Sigrún Davíðsdóttir's Icelog

The Icelandic High Court has just ruled on whether deposits are priority claims. The ruling implies that the Icelandic Emergency Act, passed on Oct. 6 2008, do not go against the constitution. A ruling that some have called ‘the ruling of the century.’

The ruling comes after several cases where creditors sought to challenge the emergency measures, passed on Oct. 6 2008, which severely diminished the recovery that creditors to to Icelandic banks can expect. These cases had already been through the Reykjavik County Court. The Icelandic High Court has now ruled, as did the County Court, confirming the legality of the emergency laws.

This is the last legal hindrance to pay-outs to creditors from the Landsbanki estate. It is expected that pay-outs can soon start, which means that the Icesave money to the British and the Dutch authorities can now be paid out.

This, however, will not solve the Icesave dispute, since the two countries claim interests since they took loans to cover the payments to their respective Icesave depositors. The UK authorities paid depositors in full, the Dutch up to €100.000. The Icesave dispute is about only the European minimum, €20.000, meaning that the two countries only stand to recover the first €20.000 on each Icesave account.

Follow me on Twitter for running updates.

Here is an interesting article on Dexia from the NY Times. It doesn’t mention the dubious loans but questions why all trading partners of failing banks, like Dexia, should get everything paid out in full. Why are the derivatives paid out to trading partners?

Walker F. Todd, a research fellow at the American Institute for Economic Research and a former official at the Federal Reserve Bank of Cleveland, makes an interesting point when he says that governments are setting a troubling precedent by bailing out a company and pay its trading partners in full, as occurred with A.I.G. and as might occur with Dexia.

“In the short run, it would help if the authorities would say they refuse to provide publicly funded money for the payoffs of derivatives,” he said. “This is like using public funds to support your local casino. It is difficult to see how this is good for society in the long run.”

This is an important point to keep in mind these hours are the European Union is struggling to finalise plans for recapitalising European banks. Or, as Matt Taibbi puts it: ‘Wall Street isn’t winning. It’s cheating.’

When banks were being saved left right and centre in the autumn of 2008, it was heard all over the political spectrum that this was all emergency measures – and of course, banking shouldn’t be about privatising the profit and nationalising the losses. This isn’t heard any more, expect from Occupy Wall Street and other similar movements. Yet, this seems to be about to happen again.

Follow me on Twitter for running updates.

The French-Belgian-Luxembourg bank Dexia lent its two largest shareholders to buy Dexia shares. This practice, as familiar to Icelanders as the Northern lights, was at the core of Icelandic banking. It enabled managers to control shares and to inflate the share price, as well as securing favourable connections and the left the banks fatally weakened when share prices fell. Why have banks been bailed out with no questions asked?

From 2006-2008 Dexia lent two of its largest shareholders €1.5bn to buy its own shares, with the shares as its collateral. In September 2008 the French, Belgian and Luxembourg Government bailed out Dexia with €6.4bn. At the time, lending against own shares was legal in Belgium. The two shareholders that borrowed from Dexia in these deals jointly owned 35% of Dexia’s shares and nominated two members to the board. How likely is it that this board would be truly independent in scrutinising the running of the company?

At the time, Dexia was running dangerously low on capital and used this creative method to inflate its own capital. This practice, widespread in the failed Icelandic banks, throws further light on how this can be used and the effect it has on the individual banks and the banking climate. This practice allows the managers to fool the market, fool other shareholders and, last but not least, fool the regulators.

Consequently, lending to buy own shares runs absolutely contrary to transparency and equal information to all players in the market. With this practice, the managers who carried and the shareholders who took part knew that the bank wasn’t as sound as it seemed to be whereas the regulators and other shareholders had an altogether different picture. Or, as one enlightened expert said, when Icelog explained this way Icelandic practice to him: ‘Ah, so they converted their loan book into capital.’ – Creative indeed.

In Iceland this practice of lending to buy its own shares, with the shares as a collateral, was widely practiced in all the three banks, Glitnir, Landsbanki and Kaupthing. Kaupthing used this method quite systematically. This lending practice is thoroughly documented in the SIC report.

Kaupthing’s systematic use is particularly indicative. It secured the managers a wide control over the bank since effectively the managers themselves chose the shareholders with whom they parked the shares. With this, they could fend off possible major changes in the shareholder group, ia a hostile overtake and cement the influence of the managers in all matters.

In the three Icelandic banks, the loans to buy shares in the banks were offered to favoured clients, not to just all and sundry. The loans were heavily weighted against the interest of general shareholders and in favour of these chosen clients. What they were offered was ‘risk free’ investment, ie no risk to the borrowers, all risk on the banks. In addition, this enabled the managers to offer these ‘risk free’ investments to people they wanted to be on good terms with. Some people would perhaps use the word ‘bribe’ in this context.

How badly these loans affected the banks became inordinately clear when the shares began to fall. The banks couldn’t make margin calls as they can with other collaterals. The banks couldn’t rake in their own shares, since they could neither hold them nor sell them. Selling them in big quantities would of course have caused further falls and ultimately there were no buyers. The SIC report points out that how these loans weakened the banks, creating what the report calls ‘weak capital.’

All these effects would apply to Dexia. It would be really interesting to know on what terms these two institutional clients were offered the loans. The bank claims the loans were just normal loans. Well, I wonder. The collaterals weren’t normal nor was it in any way normal for the bank to be lending to stimulate the sale of its own shares, thereby weakening its own capital. Why were these two shareholders offered this deal? And was the risk equally divided between borrower and lender? Obviously not since Dexia couldn’t do margin calls etc as was demonstrated in the Icelandic cases. Consequently, these loans can never be normal loans.

Dexia shareholders should be up in arms about this, as should the owners of the two companies that participated in this cosy deal with Dexia, not to mention the three governments that have now twice bailed out Dexia.

It’s interesting to note who Dexia’s two favoured shareholders were. Arco, borrowing €275m, invests for the Belgian trade unions. Holding Communal, borrowed €1.2bn, claims that the whole sum wasn’t used on shares, but it’s still fair to surmise that a large part of it was. Holding Communal belongs to Belgian municipalities.

And what’s now happening to Holding Communal? It’s being bailed out itself by Belgian regional governments by a state guarantee of €450m and a federal government contribution of up to €132.5m. In addition, Dexia will write off €101.5m of Communal Holding debt.

With the banking crisis now dragging on for three years and nothing really resolved it’s about time to consider that the bailed-out banks weren’t closely scrutinised by the governments who so freely have poured billions of tax-money into these banks. It’s quite understandable that this couldn’t be done when it was all happening in October 2008 – but the fact that it hasn’t happened since then is a gross negligence on behalf of those who are in charge, both regulators and financial services authorities.

At the core of the Eurozone crisis is reckless lending. And the reckless lending is part of reckless, possibly corrupt, banking that hasn’t been stopped although so many banks have been and are being saved by governments. These governments are trusted by their voters to make the best use of public money. In the case of Dexia and many other banks governments haven’t at all scrutinised what public money is bailing out. That is a serious failure of public duty.

*Earlier Icelogs on corruption and its effects on the Eurozone crisis can be found here and here.

Follow me on Twitter for running updates.

On September 30, the Icelandic Government answered the EFTA Surveillance Authority, ESA, reasoned opinion concerning alleged failure of Iceland to comply with Directive on deposit guarantee schemes and/or an article in the EEA agreement on non-discrimination.

Yet again, the Icelandic answer seems to consist of matters irrelevant to the ESA opinion, such as the state of the Landsbanki estate and its pay-out schedule. Regarding the deposit guarantee the answer reiterates earlier points, going against the ESA understanding of  ‘obligation of results’ and denying that foreigners were left worse off than Icelanders.

The Icelandic government denies that a declaration of will, issued by the Icelandic and the Dutch Government October 8 2008, indicates an acceptance on behalf of Iceland of the EU deposit guarantee. Iceland also points out new aspects of the deposit guarantee put forward in a draft of a new EU deposit guarantee.

It is now up to ESA to ponder its next step. It could either accept the Icelandic arguments – which is, to say the very least, extraordinarily unlikely – or it will send the case to the EFTA Court, which is nigh certain.

The only thing that could possibly hinder a court case is if the Brits and the Dutch – satisfied that the Icelandic Deposit Guarantee Fund, with its priority claim in the Landsbanki estate, will soon start paying back its debt to the two countries – would drop their claims. That’s however not entirely plausible since the two countries aren’t only seeking a refund of the deposits but some interests on their pay-out.

Landsbanki is still hampered by ongoing law-suits and its pay-out schedule is consequently unclear. Ergo, it’s unclear when exactly the two countries can expect to recover the money they paid to their Icesave depositors. Landsbanki recovery will, according to the latest estimates, cover priority claims and possibly interests of the UK and Dutch payout. Bondholders will more or less be left with nothing, which might lead to further court cases as bondholders seek to cover their damages.

In an interview with Ruv, Lee Buchheit who led the third and last Icesave negotiations recently pointed out that in its answer to ESA Iceland should have underlined that all depositors had indeed been paid out and that it didn’t really matter who had paid them. The main thing was that no depositor was left unpaid. Further, Iceland should have made the case to ESA that the Icesave dispute was now solely a matter for the three countries to resolve and had nothing to do with ESA any longer.

In its first answer to ESA the Icelandic Government failed to make this point except in a footnote.

Follow me on Twitter for running updates.

The British use of the a legislation with the word ‘terrorism’ in its name to freeze the assets of Landsbanki cost Icelandic companies and other entities ISK5.2bn, (€32.6m) according to a new report, done at the behest of the Icelandic Ministry of finance. The Ministry has indicated it will use the report to prepare litigation for damages against the UK Government.

Although the sum of ISK5bn is not a trivial sum it dwarfs the potential cost that the collapse of the banks caused the Icelandic economy. A Norwegian comparison indicates that the cost might have equivalent to 18-40% of the Icelandic GDP, or ISK300-600bn. The question is who should be sued for these much more substantial damages to the Icelandic economy.

It’s clear from the SIC report and from the Ruv interview with Alistair Darling, at the time Chancellor of the Exchequer, that both the Chancellor and other UK public bodies felt they were not getting correct information on the state of the Icelandic banks. That is not to say that the Icelandic Government was misleading the UK authorities. The Icelandic banks did allegedly not provide a clear data on their positions.

Without placing any blame here, it’s well possible that if the Icelandic Government considers damage litigation the UK Government might evaluate its options. On the other hand, Icelandic issues, Icesave included, are of no burning importance in the UK Treasury. The political discussion between the two countries now mostly focuses on the prospects of an Icelandic EU membership.

With an increased insight into the collapse of the Icelandic banks it’s become clear that the banks’ financial position was already questionable in late 2007. The damages would have been less if the banks had collapsed earlier. How the messy collapse would have come about if the Brits had not stepped in, is unknown. However, any delays might have increased the cost. Seen from this angle, albeit possibly too flippant for some Icelanders, it could be argued that the UK action against Landsbanki and Kaupthing potentially lessened the cost to the Icelandic economy.

If the cost of the British action against Iceland can be estimated to be ISK5.2bn (the report points out the cost could range from ISK2-11bn but lands on 5.2bn as a likely sum), what about the cost of the collapse to the Icelandic economy? There is no direct data on this but an earlier Norwegian crisis is an indication. The Norwegian banking crisis was on a much smaller scale and was estimated to have cost the Norwegian economy around 13-22% of their GDP. Taking into consideration the scale of the Icelandic banking crisis, it can be argued that the cost to the Icelandic economy was 18-40% for Iceland, or ISK300-600bn.

If the Icelandic Government is considering litigation against the UK Government why isn’t it doing anything about the serious damages caused by the reckless banking causing the collapse of the banks? As far as I know, that’s not being looked into, not a simple case. However, the Office of the Special Prosecutor is investigating possible crimes related to the collapse, with a focus on recovering any funds obtained illegally.

But it is a greater surprise that the Icelandic pension funds, which suffered serious losses as the banks collapsed, haven’t taken a clear stance on the issue of possible damages and means to recover these damages by suing the banks’ managers and their major shareholders who also benefitted from the banks’ reckless lending.

The Icelandic pension funds, sitting on one of the best funded pension systems in the world, were very slow at admitting losses and slow at investigating their cost and connections with the bank. In the small Icelandic society, the personal relationship between bankers and pension funds were quite cosy. There is now an investigative commission, working at the behest of the Icelandic Pension Funds Association, but it’s report is delayed and isn’t expected until towards the end of the year or later.

Broadly speaking, the pension funds could investigate two things: on one hand, the advice the banks provided; on the other, the funds’ losses stemming from being shareholders in the banks, ie the losses the banks suffered by their managers’ ill-advised lending. In general, the banks advised the funds to hedge their foreign assets by being long on the ISK. Though there could have been a clear rational behind this advice it turned out to cause disastrous losses. The question is if everyone was receiving similar kind of advice or if losses were heaped on the funds because they were strong anyway.

The OSP had been investing a case related to a few pension funds, sent to it by the FME, for breach of the funds’ investment framework and incorrect FME reporting on their investment in 2008. This investigation has now been terminated with no charges brought. Other cases regarding damages is a case brought by Landsbanki’s Winding-Up Board against three of the bank’s managers for certain loans to its major shareholders just before the collapse of the bank, alleging the managers caused the bank a loss of ISK37bn.

The feeling in Iceland is still that thirty men or so, bank managers and the banks’ main shareholders, caused the collapse of the banks. For many Icelanders it’s a disturbing thought if this group, possibly causing losses of 18-44% of GDP, will be able to simply brush the dust of the collapse off their shoulders and carry on as if nothing did happen. The major shareholders still seem to be leading a good life, though somewhat scaled down compared to pre-collapse times.

Iceland has moved on after the collapse and can now positively seen to be doing better than badly hit countries in the eurozone like Ireland and Portugal, not to mention the Greek catastrophe. There might even be close to a 2% growth of GDP this year, though partly depending on external factor like the state of the European economy. But so long as Icelanders feel that this group of thirty could wreck the Icelandic economy and then walk away as if nothing had happened there is likely to be a latent and brewing discontent.

The feeling is that if those who grew their businesses because of access to favourable financing from friendly bankers are still in business it’s partly because they are still enjoying the old favours.

Follow me on Twitter for running updates.