Sigrún Davíðsdóttir's Icelog

There is yet no clear plan in sight as to how to deal with the estates of the failed banks and, eventually, lifting the capital controls in Iceland. However, the fact that the government has declared it intends to use a given “wind-fall” from the estates indicates that there is a certain wish(ful thinking). The question is how this “wish” will materialise – and most of all, if the creditors will stage some counteraction, either as a group or single creditors, to seek to claim their foreign assets in foreign courts.

“I hope to see you and your money! in Iceland,” said prime minister Sigmundur Davíð Gunnlaugsson at the end of his speech at “Iceland Investment Forum” in London September 19. His words were met with laughter, more nervous than merry. Many of those present are creditors to the Icelandic banks, possibly not eager to invest more in Iceland until the fate of their last investment is clear.

In his speech the prime minister sought to stress that Iceland was keen to receive foreign investors in Iceland. “My government understands that vibrant business and industry is the basis of growth and welfare. We, therefore, welcome investments in Iceland and are willing to create an environment that is conducive to your needs as investors.”

Interestingly, last Saturday the prime minister said on Rúv that Iceland was not necessarily in need of foreign investments. Although foreign investment might in some cases bring the added value of knowledge, it was essentially a foreign loan; foreign investors just intended to get more out of their investments than they put into it. – An interesting insight into the PM’s business acumen.

In his London speech the prime minister did air his so oft repeated statements of the “leeway” in the estates of the fallen banks:

This brings me to my fourth point, namely the necessary settlement of debts of failed financial undertakings and assets of insolvent estates. My government intends to take advantage of the leeway, which inevitably will develop in tandem with the settlement of the insolvent estates, to address the needs of borrowers and persons who placed their savings in their homes. I have described this as a win-win situation as these settlements will allow us to lift the capital controls to the benefit of the creditors and borrowers alike.

The intriguing question for creditors is what this means for their recovery.

Spending time in Iceland recently I sought to gather impressions on a possible plan regarding the estates. My feeling is that this win-win situation will mostly apply to the government. For the creditors it might be more lose-lose in terms of their Icelandic assets though everyone with interests in Iceland will eventually win-win by having the capital controls lifted.

No doubt the creditors are aware of this – and might be contemplating their next move. In total, the claims against the three estates run to ISK7836, €47.6bn. The three estates hold ISK2750bn, €16.7bn. The difference is what the creditors have already lost.

So far, the estates’ foreign assets amount to ISK1793 bn, €11bn (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii). Of this sum, 57% is liquid funds. Although these are foreign assets, to a large extent held abroad and do not threaten the financial stability of Iceland, the CBI has not allowed them to be paid out, thus securing that Icelandic authorities keep an upper hand in the wrangle over the estates.

The Icelandic upper hand could however quickly turn limp if the foreign creditors, either as a group or single creditors, would choose to test their luck abroad. The fact that the government has only yesterday levied tax on the estates, could possibly instigate legal action, in this case from the estates themselves.

Below, I will try to go through issues related to the capital controls as things stand now. The topics of interest are the Landsbanki bonds, a recent Supreme Court ruling in Iceland regarding old Landsbanki, LBI, guesses as to what the government might be contemplating and what the creditors might be contemplating.

The reality behind the Landsbanki bonds

The three failed banks – Kaupthing, Glitnir and Landsbanki – were, each of them, split in two parts. Not bad and good bank, as might have been logical, but into an domestic operating bank, overtaking domestic, i.e. Icelandic, deposits and other domestic assets and liabilities and then an estate holding foreign deposits and other foreign assets and liabilities. Thus there are the three estates – LBI, Glitnir and Kaupthing – and respectively the new operating banks, Landsbankinn, Íslandsbanki and Arion Bank. The two latter are owned by the estates, i.e. the largest assets of the tow old banks are the two new banks whereas the state owns Landsbankinn.

Because of Icesave – the Landsbanki internet accounts set up in the UK and the Netherlands 2006 and 2008 – the main creditors of LBI are the deposit guarantee schemes of these two countries, both with priority claims. To some degree there is an overlap between the general creditors of the three banks. Around half of the creditors are the original bondholders; the rest has bought claims on the secondary market.

Due to uncertainties regarding Landsbanki assets, the new bank, Landsbankinn, eventually issued two bonds to LBI, to be paid in 2014-2018, mostly in foreign currency. It has been clear for a while that the scheduled repayments are too steep for the economy, i.e. LBI does not holds enough foreign currency to cover the repayment and there is not enough left on the current account for it to buy from the CBI.

The payment schedule is: 2014 ISK17bn, €100m, then ISK60-74bn, €360-450m, the next three years, having then paid the bonds in full 2018. It is disputed how much is needed. The numbers flying around have ranged from ISK50bn, €300m to 200bn, €1.21bn. This does not mean the new bank doesn’t have the funds to pay. It does, but not in foreign currency.

Under normal circumstances, a bank never pays up all its debt in full but refinances. As things are now, that is not a realistic option for any Icelandic financial firm – Icelandic financial companies do not have access to sustainable funding. That could change but for the time being the option is not there.

The Landsbanki bonds, its stakeholders and a step towards abolishing capital controls

After some wrangling between Landsbankinn and LBI, echoing in the Icelandic press this summer, the two entities have now entered into negotiations “on possible adjustments” to earlier settlement regarding the bonds (press release here).

The outcome will be interesting for several reasons: it will remove a certain threat, explained above, to Landsbankinn and its owner, the Icelandic state; it will indicate positions of those negotiating the bonds – and it is a first big step, regarding the estates, towards abolishing the capital controls. The numbers at stake here are considerable: the expected recovery of LBI is now ISK1531bn, €9.29bn with priority claims at ISK1325, €8.04bn. This leaves ISK206bn, €1.25bn, for general claims.

The management of Landsbankinn seems to have felt that LBI was not being very forthcoming in negotiating. On the LBI side the priority creditors, essentially the Dutch and the British governments, certainly have a lot to say on this issue.

The Dutch and the British governments stand to recover their Icesave compensations, i.e. minimum compensation of €20.000 for each depositor. They have already recovered 53.9% of what they expect to get, paid out in three instalments. However, it makes quite some difference to them if they recover everything by 2018 or have to wait considerably longer.

From what I understand there is still some pent-up Icesave irritation among the Dutch and the British negotiators. But the general creditors have also been vocal on rescheduling. Although they stand to get “only” ISK206bn, this is money as well. But since general claims are not paid out until priority claims have been paid out in full, any extension of the Landsbanki bonds will mean that their waiting is prolonged.

The CBI views the rescheduling as the first firm step towards abolition of the capital controls. Many of the general creditors are also creditors to the two other banks, making the Landsbanki bond negotiation interesting in terms of issues that need to be settled re the two other estates. The Landsbanki negotiations can thus be seen as a dress rehearsal for the full performances to come.

Landsbanki bonds – possible solutions

It is clear to everyone involved that the Landsbanki bonds need to be extended. The prospect of the Icelandic economy will be debated, in terms of what could possibly be set aside of foreign currency towards bond payments but also to what extent Landsbankinn could possibly refinance its debt. All of these issues will be mulled over by those negotiating the rescheduling, in addition the more specific terms and conditions of the bonds themselves.

In Iceland, it has officially be mentioned that the rescheduling needs to be “a few years” but that seems far too optimistic. Ten or 15 years seems a more reasonable number. As it is now, the interest rates are low, which means that interest rates will no doubt be negotiated.

Landsbankinn and its owner, the state, are obviously unwilling to see the bank fail. With the bonds being a sizeable chunk of the LBI assets, its creditors are no doubt adamant to secure that the bonds get paid – if not on time then in the foreseeable future.

It is however very difficult to imagine that LBI will agree to any extension unless the creditors get something substantial in return. The intriguing question is what this “substantial” could be. An obvious bit would be a substantial up-front payment. Steinþór Pálsson CEO of Landsbankinn has already mentioned (in Icelandic) a sum of ISK70bn, €420m.

Another – and a truly interesting “substantial” – would be for the LBI to get a permission from the CBI (which has to agree to all payments) to pay out all the foreign assets of the LBI. The reason this is so interesting is that so far, none of the estates have paid out any of the foreign assets, although they, as pointed out above, to not threaten financial stability in Iceland.

At a meeting in London September 26 possible solutions were introduced. It is a pure guess as to what exactly has been offered to the LBI but it is difficult to imagine that the creditors will not try to use their bargaining position to get their foreign assets paid out.

And it is also clear, that the prime minister and Bjarni Benediktsson minister of finance, representing Landsbankinn’s owner, will need to accept whatever solution is negotiated. It must be equally likely that only a solution that the owner accepts a priori will be seriously discussed.

The two tales of a Supreme Court judgment re LBI

September 24, the Icelandic Supreme Court ruled in a case (553/2013) brought by creditors of LBI, both priory and general claimants and the Icelandic state against the LBI. The case centred on how partial payments in foreign currency should be calculated, i.e. what ISK exchange rate should be used. The LBI had used the exchange rate on April 22 2009, the date when the winding-up proceeding commenced. The Reykjavík District Court had originally ruled in favour of LBI but the Supreme Court reversed that ruling.

This case has been interpreted in two distinctly different ways in Iceland, basically spinning two different tales.

The first one is a low-key tale: this ruling brings no fundamental changes. It points out, what was already known, that once the winding-up proceedings starts the assets in an estate holding foreign assets are converted into ISK, for accounting purposes. An estate can – but does not need to – pay out in foreign currency. The exchange rate for payment in foreign currency should be the rate on the day of the payment. This is how several lawyers have interpreted the ruling in the Icelandic media.

The other interpretation is a more sensational tale, so far mostly heard from politicians, i.a. the minister of finance: this ruling is a fundamental confirmation that the estates are in ISK and should only pay out in ISK.

It is interesting that both creditors and the Icelandic state supported the conclusion of the Supreme Court. The motive behind the state’s view is a remnant from the Icesave case where it held the view that the exchange rate on payment day should be used, hoping in due course to gain from ISK appreciation, as a set-off against the interest rates.

Is paying out the estates in ISK the way out of the ISK dilemma?

As mentioned above, the three estates hold ISK2750bn, €16.7bn, of which 2/3, ISK1800bn, €11bn is in foreign assets and 1/3 is ISK assets. This 1/3 is part of the problem that the capital controls keep at bay: there is not, and will not be in the foreseeable future, enough foreign currency to convert these (and some others) ISK assets, owned by foreigners. This problem is further crystallised by the fact that 5% of the claims are domestic, 95% foreign whereas 33% of the assets are domestic, 67% foreign (Central Banki of Iceland, CBI Financial Stability 1, 2013, chapter viii).

Listening to politicians following the Supreme Court judgment, it sounds as if paying out all of the assets of the estates in ISK, the total ISK2750bn, would be the solution to the ISK problem. A priori, as seen from the numbers above, paying all out in ISK can hardly be a solution to anything but only make a huge problem utterly humungous.

Unless, of course, something else is done as well, such as offering the creditors, now holding nothing but ISK, a certain exchange rate in order to exchange their Hvannadalshnjúkur (the highest summit in Iceland) of ISK into foreign currency, with the government then having found its frequently mentioned “leeway” there. More on that below.

As an Icelandic lawyer (not working for the creditors) said recently: “If Iceland wants to remain on good terms with the outer world the estates will be allowed to pay out their foreign assets in the foreign currency they own,” meaning that the ISK problem needs to be solved separately.

Glitnir, Kaupthing and composition

Glitnir and Kaupthing have both applied for an exemption from the capital controls, under the Foreign Exchange Act No. 87/1992 in order to proceed with composition. In this respect, composition means that the estates will be run as holding companies, working on recovering and realising assets on behalf of creditors and eventually paying out the funds recovered.

From the point of view of creditors this process is preferable to bankruptcy proceedings because a bankrupt estate needs to sell off assets in a shorter time. One of the comments heard in Iceland after the LBI ruling was that bankruptcy would allow for all assets to be paid out in ISK. This is however wrong. There is no difference as to payment between composition or bankruptcy.

Both Glitnir and Kaupthing sent an application for composition to the CBI before end of last year. CBI has not answered but following a query this summer from Glitnir, the CBI has now answered Glitnir in a letter September 23. The bank emphasises that analysis of the situation of the Glitnir estate is on-going, both within the bank and the estate.

Although a detailed analysis is not yet complete, it is clear that the Central Bank of Iceland cannot give a positive answer to the Glitnir winding-up committee’s exemption request without a solution concerning the assets that, other things being equal, will have a negative effect on Iceland’s balance of payments when they are disbursed to creditors, 93.8% of whom are non-residents, as is stated in Central Bank of Iceland Special Publication no. 9. Reference is made here to the classification of creditors, to Glitnir hf.’s króna assets (including shares in Íslandsbanki), and foreign-denominated claims against domestic parties. In order for the Central Bank to be able to grant an exemption for the above-mentioned composition agreement, there must be a solution concerning these assets, so that Iceland’s balance of payments and planned capital account liberalisation provide scope for disbursement to foreign creditors. It is important to emphasise that this is not a matter for negotiation. Either this condition is fulfilled, or it is not. Glitnir’s exemption request does not fulfil this condition at present.

In view of the foregoing, the Central Bank considers that there are no premises for setting up a process of the type proposed in the winding- up committee’s letter, and certainly not one subject to binding time limits. It is the role of the Glitnir hf. winding-up committee, in connection with its exemption request, to create the conditions that allow for the approval of an application for a composition agreement. As before, the Central Bank of Iceland is prepared to assess whether it is likely that specified options fulfil the above-mentioned conditions. If the Glitnir hf. winding-up committee has developed ideas of this type, as is asserted in its letter, the Bank is ready and willing to discuss them.

This letter indicates that the estate – and this would assumedly apply to Kaupthing as well – will need to come up with a solution on the ISK assets. The CBI is not going to negotiate though it seems to indicate willingness to engage in assessing if conditions are met or not.

Creative taxing: taxing estates of financial companies

The first action taken by the new coalition government, in power since May, regarding the estates of the fallen banks is a tax on the estates of failed financial companies, announced October 1 in the budget proposal for 2014. Bank tax will be increased from 0.041% to 0.145%, levied on all licensed financial companies, operating or in winding-up proceedings.

At first sight, this might seem to indicate all financial companies in winding-up proceedings, i.e. the three estates but also other failed financial companies such as Saga Capital, VBS, Icebank and some saving societies. However, according to the FME (Icelandic FSA) website over licensed financial companies there is only one such licensed company, now in winding-up proceedings, LBI. The other failed financial companies have all lost their licensed status and are mere holding companies.

The idea was hardly to tax only LBI but as the proposal stands, the tax apparently only hits LBI. If the tax should cover the other estates the proposal, as far as can be seen, needs to be rewritten or clarified along the lines of “companies, which were once licenced/licensed before/after anno XXX as financial companies…”

Taxing estates is, I’m told, normally not done and has, to my knowledge, never been the practice in Iceland, anymore than in other countries. Lawyers have mentioned that a tax on failed companies could be seen as an expropriation. The ministry of finance has definitely shown remarkable creativity here.*

What the government wants – all of the ISK assets and/or even more?

It is safe to conclude that the Progressive Party was voted to power on the basis of its election promises of finding a “leeway” in the estates of the collapsed banks in order to provide what the prime minister has called the most extensive debt-relief in the world. He has been unwilling to mention any numbers but one persistent number is ISK300bn, €1.8bn.

The debt-relief has been widely criticised, i.a. because of inflationary effects, by economists. It also goes against promises of the Independence Party of a sustainable fiscal policy and paying down public debt.

The government and some businessmen have been pointing out lately that it is wrong to portray the problem of capital controls as touching solely creditors locked in with their assets in Iceland. All Icelanders are locked in. Consequently, drastic moves are needed to abolish the controls.

It now seems that one of the solutions possibly contemplated by the government is to “take over” all the ISK assets and possibly some of the foreign assets – though how this would be possible is still unclear. The motive for this drastic move is that the Icelandic current account will not, for the many coming years, allow for any foreign currency to be used to convert ISK assets of foreign creditors.

Those who propose this “take over” seem to feel that the “ISK-isation” of the estates, i.e. regarding all the assets as ISK assets and paying them out in ISK, is an essential move. Writing the assets down via the exchange into foreign currency would then be one possible way of achieving this “take over.”

Although – as far as I can see – creating quite a number of problems, this would however solve two fundamental problems for the coalition government: it would provide the Progressive Party with the ISK300bn, or whatever it will decide is needed for the debt relief – and it will placate those within the Independence Party who think that “estate-windfall” should benefit Icelanders in paying down public debt.

From the numbers above, it is possible to guess at the numbers involved: all the ISK debt is about 1/3 of the estates, ISK950bn, €5.76bn, meaning there would be something like ISK650, €3.94bn, out of this process, a third of Icelandic GDP, to pay down public debt. Given that the Icelandic public debt to GDP is forecasted to be just below 100% of GDP this year, this sum would reduce the debt by a third.

Will the government proceed with these ideas? Time will tell. Relevant ministries and the CBI all have legal opinions at hand, underlining Icelandic law on property right, the importance of keeping all actions within Icelandic law etc. But if the wishful thinking becomes so strong, fuelled by little sympathy for foreign creditors, one never knows. All solutions can be made pretty in an excel document – but to turn them into something that withstands legal challenges and doesn’t just solve the problem like warming one’s toes by peeing in the shoe is quite another matter.

What the creditors could do

Five years from the collapse in Iceland, the capital controls are still in place and the foreign creditors have not yet received any of their assets, apart from the priority creditors to Landsbanki. The priority claimants to Kaupthing and Glitnir have already been paid out, respectively ISK130, €790m and ISK54bn, €330m.

Faced with the possibility that their assets will now be gnawed into by tax, it is seems likely that the estates will take a legal action to challenge the new taxation.

It has taken some years to clarify various legal issues. From the point of view of the foreign creditors, the cash part of the foreign assets – ISK1029bn, €6.24bn, of the ISK1793bn, €10.88bn or 57% – is just waiting there to be paid out.

However, that is not happening as long as the fate of the ISK assets has not been settled. And after a change in the foreign currency law in March 2012, the CBI has to agree to, give exemption to, all payments of the estates.

The bondholders and other creditors may eventually lose patients and sell their claims. In Iceland, much is made of the huge profits made by creditors. That is somewhat misleading. The bondholders have already incurred huge losses though large institutions have no doubt sought shelter behind CDS. Depending on when the buyers in the secondary bought some of them will profit handsomely.

Invariably when creditors lose hope and patience claims get sold and the buyers are those who specialise in difficult assets. These creditors use the courts as much as they can. From small creditors in the Icelandic banks I have heard that there is no lack of suitors from this pack.

It is difficult to avoid the thought that at some point the creditors might lose patience – either as a group or single creditors – and seek legal action against the Icelandic state. That would then most likely start with proceedings where the foreign assets are, to get the assets frozen, after which the creditors would try to prove that they have been waiting needlessly long and nothing is being done to solve the issues.

The Icelandic government has, until earlier this year, not been party to the fate of the estates. With a change in the foreign currency law (nr. 87/1992), the minister of finance and minister of banking have to agree to CBI exemption regarding companies with a larger balance sheet than ISK400bn, €2.42bn, which includes the estates.

This might prove to be a double-edged sword in the sense that the government now risks to be sued because of the estates of the collapsed banks.

The creditors are much vilified in the Icelandic debate, seen as vultures and predators and no politician mentions them without these words. It is ironic that now on the fifth anniversary of the collapse there are again foreigners to blame, thus clouding the fact that the creditors are there as a result of actions taken by a group of ca. thirty Icelanders.

There is much at stake for the creditors, as there is for everyone who stands to gain from the abolition of the capital controls. But those who can gain most from a successful abolition – and consequently stand to lose most from mishaps and delays – are Icelanders themselves. Hopefully, all those involved will recognise this and have the good sense to seek constructive solutions. As an economist said recently: “Capital controls are a slow death.”

*At a closer look, the three estates – of Kaupthing, Landsbanki and Glitnir – are named in the budget proposal (the budget proposal, in Icelandic). As mentioned above, there are other estates of failed financial companies in Iceland but apart from size, the real difference between these other estates and the three big estates is that in the small ones most of the creditors are Icelandic whereas the creditors to the three big ones are 93% foreign entities. – The text seems ambiguous and will most likely be clarified at some later stage.

These are all complicated issues. I hope I haven’t made mistakes, will correct them if found. However, I hope Icelog readers do check the sources if needed.

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Again and again prime minister Sigmundur Davíð Gunnlaugsson has been asked about his exact plans for the abolition of the capital controls. But so far, it is entirely unclear how the government plans to proceed on debt relief, the estates of Glitnir and Kaupthing, the issues concerning Landsbanki and ultimately the abolition of the capital controls. There are by now some indications that the two coalition parties find it difficult to advance on these issues because the two parties disagree much more fundamentally than has appeared hitherto.

During the election campaign Sigmundur Davíð Gunnlaugsson leader of the Progressive Party and now prime minister said there was scope to get a considerable sum of money out of the estates of Glitnir and Kaupthing. These funds were to be used for a “correction fund” to finance debt relief for those whose loans had gone up but who had not profited from the extensive debt relief, the so-called 110% way (explained here), put in place by the previous government.

The voters seemed untroubled by the fact that the Progressive Party never clarified in detail how exactly this considerable sum could be extracted from the estates, which after all are the estates of two failed private banks. The fact that the government needs to agreed to terms of the composition of these two banks – due to the foreign-owned ISK assets (not enough foreign currency to exchange the ISK assets) – has been presented by the Progressive Party as a way to create this, in Progressive-speak, “scope” to gain funds.

In the coalition agreement the following (in my translation) is stated:

As indexed debt increased and asset prices fell, i.a. because of the effect of the collapse of financial firms and because of their appetite for risk leading up to the collapse, it is right to use the scope – which will most likely be created parallel to the winding down of the estates (of the collapsed banks) – to assist borrowers and those who put their savings towards their homes, just like the Emergency Law (passed on October 6 2008) secured that the assets of the estates were put to use to defend financial assets and to resurrect domestic banking. The Government keeps open the possibility to set up a special correction fund to reach it goals.

This was neither elegant nor clear (the clunky prose reflects the Icelandic original). Then came the opening speech of the prime minister as Althing gathered in early summer but the speech threw no light on how this “scope” would be created.

Last week, the prime minister was interviewed on Rúv’s morning programme where the two journalists asked the prime minister if he could clarify what people could expect in terms of debt-relief, the funding of the “correction fund” and how the estates would be treated. The prime minister said he now was much more optimistic than earlier, the “scope” was much greater than he had expected but unfortunately he did not share with listeners what his exact plans are. He did say that he had by now talked about these issues so often that it should be clear what he had in mind but as the journalists pointed out it is still not clear because it has never be clarified.

Yesterday, Althing gathered again after the summer recess. In his speech (in Icelandic) there was one sentence on the capital controls (my translation):

New plan on the abolition of the capital controls is forthcoming. A special consideration will be given to minimising the possible negative influence of the winding-up of the collapsed banks and to strengthening the framework of the financial system, which is one of the prerequisites of a successful abolition of the controls.

Tonight, the prime minister was interviewed on Rúv and yet again he was asked about the by now usual topics: the “correction fund,” the capital controls and what people could be expect in terms of debt relief. Again, no clarity, no detail but the prime minister said one rather remarkable thing: if people wanted to understand better what to expect they could calculate it from the coalition agreement. – Having read the agreement back and forth, I can’t possibly find anything in the agreement that gives any clear indication as to what people can expect. (I have sent an email to the prime minister’s spokesman asking what part of the agreement the prime minister is referring to and how that part can be used in the way the prime minister indicates.)

Clear what the creditors want – unclear what the government wants

During the election campaign earlier this year Bjarni Benediktsson leader of the Independence Party and now minister of finance repeatedly said that abolishing the capital controls was easy and would not take long. That might be true if there were a plan in place to abolish them. That plan does not seem to exist – or at least, nothing credible has been heard of it.

The Central Bank of Iceland has clearly done extensive work in terms of clarifying the macro economic aspects of the economy. The estates of Glitnir and Kaupthing, as well as the creditors have also done extensive analysis of the financial situation of the estates.

The prime minister has indicated that he is now waiting for the creditors to make a move. However, he seems to ignore that the creditors have already made a move: both Glitnir and Kaupthing have presented a detailed draft of composition to the CBI – but so far no answer. It is abundantly clear to the CBI what the creditors want. The only unclear thing is what exactly the government wants to do and how it wants to proceed.

Keep Icelandic banks Icelandic

The CBI has indicated that if one of the two new banks – Íslandsbanki and Arion, owned respectively by Glitnir and Kaupthing – could be sold to foreign investors the sale, in foreign currency, would facilitate solving the problem of the foreign-owned ISK assets. There is already news that Hong Kong investors have shown interest in buying Íslandsbanki and other offers might surface.

Without intending to launch some conspiracy theories it is safe to assume that parts of the political establishment and parts of the Icelandic business community want to keep ownership of the Íslandsbanki and Glitnir on Icelandic hands. If the government listens to these voices, as it well might do, it is highly likely that part of its equation is not only how to create the “scope” for finding the money for the “correction fund” but also how to keep the two banks in Icelandic ownership.

This angle of the whole controls conundrum does not make it any easier to solve and it adds yet another political non-financial hurdle to the process.

Landsbanki – a special case

Landsbanki is owned by the Icelandic state because the two major creditors of old Landsbanki – the Dutch and the UK government (harking back to the old Icesave saga) – were not willing to assist in setting up the new bank, in the same way the creditors of Glitnir and Kaupthing agreed to when Íslandsbanki and Arion came into being. Therefor the state had to step in to capitalise the new bank.

There is now the problem that new Landsbanki owes the old one ca ISK270bn, €1.67bn, in two bonds, due in foreign currency by the end of 2018. The first step towards resolving the capital controls is to find a solution to the Landsbanki bonds, i.a. extending maturity of the two bonds, changing interest rates etc. The new bank has mentioned it needs a “few years” – 15-20 years seems a more realistic solution but nothing near this number has been mentioned officially.

Is there really a majority for the Progressive’s debt relief?

As explained in an earlier Icelog, many have criticised the debt relief ideas but that does not deter the prime minister from advocating this with great fervour. However, there is also strong criticism from some members of the Independence Party parliamentary group. The last few days I have heard musings that there really might not be a majority in parliament for the kind of debt relief the Progressive Party has been advocating. At least one IP parliamentarian, Vilhjálmur Bjarnason, has aired his views openly, saying he could not support the kind of debt relief the Progressives have in mind.

In addition, there seems to be disharmony at the core of the coalition government as to how to proceed regarding the capital controls. Some weeks ago it was announced that the government was just about to appoint “abolition coordinator” who would oversee the process towards abolishing the capital controls. Two names were mentioned as the most likely ones, one from each party. So far, nothing has been done because it seems the two parties cannot agree on whom to choose.

So far, there is a complete lack of clarity as to how the government will go about solving the problems that have to be solved in order to abolish the capital controls. The feeling is that since the government does not know where it is going it is not likely to get there any time soon.

*Here is an earlier Icelog explaining the financial aspects of the capital controls.

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How to a break up a relationship? Do you say you need a break, yet making it clear it’s finite – or do you make a clean cut and say it as it is, that you really don’t want to stay in this relationship? The Icelandic government is having a major difficulty in breaking up with the European Union although the relationship was only that of negotiating a further relationship. Saying “no, it’s over” seems difficult – and that is exactly what foreigners often say about Icelanders: they find it difficult to commit themselves to final decisions. 

At meetings in Brussels earlier this summer minister of foreign affairs Einar Bragi Sveinsson made it clear that the Icelandic coalition government (led by Sveinsson’s party the Progressive Party, together with the Independence Party) does not intend to continue its accession talks with the European Union. Sveinsson was categoric, there did not seem any way back. In Brussels those involved with the talks took this to be the end, I understand, though nothing final has been said.

Formally, there was to be a report in the Icelandic Parliament, on the state of the EU and on the state of the negotiations, already now in autumn. After discussing this report decisions would be taken. Well, no decisions have yet been taken who is going to write this report – will it be a committee or some organisation? No decisions on that so far. Consequently, it is completely unclear when the Althing will be able to have a say.

In Iceland, Sveinsson has stated quite clearly that the accession talks are over and this government will not continue. Sveinsson has also said that in spite of both parties, during the election campaign, favoured a referendum on continued negotiations he now sees no need for that. Officially, the government still talks officially about a break.

There are some Independence Party MPs, as well as some influential people connected to the party, who are in favour of Icelandic membership and who feel decidedly unhappy that this matter is being dealt with by only one minister without any further debate. This creates disgruntled mood between the parties.

The situation is now as if the government is trying to find a way of saying “no” to further talks without breaking off the relationship completely – it seems afraid of taking this decision knowing that the majority of Icelanders, according to polls, want to finish the talks and vote on an agreement. Sveinsson has been pointing out that in fact the EU has rejected Iceland by discontinuing the IPA grants Iceland has enjoyed the last few years thereby trying to tell the story as if the rejection is coming from the EU side.

Leader of the social democrats Árni Páll Árnason asked Sveinsson some questions recently regarding the talks but little was clarified (here are the questions and answers, in Icelandic). What is clear is that the government does not intend to continue the talks nor does it want a referendum, which it might very well lose.

The government may well be trying to keep this uncertainty going until the EU loses it patience and calls the negotiations off. But as it is now, the way the government is handling the issue portrays a government with an unclear idea of how to break without completely locking the door. A government that wants to say “no” but does not quite know how to do it and does not quite dare to do it. Since the government has only been in power for a few months this does not bode well for the major decisions that will have to be taken in the coming months, i.a. re capital controls.

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The foreign creditors of Glitnir and Kaupthing understand full well that they will not get the foreign assets of these two estates until a way has been found to deal with their ISK assets. There is not – and will not be for the many coming years – enough foreign currency in Iceland to convert their ISK assets. All of this is explained in an earlier Icelog.

Tonight, I reported on Rúv (in Icelandic) of an idea to put some of this ISK problem aside, so to speak. The idea is that considerable funds, perhaps ISK50bn from each estate, ISK100bn, €3.1bn, will be put in a fund, which will become the property of the Icelandic nation. The fund could be used for public good such as initiatives in education and health.

The government has said it wants to “extract” – how, is still unclear – considerable funds out of the liquidation process in order to fund an extensive debt relief fund, called “correction fund” for those who are too well off to have profited from earlier debt relief. It will be interesting to see what its reaction will be to this new idea – no comments forthcoming when Rúv sought comments tonight.

Meanwhile, the capital controls continue to hurt Iceland. Icelandic investors with money abroad shy away from bringing funds to Iceland. Salary is low in Iceland compared to the neighbouring countries. The government might think it is safest to wait and see – but that is actually a very expensive option for Iceland.

The Glitnir estate has hired the economist Lord Eatwell president of Queen’s College Cambridge as its special adviser in the winding-up process of the estate.

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According to Rúv, prime minister Sigmundur Davíð Gunnlaugsson (Progr.) will next week appoint someone to a new post to oversee work towards the abolition of the capital controls and be in charge of contacts with the creditors of the failed banks. The idea is to simplify the work regarding the capital controls and failed banks since this work concerns many ministries and institutions. This person will lead a group of experts who all will work towards abolition of the capital controls.

The really interesting thing is of course who this person is. Will this be a person who is undisputedly qualify to lead this work in a convincing and professional way and likely to succeed? Will it be a politician but professionally unconvincing? Someone with close ties to the Progressive Party and the prime minister? Or someone who has little pondus and is unlikely to achieve much?

We will have to wait until next week, unless the name leaks out, in which case I will update this post.

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Ever since the financial crisis erupted in Iceland in October 2008, foreign media has been obsessed with events in Iceland though it often seems to struggle to understand the financial issues at stake. However, that is of little real importance since the intensive media focus has drawn attention to Iceland as a tourist destination and life is too short to search for erroribus. But sometimes the errors and misunderstanding are  just so comical that it merits some attention.

“Another Icelandic meltdown may be coming. That would reignite investor fear, leading to yet another panic on the continent,” writes Cyrus Sanati for Fortune Magazine. – As happens in every country, Icelanders sometimes feel that they are the epicenter of the universe but Sanati seems to outdo most Icelanders. I can’t remember ever having run into anyone with any insight into finance or economics who thinks that events in Iceland have led to or are likely to lead to a “panic on the continent.”

Sanati seems partly to base his article on the latest IMF report on Iceland, though not quoting it, but seems to have read it rather hastily and to draw rather more alarming and far-reaching conclusions than the IMF economists.

According to Sanati “(s)ince 2008, the small island nation has been able to avoid an all-out economic meltdown thanks largely to government-imposed capital controls that have kept its currency from imploding. At the same time, the nation’s zombie banks have managed to avoid total collapse thanks to delay tactics that have allowed them to avoid settling with their creditors.”

The capital controls were introduced end of November 2008 at the advice of the IMF but in full agreement with the government. The new Icelandic banks were formed swiftly in early October 2008 by splitting the old banks into foreign operations, kept in the old failed banks and the domestic operations, in the new banks, the now operating banks.

The new banks are much less zombie-like than many other European banks, partly because bad loans were left with the estates of the three failed banks, partly because assets were moved into the banks at reduced value. The new banks have nothing to settle with the creditors of the failed banks. The two new banks, Íslandsbanki and Arion are owned respectively by the estates of Glitnir and Kaupthing, which in turn are owned by creditors who mostly are foreign financial institutions.

It’s quite right that the main problem in Iceland is the capital controls but the effect isn’t quite as Sanati depicts it:

Capital controls imposed by the government in 2008 are still in effect, forcing its citizens, and, more importantly, the nation’s massive pension fund, to invest mainly in Iceland. At the same time, Icelandic consumers still find it hard to buy foreign goods, forcing them to buy less-desirable local equivalents, giving an artificial boost to the domestic economy. Meanwhile, high interest rates have made borrowing expensive.

Yes, the nation’s massive pension funds are forced to invest in Iceland, which might in the longer run lead to too many kronas, ISK, chasing too few investment opportunities. Asset prices have been rising and are closely monitored by the Central Bank of Iceland and financial analysts in Iceland. So far, the rising prices are deemed to be sustainable but the bubble risk is certainly there, a well-known risk in countries with capital controls.

Consumers are however not much touched by the capital controls since importers can still import, just as exporters can export. There is no lack of foreign goods in Iceland and even if Icelanders were buying more of home-produced goods that is hardly artificial growth – the competition with foreign goods is still in place. The high interest rates in Iceland reflect inflation, which is high as has so often been the case in Iceland.

Re growth Sanati writes that “… real output in Iceland remains 10% below the pre-crisis peak. And while GDP did grow at around 2.9% in 2011, it slowed to around 1.6% last year and is expected to fall even further this year. This is the ugly side of capital controls. In short, by restricting what people can buy and invest in, i.e. only Icelandic goods and opportunities, individuals eventually stop spending.”

The IMF report states that “legacy vulnerabilities weigh on growth. Real output is still 10 percent below its pre-crisis peak. GDP growth, which reached 2.9 percent in 2011, slowed to 1.6 percent in 2012 amid private sector deleveraging and weak external demand.”

IMF gives a rather more nuanced picture of the slowing growth:

Deleveraging is constraining consumption and investment. Private consumption weakened in the second half of 2012, as one-off supporting factors (early pension withdrawals and mortgage interest subsidies) waned and households and firms continued paying down debt (Box 2). Fiscal consolidation, while necessary to reduce high public debt, is limiting the public sector contribution to growth.

            Slow progress in removing the capital controls is undermining confidence. While the controls safeguarded external and financial stability during the crisis, slow progress in lifting them is undermining confidence and inhibiting investment. At the same time, uncertainty about exchange-rate developments following the lifting of controls has hindered the anchoring of inflation expectations.

            Legacy risks in the financial sector are holding back credit expansion. Banks are still burdened by bad assets and continue grappling with uncertain loan valuations and risks stemming from their reliance on captive funds locked in by capital controls.

            The challenging external environment is weighing on exports. In 2012, less favorable terms of trade and weak external demand for real goods exports more than offset the improvement in services exports, notably tourism.

According to Sanati “domestic consumption and investment in Iceland are both down 20% from their pre-crisis levels and continue to fall. Icelanders are instead choosing to pay down their debts, which, while positive, comes at the expense of economic growth. And despite the debt paydown, household and corporate debt remain high, coming in at 109% and 170% of GDP, respectively.”

Again, the IMF report gives a more nuanced overlook:

Unique characteristics of Icelandic household debt complicate the deleveraging process. Household debt consists largely of home mortgages that are CPI-indexed, implying that the debt stock rises with inflation. Moreover, 85 percent of mortgages were issued in 2005–07 and have long maturities and back- loaded repayment profiles.

High private sector debt weighs on consumption and investment. Consumption is still 20 percent below its pre-crisis peak and 10 percent below trend, somewhat stronger than in euro area program countries but weaker than in other advanced economies. Domestic investment is about 20 percent below trend despite significant corporate debt deleveraging, likely reflecting factors such as capital controls. Growth will therefore likely remain modest for some time. To illustrate, average private consumption growth in Sweden and Finland hovered around 1 percent during the deleveraging period before rising to 21⁄2 percent post-deleveraging. Cross-country comparisons also show a negative relationship between private sector balance sheet stress and growth.”

The IMF report points at the comparison with crisis-struck Sweden and Finland in the 1990s:

International experience, however, suggests that further household adjustment should be expected. Peak-to-trough deleveraging of Swedish and Finnish households in the 1990s took as long as 8 years with debt declining by 30 percentage points.

Pointing only at the capital controls is an over-simplification. For the economy as a whole it does matter that Iceland’s largest trading partners, countries in the European Union, have been struggling. A returning growth in Europe is good news for Iceland. – And Icelanders, always great spenders, keep on spending, happily not restricted to Icelandic-only goods as Sanati seems to think.

Normalised household debt-to-disposable income peaked at 100% in 2010 in Iceland and is now ca. 85%, as shown in the IMF report.

So what now? According to Sanati “The new government promised during the campaign to lift the capital controls and to force banks to cut people’s mortgage principals. This has understandably shaken the rating agencies. S&P lowered its outlook on Iceland to negative in June on concern that the new government will go through with its plans. The IMF has expressed similar reservations.”

This is a rather misleading description of the latest event. The new government did not promise “to force banks to cut people’s mortgage principals.” It aims at getting money out of foreign creditors of the two collapsed banks, Glitnir and Kaupthing. What has shaken S&P is the lack of clarity as to how the government is going to fulfil its promises of extensive debt relief and its effect on the economy. The IMF is worried about these same promises and its possible effect on the state finances and the economy as a whole. In an earlier Icelog I have gone into some detail re the capital controls and possible ways of abolishing them. The CBI has published extensive reports on these same issues.

As are some Icelanders, Sanati is worried about the perspectives in Iceland. “Iceland has few good options. If it keeps the capital controls in place its economy will continue to shrink; lift them and asset values will fall as Icelanders ship their cash out of the country. The new government says that foreign direct investment will make up for the capital outflows, but they are either extremely optimistic or completely misguided. The lifting of capital controls will cause housing prices and other Icelandic assets to fall dramatically leading to yet another bank panic. In the wake of this chaos the Icelandic government believes foreign investors will come strolling in?”

It is true that Iceland has few good options but the new government isn’t planning on solving the problem of the capital controls with foreign direct investment. That would indeed be insanely optimistic as FDI has always been low in Iceland. The core of the capital control in Iceland is, as I have explained earlier (see the above Icelog link), that ISK exposure to foreigners is higher than the currency reserves can serve. The CBI is working hard on coming up with viable solutions as is the government and the foreign creditors whose kronas are stuck in Iceland.

Back to Sanati’s sense of importance of Iceland in Europe:

Iceland is facing many of the same issues afflicting much larger economies. For example, capital controls have been instituted in several European nations amid the fallout from the sovereign debt crisis. How and when those nations choose to lift such controls will have a profound impact on the value of the euro and thus the economic integrity of the entire continent.”

Eh, in Europe only Cyprus has capital controls and its economy amounts to 0.2% of the Eurozone. But that Iceland, neither part of the EU nor the Eurozone, and tiny Cyprus are both grappling with capital controls is unlikely to have the impact Sanati surmises.

Then there are further dizzying claims regarding the significance of Iceland:

Furthermore, Iceland’s banks are not unlike those in Spain as they both financed housing booms gone bust. How Iceland’s banks deal with the problem of its bad loans after capital controls are lifted could have a major impact on the way investors choose to look at Spain and its bank issues. Iceland’s banks are expected to force losses of around to 75% to 100% on their investors and large depositors, many of which are hedge funds that also buy and sell sovereign debt and the insurance linked to it. How these hedge funds will retaliate could be replicated in Italy or in France where sovereign debt continues to mount relative to the size of their economies.

The housing boom in Iceland bears little resemblance to the building boom in Spain nor did it cause the same kind of trouble for the Icelandic banks. I’m sure few investors will make the same assumptions Sanati does. Given that Spain has different kind of banking problems and no capital controls I doubt the major impact Sanati is expecting.

No, Icelandic banks are not expected to force any direct losses on their investors and certainly not on large depositors. The question of further write-down regards the creditors of the two failed banks and their ISK assets as mentioned above. Selling or buying of sovereign debt has nothing to do with the Icelandic sovereign. The foreign creditors are creditors to the two failed private banks, not the sovereign and this has no bearing on Italy (most of Italian sovereign debt is actually held by Italians and Italian institutions, unlikely to launch a financial terrorist action against their state) or France.

I rather agree with Sanati that “Iceland shouldn’t be ignored” but not for the reasons he lists:

After all, it was the first country to implode during the financial crisis and was one of the first ones to see its GDP rebound. Its small size and simple economy means that it is less able to bury its problems under a pile of confusing monetary actions. This forces Iceland to face the music much sooner than larger nations in similar predicaments. As such, investors will be watching what Iceland’s new government does intently. If it begins to falter, the rest of Europe could be next.

The problems in Iceland have been pretty clear from the beginning, also thanks to the fact that Iceland was in an IMF lending programme, consequently monitored by the Fund. And yes, everyone interested in Iceland, most of all Icelanders themselves, will of course closely follow what the government does.

But not even Icelanders with a healthy sense of self-importance think that it might take the rest of Europe with it if it falls. There might have been fears for the destiny of the country as Ireland, UK and other countries were fighting to keep their financial systems afloat in September and October 2008. But the fear in Iceland has long abated.

So far, with growth and lower unemployment, Iceland has something to be content with but there is no room for complacency. The capital controls are the most serious issue to solve and until they have been abolished Iceland can’t “graduate” from the financial crisis. But events in Iceland won’t shake the world – unless there is another volcanic eruption.

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If anyone is in doubt what matters in Iceland, the answer can be found in who are the top earners in Iceland. Now we know: fishing matters, again – and fishermen are the highest earners. It also indicates the strong standing of Icelandic fisheries and how well this business is going.

When the Icelandic banks collapsed in October 2008 the news went around the world that now Icelandic bankers were turning fishermen. The reason was that some journalists had indeed found a banker or two who had secured a place on a trawler or a fishing boat. Since then, I don’t know how often I have been asked if this was indeed the case – that Icelandic bankers were turning to fishing en masse. No, it isn’t. Though there certainly may have been bankers who secured themselves a place on a fishing boat (most likely through family relations) this was not a general trend.

But if it had been a general trend, ex-bankers would be doing just fine. It turns out that fishermen are indeed the group with the highest income in – and yes, they beat CEOs… and bankers.

Every year, the Icelandic business magazine Frjáls verslun (Free trade), publishes an issue entirely devoted to income – of social groups and well known individuals from all walks of life, i.a. politicians, media people, artists and business men. In total, the issue publishes the earnings of 3500 individuals. This is possible because the Inland Revenue in Iceland publishes every year, around this time, what every individual in Iceland pays in tax. (Yes, this may sound incredible to foreigners but this is transparency the Icelandic way: the overview is only open for a few days and only in books one has to visit in person at the Inland Revenue offices). From the tax, it is possible to calculate income, i.e. the ISK people get into their pockets. Thus, these numbers tell a certain story of salary but not the whole story of assets, income from dividends etc.

This year, the Frjáls verslun income issue publishes this week, shows that fishermen have superseded CEOs in terms of income. The general salary reference in Iceland is not a year’s income but the monthly income. The top 200 fishermen earners now have ISK2.5m, €15.6000, a month, compared to CEOs’ ISK2.3m, €14.400.

This is interesting in terms of salary, social groups and their social leverage. But it of course is also an interesting indication of Icelandic fisheries. Whereas fisheries are heavily subsidised in many countries, almost political pet projects, Icelandic fisheries are a booming industry.

What is clear from the Frjáls verslun data is that salary of CEOs, bankers and fisherman is rising much more rapidly than inflation. This may bode ill for the Icelandic economy since there will be wage negotiations for large groups in the labour market later this year. The tendency among these three groups will set the tone for these negotiations. Already, some are pointing out that CEOs and bankers are showing great irresponsibility, unavoidably egging other groups to irrational and unreasonable wage demands.

No, no one is blaming the fishermen because their salary is set, to a great degree, by what they fish and the value of their catches. Their catches, mostly sold abroad, went up in value with the collapsing krona, in addition to price increases due to improved marketing. And in general, fishermen tend to have a brahmin stature in Iceland: they are rarely criticised and certainly, politicians do not make disparaging remarks about fishermen since in many ways fishermen are seen as pillars of society. In Iceland, fishermen are talked of as “heroes of the oceans.”

As to public figures, the president of Iceland Ólafur Ragnar Grímsson now earns ISK2m, €12.5000, a month, up by ISK400, €2.500, from last year. The prime minister earns ISK1.5m, €9.400, a month.

As to social groups the average monthly salary of the top 200 earners in every group is the following:

                                                        2012       2013 
Fishermen                                   ISK2,4 m        ISK2,5 m
CEOs                                             ISK2,2 m        ISK2,3 m
Financial companies               ISK 1,6 m        ISK1,7 m
Managers (below CEOs)         ISK2,0 m        ISK1,6 m
Top 100 in education               ISK0,9 m.       ISK1,0 m
Health services                          ISK1,5 m        ISK1,4 m

*Here is an overview of the income issue, in Icelandic, from Frjáls verslun.

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Cyprus is struggling with its capital controls, with no fixed abolition date in sight. Iceland has also discovered that the best way forward is to have a plan with benchmarks but no time limit. Here are some facts on the Icelandic controls, what is at stake and for whom. As Cyprus might find out – and Iceland is already experiencing – the longer the controls are in place, the stronger the forces against abolishing them.

Capital controls come in many shapes and sizes and capital controls in Iceland and Cyprus are of different nature, set to solve different problems. In Iceland, the controls were put in place end of November 2008. At the time, more capital was flowing out of Iceland than could ultimately be converted into foreign currency. The problem stemmed from ISK600bn, €3.76bn, owned by foreigners (or entities abroad), hence the name “offshore krona/ISK” – there was no way the Central Bank of Iceland could find enough foreign currency to convert these ISK investments into foreign currency. Like in Asia in the 1980s these investments, in Iceland called “glacier bonds,” were made to profit from high interest rates in Iceland.

With time, new sources of ISK that need to be paid out in foreign currency have piled up, in total creating a problem amounting to about ISK1200bn, €7.52bn, ca. 70% of the GDP of Iceland. The core of the problem is ISK assets, needing to be converted into foreign currency at some point and kept firmly in place for now by the capital controls. With the controls in place there are various restrictions on movement of assets in out and of the country. I.a., every Icelandic citizen in Iceland has to hand over to the CBI whatever they earn in foreign currency.

The situation in Cyprus, part of the Eurozone, is different. The Cypriot capital controls were needed to prevent a run on the banks, i.e. hindering that deposit holders would empty the banks. Consequently, the controls were more invasive and much more felt, with maximum withdrawal etc. The controls have gradually been eased but there is now, as far as I can see, no certainty as to when or exactly what conditions need to be in place to abolish them.

The laws on capital controls in Iceland expired last year but there is now no time limit. The CBI has certain benchmark needed to be reached.

In Icelandic, one way of describing a short-lived blessing is “peeing in one’s shoes” – it is a quick warmer but the effect does not last and ends up as a messy problem. That is exactly what capital controls are: a quick blessing, which in time turns out to be costly and eventually costlier than the benefits. It is well established that the longer capital controls are in place the greater the damage: they tend to create an asset bubble as too many currency units chase too few investment opportunities, they distort the business environment and eventually they are inductive to criminal behaviour and corruption and – as anecdotal evidence now shows in Iceland: capital controls create unjustified privileges.

The ISK1200bn problem held in place by capital controls

In Iceland, the capital controls now hold three more or less equally large batches of ISK seeking to be paid out in foreign currency. The glacier bonds now amount to ca. ISK400bn, €2.51bn. Those who own them may to a certain degree be patient investors, happy to enjoy Icelandic interest rates, still quite a bit higher than in the Eurozone.

The second ISK400bn batch consists of ISK exposures with direct or indirect state guarantees. The largest part, ISK270bn or €1.69bn, are bonds exchanged between the new and the old Landsbanki when the new one was set up. Other exposures here are loans of state owned companies like Landsvirkjun, the energy company.

The third ISK400bn batch consists of ISK assets in the estates of Glitnir and Kaupthing, which need to be paid out in foreign currency. Ca. 90% of these assets are owned by foreigners but Icelandic creditors like the CBI and Icelandic pension funds own ca. 10% of these assets, meaning that 10% would float back into Iceland when/if these assets (and the estates’ foreign assets) are paid out. It also means that whatever happens to these creditors (i.e. whatever measures used to dissolve the estates and pay out creditors), does not only apply to foreigners but also to Icelandic creditors. And 10% is not a trivial figure in proportion to the Icelandic economy.

In order to lift the capital controls it is necessary to solve the problems that keep the controls in place. This means that in Iceland the size of the problem is roughly 70% of GDP. That in itself would be no mean feat – but in addition, the government (or at least the Progressive Party) has declared that this process has to create a windfall of ca. ISK300bn, €1.88bn, which it wants to use for further debt relief for those who are too well off to have benefitted from earlier debt relief (which so far is the most extensive debt-relief in any debt-hit European country).

Basically every one who does not have debt at stake thinks this policy, first launched as an election promise by the Progressive Party before the election in April, is a bad idea (i.a. potentially inflation-fuelling; funds would be better used to pay down sovereign debt, i.e. benefitting the whole population), amongst them the CBI, OECD, and the IMF. As reported earlier on Icelog, Prime Minister Sigmundur Davíð Gunnlaugsson does not take seriously criticism from foreign “acronyms,” meaning the OECD and IMF – but that is another story.

The glacier bonds and the state-guaranteed assets – 2 x ISK400bn

Though the two estates pose the trickiest problem, the two other batches also need to be dealt with. The glacier bondholders may well get some offer inducing them to stay, such as unfavourable exchange rate/levy. Also, as mentioned above, some of these investors may be in no hurry to leave.

The CBI and others have indicated that the real problem of state-guaranteed ISK assets, though ISK400bn in total, is thought to be ISK250bn because there are ca. ISK150bn worth of foreign assets/revenues to offset it.

Part of the solution would be to extend the maturity of the Landsbanki bonds, now the topic of intense negotiations between the Landsbanki estate and the new Landsbanki. Due to Icesave, the Dutch and the UK guarantee deposit schemes are the estate’s largest shareholders. Dutch and British officials have a thing or two to say on this matter and they are not necessarily dripping with milk of human kindness after the EFTA Surveillance Authority and the EU unexpectedly lost the Icesave case at the EFTA Court.

The trickiest ISK400bn batch

It is clear that the funds for the debt relief should not come from just any of the three problem batches but from the one that mainly regards foreign creditors, i.e. the Glitnir and Kaupthing batch. Politicians, mainly from the Progressive Party, hoping for a windfall here, seem to hope that although the ISK400bn assets are not trivial, the foreign creditors might be willing to negotiate a write-down – or some other measure that would result in funds for the government (though these are assets of private companies) – in order for the creditors to get their hands on the foreign assets in these two estates, the equivalent of ISK1500bn, €9,40bn, close to 90% of Icelandic GDP.

These foreign assets are sitting there, ready to be handed over – ca. ISK1000bn, €6.26bn, in cash, the rest in assets. It is clear though that the CBI, which by law needs to agree to the estates’ composition (or whatever happens to them) will not grant any asset payout until the destiny of the ISK assets is decided. No piecemeal service here.

The possible measures and solutions re Kaupthing and Glitnir are now being furiously pondered on and discussed among those who have a skin in this game – meaning the administrators of the two estates, the creditors (or their ad hoc creditor committees and their representatives), the CBI and the government, probably mostly within the ministry of finance.

Bjarni Benediktsson minister of finance and leader of the Independence Party is well positioned to make an enlightened choice since he has all relevant experts at his fingertips. Also, IP is traditionally well connected to the ministerial administration. Gunnlaugsson, who no doubt will want to follow this closely – given the election promises at stake for him and his party, ultimately his credibility – might find himself in a more difficult position in terms of access to the same kind of expertise, if he wants to make his own independent assessment. The PP, out of government from 2007 to 2013, might not have the same access as the IP.

Why postponing a solution may be a costly option

Foreigners, who have had dealings with Icelanders, often mention that it is notoriously difficult to get Icelanders to make up their mind and commit to a final decision. The estates might be one such problem where the government will find it very difficult to make up its mind, not least because the PP, after their rhetoric and promises, have to present a solution that looks like a victory over the foreign creditors, with the funds to show.

These problems have been clear to everyone concerned for a long time and clearly all those involved with the two estates have been problem-crunching for months now. One of my sources pointed out to me that if this problem is not solved relatively quickly, i.a. a solution presented in the coming month (though the fine and final details make take some mulling-over) this might drag out for quite a while because it would suggest a fear to bite the bullet rather than a lack of informed options.

But can’t the government just wait around until it has found the perfect solution for the two estates? Not necessarily because without a solution the capital controls stay in place. And the longer it takes to solve the issues of the two estates the harder it is to solve. Delays of half or whole years might burden Iceland with added costs of the capital controls.

A delay can have two-fold effect on the estates: the assets will change – and claims will most likely be sold to a different category of investors compared to present creditors.

As to the assets, unsold assets give scope for negotiation of value. The more assets sold and turned into cash, the less scope to negotiate on value. The thinking among some in Iceland is that the creditors of Kaupthing and Glitnir could just solve the problem by giving the ISK assets to the state (for example, handing the over the CBI), in order to get at least the ISK1500bn foreign assets. Negotiating a write-down is more or less the rule in this situation but a pure gift sounds more than wishful since all creditors have to maximise their recovery. Amongst them are the CBI and Icelandic pension funds, which might find it difficult to justify this kind of magnanimous action.

That said, the creditors may in due time well show some creativity and present a solution that indicates they understand the problems Iceland faces. Remains to be seen.

As time passes, it will be more difficult for creditors to show any kind of creativity because more assets will be sold and converted to cash, leaving only the currency rate to be negotiated.

Thus, it can be argued that time is not on the side of the state. The creditors will not be happy to wait but they can get out of the situation if they want to and they, being professional investors and institutions, have seen all of this before.

Here is what delays might do to the creditor group. For now, the original bondholders in Kaupthing and Glitnir own more or less half the claims, with the other half having been sold off to those who specialise in distressed debt. The division is not quite clear-cut because banks and big creditors often invest with the buyer when they sell off their claims in order to get a cut of the up-side if there is any.

If creditors start to think that the assets will be dealt with “sub specie aeternitatis” they will sell their claims – and the more hopeless it seems the more the write-off and the more virulent the buyers. The vulture kind, prepared to sue everyone to hell in order to get as much out of the claims as possible. – This potential change of creditors will of course not happen over night but yes, over time if creditors start to lose hope and just want to get however little out of what they have.

Consequently, the longer it takes to find a final settlement re Kaupthing and Glitnir the greater the difficulties in finding a solution, bringing on losses for domestic creditors as well. And, worst of all, the capital controls stay in place.

The destructive effect of capital controls and the rise of a new Icelandic nomenklatura

In several reports, i.a. on financial stability, the CBI has in no unclear terms spelled out the cost of capital controls for the Icelandic economy brought on by a potential asset bubble and distorted business behaviour. The CBI deems that these are potential risks, which have not yet happened.

It is notoriously difficult to tell when there is bubble, i.e. when assets are mispriced and asset prices have been rising fast in Iceland, i.a. property prices and shares of listed companies. Both the CBI and financial analysts say that so far, these price increases are in tune with the economy, not a bubble.

The no less worrying effect is, I think, that capital controls are potentially fertile ground for corruption. With time, they create a booming industry seeking to avoid the controls. And with time this industry will do what it can to keep the controls in place.

This is a general course of events in countries with some kind of capital controls. In addition, the capital controls in Iceland are slowly creating its own special kind of a privileged nomenklatura that can buy assets at a cheaper price than other Icelandic mortals.

In order to relieve the pressure of the offshore ISK, the CBI came up the with the idea of offering offshore ISK owners a way of investing this money, given certain terms and conditions, if they bring in foreign currency in addition to the offshore ISK. This seemed like a reasonable way to attract foreign investment to Iceland. The problem is that this has, apparently, not attracted foreign investors but gives Icelandic investors, with foreign assets (which have to be since before the capital controls) and offshore ISK, the possibility of buying assets in Iceland, be it property or financial assets, at a ca. 20% discount to Icelanders who have nothing but their hard-earned not-worth-much ISK.

This new nomenklatura is now pretty clear and known to everyone though it is hardly ever mentioned in the Icelandic debate. I can certainly not remember ever having heard a politician mention this (but here I might be wrong since I don’t follow the Icelandic debate in detail).

Another sneakier way is less well known but indeed existing, I’m told.

It is always presumed that the glacial bondholders are foreigners. That is probably how it was in the beginning of time, i.e. when these investment objects were created and up to the collapse. What I now hear from various sources is that there are Icelanders in this group. No, not necessarily the notorious billionaire “Viking raiders” but wealthy Icelanders, in Iceland, who have bought the bonds after the collapse and now hold them through foreign companies or “nostro” accounts of foreign banks. Out of the total ISK400bn these may not be high sums but, again in Icelandic context, quite a bit of money.

Here is the trick: the law on capital controls allow glacial bondholders to convert the interest rate of glacier bonds into foreign currency and move them abroad. Icelandic glacial bondholders can then take this foreign currency and bring it back to Iceland through the CBI investment offer, to buy Icelandic assets, meaning they get the Icelandic assets at ca. 20% discount, as mentioned above.

It would be very interesting to know who these alleged Icelandic glacial bondholders are. It would throw light on how privileges are meted out in the regime of capital controls and clarify the stance that certain individuals may take in the public debate.

Waiting is not an option – if the cost of capital controls matters

As argued above, there are various reasons why waiting is costly, why waiting compounds the problem of the capital controls and makes the ensuing problems more engrained over time. Needless to say it is extraordinarily difficult to say exactly at what point the cost is greater than the benefits of the controls. Also, assessing the cost of the corruption the capital controls create is particularly hard to evaluate.

The capital controls in Iceland have been in place for the best part of five years – in Cyprus only for five months. Although the controls in the two countries are of different nature, put in place to solve different problems, Iceland can be an interesting example for Cyprus – and possibly, with time, an example of what to avoid.

*Here are some earlier Icelogs on capital controls.

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Now that Germany is such a heavy-weight in Europe, non-German European politicians should do more of traveling in Germany in order to understand the Germans a bit better. After just a few hours in Berlin I had understood that it’s not just German politicians who like to tell their foreign counterparts how to do things – this is indeed very much a German character trait and it’s well-intended

Asking the bus driver at Schönefeld airport if there were other buses going into Berlin he pointed at an info point a few meters from the bus where I could study the various travel options. Having done that, I opted for the bus. Once again on the bus, I asked for a ticket. Sighing, the bus driver pointed at the ticket machine next to the info point – I could have bought the ticket there, he said; then he would not have to sell me the ticket and lots of good things would have ensued from it, which did not happen now that I had not had the foresight to buy the ticket from the machine.

The following day, a taxi driver to whom I made some comment about the Berlin traffic gave me a long lecture on how best to drive in Berlin. Unfortunately for the traffic and Berlin travellers, not so many drivers were as enlightened as my driver.

I came to think of all the media coverage where various European non-German politicians have aired their irritation with their German counterparts lecturing them on economic prudency and other virtues Germans feel they are better endowed with than most others. This is generally taken as German politicians being arrogant. My first 24 hours in Berlin taught me otherwise – the willingness to lecture others is a German trait in general. If non-German European politicians spent a few days in Germany they would understand the Germans better – and, most of all, understand that it is well meant, not just arrogance.

That said, I warmly recommend spending some time in Berlin. I adore living in London but Berlin has some great things to offer – and most of all, it can teach us (yes, a bit of lecturing here) some interesting things about what makes a city an interesting city.

What the indies tell us about Berlin – and London

On the corner of Unter den Linden, facing one of the tourist magnets of the city – Brandenburger Tor – there is a Starbuck café. Otherwise, the city is full of independent coffee shop. My favourite part of Berlin is where I happened to be staying this time, Die Mitte and it is, as other parts of the city attracting youngish crowd, full of very tempting cafés. This being such a great neighbourhood, I spent most of my time there, as well in Kreuzberg, around Bergmannstrasse.

The cafés hark back to the pre-war times and the city’s cultural life. But it is also a sign of the fact that although property prices have gone up quite a bit in the last few years it still seems possible to make a living by running just one café in the centre.

Another sign of the same are all the antiquarians. For anyone who loves books, Berlin is a wonderful place to peruse. And prices are low. I picked up an Insel Verlag book with a great selection of Otto Dix’ work for €3 – no need to read German to enjoy it.

Then there are the small shops of fashion and design – again, shows that small can be done in Berlin.

In London, independent places like these can be found almost nowhere in the centre. The number of independent coffee places might be going up in central London but it seems that these places are quite often a hopeful first in planned mini-chains and chains. Second-hand books are now mostly found in charity shops in central London. Very few second-hand bookshops are run by dedicated book lovers any more, as the Berlin shops in the centre.

Yes, London has benefitted from being the favoured place of bankers, oligarchs, wealthy entrepreneurs and other billionaires. But this influx of money has killed off everything that makes Berlin a vibrant and quirky place. And part of the vibrancy and quirkiness comes from the artists, both German and foreign – quite a number of British artists among them – who find Berlin such a congenial place to live and work in.

Berlin house-prices – upward movement but still on a human level

My Berlin friends tell me that house prices have gone up a lot in the last four or five years. However, the square-metre in Mitte, one of the more expensive parts of central Berlin, is around €3.500. A four-room flat (three bedrooms, one living room) with one bathroom can be rented for €700 a month, in Mitte. A four-room flat (two bedrooms, two living rooms) with two bathrooms in Kreutzberg costs €1400 a month. And so on. Compared to London, this is heaven.

Ever since Berlin replaced Bonn as a capital there has been talk about an imminent property boom in Berlin. But in spite of recent up-ward trend it has not really happened. Not on the scale of London, not even on the scale of Paris. The bureaucrats who moved from Bonn to Berlin, used to the leafy villa quarters in Bonn, opted for the Berlin suburbs and did not move prices in the centre.

The bankers are still in Frankfurt – Gott sei Dank, from the point of view of those with less well-paying jobs, such as the artists that flock to Berlin. Creative industries such as design and advertisement are also increasing their presence. What could move the prices are people from pharmaceuticals and other industries that are increasingly settling down in Berlin.

Russians are now flocking to buy property in Helsinki, moving the market there. So far, nothing like this has happened in Berlin. Eric Schmidt chairman of Google, preparing to fork out £30m for a suitable London home, could buy a whole quarter of Berlin Mitte for that sum.

But then, some of the most fantastic flats in Mitte can’t be bought for ready money at all – the city itself owns some stunning flats in Mitte, true “Herrschaftswohnungen,” and offers artists to live there for a very decent rent.

Where the UK does not exist

It was an interesting experiment reading the German papers en masse every day. Plenty of coverage of all things Europeans, usually with some focus on the stance of other leading EU countries on the various issues. Britain was hardly ever mentioned except there was some weird news about Prince Charles and his tenants. So much for the British political relevance on the continent.

Germans do politics differently from the British. In so many ways. One thing is that German politicians are not afraid of serious culture like opera. Chancellor Angela Merkel attends Wagner operas in Bayreuth and the press invariably covers her visits as those of other politicians. For the last many years, I cannot remember ever having seen news of a leading UK politician going to Glyndebourne or the Royal Opera (and if they do, they seem to go incognito). Germans are not afraid of art and culture nor are German politicians afraid to show their interest in the kind of culture the British call posh.

There is just a much more ingrained interest in culture in Germany than there is in Britain. It shows in the newspapers – plenty of serious culture-related articles. Earlier this year, Die Zeit published a 40 page supplement where leading philosophers wrote on various topics.

In addition, there are all the German regional papers, can’t remember if Berlin has two or three and they are good. Much more substantial than just real estate ads and short news on a blotter being seen in a park. But Germany doesn’t have anything like the BBC – but then, the BBC is pretty unique.

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Mainstream shopping is not my thing (Kurfürstendamm is i.a. the street for that in Berlin) but there are certain very interesting shops in Berlin.

I don’t hesitate to say that The Different Scent, at Krausnickstrasse 12 in Mitte, must be one of the most interesting and exciting perfume shops in the world. Not only does it sell the best of young labels like the Geneva-based Ys-uzac (the maker of Pohadka, a stunningly intriguing and original scent as well as other of their interesting scents like Lale, Metabole and Monodie and its brand-new additions, Immortal Love and Satin Doll) but the shop owner has a fantastic insight and knowledge of the rarefied world of scent. This shop is just about scent and the discovery of the best made and most interesting scents and I love the fact that the décor is Spartan, firmly placing the attention on the essentials, the scents sold there.

For those interested in costume jewellery, Berlin is haven. At markets there are stalls with interesting offers, even at collectors’ level. Rianna, Grosse Hamburger Strasse 25, Mitte, has a fabulous selection of costume jewellery, also new pieces in a vintage shop with an extraordinary selection of clothes from labels such as Pucci, Yves Saint-Laurent and Dries van Noten, mostly echoing the Greek Rianna’s own love of interesting bling and riotous colours. As can be expected in a specialised shop the prices are in accordance with the pieces, not cheap, but for anyone interested this is a place that holds many wonders.

There are so many vintage shops in Berlin – one of its many attractions – and “No Name” at Torstrasse 62, Mitte, has a great selection of costume jewellery, as well as clothes, carefully chosen by its young owner with a great eye for quality and originality. The reasonable prices are part of the joy of visiting this small but excellent place.

The Barn is a café, on Koppenplatz, just off Auguststrasse with good coffee, great sandwiches and cakes (German cafés all seem to do cappuccino with soft froth whereas I prefer the Italian stiff, dry froth but the coffee in so many of the Berlin cafés is exceptionally good).

Bar+wine shop, Not just another Riesling Schleiermacherstrasse 25 (side street from Bergmanstrasse, Kreutzberg, by the market hall, great if you are buying food to cook) is a welcoming place where you get to taste wine before buying it and can have any bottle + €9 corkage to drink, also some nice cheese and charcuterie. Had a fabulously interesting Saignée from Josten & Klein, a lovely and fresh sparkling Mosel (I think) whose name I did stupidly not write down and one of the most interesting red wines I have had recently, the Spanish Bancal del Bosc 2011 – all of these wines around €15 or less.

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Loans in foreign currencies, widely issued by Icelandic banks during the boom, turned into a major liability when the banks collapsed, dragging the Icelandic krona down. But forex loans have been a liability elsewhere, i.a. in Croatia where borrowers formed an organisation and sued banks, issuing forex loans, for misleading information. The Franc organisation has now won a case against the banks but the case will now go to an appeal court.

Forex loans issued by the Icelandic banks during the boom times before the collapse in 2008 were popular because the interest were much lower than Icelandic interest rates, which mirrored the inflation in Iceland. These loans were mostly used for buying cars, less for mortgage though not unknown there. It seemed like a brilliant idea at the time since the Icelandic krona was strong. Historically, the strong krona was anomaly but the banks did not dwell much on that fact.

After many court cases it has now been established that it is illegal to bind interest rates in Iceland to anything but Icelandic interest rates, not to foreign rates but lending in foreign currency is legal. The thousands of loans issued were variously documented, some legal, others not. The banks have been obliged to recalculate forex loans, binding the interest rates to the CBI rates, much lower than the general lending rates. Some people got lucky there, others not.

In Croatia there were similar circumstances – domestic rates were higher than i.a. Swiss rates so banks started offering loans in Swiss francs. The the Croatian “kuna” collapsed these loans turned into serious liabilities. Contrary to Iceland, where the plight of forex borrowers caused great consternation among politicians, Croatian politicians have mostly been wholly unsympathetic to these borrowers, telling them squarely they should have been better informed and borrowing always implies risk.

In order to advocate their cause the borrowers formed an organisation, Franc organization and sued eight banks, on grounds of consumer protection, pleading that the banks had not informed people properly about the risk. People were given loan contracts of many pages but told they did not need to read it. After privatisation of the banks most Croatian banks are now owned by foreign banks, as can be seen by the eight banks sued: UniCredit – Zagrebačka Banka, Intesa SanPaolo – Privredna Banka Zagreb, Erste & Steiermärkische Bank, Raiffeisenbank Austria, Hypo Alpe-Adria-Bank, OTP Bank, Société Générale – Splitska banka and Sberbank formerly Volksbank.

Although the Croatian court system leaves much to be desired this case has already been ruled on – and Franc won. The case is not quite over though as will now go to an appeal court.

One thing that has made these loans such a liability, as pointed out to me by some of those involved with Franc, is Croatian law on bankruptcy, which has no time limit, meaning that once bankrupt, eternally bankrupt. Loans are not written off or written down and claims live forever. One thing Croatian politicians should definitely look into.

*Here is a report in Icelandic I did on the Croatian loans 17.8. 2012 after I had talked to Petra Rodik, one of Franc’s founders and Franc’s lawyer Nicole Kwiatkowski.

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