Sigrún Davíðsdóttir's Icelog

Understanding constellations in Icelandic politics, not solely the economics, is the key in order to understand what could and might happen in Iceland regarding the capital controls. Although ex-prime minister Davíð Oddsson left office in 2004 he still seems to be the puppet master and king maker in Icelandic politics. Thus, Morgunblaðið, edited by Oddsson can be read like entrails in the olden times. Comparing the recent IMF report and what Morgunblaðið states provides some hints to what might come – and none of it is uplifting in view of general Icelandic interests.

On an Icelandic debate programme earlier this year one of the participants claimed that when it comes to the capital controls Icelanders are fighting to solve a problem of “hundreds of thousands of billions króna.” – None of the other participants corrected this. The Icelandic GDP 2013 was ISK1786bn, €11.5bn, which would make “hundreds of thousands of billions króna” a truly staggering, if not a hopeless problem to solve. Luckily, the problems are not quite that towering though in no way easy to deal with.

For control-watchers, reading Morgunblaðið like entrails, looking for hidden signs, is essential. A point in case is a recent article on Project Irminger.

Davíð Oddsson, its editor, used to run the country and his party, the Independence party in the 1990s, then switched over to run the CBI (needless to say a lawyer ex-prime minister turning governor of a central bank is unthinkable in all Western countries except Iceland) where he oversaw the collapse of the Icelandic economy and the CBI and from where he was ousted by public demonstrations in early 2009. As editor of Morgunblaðið he has overseen a steep fall in subscription but its owners – 50/50 a fishing-industry with Independence party ties and a Skagafjörður co-op traditionally linked to the Progressive party, thus miraculously mirroring the present coalition government – are more than happy to have him in charge, even after a recent gaff of staggering dimensions.*

The Morgunblaðið entrails and other signs could indicate that the lifting of the controls will be used to steer the two new banks – Arion and Íslandsbanki – into Icelandic ownership. And there needs to be something that looks like a victory for the Progressive-lead government. Prime minister Sigmundur Davíð Gunnlaugsson has time and again talked about the “inevitability” of the state profiting from lifting the controls.

While waiting for the next step towards lifting the capital controls appointing a new governor of the CBI will be a significant indication of the direction the government is heading into.

IMF: the orderly and the disorderly legal route

In its latest report on Iceland the IMF is worried about downward-tilted risks, i.a. in lifting or unwinding the capital controls: “A disorderly unwinding of capital controls could weaken the krona, lower reserves, and bring down market confidence and growth.” “An orderly lifting of capital controls, however, would prevent large capital outflows and disruptions to financial markets.” It is thus glaringly obvious what the IMF wants to avoid sternly warning the government of the dangers of actions leading to disruption and disorder. After all, Iceland very much needs continued access to financial markets.

Creditors cannot be paid out until the estates of the old banks are resolved, either by putting them up for bankruptcy or with a composition agreement. Here the IMF is also clear as to what constitutes an orderly route out of capital controls:

Two broad legal avenues are being discussed, one involving composition agreements that would provide an agreed roadmap for exit and the other involving bankruptcy proceedings (liquidation) with an uncertain exit from controls.

And then there is the reputational risk to keep in mind:

“Staff noted the importance of carefully considering the legal and reputational risks surrounding the strategy for addressing potential BOP pressures now locked in by capital controls, including the resolution of the old bank estates.” (My take on the IMF report is here.)

Project Irminger

The above-mentioned article in Morgunblaðið stated that the government kept the IMF thoroughly informed on every step. Consequently, the IMF was now aware of the government’s estimate of the problems and the avenues it believes passable. Further, according to the article, the IMF agrees with the government it is important not to exclude any possibilities; this was necessary in order to create incentives for creditors to bring to the table a solution fitting the Icelandic balance of payment.

Although the article was published weeks after the IMF report on Iceland the report does not figure in the Morgunblaðið article. On the contrary, the article creates the feeling that the IMF was equally in favour of the two legal routes and broadly in favour of what the government had in mind.

As can be seen from the quotes from the IMF report the Fund is indeed not mincing its words as to the best and most viable routes. Knowing from Morgunblaðið that the IMF is well informed there can be no misunderstanding when it i.a. clearly warns against the bankruptcy route that both the prime minister and minister of finance mention as an option every time they discuss publicly the capital controls and the estates.

The Morgunblaðið article states that the government is now working on a project called Project Irminger (named after an ocean stream that brings warm water to the South West coast of Iceland). The Irminger project seems to give no scope for negotiations with the creditors in spite of their attempts in that direction, at least since end of 2012 when both Glitnir and Kaupthing presented a draft of a composition agreement to the CBI.

Instead, possibly in September (unlikely soon, to my mind; every step announced by the government tends to take much longer than planned) according to the article, creditors will be presented with an analysis of Iceland’s economy, balance of payment etc after which they can adopt their composition agreement to this analysis. It does not seem there will be any negotiation but some sort of a “take-it-or-leave-it” analysis (more or less as the government has been saying from its birth last year: the creditors should understand and appropriately adapt to the reality, as defined by the government). The government will wait for no longer than three months or so and if nothing is forthcoming from the creditors the bankruptcy route will be taken, the article states.

The article is not clear about in what order things will be done. The CBI and the IMF have stressed the importance of resolving Glitnir and Kaupthing’s ISK assets and the Landsbanki bonds. The pension funds and other Icelandic investors are also seeking to direct investments abroad. The order of “exiting parties,” i.e. those allowed to take/convert ISK into fx is important. Whatever the order, the IMF has clearly indicated that the “exits” can only happen over some years and it favours letting the creditors out first; an advise that is easily turned into something anti-Icelandic in the Icelandic debate (see here on the interests of the pension funds in lifting the controls).

As so often with Morgunblaðið articles on hot political topics the Irminger-article seems to be a carefully crafted leak, published to warn, threat and mis-inform.

Rumours and sentiments as to what is in the making

Key issue in solving the ISK problem of Glitnir and Kaupthing is the sales of Íslandsbanki and Arion (more here). Some control-watchers claim that the government plans to instigate a disorderly and messy winding-up process for Glitnir and Kaupthing to ensure a fire sale of two new banks enabling a sale to investors close to the government (two banks, one for each party).

As to possible actions the ideas flying around are i.a. legal measures to isolate the estates from the economy so pension funds and other Icelandic entities can convert ISK to fx, i.a. for investing abroad, i.e. would exit from the controls before the estates. Again, such measures would not be a solution, only another hammock.

There are also tentative ideas that Eignasafn Seðlabanka Íslands, ESÍ (the CBI holding company) and some pension funds could form a joint venture to buy out the new banks. The fear is that none of this is thought through or creditors’ reactions taken into account; in short that these and other rumoured measure will not at all be the orderly route the IMF recommends.

The feeling all along has been that the aim of the government has been to get hold of the banks – to secure Icelandic ownership in Icelandic interest or in Icelandic special interests, depending whom to believe. Iceland is apparently the only country in Western Europe where no foreign banks operate and where domestic investors own all banks (apart from the accidental ownership of Arion and Íslandsbanki and foreign investors in MP Bank).

It is difficult to argue why it would be the end of Icelandic businesses if Glitnir and Kaupthing were sold to foreign investors, paying in fx – thus solving the estates’ ISK problems. Foreign ownership might possibly end banking the Icelandic way that played a big role in bringing down the Icelandic financial system but those who profited from that system might certainly want to reinstate it.

Glitnir and Kaupthing – but what about selling new Landsbankinn? Incidentally, that bank is owned by the Icelandic state but the bank cannot be sold until the problems of the Landsbanki bonds is solved. There is now an agreement in place and although it seems to be close to what the CBI had advised (and after all, it can hardly have been done against the wishes of the bank’s owner, the state) the government seems unwilling to take the steps needed to ensure the agreement. Intriguingly, new bank is at the mercy of its bondholder, the Landsbanki estate where the creditors from the two other estates wield power.

The frustrating thing is that possible solutions, in the general interest of Iceland and not narrow interests, are not that difficult to map out – complicated but not complex. There are even some Icelandic civil servants who would like to negotiate with the creditors, believing that beneficial solutions could be found relatively easily and fast: it is after all in the interests of not only creditors but also Icelanders to lift the controls though Icelandic politicians tend to speak as if Iceland can wait but the creditors are in a hurry.

Interestingly, civil servants have mostly been kept away from the plans of the present government, which instead makes use of a few trusted lieutenants. The government keeps appointing Icelandic “individual experts/advisers” as it calls them in press releases though then calling them a “group” when their role is discussed. It is not clear why this systematic mis-presentation of their roles but one reason might be that formal working groups are expected to be made up of men and women whereas the two capital controls “groups” have been all-male.

The importance of a(n independent) central bank

Lastly there is the importance of CBI in what ever will happen in Iceland, soonest regarding the Landsbanki bonds agreement.

In general, IMF is adamant about the importance of independent central banks. For good reasons, the IMF has been worried about the CBI and states in its last report on Iceland: “Maintaining a financially sound, independent, and accountable central bank is important for policy credibility and anchoring inflation expectations, which in turn supports stability and growth.”

It is most likely only a matter of days until the name of the next governor will be announced. As I have written earlier the feeling is that professor Ragnar Árnason is the government’s favourite for the position though the third leading candidate, professor Friðrik Már Baldursson might be a possible compromise. It would be a stretch to see CBI’s independence strengthened with Árnason who most recently has i.a. been the government’s representative on the CBI board and the chairman of an advisory council for the minister of finance, in addition to earlier services to the Independence party for more than a decade.

In addition to the present governor Már Guðmundsson the selection committee , which was called “bizarre” in a recent article in Central Banking, deems that both Árnason and professor Friðrik Már Baldursson are equally fit to serve as a governor. To put the three side by side as equally fit is quite remarkable, to say the very least, considering Guðmundsson’s experience and standing.

The governor of the CBI will be a key person when it comes to lifting the capital controls – and in the asset sale of the century, the sales of Arion and Íslandsbanki. Hardly anything re the capital controls and the estates can be decided on without assistance of the CBI, most notably the governor of the CBI.

If Már Guðmundsson will not be reappointed as a governor it sets in jeopardy any orderly route towards lifting the capital controls. Ousting Guðmundsson might well indicate that there are interesting times ahead in Iceland but not necessarily the best of times for financial stability and the interests of Iceland as a whole.

*The Oddsson/Morgunblaðið gaff: recently, Morgunblaðið published, in quotation marks, what it claimed was part of an email written by the Althingi Ombudsman Tryggvi Gunnarsson who was on the Special Investigative Commission. The email was published July 12 in a weekly column, called “Letter from Reykjavík,” traditionally unsigned but known to be written by the editor, now Davíð Oddsson. Morgunblaðið claimed Gunnarsson had sent the mail to many news outlets in January late at night, a claim Icelanders take as a hint that the email-writer was drunk. In the email Gunnarsson sided with the Brits (highly dubious in the view of Morgunblaðið) in using the so-called terrorism legislation to freeze Icelandic assets in the UK. Further, Gunnarsson spoke badly of the president of Iceland, who Morgunblaðið holds in high esteem after he hindered an agreement in the Icesave dispute. On the day Morgunblaðið published the Tryggvason email the paper published a correction on its website, stating that the email was a forgery only to admit later in the day, with apologies to the Ombudsman, that the letter was indeed written by a certain Tryggvi Gunnarsson, namesake of the Ombudsman and not the Ombudsman. The namesake is apparently known among Icelandic media people as a prolific email writer whose opinions are never reported; his email is a Hotmail address. There was absolutely nothing in the email to indicate that the Ombudsman had written it. The second, and no less interesting part of the “Tryggvason email” story is that the editor’s atrocious mistake has had no consequence for the editor who continues in his job, unchallenged as before. The gaff was like a stone thrown into a lake producing no rings on the surface; an airy phenomenon. – Journalist Egill Helgason notes on his blog that Oddsson is driven by such hatred that in attacking his enemies scrutiny of sources is easily forgotten. – The last thing to draw attention to Oddsson’s view of the world is that Morgunblaðið’s Letter from Reykjavík July 26 talks about “Barack Hussein Obama II,” characterizing him as “indeed a mulatto,” a word that is generally no longer used in Icelandic and has the same connotations as in English.

Follow me on Twitter for running updates.