering flights. This type of eruption happens frequently, with no particular disruption in the air. The floods, however, can often wash away roads and bridges but the infrastructure there is made with this in mind. Remains to be seen what forces are at large this time. The last eruption in Grímsvötn was in 2004 when the ‘leap’ was strong and destructive.

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Baugur, the investment company of Jon Asgeir Johannesson, his family and few others, started its life as a listed company that Johannesson later took off market. In 2002, while still a listed company Baugur was investigated for financial irregularities. Eventually, charges were brought against the company. As the case came to court, most of the charges, but not all, were thrown. Johannesson was finally sentenced to a three months conditional imprisonment in the summer of 2008. The sentence meant he had to leave the boards of several companies where he sat.

The demise of the Baugur case – Johannsson was sentenced but many of the claims were thrown out – is fresh in the memory of those now investigating not only Johannesson’s businesses but also other cases related to the collapsed banks. There are some intriguing parallels between the Baugur case and a recent case.

Glitnir, one of the three banks that collapsed in October 2008, is now bringing a case against Johannesson, his long-standing business partner Palmi Haraldsson, the Glitnir CEO Larus Welding, brought in when Haraldsson and Johannesson became major shareholders in Glitnir in spring of 2007 and three employees of Glitnir. The Glitnir case regards the sale of Aurum shares from one Haraldsson company to another Haraldsson company, a case Icelog has reported on earlier as a modern amorality tale.

The first Baugur charge to be thrown out by the Reykjavik County Court judge Arngrimur Isberg regarded a sale of shares in a company called Voruveltan by another company, Fjarfar, to Baugur, then a public company. According to the prosecutor Johannesson was guilty of fraud and breach of fiduciary duty for his part in this sale.

The judge saw it differently. To him, the charges merely described a business transaction. He did though acknowledge that the listed company Baugur had quite possibly lost ISK325m and Johannesson and his associates had profited by ISK200m but their cost, ia brought on as they tried to hide ownership and business relations, had been considerable. Consequently, it wasn’t a crime to trick Baugur and make ISK200m on the side.

The Aurum case rises from a Glitnir loan of ISK6bn related to sale of the Aurum shares. There is a significant difference between the Aurum case and the Baugur case: in the former case Glitnir is suing for damages, the latter was a criminal case brought on by the prosecutor (not the Office of the Special Prosecutor, which is a new office, set up to investigate cases related to the collapsed banks).

The Aurum sale was a classic deal in the Icelandic pre-collapse business environment: a sale between related entities. Glitnir’s employees valued the Aurum shares, at most, at ISK1.5bn. Johannesson and Haraldsson wanted a loan of ISK6bn where the Aurum shares should be worth at least ISK4bn.

Their evaluation was based on ‘Head of Terms’ from the Damas International, a big Dubai jewellery chain that in the summer of 2008, just at the time that the Aurum sale was being organised, had shown an interest in Aurum. It was a Kaupthing contact in the Middle East who brought Aurum and Damas together.

Johannesson and Haraldsson discredited Glitnir’s evaluation and convinced the bank to accept the Damas evaluation. Damas, by the way, never bought Aurum. Last year, three brothers who are Damas main shareholders and managers, were banned by the Dubai Financial Services Authority from the board of Damas International for 10 years and imposed penalty for having illegally withdrawn $165m from Damas, a public company.

The Aurum sale went through as Johannesson and Haraldsson wanted. Of the ISK6bn 4bn was used to pay off older loans, one billion went to Haraldsson’s Kaupthing Luxembourg account and a billion went into Johannesson’s private account with Glitnir. A loss of ISK6bn landed with Glitnir late 2008 because of a buy back clause obliging Glitnir to buy the 6bn indebted SPV for the royal sum of 1 krona.

In a report in the Aurum case, Johannesson’s lawyer Gestur Jonsson claims that Johannesson neither sat on the board of Glitnir nor was in any position to influence Glitnir. This echoes the defence in the Baugur case, where Jonsson was also acting on behalf of Johannesson. In an email published in the Glitnir charges Welding complains that the bank’s main shareholders treated him like a branch manager.

With the SIC report it became abundantly clear that Johannesson was diligent sending emails to Welding and other Glitnir managers and in general to managers in the three banks where he was among the biggest clients. Actually such a big client with all of them that the power was reversed: the banks had no power over him; he had all the power over the banks because on their books he was too big to fail. Consequently, he had to be saved, at all cost, with loans upon loans from late 2007 until the bitter end of the three banks. In addition, he and his business associates were closely involved with Byr, one of the small Icelandic savings banks.

The Aurum case has indirectly come up in a UK court. In relation to the Aurum case in Iceland, Glitnir asked for an international freezing order in a UK Court, confirmed last summer by Justice David Steel. Regarding the Aurum case, Justice Steel concluded that ‘even if Mr Johannesson has some prospect of answering the (Aurum) claim in Iceland, nonetheless the prospect of establishing that he had no control over the bank and/or that the loan was a bone fide commercial transaction looks somewhat forlorn.’

From the Voruvelta deal Johannesson profited at least ISK200m, a small sum compared to what was to come. Johannesson and Haraldsson got each a billion from the Aurum sale. From a third deal, the so-called Stytta deal, another remarkable 2008 loan story, Fons netted ISK2bn.

All this isn’t just an old story. The deals made with the bank’s favoured clients during 2008 secured them well beyond the collapse of the banks. And they are still profiting from these deals. In a recent interview, professor William Black said:  ‘If cheaters prosper, cheaters will dominate. It is like Gresham’s law: Bad money drives out the good. Well, bad behavior drives out good behavior, without good enforcement.’

This is what Iceland is wrestling with: to make sure that it’s not the unnatural, counter-market law of the cheaters that still rule the market.

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According to the last report from the Landsbanki Winding-Up Board, the recovery from the Landsbanki assets is now expected to cover 94% of the priority claims, using the currency rate end of last March. More interestingly, it covers 99% at the currency rate of 22.4. 2010. It’s the currency rate of that date against which the claims were sat in order to lessen the currency risk when it comes to settle with creditors. The value of the assets is now estimated to be ISK1.3bn, with the priority claims at 1.319bn.

Johannes Karl Sveinsson, who was on the negotiation committee, said to Ruv yesterday that he’s still worried about certain aspects of the eventual ESA process, the recovery won’t change anything re ESA though the improving recovery is good news. There is, says Sveinsson, still the risk that the UK and the Netherlands will bring Iceland to court since the two countries compensated Icesave depositors and claim Iceland owes them for it.

Minister of finance Steingrimur Sigfusson points out that the improved recovery is good news but won’t change anything regarding the dispute with the UK and the Netherlands nor ESA. He is referring to the fact that the countries claim they have an outstanding loan to Iceland. The ESA process regards whether Iceland has violated the deposit guarantee.

Sigfusson’s comments are interesting. After the referendum that rejected the Icesave agreement Sigfusson indicated that there was nothing to worry about, there was enough money to pay. That is, of course not the relevant point, as Sigfusson now indicates. Reality is slightly more complicated.

Landsbanki can’t start to pay out to creditors until the Icelandic High Court has confirmed that deposits are priority claims, as the Icelandic Government stipulated in October 2008. The ruling is expected in autumn. The Reykjavik County Court has already ruled that deposits are priority claims.

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Among the more memorable news events of last year were the US Senate Subcommittee on Investigations’ hearings into the financial crisis.* This April, the Subcommittee published its 650 pages report on the crisis, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, focusing on four aspects:

High Risk Lending

Regulatory Failure

Inflated Credit Ratings

Investment Bank Abuse

The report concludes that a severely compounding factor in the crisis was investment bank abuse. Case studies in the report relate to the cooperation between Goldman Sachs and Deutsche Bank. Quite interesting since I firmly believe that the contacts between Deutsche Bank and the Icelandic banks merit some attention (hope to clarify this on Icelog in the near future).

Summaring, the report points out:

The four causative factors examined in this Report are interconnected.  Lenders introduced new levels of risk into the U.S. financial system by selling and securitizing complex home loans with high risk features and poor underwriting.  The credit rating agencies labeled the resulting securities as safe investments, facilitating their purchase by institutional investors around the world.  Federal banking regulators failed to ensure safe and sound lending practices and risk management, and stood on the sidelines as large financial institutions active in U.S. financial markets purchased billions of dollars in mortgage related securities containing high risk, poor quality mortgages.  Investment banks magnified the risk to the system by engineering and promoting risky mortgage related structured finance products, and enabling investors to use naked credit default swaps and synthetic instruments to bet on the failure rather than the success of U.S. financial instruments.  Some investment banks also ignored the conflicts of interest created by their products, placed their financial interests before those of their clients, and even bet against the very securities they were recommending and marketing to their clients.  Together these factors produced a mortgage market saturated with high risk, poor quality mortgages and securities that, when they began incurring losses, caused financial institutions around the world to lose billions of dollars, produced rampant unemployment and foreclosures, and ruptured faith in U.S. capital markets. (P. 12.)

Professor William Black (the link is to an interview with Black on the S&L crisis vs now) and others have been calling out for criminal investigations into the role of the major banks during the crisis, comparing the situation now with investigations into the Savings & Loan crisis of the ‘80s when a number of lenders actually went to jail. An article in the latest issue of Rolling Stones Magazine, based on the Senate’s report argues that the report has laid out the evidence. Now the Justice Department should bring criminal charges against the bankers responsible for what the banks did.

As often pointed out earlier on Icelog, the Icelandic Special Investigative Committee outlined many cases in its report now being investigated in Iceland. The SIC informed the Office of the Special Prosecutor of findings it found to be suspicious. The UK Serious Fraud Office is conducting an investigation into Kaupthing’s operations.

*The hearings can still all be watched on C-Span, ideal to watch while you cook or do other things that leave your mind mostly free. Senator Carl Levin was the absolute star, some memorable moments when he was questioning the squinting Goldman Sachs CEO Lloyd Blankstein.

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