Sigrún Davíðsdóttir's Icelog

Although it’s tempting to think of the trial of ex-PM Geir Haarde as a national katharsis and a truth commission that’s not the case at all. There is one person on trial and that’s Geir Haarde. The witnesses throw their own light on facts and events and it’s of great interest to hear the different versions of events. Even though much of it is already known from the SIC report it’s interesting to hear the different persons recount different things. As is in the nature of the whole exercise, prosecutor Sigridur Fridjonsdottir uses the questioning to fill in and clarify documents, which have been collected.

The charges against Haarde are the following:*

1 A serious omission to fulfil the duties of a prime minister facing a serious danger

2 Omitting to take the initiative to do a comprehensive analysis of the risk faced by the state due to danger of a financial shock

3 Omitting to ensure that the work of a governmental consultative group on financial stability led to results

4 Omitting to guarantee that the size of the Icelandic banking system would be reduced

5 For not following up on moving the Landsbanki UK Icesave accounts into a subsidiary

The five charges against Haarde do steer the questioning but a whole range of issues has been touched upon.

During his day in court, Haarde underlined that by 2008 there was nothing that he as a PM could have done to prevent the collapse of the three banks – Glitnir, Landsbanki and Kaupthing. Any necessary measures would have taken too long – selling assets would for example have been impossible at the time – and he would hardly have had the support of Althing. The main point was also, said Haarde, how far the state should go to save private companies. Ia it transpired from Haarde’s testimony that the FSA was more reluctant to accept Icesave than has been thought earlier.

As is clear from the SIC report Minister of Banking at the time Bjorgvin Sigurdsson (soc.dem.) didn’t seem to have much understanding of what was going on in the banks and his co-ministers seem not to have trusted him. His testimony indicated much the same.

Arnor Sighvatsson was the chief economist at the CBI at the time. He said that already in 2005 – two years after the privatisation of Landsbanki and Bunadarbanki ended – the banks were facing problems and their CDS were rising. In hindsight, Sighvatsson said, already at that time there were some danger signals though only later did it become clear how poor the assets of the banks were and that they were financing the acquisition of their own shares.

Sighvatsson wasn’t aware of Icesave opening in the Nethelands (in May 2008) until later. At this time, said Sighvatsson, there was nothing the CBI could do. The FME should have acted on Icesave at the beginning. Deposits are a standard solution to lack of liquidity – the banks, met with suspicion already in 2005, lacked liquidity and Landsbanki turned to Icesave.

The prosecutor asked if Sighvatsson thought Landsbanki should have been required to put Icesave into a subsidiary. His answer was that since Icesave was set up to solve a liquidity problem and the lack of foreign liquidity putting Icesave in a UK subsidiary wouldn’t have solved the bank’s problem.

Lack of liquidity is like a heart attack, he explained, whereas lack of own capital is like cancer. In the end, a terminally ill cancer patient got a heart attack. People were hoping the liquidity problem would pass – now, said Sighvatsson, it’s clear there was never any of hope of that. If the state had lent to the banks, Iceland’s sovereign debt would be close to Italy’s.

Sighvatsson thinks that from the beginning the Icelandic banks were met with great suspicion abroad. In 2005, he attended at meeting with bankers from Barclays who already then were rattled by the rapid growth of the Icelandic banks and their lack of transparency. At the time, neither he nor Barclays knew of the poor quality of the banks’ assets. This suspicion eventually led to European banks stopping all lending to the Icelandic banks in 2006 but the banks saved themselves by borrowing from US banks.

Interestingly, said Sighvatsson, the banks didn’t seem to worry that their CDS shot up. They didn’t seem to care about the rates they had to pay on their loans.

Would asset sales have solved the problem in 2008? No, Sighvatsson thought that was out of the question. If the banks had sold their best assets they would have been left with only junk. Any buyers would also have conducted due diligence – and that would have thrown light on various things, Sighvatsson said.

No matter what, the banks were doomed and they had much better rating than they deserved – yet another indication of the colossal failure of the rating agencies.

In Iceland, David Oddsson widely seen as one of the main culprits in the collapse of the banks – as a PM in the 90s he led the privatisation of the banking system and shaped the political climate at the time. A climate both favourable to and uncritical of the banks. And he was a Governor of the CBI in the critical time from 2005-2009.

The thrust of his testimony was that he had been very worried for a long time but his views had not been appreciated within the bank. – This is interesting, considering how worried and critical Sighvatsson evidently was. It’s been said that Oddsson was isolated within the CBI, not necessarily because of his views but because he wasn’t an economist and didn’t know how to steer this machine that a central bank is.

He himself underlined that he wasn’t the only governor – there were three – but says that by 2007 his colleagues agreed with him. Anyone used to reading central bank reports, he said, should have seen that the CBI was issuing warnings. Oddsson said that for a long time he didn’t believe the infrastructure of the banks was weak. After all, their accounts were signed by the banks’ managers and the leading auditing firms. There didn’t seem to be any reason to distrust them.

An insight into little Iceland: Oddsson said that after he stepped down as a PM there were fewer meetings between the PM and the CBI governor. There was less formality because Haarde and Oddsson had known each other since they were kids.

Oddsson said that the crisis in 2006 had been a close call – the PM at the time Halldor Asgrimsson had called him one weekend, telling him that the banks would all fail the following Monday. That’s what the CEOs themselves thought, said Oddsson. But the banks did survive in the end. This had taught Oddsson that things might be a lot more precarious than they appeared and move swiftly.

Oddsson said that Ingibjorg Solrun Gisladottir leader of the Social democrats and Minister of Foreign Affairs had suggested the state should lend €30-40bn to the banks. That would have killed the Icelandic state, said Oddsson. – As far as I know, this is news; Gisladottir will be a witness later and must address this point since it won’t do her political legacy much good.

Following the acute 2006 crisis the CBI tightened its liquidity control and posed serious questions to the FME regarding the cross-ownership and cross-lending of the banks. Not until the collapse of Glitnir was it clear how loosely the FME defined “related party,” the banks’ lending beyond legal limits to their biggest shareholders and how the banks were lending each other. Oddsson says he never hid his opinion that the FME was much too weak to put up any fight with the banks.

Oddsson is a known humorist. It caused some laughter when he pointed out that Landsbanki didn’t define the bank’s largest shareholders, the father-and-son duo Bjorgolfur Gudmundsson and Bjorgolfur Thor Bjorgolfsson, as “related parties” – and that he had once asked Gudmundsson’s wife is she didn’t find this embarrassing.

In February 2008 Oddsson had met abroad with foreign bankers and rating agencies, which made him very alarmed over the situation in Iceland. Back home he tried to communicate this anxiety but realises in hindsight that the banks were already beyond salvation and there wasn’t much the Government could have done. Though the banks were complaining that they could only borrowed in ISK it later transpired that by getting loans from the ECB their euro loans were indeed higher than their ISK loans. These were smart men, Oddsson said.

Asked about a letter from Mervy King in spring 2008 where King refused a currency swap but offered some help – Haarde said on Monday that the offer from King was never refused; it just wasn’t reacted on in Iceland – Oddsson said that this offer had just been a bit of “nicety.” The main thing was the refusal of doing a swap.

It seems clear both from Oddsson and Sighvatsson’s testimonies that not even at the beginning of Icesave, in autumn 2006, did Landsbanki have the assets to back up Icesave in a UK subsidiary. Much less was this possible in 2008. Landsbanki complained bitterly over the FSA demands. Oddsson said that Landsbanki Iceland clearly didn’t have assets that would have satisfied the FSA and even if it did, the transfer would have weakened the bank in Iceland.

Jon Th Sigurgeirsson, who became head of the Office of the board of Governors at the CBI in April 2008, said that already in November 2005 it was clear where the Icelandic banks were heading because he heard that foreign banks were ready to short-sell Icelandic bank shares. He also pointed out that it’s incredible how renowned auditors could sign the audit of the banks.

In a few words: The above is just a much digested version but it’s clear that the real problem of the Icelandic banks wasn’t lack of liquidity – they were short of capital. They had massively eroded their own capital by lending to buy shares in themselves. This didn’t start in 2008 as a way to save the banks – this tendency had started earlier. The feeble standing of the Icelandic banks is an indictment over those foreign banks that lent them money, the rating companies and the auditing companies.

It seems that from the beginning Landsbanki didn’t have the assets to back up Icesave in a UK subsidiary. The FSA wasn’t tough enough in dealing with Landsbanki. The Icelandic FME was of the opinion that it couldn’t stop the accounts. It’s absolutely incredible that the Dutch FSA allowed Landsbanki to open Icesave in the Netherlands in May 2008. It can’t hid behind EU rules – certainly, the EU passport rules can’t set a lower limit than the home banks have to follow (I understand that these rules have now been changed).

By 2008 the banks couldn’t be saved – but the question is why they were allowed to become so big, relative to the Icelandic economy, considering how weak they were already in 2006. It’s not unique in a country that the banks are beyond and above the political power but it’s unique that the banks, which had demonstrated their weaknesses early on, were still allowed to grow so wildly.

Oddsson was sure that the Icelandic Deposit Guarantee Scheme didn’t apply to Icesave. Others have been less clear on it – but even though many understood the implication for the Icelandic economy, no one seems to have done anything to clarify how these matters stood.

*Revised from an earlier blog.

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