Sigrún Davíðsdóttir's Icelog

On October 6 the Supreme Court in Iceland ruled in one of the largest collapse cases so car where nine Kaupthing managers were charged for market manipulation (see an earlier Icelog). As in a similar case against Landsbanki managers the Kaupthing bankers were found guilty. The Reykjavík District Court had already ruled in the Kaupthing market manipulation case in June 2015.

This is how Rúv presented the Supreme Court judgement in October. Kaupthing’s CEO Hreiðar Már Sigurðsson was sentenced to six months in prison, in addition to the 5 1/5 years in the so-called al Thani case where the bank’s executive chairman had received a four year sentence. The market manipulation case added a year to that case. Magnús Guðmundsson managing director of Kaupthing Luxembourg was found guilty but did not receive a further sentence, having been sentenced to 4 1/2 years in the al Thani case.

Other sentenced in October were Ingólfur Helgason managing director of Kaupthing Iceland, 4 1/2 years and Bjarki Diego head of lending 2 1/2 years. Four employees were found guilty: three of them got suspended sentences. The fourth, Björk Þórarinsdóttir was found guilty but not sentenced.

The investigations by the Office of the Special Prosecutor, now the District Prosecutor, have so far resulted in finding guilty around thirty bankers and others related to the banks. As I have often pointed out: the penal code in Iceland is mostly similar to the code in other neighbouring European countries but the difference was the will of the Prosecutor to investigate very complex cases, taking on a huge task undaunted. That’s the difference – no case was seen as being too complicated to investigate.

Last week, the following article was in one of the Greek papers. From the photos I can see that this article is about the above case. Something for the Greeks to ponder on: what’s done in Iceland, less in Greece.

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Last year, Kaupthing’s second largest shareholder Ólafur Ólafsson was sentenced in February 2015 to 4 1/2 years in prison in the so-called al Thani case. After a change in the law on imprisonment shortened the time prisoners have to spend in prison under certain circumstances, Ólafsson was recently released to a half-way house in Reykjavík. He is now electronically tagged but can go to work – he is still one of the wealthiest men in Iceland and owns inter alia a large shipping company, Samskip.

Yesterday, a helicopter accident drew some attention to Ólafsson: it turned out he was on a sightseeing flight together with three foreign business partners and a pilot when the helicopter came down. All on board were injured but none of them suffered life-threatening injuries.

The helicopter, owned by Ólafsson and registered in Switzerland, according the Stundin, though a Danish and a Swiss company. Allegedly, the helicopter has been used a lot lately, allegedly twice turning off the device that allows the helicopter to be tracked.

According to Stundin a group of hikers saw a helicopter eight hours before the crash, flying in a dangerously daring way, close to the scene of the accident. It’s not been confirmed if the helicopter observed was the one owned by Ólafsson.

The accident has also drawn the attention of authorities to the fact that tagged prisoners can in theory travel abroad – it’s not banned – as long as they are back at 9pm. The reason foreign travel isn’t forbidden is only because it’s not until now that there have been prisoners wealthy enough to own their own planes. This will now be taken up.

The Icelandic magasine Séð og heart has now pointed at a weird coincidence. Ólafsson has a very close business partner, Hjörleifur Jakobsson, who like Ólafsson moved to Switzerland, has in general been closely involved in Ólafsson’s business ventures for decades and has often been called Ólafsson’s right hand in Icelandic media.

It turns out that as the Icelandic Prison Service is starved for funds it has outsourced the electronic tagging and the surveillance involved to a company called “Öryggismiðstöðin,” which is owned by no  other than Ólafsson’s right hand man, Jakobsson. The magasine is not alleging that Jakobson’s company is granting Ólafsson any favours, merely pointing out that such coincidences can happen in little Iceland.

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“No” is the short answer. The Icelandic penal code on i.a. breach of fiduciary duty and market manipulation is similar to law in Western countries. The difference in Iceland was the swift awareness in autumn 2008 that there might be something worth investigating, later supported by setting up an Office of a Special Prosecutor, Special Investigating Commission and strengthening the financial supervision. Also, the Special Prosecutor quickly realised that behind the invariably complicated web of shell companies and transactions stories of fraud are in reality quite simple and follow the same patterns over and over again. This is why bankers and shareholders have been successfully prosecuted in Iceland – not because Iceland has better penal code.

“How come that Iceland is successfully prosecuting bankers, getting them sentenced to lengthy prison terms when no one else is doing it?” This is a question I keep being asked. The short answer is the one above but there is also a longer one.

Soon after Icelanders got used to the fact that the three large Icelandic banks had collapsed, in early October 2008, the country and the media was rife with rumours that something not entirely normal, not entirely legal, had been going on in the banks. Some tried to explain alleged irregularities by the unavoidable panic; that well, perhaps the bankers had in some cases overstepped the legal borderline, strayed into grey territories, as they fought to keep the banks as going concerns.

The Icelandic parliament, Alþingi, took two measures in December 2008 to clarify the collapse: it set up an investigative commission, The Special Investigative Commission, SIC, into the banking collapse – and it set up an Office of a Special Prosecutor, OSP.

The SIC already came across a number of cases it could not quite align with normal banking practices. These cases were outlined in its thorough report in April 2012 and it also presented its findings to the OSP. At the same time the financial supervisor, FME, was diligently reviewing the operations of the banks prior to the collapse. This meant that the OSP i.a. got input from these two institutions.

The Icelandic lesson from dealing with fraud related to the banks’ operations up to the banking collapse just proved the old saying: where there is a will there is a way.

A meagre and humble start

The beginnings of the OSP were not promising. First, no one applied for the job. Then a small-town sheriff was asked to apply and that is how Ólafur Hauksson, from Akranes across the bay from Reykjavík, got the job. This is a story often told before: Hauksson had never seen anything more serious than speed-driving, drunk driving, moonlighting, domestic violence, break-ins and drunken brawl, the average criminality in an Icelandic small town.

But Hauksson proved that give a person the occasion to shine and he/she very well might. He got funds to hire staff, three prosecutors were hired. Slowly slowly, the charges emerged. Slowly slowly, bankers started to pack to go on an unexpected trip, sent by the Supreme Court, to Snæfellsnes, the beautiful peninsula visible from Reykjavík, to an old farm, Kvíabryggja, a prison for non-violent prisoners.

Last year, following a system change, the OSP was moved into a bigger structure, the Office of County Prosecutor. This time, several people applied to lead the new institution. Hauksson was among the applicants and landed the job.

Digging out the simple truth from entangled webs of emails, shell companies and transactions

The main stories emerging from the collapse cases so far have revolved around market manipulation and breach of fiduciary duty. The real lesson here is the same as everywhere else: these cases look complicated, there are mountains of documents to read, often complicated web of shell companies and offshore companies, money floating around. Interestingly, phone tapping has been used successfully and there are also recordings from the old banks.

However, as in all such cases the underlying stories tend to be simple: the ways to commit a crime are not myriad. Think Enron: looks complicated, with all of the above – at the bottom, a simple story how losses were hidden from shareholders. Another entangled web is the Savings & Loan scandals in the US in the 1980s, nota bene where cases were really investigated and people sentenced to prison.

And these things do not happen by themselves. In every case it takes more than one to do all the necessary things. A prosecutor then decides whose deeds are grave enough to prosecute, who bears the responsibility etc.

Considering how little has been done i.a. in the UK to investigate the banks’ operations leading to the autumn 2008 banking collapse there and considering the screamingly obvious inactions by authorities in Luxembourg regarding banks – all the worst cases in Iceland have ties to the banks’ operations in Luxembourg – it is ironic that the OSP would have been a lot less successful were it not for a fruitful cooperation with these two countries. Authorities in both countries have carried out house searches and assisted in finding and identifying documents relevant for the OSP’s work. Yes, that is hugely ironic…

Market manipulation: burying shares like drug dealers with too much cash

Icelandic cases of market manipulation where bankers have been sentenced have mainly been carried out in two ways: through the banks’ own trading and by parking the banks’ shares into shell companies, invariably owned by clients with some particularly cosy ties to the banks and/or the banks’ shareholders.

Although Landsbanki and Kaupthing, Glitnir to a much lesser extent, were successfully running high interest rates internet accounts, to fund their operations (Landsbanki and the ill-fated Icesave), all three banks relied on selling bonds on international markets. This funding kept the banks going like mills with water. When funding dried up in summer 2007 it was clear that the banks would come to a grinding halt.

That is also what foreign banks sensed, quickly starting to call in loans and, with sinking asset prices, making margin calls on the big Icelandic businesses, i.e. the banks’ main shareholders and their closest partners. Since Icelandic bank shares were the collaterals in most of these loans (after all, the banks had lent the large shareholders money to buy their shares, another aspect that made Icelandic banks weak), it was clear that the markets would be flooded with Icelandic bank shares if the margin calls went through.

Faced with this the Icelandic banks decided to increase the lending to their largest clients – yes, all of them large and the largest shareholders in the banks – in order to prevent this flooding. The feeling when reading the court rulings in these cases is that the banks were like drug dealers with more cash than they can stash, needing to bury it etc.; i.e. the shares were buried in various companies and these transactions were funded by the banks.

Lending on contracts with no provisions to hinder possible losses

Breach of fiduciary duty has figured prominently in banking collapse cases leading to imprisonment. These cases all revolve in some way around lending where the bank carries all the risk, where eventual losses, were they to arise, would always fall on the bank, i.e. losses were foreseeable.

It seems to me that there are some Irish cases very similar to the Icelandic ones of foreseeable losses, i.e. the management didn’t seem to have the interest of the banks and their shareholders at heart but assisting individual clients beyond rhyme and reason.

These Icelandic loan agreements were often only agreed on by the banks’ managers, i.e. outside of regular processes, without the knowledge of credit committees etc. There would then be lower-placed trusted lieutenants who organised the lending. In some cases they have also been charged and sentenced, in some cases not.

Thus, the banks lend in such a way, apparently knowingly, that would the borrower not be able to pay, it would lead to the bank losing money. Here it is important to keep in mind that these banks were public companies with thousands of shareholders – Kaupthing had well over thirty thousand shareholders – losing money on bad lending.

“No society can tolerate that certain parts of it are beyond law and justice” – well, some can…

From reading the SIC report it is clear that some cases have been prosecuted, others not. There was too much of this going on but yes, the managers and the top tier, in some cases also shareholders, have been targeted by the OSP.

It is important to keep in mind that bankers in Iceland have not been sentenced for stupid or unwise decisions but for actions which the Supreme Court has then ruled were criminal actions.

When I talked to Hauksson following the conviction in the so-called al Thani case, in February 2015, he pointed out that the Supreme Court’s decisions showed “that it is possible to bring complicated financial cases to court and get conviction. Building up the expertise has been a long process but the ruling today demonstrates that setting up an office, which didn’t exist earlier, was fully justified. No society can tolerate that certain parts of it are beyond law and justice.”

For some reason, countries like the US and the UK, with old and esteemed legal traditions have in many cases decided to fine rather than prosecute for financial crimes, thereby showing the opposite of the Icelandic examples show – the US and the UK have indeed at times shown that yes, certain parts of society are indeed beyond law and justice. That has sadly been the UK and the US lessons of the financial calamities of 2008.

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Thirteen people, mostly ex-bankers, have now been sent to prison in cases connected to the banking collapse brought by the Office of Special Prosecutor. Four of these prisoners keep giving rise to media coverage in Iceland: earlier in November it turned out that they had applied for a riding course, organised by the Agricultural University of Iceland. In the end, the director of the Prison Service refused to accept that this expensive course fulfilled the set criteria for prisoners’ rehabilitation. It also ensued that these prisoners have allegedly made use of PR firms.

For the time being, three former top managers of Kaupthing – Hreiðar Már Sigurðsson, Magnús Guðmundsson and Sigurður Einarsson – and the bank’s second largest shareholder Ólafur Ólafsson are in prison, serving sentences from four to six years. The prison that houses them, Kvíabryggja, is on the Northern side of Snæfellsnes, close to the tip of the peninsula that can be seen from Reykjavík on a clear day.

These four prisoners, sentenced in the so-called al Thani case, are not the first sentenced in relation to the banking collapse but they are the first to continuously making media headlines. In 2003 a member of Alþingi was sentenced to prison for embezzlement from public funds. Also staying at Kvíabryggja he procured new mattresses for the prison.

Shortly after the four were imprisoned there were news that also they wanted to pay for some improvements at Kvíabryggja but this is no longer legal: prisoners can’t use their funds things at Kvíabryggja at their own will.

An exclusive course for wealthy prisoners

In early November the Icelandic media covered a story regarding a riding course these four prisoners allegedly wanted to take part in. The Agricultural University offers riding courses, intended for A level students and was willing to offer it to the four prisoners at Kvíabryggja. The course was to run on weekends this winter, starting early November, in a riding hall at a farm next to but not belonging to the prison.

The cost was €3.800 per participant. The course only included the teaching, which meant the prisoners had to provide a horse, saddle and other things needed, apparently not a problem. Ólafsson who for years has owned a grand summerhouse close by the prison is known in Icelandic equestrian circles as the owner of some of the most expensive and outstanding horses in Iceland.

It seems that when the director of the Prison Service Páll Winkler heard about this he inquired if the course was offered to all prisoners. Apparently that was not the case. Though being part of the curriculum offered by the Agricultural University in this case it was allegedly tailor-made for these four prisoners, at a price only very few prisoners will be able to afford. Consequently, Winkler interfered and the course was called off.

Prisoners, a riding course and human rights

Following Winkler’s comments to the media that the riding course did not fit rules on courses acceptable for prisoners the wife of Ólafsson, Ingibjörg Kristjánsdóttir, wrote an article in one of the Icelandic papers, Fréttablaðið, accusing Winkler of inappropriate comments and breaching the prisoners’ human rights. Interestingly, the paper is owned by Ingibjörg Pálmadóttir, the wife of Jón Ásgeir Jóhannesson; Jóhannesson is charged by the OSP in a pending case.

Kristjánsdóttir claims that Winkler’s comment breached the prisoners’ human rights, made at the cost of people he should be protecting, “prisoners who have few to speak for them in a society of hate and revengefulness, prisoners that Páll knows are not allowed to speak to the media. Thus the prisoners are defenceless against the attack by the director of the Prison Service.”

Winkler answered, claiming that talking about “breach of human rights” showed Kristjánsdóttir’s “lack of understanding and utter lack of respect for people who have really suffered breach of human rights from public institutions, either in this country or abroad.” Rules had been followed and he had no further comments to this case.

Prisoners with PR people

In relation to the riding course Winkler said to Rúv that a very small group of prisoners has access to millions of króna and even makes use of public relation firms to contact him and the prison service. “PR firms have contacted me, asking me to say a, b or c or not to say a, b or c. I found this utterly preposterous and was left speechless.”

Winkler also says that wealthy prisoners have tried to buy services that are not offered to prisoners in general. “This is a delicate balance because if this is something offered to all prisoners I am of course only glad when the situation can be improved.” However, services for only a select group of prisoners is unacceptable.

As an example Winkler mentions a new association, “Friends of Kvíabryggja” set up to improve life at Kvíabryggja, offering funds for improvements but this is, according to Winkler, unacceptable. He has i.a. refused requests for a yoga course and more tv channels. “If you are powerful and want to improve the situation for prisoners you turn to Alþingi and do it through the Budget.”

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Icelandic authorities ignored warnings before October 2008 on the expanded banking system threatening financial stability but the shock of 90% of the financial system collapsing focused minds. Disciplined by an International Monetary Fund program, Iceland applied classic crisis measures such as write-down of debt and capital controls. But in times of shock economic measures are not enough: Special Prosecutor and a Special Investigative Committee helped to counteract widespread distrust. Perhaps most importantly, Iceland enjoys sound public institutions and entered the crisis with stellar public finances. Pure luck, i.e. low oil prices and a flow of spending-happy tourists, helped. Iceland is a small economy and all in all lessons for bigger countries may be limited except that even in a small economy recovery does not depend on a one-trick wonder.

“The medium-term prospects for the Icelandic economy remain enviable,” the International Monetary Fund, IMF, wrote in its 2007 Article IV Consultation
Concluding Statement, though pointing out there were however things to worry about: the banking system with its foreign operations looked ominous, having grown from one gross domestic product, GDP, in 2003 to ten fold the GDP by 2008. In early October 2008 the enviable medium-term prospect were clouded by an unenviable banking collapse.

All through 2008, as thunderclouds gathered on the horizon, the Central Bank of Iceland, CBI, and the coalition government of social democrats led by the Independence party (conservative) staunchly and with arrogance ignored foreign advice and warnings. Yet, when finally forced to act on October 6 2008, Icelandic authorities did so sensibly by passing an Emergency Act (Act no. 125/2008; see here an overview of legislation related to the restructuring of the banks and here more broadly on economic measures).

Iceland entered an IMF program in November 2008, aimed at restoring confidence and stabilising the economy, in addition to a loan of $2.1bn. In total, assistance from the IMF and several countries amounted to ca. $10bn, roughly the GDP of Iceland that year.

In spite of mostly sensible measures political turmoil and demonstrations forced the “collapse government” from power: it was replaced on February 1 2009 by a left coalition of the Left Green party, led by the social democrats, which won the elections in spring that year. In spite of relentless criticism at the time, both governments progressed in dragging Iceland out of the banking mess.

After the GDP contracted by 4% in the first three years the Icelandic economy was already back to growth summer 2011 and is now in its fifth year of economic growth. In 2015, Iceland became the first European country, hit by crisis in 2008-2010, to surpass its pre-crisis peak of economic output.

Iceland is now doing well in economic terms and yet the soul is lagging behind. Trust in the established political parties has collapsed: instead, the Pirate party, which has never been in government, enjoys over 30% following in opinion polls.

Compared to Ireland and Greece, Iceland’s recovery has been speedy, giving rise to questions as to why so quick and could this apparent Icelandic success story be applied elsewhere. Interestingly, much of the focus of that debate is very narrow and in reality not aimed at clarifying the Icelandic recovery but at proving or disproving aspects of austerity, the euro or both.

Unfortunately, much of this debate is misleading because it is based on three persistent myths of the Icelandic recovery: that Iceland avoided austerity, did not save its banks and that the country defaulted. All three statements are wrong: Iceland has not avoided austerity, it did save some banks though not the three largest ones and did not default.

Indeed, the high cost of the Icelandic collapse is often ignored, amounting to 20-25% of GDP. Yet, not as high as feared to begin with: the IMF estimated it could be as much as 40%. The net fiscal cost of supporting and restructuring the banks is, according to the IMF 19.2% of GDP.

Costliest banking crisis since 1970; Luc Laeven and Fabián Valencia.

As to lessons to avoid the kind of shock Iceland suffered nothing can be learnt without a thorough investigation as to what happened, which is why I believe the report, a lesson in itself, by the Special Investigative Commission, SIC, in 2010 was fundamental. Tackling eventual crime, as by setting up the Office of the Special Prosecutor, is important to restore trust. Recovering from a collapse of this magnitude is not only about economic measures and there certainly is no one-trick fix.

On specific issues of the economy it is doubtful that Iceland, a micro economy, can be a lesson to other countries but in general, the lessons are simple: sound public finances and sound public institutions are always essential but especially so in times of crisis.

In general: small economies fall and bounce fast(er than big ones)

The path of the Icelandic economy over the past fifty years has been a path up mountains and down deep valleys. Admittedly, the banking collapse was a major shock, entirely man-made in a country used to swings according to whims of fishing stocks, the last one being in the last years of the 1990s.

(Statistics, Iceland)

 

Sound public finances, sound institutions

What matters most in a crisis country? Cleary a myriad of things but in hindsight, if a country is heading for a major crisis make sure the public finances are in a sound state and public authorities and institutions staffed with competent people, working for the general good of society and not special interests – admittedly not a trivial thing.

Since 1980 Icelandic sovereign debt to GDP was on average 48.67%, topped at almost 60% around the crisis in late 1990s and had been going down after that. Compare with Greece.

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Same with the public budget: there was a surplus of 5-6% in the years up to 2008, against an average of -1.15% of GDP from 1998 to 2014. With a shocking deficit of 13.5% in 2009 it has since steadily improved, pointing to a balanced budget this year and a tiny surplus forecasted for next year. Again, compare with Greece.

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As to institutions, the CBI has been crucial in prodding the necessary recovery policies; much more so after change of board of governors in early 2009. Sound institutions and low corruption is the opposite of Greece, where national statistics were faulty for more than a decade (see my Elstat saga here).

Events in 2008

In early 2007, with sound state finances and fiscal strength the situation in Iceland seemed good. The banks felt invincible after narrowly surviving the mini crisis on 2006 following scrutiny from banks and rating agencies (the most famous paper at the time was by Danske Bank’s Lars Christensen).

Icelanders were keen on convincing the world that everything was fine. The Icelandic Chamber of Commerce hired Frederic Mishkin, then professor at Columbia, and Icelandic economist Tryggvi Þór Herbertsson to write a report, Financial Stability in Iceland, published in May 2006. Although not oblivious to certain risks, such as a weak financial regulator, they were beating the drum for the soundness of the Icelandic economy.

But like in fairy tales there was one major weakness in the economy: a banking system with assets, which by 2008 amounted to ten times the country’s GDP. Among economists it is common knowledge that rapidly growing financial sector leads to deterioration in lending. In Iceland, this was blissfully ignored (and in hindsight, not only in Iceland: Royal Bank of Scotland is an example).

Instead, the banking system was perceived to be the glory of Icelandic policies in a country that had only ever known wealth from the sea. Finance was the new oceans in which to cast nets and there seemed to be plenty to catch.

In early 2008 things had however taken a worrying turn: the value of the króna was declining rapidly, posing problems for highly indebted households – 15% of their loans were in foreign currency, i.a. practically all car loans. The country as a whole is dependent on imports and with prices going up, inflation rose, which hit borrowers; consumer-price indexed, CPI, loans (due to chronic inflation for decades) are the most common loans.

Iceland had been flush with foreign currency, mainly from three sources: the Icelandic banks sought funding on international markets; they offered high interest rates accounts abroad – most of these funds came to Iceland or flowed through the banks there (often en route to Luxembourg) – and then there was a hefty carry trade as high interest rates in Iceland attracted short- and long-term investors.

“How safe are your savings?” Channel 4 (very informative to watch) asked when its economic editor Faisal Islam visited Iceland in early March 2008. CBI governor Davíð Oddsson informed him the banks were sound and the state debtless. Helping the banks would not be “too much for the state to swallow (and here Oddsson hesitated) if it wanted to swallow it.” – Yet, timidly the UK Financial Services Authority, FSA, warned savers to pay attention not only to the interest rates but where the deposits were insured the point being that Landsbanki’s Icesave accounts, a UK branch of the Icelandic bank, were insured under the Icelandic insurance scheme.

The 2010 SIC report recounts in detail how Icelandic authorities ignored or refused advise all through 2008, refused to admit the threat of a teetering banking system, blamed it all on hedge funds and soldiered on with no plan.

The first crisis measure: Emergency Act Oct. 6 2008

Facing a collapsing banking system did focus the minds of politicians and key public servants who over the weekend of October 4 to 5 finally realised that the banks were beyond salvation. The Emergency Act, passed on October 6 2008 laid the foundation for splitting up the banks. Not into classic good and bad bank but into domestic and foreign operations, well adapted to alleviating the risk for Iceland due to the foreign operations of the over-extended banks.

The three old banks – Kaupthing, Glitnir and Landsbanki – kept their old names as estates whereas the new banks eventually got new names, first with the adjective “Nýi,” “new,” later respectively called Arion bank, Íslandsbanki and Landsbankinn. Following the split, creditors of the three banks own 87% of Arion and 95% of Íslandsbanki, with the state owning the remaining share. Due to Icesave Landsbanki was a different case, where the state first owned 81.33%, now 97.9%.

In addition to laying the foundation for the new banks, one paragraph of the Emergency Act showed a fundamental foresight:

In dividing the estate of a bankrupt financial undertaking, claims for deposits, pursuant to the Act on on (sic) Deposit Guarantees and an Investor Compensation Scheme, shall have priority as provided for in Article 112, Paragraph 1 of the Act on Bankruptcy etc.

By making deposits a priority claim in the collapsed banks interests of depositors were better secured than had been previously (and normally is elsewhere).

When 90% of a financial system is swept away keeping payment systems functioning is a major challenge. As one participant in these operations later told me the systems were down for no more than ca. five or ten minutes during these fateful days. All main institutions, except of course the three banks, withstood the severe test of unprecedented turmoil, no mean feat.

The coming months and years saw the continuation of these first crisis measures.

It is frequently stated that Iceland, the sovereign, was bankrupted by the collapse or defaulted on its debt. That is not correct though sovereign debt jumped from ca. 30% of GDP in 2008 until it peaked at 101% in 2012.

IMF and international assistance of $10bn

That fateful first weekend of October 2008 it so happened that there were people from the IMF visiting Iceland and they followed the course of events. Already then seeking IMF assistance was discussed but strong political forces, mainly around CBI governor Davíð Oddsson, former prime minister and leader of the Independence party, were vehemently against.

One of the more surreal events of these days was when governor Oddsson announced early morning on October 7 that Russia would lend Iceland €4bn, with maturity of three to four years, the terms 30 to 50 basis points over Libor. According to the CBI statement “Prime Minister Putin has confirmed this decision.” – It has never been clarified who offered the loan or if Oddsson had turned to the Russians but as the Cypriot and Greek government were to find out later this loan was never granted. If Oddsson had hoped that a Russian loan would help Iceland avoid an IMF program that wish did not come true.

On November 17, 2008 the Prime Minister’s Office published an outline of an Icelandic IMF program: Iceland was “facing a banking crisis of extraordinary proportions. The economy is heading for a deep recession, a sharp rise in the fiscal deficit, and a dramatic surge in public sector debt – by about 80%.”

The program’s three main objectives were: 1) restoring confidence in the króna, i.a. by using capital controls; 2) “putting public finances on a sustainable path”; 3) “rebuilding the banking system… and implementing private debt restructuring, while limiting the absorption of banking crisis costs by the public sector.”

An alarming government deficit of 13.5% was now forecasted for 2009 with public debt projected to rise from 29% to 109% of GDP. “The intention is to reduce the structural primary deficit by 2–3 percent annually over the medium-term, with the aim of achieving a small structural primary surplus by 2011 and a structural primary surplus of 3½-4 percent of GDP by 2012.” – This was never going to be austerity-free.

By November 20 2008 IMF funds had been secured, in total $2.1bn with $827m immediately available and the remaining sum paid in instalments of $155m, subject to reviews. The program was scheduled for two years and the loan would be repaid 2012 to 2015.

Earlier in November Iceland had secured loans of $3bn from the other Nordic countries together with Russia and Poland (acknowledging the large Polish community in Iceland). Even the tiny Faroe Islands chipped in with $50m. In addition, governments in the UK, the Netherlands and Germany reimbursed depositors in Icelandic banks, in all ca. $5bn. Thus, Iceland got financial assistance of around $10bn, at the time equivalent of one GDP, to see it through the worst.

In spite of a lingering suspicion against the IMF, both on the political left and right, there was never the defiance à la greque. Both the “collapse coalition” and then the left government swallowed the bitter pill of an IMF program and tried to make the best of it. Many officials have mentioned to me that the discipline of being in a program helped to prioritise and structure the necessary measures.

Recently, an Icelandic civil servant who worked closely with the IMF staff, told me that this relationship had been beneficial on many levels, i.a. had the approach of the IMF staff to problem solving been an inspiration. Here was a country willing to learn.

Part of the answer to why Iceland did so well is that the two governments more or less followed the course set out in he IMF program. This turned into a success saga for Iceland and the IMF. One major reason for success was Iceland’s ownership of the program: politicians and leading civil servants made great effort to reach the goals set in the program. – An aside to the IMF: if you want a successful program find a country like Iceland to carry it out.

Capital controls: a classic but much maligned measure

For those at work on crisis measures at the CBI and the various ministries there was little breathing space these autumn weeks in 2008. No sooner was the Emergency Act in place and the job of establishing the new banks over (in reality it took over a year to finalise) when a new challenge appeared: the rapidly increasing outflow of foreign funds threatened to sink the króna below sea level and empty the foreign currency reserves of the CBI.

On November 28 the CBI announced that following the approval of the IMF, capital flows were now restricted but would be lifted “as soon as circumstances allow.” De facto, Iceland was now exempt from the principle of freedom of capital movement as this applies in the European Economic Area, EEA. The controls were on capital only, not on goods and services, affected businesses but not households.

At the time they were set, the capital controls kept in place foreign-owned ISK650bn, or 44% of Icelandic GDP, mostly harvest from carry trades. Following auctions and other measures these funds had dwindled down to ISK291bn by the end of February 2015, just short of 15% of GDP. However, other funds have grown, i.e. foreign-owned ISK assets in the estates of the failed banks, now ca. ISK500bn or 25% of GDP.

In addition, there is no doubt certain pressure from Icelandic entities, i.e. pension funds, to invest abroad. The Icelandic Pension Funds Association estimates the funds need to invest annually ISK10bn abroad. Greater financial and political stability in Iceland will help to ease the pressure. (Further to the numbers behind the capital controls and plan to ease them, see my blog here).

With capital controls to alleviate pressure politicians in general have the tendency to postpone solving the problems kept at bay by the controls; this has also been the case in Iceland. The left government made various changes to the Foreign Exchange Act but in the end lacked the political stamina to take the first steps towards lifting them. With up-coming elections in spring 2013 it was clear by late 2012 that the government did not have the mandate to embark on such a politically sensitive plan so close to elections.

In spring 2015, after much toing and froing, the coalition of Independence party led by the Progressive party presented a plan to lift the controls. The most drastic steps will be taken this winter, first to bind what remains from the carry trades and second to deal with the estates, where ca. 80% of their foreign-owned ISK assets will be paid as a “stability contribution” to the state. (I have written extensively on the capital controls, see here). The IMF estimates it might take up to eight years to fully lift the controls.

It is notoriously difficult to measure the effects of capital controls. It is however a well-known fact that with time capital controls have a detrimental effect on the economy, as the CBI has incessantly pointed out in its Financial Stability reports.

In its 2012 overview over the Icelandic program the IMF summed up the benefits of controls:

“… as capital controls restricted investment opportunity abroad, both foreign and local holders of offshore króna found it profitable to invest in government bonds, which facilitated the financing of budget deficit and helped avoid a sovereign financing crisis.” – Considering the direct influence of inflation, due to CPI-indexation of household debt, the benefits also count for households.

Again, measuring is difficult but the stability brought by the controls seems to have helped though the plan to lift them came none too soon. Some economists claim the controls were unnecessary and have only done harm. None of their arguments convince me.

Measures for household and companies

Icelandic households have for decades happily lived beyond their means, i.e. household debt has been high in Iceland. The debt peaked in 2009 but has been going down rapidly since then.

CBI

Already in early 2008, the króna started to depreciate versus other currencies. From October 2007 to October 2008 the changes were dramatic: €1 stood at ISK85 at the beginning of this period but at ISK150 in the end; by October 2009 the €1 stood at ISK185.

Even before the collapse it was clear that households would be badly hit in various ways by the depreciating króna, i.a. due to the CPI-indexation of loans as mentioned above. In addition, banks loaded with foreign currency from the carry trades had for some years been offering foreign currency loans, in reality loans indexed against foreign currencies. With the króna diving instalments shot up for those borrowing in foreign currency; as pointed out earlier, 15% of household debt was in foreign currency.

The left government’s main stated mission was to shield poorer households and defend the welfare system during unavoidable times of austerity following the collapse. In addition, there was also the point that in a contracting economy private spending needed to be strengthened.

The first measure aimed directly at households was in November 2008 when the government announced that people could use private pension funds to pay down debt.

Soon after the banking collapse borrowers with loans in foreign currency turned to the courts to test the validity of these loans. As the courts supported their claims the government stepped in to push the banks to recalculate these loans.

In total, at the end of January 2012 write-downs for households amounted to ISK202bn. For non-financial companies the write-downs totalled ISK1108bn by the end of 2011 (based on numbers from Icelandic Financial Services Association). In general, Icelandic households have been deleveraging rapidly since the crisis.

CBI

Governments in other crisis countries have been reluctant to burden banks with the cost of write-downs and non-performing loans. In Iceland, there was a much greater political willingness to orchestrate write-downs. The fact that foreign creditors owned two of the three banks may also have made it less painful to Icelandic politicians to subject the banks to the unavoidable losses stemming from these measures.

Changes in bankruptcy law

In 2010 the Icelandic Bankruptcy Act was changed. Most importantly, the time of bankruptcy was shortened to two years. The period to take legal action was shortened to six months.

There are exemptions from this in case of big companies and bankruptcy procedures for financial companies are different. However, the changes profited individuals and small companies. In crisis countries such as Greece, Ireland and Spain bankruptcy laws has been a big hurdle in restructuring household finances, only belatedly attended to.

… and then, 21 months later, Iceland was back to growth

It was indicative of the political climate in Iceland that when the minister of finance, trade and economy Steingrímur Sigfússon, leader of the Left Green party, announced in summer 2011 that the economy was now growing again his tone was that of an undertaker. After all, the growth was “only” forecasted to be around 2%, much less than what Iceland had enjoyed earlier. Yet, this was a growth figure most of his European colleagues would have shouted from the rooftops.

Abroad, Sigfússon was applauded for turning the economy around but he enjoyed no such appreciation in Iceland.

As inequality diminished during the first years of the crisis the government could to a certain degree have claimed success (see on austerity below). However, the left government did poorly in managing expectations. Torn by infighting, its political opponents, both in opposition and within the coalition parties never tired of emphasising that no measures were ever enough. That was also the popular mood.

The króna: help or hindrance?

Much of what has been written on the Icelandic recovery has understandably been focused on the króna – if beneficial and/or essential to the recovery or curse – often linked to arguments for or against the EU and the euro.

A Delphic verdict on the króna came from Benedikt Gíslason, member of the capital controls taskforce and adviser to minister of finance Bjarni Benediktsson. In an interview to the Icelandic Viðskiptablaðið in June 2015 Gíslason claimed the króna had had a positive effect on the situation Iceland found itself in. “Even though it (the króna) was the root of the problem it is also a big part of the solution.”

Those who believe in the benefits of own independent currency often claim that Iceland did devalue, as if that had been part of a premeditated strategy. That however was not the case: the króna has been kept floating, depreciating sharply when funds flowed out in 2008. The capital controls slammed the break on, stabilising and slowly strengthening the króna.

Lately, with foreign currency inflows, i.a. from tourism, the króna has further appreciated but not as much as the inflows might indicate: the CBI buys up foreign currency, both to bolster its reserve and to hinder too strong a króna. Thus, it is appropriate to say that the króna float is steered but devaluation, as a practiced in Iceland earlier (up to the 1990s) and elsewhere, has not been a proper crisis tool.

Had Iceland joined the EU in 1995 together with Finland and Sweden, would it have taken up the euro like Finland or stayed outside as Sweden did? There is no answer to this question but had Iceland been in the euro capital controls would have been unnecessary (my take on Icelandic v Greek controls, see here). Would the euro group and the European Central Bank, ECB, have forced Iceland, as Ireland, to save its banks if Iceland had been in the euro zone? Again, another question impossible to answer. After all, tiny Cyprus did a bail-in (see my Cyprus saga here).

On average, fisheries have contributed around 10% to the Icelandic GDP, 11% in 2013 and the industry provided 15-20% of jobs. Fish is a limited resource with many restrictions, meaning that no matter markets or currency fishing more is not an option.

Tourism has now surpassed the fishing industry as a share of GDP. Again, depreciating króna could in theory help here but Iceland is not catering to cheap mass tourism but to a more exclusive kind of tourism where price matters less. Attracting over a million tourists a year is a big chunk for a population of 330.000 but my hunch is that the value of the króna only has a marginal effect, much like on the fishing industry: the country’s capacity to receive tourists is limited.

Currency is a barometer of financial soundness. One of the problems with the króna is simply the underlying economy and the soundness of the governments’ economic policies or lack of it, at any given time. Sound policies have often been lacking in Iceland, the soundness normally not lasting but swinging. Older Icelanders remember full well when the interests of the fishing industry in reality steered the króna, much like the soya bean industry in Argentina.

The króna is no better or worse than the underlying fundamentals of the economy. In addition, in an interconnected world, the ability of a government to steer its currency is greatly limited, interestingly even for a major currency like the British pound. What counts for a micro economy like Iceland is not necessarily applicable for a reserve currency.

Needless to say, the króna did of course have an effect on how Iceland fared after the collapse but judging exactly what that effect has been is not easy and much of what has been written is plainly wrong. (I have earlier written about the right to be wrong about Iceland; more recent example here). In addition, much of what has been written on Iceland and the króna is part of polemics on the EU and the euro and does little to throw light on what happened in Iceland.

Iceland: no bailouts, no austerity?

There have been two remarkably persisting stories told about the Icelandic crisis: 1) it didn’t save its banks and consequently no funds were used on the banks 2) Iceland did not undergo any austerity. – Both these stories are only myths, which have figured widely in the international debate on austerity-or-not, i.a. by Paul Krugman (see also the above examples on the right to be wrong about Iceland) who has widely touted the Icelandic success as an example to follow. Others, like Tyler Cowen, have been more sceptical.

True, Iceland did not save its three largest banks. Not for lack of trying though but simply because that task was too gigantic: the CBI could not possibly be the lender of last resort for a banking system ten times the GDP, spread over many countries.

When Glitnir, the first bank to admit it had run out of funds, turned to the CBI for help on September 29 2008, the CBI offered to take over 75% of the bank and refinance it. It only took a few days to prove that this was an insane plan. The CBI lent €500m to Kaupthing on the day the Alþingi passed the Emergency Act, October 6 2008, half of which was later lost due to inappropriate collaterals. This loan is the only major unexplained collapse story.

The left government later tried to save two smaller banks – a futile exercise, which only caused losses to the state – and did save some building societies. The worrying aspect of these endeavours was the lack of clear policy; it smacked of political manoeuvring and clientilismo and only added to the high cost of the collapse, in international context.

As to austerity, every Icelander has stories to tell about various spending cuts following the shock in October 2008. Public institutions cut salaries by 15-20%, there were cuts in spending on health and education. (Further on cuts see IMF overview 2012).

With the left government focused on the poorer households it wowed to defend benefit spending and interest rebates on mortgages. These contributions are means-tested at a relatively low income-level but helped no doubt fending off widening inequality. Indeed, the Gini coefficients have been falling in Iceland, from 43 in 2007 to 24 in 2012, then against EU average of 30.5. (See here for an overview of the social aspects of the collapse from October 2011, by Stefán Ólafsson).

In addition, it is however worth observing that although inequality in general has not increased, there are indications that inter-generational inequality has increased, as pointed out in the CBI Financial Stability Report nr. 1, 2015: at end of 2013 real estate accounted for 82% of total assets for the 30 to 40 years age group, compared to 65% among the 65 to 70 years old. The younger ones, being more indebted than the older ones are much more vulnerable to external shocks, such as changes in property prices and interest rates. Renters and low-income families with children, again more likely to be young than older people, are still vulnerable groups.

In the years following the crisis the unemployment jumped from 2.4% in 2008 to peak of 7.6% in 2011, now at 4.4%. Even 7.6% is an enviable number in European perspective – the EU-28 unemployment was 9.5% in July 2015 and 10.9.% for the euro zone – but alarming for Iceland that has enjoyed more or less full employment and high labour market participation.

Many Icelanders felt pushed to seek work abroad, mostly in Norway, either only one spouse or the whole family. Poles, who had sought work in Iceland, moved back home. Both these trends helped mitigate cost of unemployment benefits.

Austerity was not the only crisis tool in Iceland but the country did not escape it. And as elsewhere, some have lamented that the crisis was not used better to implement structural changes, i.a. to increase competition.

The pure luck: low oil prices, tourism and mackerel

Iceland is entirely dependent on oil for transport and the fishing fleet is a large consumer of oil. Iceland is also dependent on imports, much of which reflect the price of oil, as does the cost of transport to and from the country. It is pure luck that oil prices have been low the years following the collapse, manna from heaven for Iceland.

The increase in tourism has been crucial after the crisis. Tourism certainly is a blessing but the jobs created are notoriously low-paying jobs. As anyone who has travelled around in Iceland can attest to, much of these jobs are filled not by Icelanders but by foreigners.

Until 2008, mackerel had never been caught in any substantial amount in Icelandic fishing waters: the catch was 4.200 ton in 2006, 152.000 ton in 2012. Iceland risked a new fishing war by unilaterally setting its mackerel quota. Fishing stocks are notoriously difficult to predict and the fact that the mackerel migrated north during these difficult years certainly was a stroke of luck.

The non-measureables: Special Prosecutor and the SIC report

As Icelanders caught their breath after the events around October 6 2008 the country was rife with speculations as to what had indeed happened and who was to blame. There were those who blamed it all squarely on foreigners, especially the British. But the collapse also changed the perception of Icelanders of corruption and this perception has lingered in spite of action taken against individuals. This seems to be changing, yet slowly.

When Vilhjálmur Bjarnason, then lecturer at the University of Iceland, now MP for the Independence party, said following the collape that around thirty men (yes, all males) had caused the collapse, many nodded.

Everyone roughly knew who they were: senior bankers, the main shareholders of the banks and the largest holding companies, all prominent during the boom years until the bitter end in October 2008. Many of these thirty have now been charged, some are already in prison and other fighting their case in courtrooms.

Alþingi responded swiftly to these speculations, by passing two Acts in December: setting up an Office of a Special Prosecutor, OSP and a Special Investigative Committee, SIC to clarify the collapse of the financial sector. These two Acts proved important steps for clearing the air and setting the records straight.

After a bumpy start – no one applied for the position of a Special Prosecutor – Ólafur Hauksson a sheriff from Reykjavík’s neighbouring town Akranes was appointed in January 2009. Out of 147 cases in the process of being investigated at the beginning of 2015, 43 are related to the collapse (the OSP now deals with all serious cases of financial fraud).

The Supreme Court has ruled in seven cases related to the collapse and sentenced in all but one case; Kaupthing’s second largest shareholder and three of the bank’s senior managers are now in prison after a ruling in the so-called al Thani case. – Gallup Iceland regularly measures trust in institutions. Since the OSP was included, in 2010, it has regularly come out on top as the institution enjoying the highest trust.

As to the SIC its report, published on 12 April 2010, counts a 2600 page print version, which sold out the day it was published, with additional material online; an exemplary work in its thoroughness and clarity.

The trio who oversaw the work – its chairman then Supreme Court judge Páll Hreinsson (now judge at the EFTA Court), Alþingi’s Ombudsman Tryggvi Gunnarsson and Sigríður Benediktsdóttir then lecturer in economics at Yale (now head of Financial Stability at the CBI) – presented a convincing saga: politicians had not understood the implication of the fast growing banking sector and its expansion abroad, regulators were too weak and incompetent, the CBI not alert enough and the banks egged on by over-ambitious managers and large shareholders who in some cases committed criminality.

How have these two undertakings – the OSP and the SIC – contributed to the Icelandic recovery? I fully accept that the effect, as I interpret it, is subjective but as said earlier: recovery after such a major shock is not only about direct economic measures.

Setting up the OSP has strengthened the sense that the law is blind to position and circumstances; no alleged crime is too complicated to investigate, be it a bank-robbery with a crowbar or excel documents from within a bank. The OSP calmed the minds of a nation highly suspicious of bankers, banks and their owners.

The benefit of the SIC report is i.a. that neither politicians nor special interests can hi-jack the collapse saga and shape it according to their interests. The report most importantly eradicated the myth that foreigners were only to blame – that Iceland had been under siege or attack from abroad – but squarely placed the reasons for the collapse inside the country.

The SIC had a wide access to documents, also from the banks. The report lists loans to the largest shareholders and other major borrowers. This clarified who and how these people profited from the banks, listed companies they owned together with thousands of Icelandic shareholders.

The SIC’s thorough and well-documented saga may have focused the political energy on sensible action rather than wasting it on the blame game. Interestingly, this effect is no less relevant as time goes by. To my mind, the atmosphere both in Ireland and Greece, two countries with no documented overview of what happened and why, testifies to this.

In addition, the report diligently focuses on specific lessons to be learnt by the various institutions affected. Time will show how well the lessons were learnt but at least heads of some of these institutions took the time and effort, with their staff, to study the outcome.

A country rife with distrust and suspicion is not a good place to be and not a good place for business. Both these undertakings cleared the air in Iceland – immensely important for a recovery after such a shock, which though in its essence an economic shock is in reality a profound social shock as well.

I mentioned sound institutions above. Their effect is not easily measureable but certainly well functioning key institutions such as ministries, National Statistics and the CBI have all been important for the recovery.

Lessons?

In its April 2012 Ex Post Evaluation of Exceptional Access Under the 2008 Stand-by Arrangement the IMF came up with four key lessons from Iceland’s recovery:

(i) strong ownership of the program … (ii) the social impact can be eased in the face of fiscal consolidation following a severe crisis by cutting expenditures without compromising welfare benefits, while introducing a more progressive tax system and improving efficiency; (iii) bank restructuring approach allowing creditors to take upside gains but also bear part of the initial costs helped limit the absorption of private sector losses by public sector; and (iv) after all other policy options are exhausted, capital controls could be used on a temporary basis in crisis cases such as Iceland, where capital controls have helped prevent disorderly deleveraging and stabilize the economy.

The above understandably refers to the economic recovery but recovering from a shock like the Icelandic one – or as in Ireland, Greece and Cyprus – is not only about finding the best economic measures, though obviously important. It is also about understanding and coming to terms with what happened.

As mentioned above, I firmly believe that apart from classic measures regarding insolvent banks and debt, both sovereign and private, the need to clarify what happened, as was done by the SIC and to investigate alleged criminality, as done by the OSP, is of crucial importance – something that Ireland (with a late and rambling parliamentary investigation), Greece, Cyprus and Spain could ponder on. All of this in addition to sound institutions and sound public finances before a crisis.

The soul lagging behind

In the olden days it was said that by traveling as fast as one did in a horse-drawn carriage the soul, unable to travel as fast, lagged behind (and became prone to melancholia). Same with a nation’s mood following an economic depression: the soul lags behind. After growth returns and employment increases it takes time until the national mood moves into the good times shown by statistics.

Iceland is a case in point. Although the country returned to growth, with falling unemployment, in 2011 the debate was much focused on various measures to ease the pain of households and nothing seemed ever enough.

The Gallup Expectations monitor turned upwards in late 2009, after a steep fall from its peak in late 2007, and has been rising slowly since. Yet it is now only at the 2004 level; the Icelandic inclination to spending has been sig-sawing upwards. – Here two graphs, which indicate the mood:

With plan in place to lift capital controls, the last obvious sign of the 2008 collapse will be out of the way. Implementation will take some years; a steady and secure execution this coming winter will hopefully lift spirits in the business community.

Living intimately with forces of nature, volcanoes and migrating fish stocks, and now tourists, as fickle as the fish in the ocean, Icelanders have a certain sangue-froid in times of uncertainty. Actions by the three governments since the collapse have at times been rambling but on the whole they have sustained recovery.

A sign of the lagging soul is that growth has not brought back trust in politics. Politicians score low: the most popular party now enjoying ca. 35% in opinion polls, almost seven years after the collapse and four years since turning to growth, is the Pirate party, which has never been in government.

Recovery (probably) secured – but not the future

As pointed out in a recent OECD report on Iceland the prospect is good and progress made on many fronts, the latest being the plan to lift capital controls: “inflation has come down, external imbalances have narrowed, public debt is falling, full employment has been restored and fewer families are facing financial distress. “

However, the worrying aspect is that in addition to fisheries partly based on cheap foreign labour the new big sector, tourism, is the same. Notoriously low productivity – a chronic Icelandic ill – will not be improved by low-paid foreign labour. Well-educated and skilled Icelanders are moving abroad whereas foreigners moving to the country have fewer skills. Worryingly, there is little political focus on this.

As the OECD points out “unemployment amongst university graduates is rising, suggesting mismatch. As such, and despite the economic recovery, Iceland remains in transition away from a largely resource-dependent development model, but a new growth model that also draws on the strong human capital stock in Iceland has yet to emerge.”

Iceland does not have time to rest on its recovery laurels. Moving out of the shadow of the crisis the country is now faced with the old but familiar problems of navigating a tiny economy in the rough Atlantic Ocean.

This post is cross-posted with A Fistful of Euros.

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The ongoing case against nine Kaupthing managers and staff gives an intriguing insight into the bank’s extensive buying and selling of own shares, which the Office of the Special Prosecutor claims involves market manipulation and breach of fiduciary duty. Witness statements by foreign employees have been especially informative.

In a witness statement today Jan Petter Sissener former head of Kaupthing Norway said he had not had faith in Kaupthing’s annual accounts for 2007. Irked by the bank’s reporting on buying and selling of own shares he asked a law firm in London to look at the bank’s activities from the point of view of international business ethics.

The firm concluded the bank’s behavior was entirely unacceptable. Sissener said that following heated conversation with Kaupthing’s CEO Hreiðar Már Sigurðsson, one of the nine charged now, and the bank’s chief legal officer Helgi Sigurðsson these trades had been stopped for a while but then later resumed again. Sissener left Kaupthing in February 2008 because of these differences of opinion regarding Kaupthing’s reporting on proprietary trading in own shares, which the bank funded to a large extent as shown extensively in the SIC report in 2010.

Another foreign employee, Nick Holton, an international compliance officer with Kaupthing, resigned at the end of July 2008, following a disagreement with senior management. Holton wanted to make some changes but failed to secure support. He said he had had serious doubts about what was going on and wondered at the time whether it was due to negligence or lack of organization. In addition, he worried about his own reputation after working for Kaupthing. He said he had pointed out to the chief legal officer that trading in own shares was illegal in many countries. Holton said it had come as a surprise when he realized that Kaupthing owned 4% of own shares but he did not know at the time that Kaupthing had funded big purchases of its shares for clients nor was he aware of losses stemming from these transactions.

Niels de Connick-Smith, a Danish business man, who sat on the board of Kaupthing, said that as far as he knew Kaupthing’s purchase of own shares had not been discussed on the board.

Senior Kaupthing managers now charged – Sigurður Einarsson, Hreiðar Már Sigurðsson and Magnús Guðmundsson, all of them already in prison following a judgment in the al Thani case – have all been questioned. They deny all charges. The same goes for Ingólfur Helgason, formerly the CEO of Kaupthing Iceland.

The five employees, charged in this case, who carried out the trades said they did so on orders, mostly from Ingólfur Helgason. Helgason denies having operated on his own but would have taken orders, mostly from Sigurðsson. Einarsson claims that being the chairman of the board meant he had no direct involvement in transactions of this type and consequently they would have been outside of his horizon.

Parking shares

The prosecutor has played informative recordings from phone tappings. In one of them the bank’s chief legal officer is talking about transactions in 2008 where the bank lent over ISK10bn, to an offshore company, Desulo Trading owned by an Icelandic business man, Egill Ágústsson. Desulo Trading then bought Kaupthing shares; over a few months it bought 2% of the bank. According to the legal officer the bank was “literally parking the shares” in what he called quite “clearly fictive trades.”

The owner of Desulo Trading has said in an earlier witness statement that he was not told of these transactions and was quite shocked when he saw the substantial loans issued to his company. One Kaupthing Luxembourg employee said the company was, in the end, quite obviously “just like a dustbin” in the bank. Apart from loans to Desulo Trading two other companies are involved in this case, also belonging to big Kaupthing clients, Holt Investment owned by Luxembourg investor Skúli Þorvaldsson and Mata Investments, owned by Gísli V. Einarsson and his family.

Þorvaldsson is charged in another case regarding embezzlement from Kaupthing, together with Sigurðsson, Guðmundsson and Guðný Arna Sveinsdóttir Kaupthing’s chief financial officer, seen to have been very close to the Kaupthing management.

In total, Kaupthing sold almost 18% of the bank’s share in seven large transactions shortly before it collapsed, in all cases funding the share purchase with Kaupthing loans. The largest transaction was when a Qatari sheikh bought 5,1% for which the three above mentioned managers and Ólafur Ólafsson, the bank’s second largest shareholder, are now serving 3 to 5 1/2 years in prison in the so-called al Thani case.

I have earlier stated that I wonder if anything like this was going on in other banks up to the crisis. Here, some Irish banks come to mind re loans to ten shareholders in Anglo Irish. An Irish Court found two bankers guilty but they were not sent to prison because the judge found regulators had failed to warn the bankers of the illegal activity. Icelandic senior bankers have been less lucky.

*This report is based on Rúv reporting on the ongoing case, found here, in Icelandic.

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As reported earlier on Icelog, the French investigative judge Renaud van Ruymbeke is conducting an investigation of Landsbanki Luxembourg activities in France regarding the bank’s equity release loans. With the investigation ongoing it was assumed that the bank’s liquidator Yvette Hamilius would suspend recovering assets by sending bailiffs to the bank’s customers in France.

This however has not been the case as the Luxembourg Paperjam reports (yet again by Véronique Pujoul who has followed this case diligently) and Icelog has heard. Lawyers for the clients are now asking if this could be seen as both harassment from the administrator and also constitute a contempt of the French Courts with an ongoing investigation where charges have been brought.

Icelog has earlier reported extensively on this saddest part of the Icelandic banking collapse saga. What is truly shocking is the utter and complete disregard Luxembourg authorities have shown the clients who have at length described their dealings with the bank and administrator, i.a. conflicting messages from the administrator on outstanding debt. Part of the scheme were investments, which the clients have questioned as they got more understanding of them as well as being kept in the dark about the administrator’s handling of the investments.

Instead, the Luxembourg state prosecutor has, without any investigation, placed himself firmly on the side of the administrator by claiming that the clients were only trying to evade paying back their loans. This behavior by a public prosecutor in a European country is utterly inconceivable.

Although investigations into the banks are ongoing in Iceland, with serious charges and severe prison sentences, Luxembourg has done nothing to investigate the Icelandic operations in Luxembourg, i.a. that of Landsbanki. Yet, the Icelandic investigations show that in many of the worst cases, such as in the so-called the al Thani case, the schemes were partly planned and carried out in the Icelandic banks in Luxembourg. In many cases, the alleged and proven criminal wrongdoings by the Icelandic banks could not have been done without their Luxembourg operations. Yet, Luxembourg ignores the banking problems in its own front yard.

 

 

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“The results today shows that it is possible to bring complicated financial cases to court and get conviction,” Ólafur Hauksson head of Office of the Special Prosecutor said to Icelog, now that the Supreme Court has ruled in one of the OSP’s major cases, the al Thani case. “Building up the expertise has been a long process but the ruling today demonstrates that setting up an office, which didn’t exist earlier, was fully justified. No society can tolerate that certain parts of it are beyond law and justice.”

Those four charged were Sigurður Einarsson chairman of Kaupthing board, Magnús Guðmundsson manager of Kaupthing Luxembourg, Kaupthing CEO Hreiðar Már Sigurðsson and Ólafur Ólafsson the bank’s second largest shareholder. Reykjavík District Court had earlier ruled in the case where Einarsson was sentenced to 5 years in prison, Guðmundsson 3 years, Sigurðsson 5 1/2 years and Ólafsson 3 1/2 years. The Supreme Court has confirmed the ruling over Sigurðsson whereas Ólafsson has now been sentenced to 4 1/2 years, Einarsson to 4 years instead of 5 years and Guðmundsson to 4 years.

As detailed in an earlier Icelog the core of the al Thani case were loans to Ólafsson and Sheikh Mohammed bin Khalifa al Thani, a Qatari investor from the country’s ruling family. It is important to notice that the issuing of these loans was the criminal deed in the case – the three Kaupthing managers broke law by doing it and Ólafsson was complicit in that criminal deed.

The story behind the case is that in in September 2008 Kaupthing made much fanfare of the fact that Sheikh al Thani bought 5.1% of Kaupthing’s shares. The 5.1% stake in the bank made al Thani Kaupthing’s third largest shareholder, after Olafsson who owned 9.88%. This number, 5.1%, was crucial, meaning that the investment had to be flagged – and would certainly be noticed. Einarsson, Sigurðsson and Ólafsson all appeared in the Icelandic media, underlining that the Qatari investment showed the bank’s strong position and promising outlook.

What these three didn’t tell was that Kaupthing lent al Thani the money to buy the stake in Kaupthing – a well known pattern, not only in Kaupthing but in the other Icelandic banks as well. A few months later, stories appeared in the Icelandic media indicating that al Thani was not risking his own money. More was told in SIC report and the SIC recount indicated a fraudulent behaviour. The ruling today has confirmed the doubts, which have surrounded this investment from early on.

Although the case draws its name from Sheikh al Thani he has not been accused of any wrongdoing. He was one of the witness in the case, gave a statement over the phone.

As I have pointed out earlier there is an echo of this investment story in the ongoing investigation into Qatari and Middle East investment in Barclays, which saved the bank from seeking state support in autumn 2008.

The ruling in Iceland is i.a. in stark contrast to how Irish courts have tackled financial crimes related to the Irish collapsed banks. In April last year a court ruled that two former Anglo Irish managers, who had been convicted of issuing loans to prop up the bank’s share price, should not be imprisoned in spite of being found guilty. The judge ruled it was unjust they should go to prison for a criminal deed because they believed they had acted lawfully. Sean FitzPatrick, the bank’s former chairman, was cleared in this case. I find this Irish ruling truly incredible. This loan saga – loans to the so-called “Golden Circle” – has striking parallels in other Icelandic cases, which are being processed.

Icelandic law on financial fraud is in most respect similar to law on these issues in Northern Europe. There is nothing special about the Icelandic situation – except the will to carry out investigations and bringing cases to court. As Hauksson pointed out financial crimes need not be too complicated to be successfully prosecuted – and no part of society should be beyond the reach of the law.

*Update: I have seen some comments that because the four sentenced to prison in the al Thani case are living abroad they are unlikely to go to prison. That is not correct: the fact that they live abroad – in London, Switzerland and Luxembourg – will apparently not change anything. Ólafsson has already said he will come when called to go to prison. That is an unavoidable consequence of the sentencing. 

*Update 25.2. 2015: Ólafsson asked to start his sentencing as soon as possible. According to Icelandic media he is now already in prison at Kvíabryggja, Snæfellsnes, where this sentenced in earlier banking collapse cases have been sent to jail (see here for details of this prison).

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After the banking collapse in October 2008, three things were set in motion by the government at the time (Independence Party, together with the Social Democrats): an investigation into the causes of the collapse, rewriting the constitution and an Office of a Special Prosecutor. The investigation was concluded with a report of 2400 pages published April 10 2010; so far, no country has done a comparable report on the financial crisis in 2008. Rewriting the constitution was not finished in the way intended due to a political backlash. The government now plans to review OSP’s role although the OSP was made a permanent serious fraud office in 2011 – and starve it of funds while the review is ongoing.

It did not start too well: after Althing passed an Act in December 2008 to set up an office of a special prosecutor to investigate possible fraud related to the banking collapse no one applied. Finally, Ólafur Þór Hauksson stepped forward, a sheriff (called “sýslumaður” in Icelandic) from Akranes, the village on the other side of the gulf from Reykjavík.

Though having no previous expertise in Iceland to build on, the OSP has built up the expertise and know-how in investigating fraud such as market manipulation, insider trading, embezzlement and breach of fiduciary duty. So far, six OSP cases have found their way all the way to the Icelandic Supreme Court: five ended with sentencing, one with acquittal.

The Icelandic decision to investigate possible fraud within the banks has been much noticed around the world where financial institutions often seem like holy cows, too powerful to investigate and bankers too important to jail. Examiner Anton Valukas who led the investigation into Lehman Brothers’ demise pointed out certain accounting practice, so called Repo 105, which according to the report seemed to have the sole purpose of balance sheet manipulation (see here on Valukas and the SIC report). Valukas has later clearly expressed bafflement that no charges have been filed regarding Lehman. – In Iceland, irregularities regarding the operations of the banks are being investigated and bankers prosecuted as well as other high-flying businessmen.

With the present coalition government of the Progressive Party and the Independence Party (which led the government that set up the OSP; ex-PM Geir Haarde said on Rúv tonight it had been a good step), the tone is now changed: the OSP is being starved of funds in the 2015 budget.

The government claims it is going to review the OSP operation. Interestingly, it is going to starve it first and then review it. The government seems to ignore that fact that since the law on the OSP was changed in 2011 so as to turn it into a permanent serious fraud office, there is no burning need to come up with changes of purpose and mission.

In numbers (from a recent Rúv interview with Hauksson): the OSP budget for this year is ISK900m, €5,9m; for next year its share in the budget is ISK295m, or a cut of 67%. Sixteen employees were recently fired because of the envisaged funding cuts. With the present prospect for 2015 staff will go from seventy to twenty. The number of cases now under investigation is 96; 39 of them are related to the collapse. The planned cuts also mean that opening investigations into new cases will be problematic; the outlook for seeing charges through court is uncertain.

Just to give an idea on the OSP present activity: these days, the OSP’s most extensive case so far is in the Reykjavík District where Landsbanki’s CEO Sigurjón Árnason and three Landsbanki employees are charged with market manipulation. This weekend, Rúv brought news of charges against four Spron board members and Spron CEO Guðmundur Hauksson (not related to Special Prosecutor Hauksson) relating to an ISK2bn, now €10m, loan to Exista; Guðmundur Hauksson had shares in Exista and long-time relationship with that company, the largest shareholder of Kaupthing. In January, the so-called al Thani case is coming up in the Supreme Court; appeal of the Reykjavík District Court where Kaupthing CEO Hreiðar Sigurðsson was sentenced to 5 1/2 years, executive chairman Sigurður Einarsson 5 years, Kaupthing’s second largest shareholder Ólafur Ólafsson 3 1/2 years and Magnús Guðmundsson manager of Kaupthing Lúxemborg 3 years.

On October 6 2008 Icelanders sat stunned as prime minister Haarde addressed the nation at 4pm to tell them the government was doing what was needed to prevent the collapsing banks from causing a national catastrophe. The OSP has been diligent in bringing banking high-flyers and their helpers to court. Although the task is not finished it seems the government is no longer adamant about investigating collapse-related fraud cases, let alone keeping an eye on potentially new financial fraud cases. – It is now oh so 2008…

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Acquittals in major cases brought by the Office of the Special Prosecutor have made headlines in Iceland and elsewhere. In addition, it has now surfaced that an expert, called in to be a lay judge in the Aurum case is the brother of Ólafur Ólafsson, one of the four indicted in the al Thani case.  Jón Ásgeir Jóhannesson, at the time Glitnir’s largest shareholder, was indicted in the Aurum case, together with Glitnir’s ex-CEO Lárus Welding and two Glitnir employees. Both were acquitted.

Jóhannesson has however earlier been found guilty in two cases but in both cases the prison sentence was suspended. In February last year, he was sentenced in a tax fraud case to 12 months in prison, suspended, and fined for ISK62m, €400.000. In June 2008 Jóhannesson was sentenced, as part of the long running Baugur case, to three months in prison, also suspended. Following both sentences Jóhannesson is prevented from sitting on boards of companies for some years.

In a nutshell, the Aurum case concerns Glitnir staff indicted for breach of fiduciary duty, i.e. for lending money without necessary collaterals and guarantees. Indeed Glitnir lost the ISK6bn, €40m, that the bank lent in this saga. Jón Ásgeir Jóhannesson, who profited from the loan by getting €6,5m, of the loan (because Fons, the company that got the loan and couldn’t repay it, apparently owed Jóhannesson this sum of money) was charged for aiding in the alleged illegal activities. Numerous emails brought up during the oral hearings showed his direct involvement and severe pressure on finalizing the loan, which he profited from.

Ólafur Ólafsson was indicted on similar grounds in the al Thani case last December. Reykjavík County Court found him guilty and he was sentenced to 3 1/2 years in prison. That case has been appealed to the Supreme Court. In Iceland no one goes to prison until the Supreme Court has ruled in an appealed case.

In addition to two District Court judges Sverrir Ólafsson professor at Reykjavik University was called to be an expert judge in the Aurum case. Over the weekend, Icelandic media pointed out that Ólafsson is the brother of Ólafur Ólafsson. It is still unclear if this will have consequences. (Foreigners sometimes think that everyone must know everyone in Iceland – well, not quite and Ólafsson is a common last name).

Judge Guðjón Marteinsson and Stefán Ólafsson acquitted the four. The third judge, Arngrímur Ísberg, was in minority: in his opinion all four were guilty and should have been sentenced to prison. Theoretically, if a lay judge had sided with Ísberg the outcome would have been different.

From the course taken by the Reykjavík District Court in the al Thani case, where the four indicted were sentenced to 3-5 1/2 years, it is difficult to understand the reasoning of the two judges who chose to acquit in the Aurum case. The al Thani case has been appealed and a Supreme Court decision is expected in autumn or early winter. If the Supreme Court comes to a different conclusion it would not be the first time that an acquittal in a banking-related case is turned around in the Supreme Court.

The other case ruled on last week – called the Ímon case after one of the companies involved – is part of a market manipulation case brought against Landsbanki managers. Here the loan saga is similar to the al Thani case: Landsbanki lent funds to limited liability companies with little or no collaterals, here in order to fund the buying of shares in Landsbanki only days before the bank collapsed. These deals were nothing less than the largest share purchases in Landsbanki that year – these companies were each buying around 2% of Landsbanki shares. Sigurjón Árnason and Sigríður Elín Sigfússdóttir were acquitted but a lower level employee, Steinþór Gunnarsson was sentenced to nine months in prison, of which six are suspended.

So far, all the OSP cases have been appealed and that will most likely be the route with these two recent decisions.

Apart from legalities it is clear that if banking as practiced in the above mentioned cases were applied as a general rule the bank in question would be out of business fairly soon. And who wants to be a shareholder in a bank where funds are leant out in such a way that if something goes wrong the bank can’t recover the funds?

*The verdict in the Aurum case is here and the Landsbanki verdict here (both in Icelandic). 

 

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