Sigrún Davíðsdóttir's Icelog

Last week started with a TV interview where prime minister Sigmundur Davíð Gunnlaugsson spent the best of half an hour arguing with the journalist, much to the dismay of many TV watchers. Then there was a report on Iceland and the EU, which led to the government deciding to break off EU membership negotiations, in spite of earlier promises to vote on continued negotiations; a decision ex prime minister Þorsteinn Pálsson called the greatest political betrayal in Icelandic history. And lastly, it was also last week that the government, at the 12^th hour, announced it was going to take time to set up a committee to ponder on changes, or not, at the Central Bank. This which means that the CBI will clearly not be taking any major decisions until new governor(s) are in place, which again must set some creditors thinking – and perhaps also some Icelanders.

For two days protesters have gathered outside the Icelandic Alþingi, parliament. It is not an angry mob, more like a crowd during an interval at a theatre waiting patiently for the second half. What started out as an awkward election promise is now a millstone around the neck of prime minister Sigmundur Davíð Gunnlaugsson but more seriously minister of finance and leader of Independence Bjarni Benediktsson. At the time, Benediktsson himself now against Icelandic membership of the European Union (but pro EU some years ago) but trying to avoid alienating pro-EU voters, eased out of anything final on the matter by promising a referendum on continuing the negotiations or not.

A history of broken promises

Both parties promised in no uncertain terms that they would not break off negotiations without a referendum but instead hold a referendum on whether to continue the membership negotiations. What the two parties had not foreseen was that there would be a clear majority for continuing.

Many voters now seem to feel that this promise has been broken in spite of the coalition parties offering various different version of actually-not-broken-promise. The government had said it would make up its mind on EU after a report it had promised already last autumn. Now that the report is out, a balanced overview of the negotiations and options, the government intends to skip earlier promise and instead break off the negotiations without any further ado. It even seemed to want to rush the matter through parliament last week, holding a parliamentary debate only a day after the 1000 pages report had been published thus giving MPs no time to study the report but it was forced to change its tempo and give more time.

This awkward promise of a referendum on continued negotiations now haunts the government. Benediktsson tries to spin it as being impossible to continue though he struggles to explain what should have changed since the promise was given. He did however say in a TV debate last night that he could “not completely” keep his promise.

This issue is particularly difficult for Benediktsson, less for Gunnlaugsson whose party is firmly against EU membership. Although opinion polls indicate that majority of Independence party voters are against EU membership the business elite, except for those with interests in the fishing industry, is for membership. This is turning into a major problem for the government. One Independence party member, Vilhjálmur Bjarnason, has said he will reflect the opinion of many party members and vote against breaking off the negotiation. The government’s majority is however still secure.

One who voices dismay in no uncertain terms is Benediktsson’s fellow party member ex prime minister Þorsteinn Pálsson who calls the change of course “the greatest political betrayal ever” in Icelandic politics. Pálsson is a respected commentator and many well-known Independence party members from the business community who side with him.

In addition, Iceland also now has its very own version of Sarah Palin. Last week, Progressive MP and chairman of the budgetary committee Vigdís Hauksdóttir stated during a radio debate: “There is famine in Europe now” and later said that Malta is “a self-governing zone within a larger country. It is not a country.” Before these remarkable statements her most memorable statement had been (during a TV interview on earlier promised action on the health service “at once” her party were in power) that the phrase “at once” was an “elastic concept” – a novel and highly creative interpretation that has now turned into a saying in Iceland.

CBI in limbo

By stepping in to make changes at the CBI the government has effectively kicked the CBI off the field of any major decisions regarding the estates of the collapsed banks and ultimately of the capital controls for some time, probably most of this year. This is seen a cause for worry in the business community tired of non-action on the capital controls. The bigger companies, often with foreign operations that ease the pain of the controls, find their way within the controls but smaller and medium sized companies are complaining loudly.

The first step towards changes is to set up a working group (no names yet) apparently to come up with suggestions as to what the changes should be. As pointed out earlier, it seems that the government was going to set all of this in motion at a later date but then realised, at the last moment, that by waiting it might have to pay the present governor Már Guðmundsson salary of the rest of his 5 year term, which would have been renewed automatically February 20 unless he had been notified. Which he then duly was, on that day. *

The situation now is of completely opacity as to the procedure. Also there is a complete lack of policy as to where the government is heading with the CBI. It is unclear who will come up with proposals, unclear what the government policy is (some indication that the FME, financial supervisory authority, might be put under the CBI as it was until 1998) and it is also unclear as to what the criteria will be for hiring a new governor and if there will be more than one governor. And obviously it is completely unclear as to how long all this will take and when new governor(s) might be in place.

Will the past replace the future?

Generally, countries where the government meddles in matters of the central bank do not fare well. Right now, it is not only the Icelandic government that is creating such headlines but also the governments in Hungary and Nigeria. Not exactly countries that Iceland has been comparing itself to over the years.

One of the more interesting remarks made by the prime minister in the TV interview a week ago was when he stated on CBI independence that “it would be good to have an independent central bank if we had a different government.”

The fact that the CBI had criticised the “correction” – debt write-down for borrowers who could afford their loans and consequently had not profited from earlier write-downs by the previous government – was obviously a matter of great irritation to the prime minister.

This ill-prepared intervention against the CBI has instigated a feeling in Iceland that the country is about to be steered back to the past where all public institutions and state-owned companies were carved up between the political powers. People were chosen to leading offices of power not according to merits but according to party affiliation. It came as a great surprise when Benediktsson recently appointed a young ex banker, Halla Sigrún Hjartardóttir. She has no previous experience of bank supervision but is an investor with rumoured connections to wheeling and dealing connected to the oil company Skeljungur. Not exactly a career similar to her opposite numbers in the neighbouring countries. The question is if this was only the first of similar nominations.

The question is if old politicians will now be put into power as once was the rule rather than the exception. Might ex prime minister Davíð Oddsson become the chairman of the board of Landsvirkjun? And will his successor as party leader and later prime minister Geir Haarde. So far, the rumours are utter speculations but they indicate a state of mind prepared to see the past turn into the future.

The past practices of the old banks live on (in hidden assets)

It remains to be seen if the strong feeling of the political past being projected into the future materialises. What clearly lives on from pre-collapse Iceland is the effect of the old banks’ operations, both its earlier practices and that most of the big borrowers still have access to considerable assets.

Post-crisis bankrupt companies with humongous debt and hardly any assets (left) shows how assets did migrate out of these companies to somewhere mostly out of sight and reach of administrators. Most of the well-known holding companies, supporting the ownership of the major shareholders of the banks have followed this pattern, i.a. Novator, Baugur, Exista, Fons etc. This alleged migration of wealth out of sight was facilitated by the banks’ lenient lending practices: the banks took all the risk, the favoured borrowers got covenant-light loans.

The clearest shift of risk took place during the winter of 2007 and 2008 when foreign banks, reacting to falling share price in the Icelandic banks, initiated margin calls affecting almost all of the big Icelandic bank shareholders who had placed their Icelandic bank shares as collaterals with foreign banks. The Icelandic banks, rather than seeing their shares flood the market evidently precipitating further falls in share price if not a total meltdown, stepped in and increased their lending to these shareholders. By Easter 2008, this shifting of risk and rapidly increased exposures was over and done with.

In only a few months these moves, well documented in the SIC report, hugely increased the Icelandic banks’ already considerable exposures to their largest shareholders and their business partners, in some cases going over legal limits (though in some cases the banks’ lending hovered under the legal limits by abstruse definition of “related parties”: i.a. Glitnir did not consider Jón Ásgeir Jóhannesson and his wife as related parties nor did Landsbanki classify Björgólfur Guðmundsson and his son Björgólfur Thor Björgólfsson as related parties).

Coming soon: transfer of wealth of historic magnitude

What is at stake in the coming months and years? The banks have amassed a great amount of assets that will be sold. Already, there is anecdotal evidence that the practice from the old banks, of issuing loans to favoured clients against shares with non-too punishing haircut, is abounding. After all, the banks do want to lend money and inside capital controls bad practices can fester.

The most prized assets, already for sale, are the two new banks, Íslandsbanki and Arion, owned by foreign creditors. Most likely these assets are highly coveted by certain forces in Iceland where banks have always bastions of political power and centres of handing out assets to favoured clients.

How the foreign-owned ISK assets of the estates – not only if Glitnir and Kaupthing but also of Straumur and Icebank – will be dealt with decides to a certain degree the price tag on Íslandsbanki and Arion. Any government action, affecting the price, such as converting all foreign assets into ISK/paying foreign cash out in ISK will be of huge interest to Icelanders with money and ambition to buy into Íslandsbanki and Arion.

It is no understatement that the sale of Arion and Íslandsbanki will greatly affect the business climate in Iceland in the coming years and possibly decades. If these assets could be sold on the cheap, aided by pension funds willing to act as silent owners by the side of active investors, the past might indeed be the future, not only in politics but also in the business community.

And now, over to creditors and mobile and educated Icelanders

By the end of 2012 both Glitnir and Kaupthing had presented the CBI with drafts of composition. The matter is still unsolved. Most of last year was lost to election and then a run-in time for the new government. That year went by without any bringing any clarity as to the abolition of the capital controls and the steps needed to solve the problem of the foreign-owned ISK assets.

Now the CBI is in limbo. What will creditors do when faced with an uncertain future of the CBI and an uncertain effect on how to resolve the problem of the ISK assets in Iceland? The creditors have various possibilities. Do they deem the government to be hindering access to the estates’ fx assets? If so, they could try to sue the Icelandic state abroad, i.a. in London. Argentina is the scare example of a country that for years has been kept under pressure from creditors. Not necessarily the Icelandic saga any time soon.

Some drama might come later. Then, on the other hand there will not necessarily be any big drama: some of the creditors might just silently choose to sell their claims. In troubled times the buyers are investors looking to recover their claims by litigating every penny, or in this case, every króna.

Ireland is now back in the market though the country is by no means on a safe ground yet. When will Iceland be in the market to refinance its debt? Judging from the government’s tendency to prolong problems instead of solving them it might take a while. Even a long while.

For Icelanders locked inside capital controls there is yet another “if”: if Iceland will be further isolated from other countries the effect of the growing income difference of the mobile and well educated classes compared to the neighbouring countries might take its toll. As counts for much in Iceland the changes are very gradual. Lost opportunities or loss of work force who does not return to Iceland after studies abroad is difficult to calculate.

* In his letter to CBI employees, Guðmundsson noted that he should have been alerted before midnight February 19. However, he was apparently not notified until evening of February 20. It remains to be seen if this will pose a problem for the government: if Guðmundsson will/cannot reapply, i.e. he could possibly claim that he should be paid for the rest of his term. Judging from his previous dealings regarding his salary, where Guðmundsson maintained earlier promises had been broken – he lost a court case on this issue – Guðmundsson will no doubt explore his position were he to lose his job.

See below for recent three blogs on power and politics in Iceland. The latest blog on capital controls is here. 

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This week, an Althing investigative commission delivered long awaited – or long dreaded – report on the Housing Finance Fund. It was even worse than expected, outlining greater than expected losses. It outlines how political connections – mainly the Progressive Party, now leading the government – systematically put the party’s interest before the HFF’s. The losses 1999-2012 could amount to ISK270bn, 16% of Icelandic GDP, possibly more. Add this to another blunder – the losses of the Central Bank of Iceland from repo deals with the Icelandic banks prior to the collapse – also causing a sovereign loss of 16% of GDP and it seems that Icelanders pay a lot for the political parties putting their own interests before the country’s.

,,… unfortunately, one can’t but sincerely admit that one had lots of doubt but this is what was agreed as the government was formed in 2003. If it hadn’t been done, that government would not have come into being.” This is how Geir Haarde minister of finance 2003-2007 (leader of the Independence Party 2005-2009, prime minister 2006-2009) described to the Special Investigative Commission on the financial collapse in Iceland how the 2003 coalition of the Independence Party and the Progressive Party came into being. In the elections that year, the Progressive Party campaigned on raising the mortgage level to 90% of the purchase price. In order to save the coalition of the two parties, led by the Independence Party, that party agreed to turn the Progressive campaign promise into policy. The vehicle was the Housing Finance Fund, HFF.

This policy turned out to fuel a boom that was already building up. Haarde was aware of the danger but, concludes the SIC report, his estimate was “that the expected loss for society (from this policy) was an acceptable cost to society for keeping the two ruling parties in power.”

We now know that the cost of this policy might be the somewhat unacceptable loss of ISK270bn, €1.68bn, 16% of GDP. Ironically, it now falls on the present coalition of these two parties, this time under Progressive leadership, to take a decisive step to end the Fund’s misery.

A new report (unfortunately only in Icelandic; not even an English summary), published earlier this week by an Althing investigative commission, tells the story of these huge losses and how the fund was used for political purposes. The report lays political networks bare, showing how political connections were favoured over merit and experience and how the fund continuously added to the coffers of companies connected to the Progressive Party. Regulators failed and foreign criticism, i.a. coverage in 21 reports by the OECD and the IMF, was systematically ignored. – The Fund itself disputes the numbers in the report, saying the losses are at most ISK64bn. However, the fund only put forth this number without any documentation in a press release and has not answered other matters raised in the report.

HFF, the Progressive power sphere and regulators who failed

The core of the problems was changes to the financing of the HFF and changed lending rules in 2004. The Independence Party had for some time worked on changing the issuing of HFF bonds so they would appeal to foreign investors. In 2003 the Progressive Party had campaigned on raising the mortgage level to 90% of purchase price. The changed issuance caused an immediate loss in 2004 of ISK21bn. A simple error in calculation added another ISK3.5bn, to the loss, bringing it to almost ISK25bn. Higher lending levels increased the risk and did over time cause higher levels of non-performing loans. The Fund started lending to property developers and companies, both increasing risk and losses.

The immediate loss of ISK25bn was just the beginning. Over the years, the faulty decisions taken in 2004 have caused snowballing losses, which now stand at ISK103bn of loss already on the books with the addition of foreseeable loss of 167bn, in total ISK270bn. The Fund claims the losses mainly stem from the collapse of the banks but according to the report the main losses stem from changes to the Fund in 2004. In a nutshell, it is a saga of the intertwining of political power and a public institution, the HFF.

The political connection surface in various ways. Fjárvaki, a subsidiary of Kaupfélag Skagfirðinga (once part of the Icelandic co-op movement, strongly connected to the Progressive Party and still part of the “Progressive sphere”), signed a deal to sell software to HFF. In the end the deal was terminated without Fjárvaki fulfilling it. Yet, HFF paid Fjárvaki an amount equal to the sales price. This is only one part of the HFF’s many highly questionable connections to Progressive-connected entities. And only one of innumerable similar stories in the report.

Then there is the glaring incompetence. With the 2004 changes in laws the Fund was obliged to have a proper risk management system. A Swedish consultancy, Capto, delivered the system and ran it to begin with. When the HFF staff took over it seems they neither understood it nor were able to run it, rendering the risk management useless. To make things worse, the Financial Services Authorities, FME, did not react to the Fund’s flawed risk assessment.

On the whole, all regulators and institutions, which were supposed to supervise and regulate the HFF failed. Part of the problem was that the fund was drowning in money as banks were venturing into mortgage lending, wooing clients with lower interest rates than the HFF. With changed rules, borrowers could pay up their HFF without penalties, meaning the HFF was drowning in money it could not invest at rates high enough to meet its own financing costs.

Through 2005, HFF lent ISK95bn to banks and other financial institutions, thereby financing the banks’ own mortgage lending, which was crowding out the Fund’s own mortgages – and in addition fuelling a boom. The report criticises the Central Bank of Iceland for not taking any action, thereby failing its role as a guardian of price stability.

The fervent denial of criticism

Although the extent of corrupt procurement and lack of expertise were first laid bare in the new report, the flawed public housing policy and the risk to the sovereign through the HFF’s state guarantee have been clear from the beginning and indeed heavily criticised by international organisations such as the IMF and the OECD.

The new report trawls through 21 reports from these two organisations from 1999-2012. The Fund’s clear problems and its compromising position has been a permanent fixture in reports from both organisations and still are. Yet, the various governments during all these years have ignored the warnings. And there is still no plan in place to end the Fund’s loss-making misery. The new report concludes that by not heeding the relentless warnings, Icelandic authorities have undermined their trust abroad.

In general and over all these years the intertia to solve the HFF’s problems has always been stronger than all reasoning and advice given by international experts. The question is why this inertia was so strong. The answer is twofold – there was the profound ignorance within the fund and lack of expertise. Secondly, political interests – mostly, though not solely, the interests of the Progressive Party – have been stronger than the general interest of the country. This is what invariably happens when political interest overrides merit and expertise. To the Irish and the Italians these will be familiar stories.

The present echo of ignored warnings

When Icelanders disapprove of foreign criticism of Icelandic issues, their standard answer is that foreigners do not understand the special circumstances in Iceland. The truth is of course that general rules of economics apply in Iceland as elsehwere. But it is difficult to follow any enlightened advise when political interests and connections subsitute normal reasoning.

There are now some disturbing similarities to events in 2003 and what later ensued. As then, the Progressive Party wooed voters in the spring elections with promises of debt relief almost every expert not connected to the Progressive Party warns against. The party’s promise of wide-spread debt-relief to those who are too well-off to have been eligible to earlier debt-relief offers draws criticism from the CBI as well as from the OECD and the IMF. The warning choir is loud and clear and singing from the same hymn sheet: these plans threaten financial stability and could cause inflation, all too familiar to Icelanders.

In a recent interview (in Icelandic) prime minister Sigmundur Davíð Gunnlaugsson said it did not worry him what the different “acronyms” (meaning international organisations such as the IMF and the OECD) thought of the planned debt relief. These organisations rarely welcomed radical actions such as those planned by the government, Gunnlaugsson said. In his speech on the Icelandic national day, June 17, the prime minister said that Icelanders would not let international organisations dictate what can be done for Icelandic households.

It is expensive to live in a country that is badly goverened or where corruption – difficult to avoid that word in relation to the HFF – is allowed to add its poisonous cost to every transaction. The corrupt practices, disregard for competence and expertise and political favours in HFF have so far cost Iceland 16% of its GDP and yes, more might be to come. Losses stemming from the CBI’s repo transactions with the banks before the collapse amount to another 16% of GDP. Consequently, these two mistakes have caused losses equivalent to about a third of Iceland’s GDP, the cost shared by Icelanders for bad political calculations.

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Speculating what Government will emerge from on-going coalition talks in Iceland is difficult – but guessing that the next four years will be as tough as the last four ones is easy. But first, the country needs a new Government. The election campaign revealed the power-sphere uniting the two parties that are seen as the most likely to form a coalition. But the longer it takes to form a Government, a coalition of three or more seem more likely.

Judging from the big smiles on party leaders’ faces as they left first deliberations with leader of the Progressive Party Sigmundur Davíð Gunnlaugsson, holder of the presidential mandate to form a Government, Gunnlaugsson must be good at telling them they are uniquely placed to be part of a Progressive-led coalition. Interestingly, Gunnlaugsson conducts the coalition talks alone and takes none of his fellow party members, according to Icelandic media. President Ólafur Ragnar Grímsson’s motivation for handing the mandate to Gunnlaugsson was that the several other leaders had pointed at him and that the Progressives had made the greatest election leap from 2009.

The crisp spring air in Reykjavík is thick with speculation as to if Gunnlaugsson will indeed succeed and, if not, who will be able to form a Government. Already before the election, it seemed credible that the two largest parties, Progressives and the Independence Party – the latter with more votes but both with same number of MPs – would form a coalition. The feeling now is that the longer it takes, the less likely the birth of this only option for a two-party coalition.

Apart from Gunnlaugsson and his party the focus is on the fate of the Independence Party. Traditionally the largest party in post-war Iceland, it was seen as the centre of political and financial power.

Although the President gave mandate to Gunnlaugsson, nothing excludes other party leaders to negotiate among themselves. Whoever comes first up with a credible coalition is free to go to the President and announce he/she now has a majority Government. No doubt various discussions are on-going, not only in the parties’ headquarters.

“Throw a dice”

The most remarkable comment so far on who should lead the much expected coalition of the Progressives and conservatives is that it does not really matter. The advice on Monday in an editorial of the daily Morgunblaðið was “Throw a dice.”

This gives an insight into Icelandic power politics. The editor of Morgunblaðið since autumn 2009 is Davíð Oddsson of extensive fame as the conservative leader who in secured the party the Prime Minister post from 1991 to 2004. He served as a Governor of the Central Bank 2005 to 2009 when he was ousted by the minority coalition of the social democrats and the Left Green.

Oddsson seems never to have reconciled himself with being out of power. With old allies in the Independence Party he has exerted – or tried to exert – power over the party, causing great and severe problems for the present leader, Bjarni Benediktsson.

Benediktsson went against Oddsson and his old guard by siding with the Left Government on Icesave two years ago. Only ten days before the election last Saturday a poll, allegedly paid for by a close friend of Oddsson, showed that half of those voting for the Progressives would vote for the IP if its vice-chairman Hanna Birna Kristjánsdóttir were its leader. This move, widely seen to be an attempt to get rid of Benediktsson, backfired and seemed to galvanise Benediktsson.

Oddsson’s political antipathy is strongly focused against the social democratic Alliance who many IP members see as being on a mission to destroy the Independence Party (even big parties can be paranoid). Social democrats were seen to be leaders of the pack that ousted Oddsson from the CBI but his grudge against the social democrats was allegedly born in 1994 when those who later founded the Alliance in 2000 gathered the left wing in local council elections and won majority in Reykjavík ending decades of IP rule. Consequently, Oddsson was fiercely against his successor Geir Haarde forming a coalition with the social democrats in 2007.

Morgunblaðið has, since the beginning of time, been closely connected to the conservatives and was for decades seen as a party organ. Hiring Oddsson as an editor came as a great surprise – after all, the paper had slowly developed a more independent stance from the party though its main owners were, as before, closely connected to the party.

Considering the old ties between Morgunblaðið and the IP, the paper’s favourable stance towards the Progressives, most notably to Gunnlaugsson, all through the election campaign has been surprising – unpleasantly so to some. As the Progressive fortune grew in the polls the IP fortune dwindled and Morgunblaðið did not seem at all bothered. Many devoted IP readers were dismayed, sensing that actually their old organ was much more admiring and supportive of Gunnlaugsson and the Progressives than Benediktsson and the editor’s old party.

Now, according to Morgunblaðið it does not matter who leads an IP-Progressive coalition. Just “throw a dice.”

Morgunblaðið and the merging interests

But why is the IP old guard, led by the former IP leader, suddenly so overtly pro-Progressives? Is it because it best safeguards IP interests to hook up with the Progressives – as many think – or is there a genuine Progressive rapprochement in the old guard?

The answer can possibly be found in the strife for power in Iceland. The Independence Party is not as strong as it used to be and the Progressives seem to have lurched into corners the biggest party earlier had to itself.

Here the ownership of Morgunblaðið and – as always in Iceland – personal connections are an intriguing indication of merging interests. Whereas the paper used to be owned by companies and individuals solely connected to the Independence Party it is now co-owned by entities connected to the IP – and to the Progressive Party.

After companies connected to Björgólfur Guðmundsson, the largest shareholder of Landsbanki together with his son Björgólfur Thor Björgólfsson, failed, Guðmundsson lost his ownership of Morgunblaðið. Forth came Guðbjörg Matthíasdóttir, a widow of an owner of one of the main Icelandic fishing companies she now runs together with her sons. She saved the paper and became its largest shareholder.

This was widely seen as a move by the fishing industry to secure a media to propagate its anti-EU stance, she hired Oddsson who with great zest and untiring diligence writes against the EU. Interestingly, the fishing industry makes good use of the EEA agreement to expand abroad but is equally suspicious of any foreign involvement in the fishing industry in Iceland.

Matthíasdóttir’s ownership is well know in Iceland but few have noticed that the group of owners is now more diverse than earlier. Another Morgunblaðið shareholder is Kaupfélag Skagfirðinga (the Skagafjörður Co-op), KS, a remnant of the co-op movement, which until it collapsed in the 1990s was the financial part of the Progressives’ power sphere. KS is a thriving company (I have not studied its ownership) and exerts great power in Northern Iceland and farther afield, both in fishing and agriculture. The man who has turned a small-time co-op into a modern conglomerate is Þórólfur Gíslason, one of the island’s most powerful men, who happens to be related to Oddsson. Another Morgunblaðið shareholder with a Progressive connection is a company owned by the family of Halldór Ásgrímsson leader of the Progressive party during its years of coalition with the Independence Party – and Oddsson.

One of the more peculiar comments to the election was in Morgunblaðið’s weekly Sunday column, traditionally written by its editor. Since the Sunday paper is actually distributed on Saturdays this column was written before the results were clear. In unusually big font and with striking graphs, the centerfold article quoted an old article from a business magazine, extolling the fantastic accomplishment of Governments led by Oddsson until 2004, of which his party was in coalition with the Progressives from 1995. – Whether the article was intended to remind readers of this glorious coalition, the great Prime Minister or both, many a Morgunblaðið reader (said to be much fewer now than when Oddsson became editor) whispered this truly was the strangest of many strange articles penned by the editor.

Only two years ago, it would have been impossible to imagine that the old conservative party organ would one day so openly be supporting the Progressive Party. If Morgunblaðið’s predilection has indeed migrated to the Progressive Party it indicates that power is more important than ideology. Unless the IP’s old guard thinks like Il Gattopardo in Giuseppe di Lampedusa’s novel: it is necessary to change in order to keep things as they are.

The Morgunblaðið power-sphere and the EU

This joint ownership of IP and Progressive interests in Morgunblaðið may explain the paper’s political position and the fact that to its editor is does not really matter who leads a coalition of the two parties. No matter who of the two parties leads, the Morgunblaðið two-party power-base will be close to – even at heart of – the political power in Iceland.  Consequently, both parties do equally well, thank you very much – and, most importantly, seen from the point of view of Morgunblaðið’s power-sphere, both parties should be in Government, not only one of the two parties.

But does the two-party power centre at Morgunblaðið exert any real power or is just a club of old have-beens? Gauging the extent of power is never easy. Considering the web of personal relations emanating out of Morgunblaðið it is safe to say that that this web reaches into many an Icelandic corner of business interests in the fishing sector, which have always been at the centre of politics and power in Iceland, and other companies.

If this is indeed a joint power-base of the IP and the Progressives is there anything to threaten it? Judging from the fervour the Progressives – the party is tied to interests of both fishing and agriculture – put into their anti-EU stance, only equalled by some IP leaders but outdone by the editorials of Morgunblaðið, it seems that these forces see an Icelandic EU-membership as a great threat to their power and interests.

It is however interesting to note that the Independence Party is split on the issue. As with the British Conservatives, to whom its Icelandic sister party has long looked with reverence and awe (especially during the Thatcher-years), its leadership is now thoroughly anti-EU whereas many of its members are in favour of EU-membership. For the moment, being pro-EU is not a great career-move among Icelandic conservatives.

Partly by keeping EU-membership off the political agenda so far, the Independence Party has prevented the issue from splitting the party. A referendum on membership would be a serious test, which is possibly why IP anti-EU members are doing their best to stop the negotiations, thus avoiding this difficult topic. The same avoidance can be seen among many who are opposed to EU membership, no matter from which party. The history of Swedish membership might scare: there was a Swedish majority against membership until the day of the referendum in 1994 when Swedes surprisingly voted for EU membership.

Other alternatives than a two-party coalition

The feeling is that the longer the coalition discussions drag out the less likely a two-party coalition. Although the Progressive parliamentary party is young and unattached to the party’s past, many IP members fear the stench of old corruption emanating from the Progressives. These members might favour some left collaboration rather than a two-party coalition, especially if that is the only way to secure an IP Prime Minister. Such a Government will win no favour with the IP old guard and their followers.

During the election campaign, many in the Independence party, sensing that voters were susceptible to Progressive promises of extensive debt write-down – the main reason for the Progressive’s success – were pointing out that the Progressives had a natural inclination to the left. Consequently, a vote for the Progressives meant a vote to the left, they said. But leading Progressive members took care to keep all options open, never admitting to any preferences of political directions.

With six parties in Government there are various numerical options to choose from. Though an absolute exception in Icelandic politics, some are even talking of a minority Government of Progressives. It seems however far too early to imagine this outcome, also because the problems ahead will demand strong and steady political leadership (more on the future later). Yet, it seems difficult to see who would like to be led by the Progressives with their fantastical promises of debt-relief.

Ultimately, it is the political reality and trust that counts. Although Gunnlaugsson is young in politics there are already those who allegedly whisper, even in his own party, that he is somewhat unreliable. Benediktsson is seen as someone who can easily talk to everyone. Although it now seems that one of those two is the most likely Prime Minister in spe, it is still too early to tell. There are, after all, six leaders to choose from.

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Although plenty is known about the collapse of the three Icelandic banks, given the SIC report, there is still one major unknown chapter in this saga: a loan of €500m granted by the Central Bank of Iceland to Kaupthing on October 6 2008, due to be repaid four days later. It is clear that about half of this loan will never be repaid. Now a parliamentary committee is investigating the loan. The only documentation of the loan is a recording of the phone call between David Oddsson then governor of the CBI and prime minister Geir Hard but so far the CBI is not assisting.

At 4pm on October 6 2008 prime minister Geir Haarde addressed the stunned nation on all media channels ending his speech with ,,god bless Iceland” – an uncustomary ending in a country where god is seldom called upon in the political realm. Interestingly, Haarde did not say the banks were failing but he talked at length about the dire situation abroad, which now could also be felt in Iceland with its outsized banks compared to the country’s economy. In these tough times for banks in many countries, he said deposits in Iceland were safe and the government would in the coming days do its utmost to hinder chaos and confusion in case “the Icelandic banks become un-operational to some extent.” He also announced the emergency legislation, which was passed later that day.

But when did the prime minister and the government actually known that the end of the banks was nigh and unavoidable? In the SIC report Haarde, Ossur Skarphedinsson minister of foreign affairs, trade and banking minister Bjorgvin Sigurdsson and minister of finance Arni Mathiesen all recount they understood this around 2am on this fateful October 6 when the ministers met three bankers from JP Morgan, called to Iceland to advise the Central Bank of Iceland. At this late hour, the three foreigners explained in a few but clear and concise words that there really was nothing to be done – the three banks were beyond salvation.

“… this was a really weird moment,” said Sigurdsson in his statement to the SIC. “Suddenly this was clear like morning light. The man just drew it on the white-board. Just all of a sudden. This was a sort of moment of truth after this insane roller coster ride weekend, which was in hindsight perhaps more or less based on wishful thinking.” (SIC report, vol 7, p. 104; only in Icelandic). – That is what it felt like to realise that the Icelandic banking system was failing: a simple drawing on a white-board.

At this meeting, Haarde finally realised he would have to address the nation and pass the emergency legislation and that is what he sat in motion as the day dawned.

On October 27 2008 the CBI put out a press release saying that on October 6 it had, after conferring with the prime minster, issued a loan of €500m to Kaupthing in order for the bank to meet its obligations to UK authorities related to the bank’s UK subsidiary.

What is known about this loan is that there is no proper documentation in the CBI regarding it. The only tangible evidence of the loan having been issued is apparently a recording of a phone call between the then governor of the CBI David Oddsson and Haarde. Kaupthing held some sort of “receipts” (but nothing resembling a loan agreement or any other formal documentation) for this amount having been paid to the bank. The loan had maturity four days later – i.e. it was a bridge loan but yes, an awfully short bridge. The collateral was nothing less than Kaupthing’s Danish subsidiary FIH Bank, at the time reckoned to be worth €670m and the interest rates set at 9%.

That Monday in the late afternoon, the loan was paid from a CBI account abroad into Kaupthing’s account with Deutsche Bank in Frankfurt in three instalments, totalling €500m. If or how it left Deutsche is not known. The €500m might have been enough to salvage Kaupthing Singer & Friedlander – the preceding week the FSA had demanded that £400m be paid as a guarantee since money was flowing fast out of the bank – but the €500m never seemed to reach the UK authorities.

The loan was not repaid four days later. Eventually, the CBI sold the collateral but the sale only brought in around half of the loan and less, if interest rates are taken into account. Consequently, this undocumented loan has caused the Icelandic state a huge loss of about €250m.

All this is now known – but it is still unknown why CBI and the prime minister thought it was necessary, let alone a good idea, to issue a loan of ca 4% of the bank’s total foreign currency reserve to a bank, which by the time the loan was issued hardly seemed a going concern. When and why the Kaupthing managers secured this loan is not known. It is not clear why the CBI issued a loan without any proper documentation or why, if there was no time right on the Monday, this was not put in place in the following days. And if the CBI really intended the loan to shore up the Kaupthing UK operations why did the bank not pay the money directly to the UK authorities?

A year ago, an Icelandic parliamentary committee started enquiring about this loan, which had caused the state such a loss. When it transpired that the only documentation regarding the loan is to be found in the recording of the phone conversation of the CBI governor and the prime minister the committee asked for a transcript. So far, the CBI has procrastinated. Last week, when the committee was finally going to publish a report on its findings, obviously pointing out the CBI’s lack of answer, the CBI sent a letter to the committee saying it was considering its options. It hinted at the possibility of  inviting the committee to read the transcript but then backtracked and has since been quiet on the issue.

Thus stands this intriguing story, so far without an ending. The report by the parliamentary committee might now be published in the coming days but apparently without information from the transcript.

There is however no lack of rumours and guesses as to why this loan was issued and what it was bridging. The most persistent rumours regard Kaupthing’s alleged Russian clients but it should be stressed that nothing has ever surfaced to corroborate the rumours. There is however a Russian element in the collapse saga: on October 7, the prime minister announced Russia was lending Iceland €4bn to strengthen its foreign reserve. This loan never materialised and it was never clear how this “offer” was made or by whom.

*The Icelandic Parliament has now published its report (in Icelandic but it is short; alors, Google translate is an option) – without an answer from the CBI on the transcript of the fateful telephone call mentioned. All the facts re the loan mentioned above can be found in the report.

**Update 31.3. 2013: Geir Haarde has recently stated that the recording of his conversation with CBI governor Oddsson was done without his knowledge and he would not agree that it was made public. As in many other countries, it is illegal in Iceland to record a phone conversation without making others on the call aware of it.

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One of the more incomprehensible events in the Icelandic collapse saga is the loan of €500m issued on October 6 2008 by the Central Bank of Iceland to Kaupthing. The burning question is why this loan was issued.

The collateral was the Danish bank, FIH, which CBI became the unhappy owner of after Kaupthing failed. The whole FIH saga is a sorry saga in itself – the CBI sale of FIH has incurred huge losses for the CBI, €180-423m. It’s also unclear how much of the loss stems from the CBI’s bad handling of the sale.

But back to the 500m loan. It indicates that the CBI thought Kaupthing had a greater chance for survival than Glitnir and Landsbanki, which is why the CBI issued the loan. This was a fairly widely held public belief these days. But the CBI should have known better – on Friday October 3, the Bank of England had already taken measures to close down Kaupthing by taking over all deposits coming into the bank from that day. This clearly spelled the end for the bank. Didn’t the CBI know about the UK measures? Or didn’t it care?

By Monday October 6 it was clear that the banks had no chance of survival – the politicians and others had come to terms with the facts over the weekend – and that’s what PM Geir Haarde told the stunned nation in a televised speech at 4pm that Monday. It was also abundantly clear that one big risk factor was the banks’ inter-connectedness.

After the loan came to the light it was for quite a while unclear where the money went. The SIC report from April 2012 indicates that €200m were used to guarantee Kaupthing Sweden, where the Government stepped in for the bank (I actually thought the Swedish Government stepped in, making the Icelandic guarantee superfluous but perhaps I misunderstood something?). The rest? Apparently, it was divided between various other operations, in Luxembourg, Norway and Finland.

But here is another mystery, as far as I can see. Within Kaupthing’s management it was clear that the KSF operation in the UK was a central place in the Kaupthing universe. A failed KSF would cause cross-defaults, leading to the collapse of the Kaupthing Group. As far as I know, Kaupthing got this CBI loan for saving KSF – but none of the money went to the UK.

At the trial over Geir Haarde, the ex-PM was asked what happened to the money. He said it went to a different place than Kaupthing had indicated. Unfortunately, this wasn’t pursued by the prosecutor.

But most terribly regrettably, David Oddsson former Governor of the CBI wasn’t asked at the trial why the CBI issued this loan to Kaupthing, ia if those responsible at the CBI knew that the UK action against Kaupthing had already started, what Kaupthing’s motivation was for receiving the loan and if the CBI did anything to guarantee that the loan was used for its stated purpose.

This perhaps isn’t a big issue – but it’s one of the few completely murky events of these fateful days in early October 2008. Well, there is of course the offer of a Russian loan.

*In May 2010, Vidskiptabladid (in Icelandic) wrote that on Oct. 6 2008 Kaupthing lent ISK28bn to Lindsor, a BVI company that figured in other Kaupthing transactions. The CBI loan to Kaupthing that day amounted to ca ISK80bn. The Lindsor loan was apparently used to buy bonds from Kaupthing Luxembourg and other securities from Skuli Thorvaldsson and the bank’s key managers.

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Monday March 5 was the first day of trial against Geir Haarde, Iceland’s Prime Minister June 2006 – Februar 2009. Haarde is being tried by a special court, “Landsdómur,” never before convened in the history of Iceland. This court’s only function is to try ministers and is modelled on the Danish legal system.

The trial has been covered by the world media, ia by the BBC, Guardian and Sky.

The five charges brought against Haarde regard alleged omissions in office and are the following:

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

2 He didn’t take the initiative to do a comprehensive analysis of the risk faced by the state due to danger of a financial shock

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

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

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

Regardless whether people think it’s fair to indict only one minister it is already clear after the first two days that the trial will provide an interesting insight into a whole range of issues related to the collapse of the banks. Although the setting and the purpose differ, in Iceland the court hearings are being compared to “a truth commission” since it will give the general public the possibility to hear what politicians, civil servants and bankers have to say on the various issues in question.

Unfortunately, the court has decided against broadcasting the hearings. There are only ca 40 places available in the court hall for the media and the general public to share. The court has been asked to reconsider its decision. The hope is very much that it will change its mind.

On the first day, Haarde was questioned for eight hours. Tuesday, witnesses were called in for questioning. Below is a list of the witnesses published by the court:

Monday March 5:

Geir Haarde

Tuesday March 6:

Bjorgvin Sigurdsson former Minister of Trade

Arnor Sighvatsson former chief economist, CBI

David Oddsson former Governor of the CBI

Wednesday March 7

Ingimundur Fridriksson former Governor of the CBI

Baldur Gudlaugsson former permanent secretary of the Ministry of Finance

Bolli Thor Bollason former permanent secretary of the Prime Minister’s Office

Aslaug Arnadottir former head of department in the Ministry of Trade and chairman of the board of the Deposit Guarantee Fund

Jon Sigurdsson former chairman of the board of the FME and member of the board of the CBI

Jon Th Sigurgeirsson head of the Office for the Board of Governors of the CBI

Thursday March 8:

Jon Thor Sturluson former assistant to the Minister of Trade

Jonas Fr Jonsson former director of FME

Jonina Larusdottir former permanent secretary of the Ministry of Trade

Hreidar Mar Sigurdssonr former CEO, Kaupthing

Gudjon Runarsson director of the Icelandic Financial Services Association

Runar Gudmundsson head of the Insurance Department FME

Thorsteinn Mar Baldvinsson former chairman of the board at Glitnir

Friday March 9:

Sigurdur Sturla Palsson former head of CBI’s International Department

Tryggvi Thor Herbertsson former economic adviser to the Government

Vilhelm Mar Thorsteinsson former head of treasury, Glitnir

Heimir V Haraldsson former member of Glitnir ResCom

Johannes Runar Johannsson former member of Kaupthing ResCom

Larentsinur Kristjansson former chairman of Landsbanki ResCom

Vignir Rafn Gislason certified accountant PWC

Kristjan Andri Stefansson former head of department, Prime Minister’s Office

Sylvia Kristin Olafsdottir former head of contingency planning, CBI

Ossur Skarphedinsson former Minister of Industry

Johanna Sigurdardottir former Minister of Social Affairs

Monday March 12:

Ingibjorg Solrun Gisladottir former Minister of Foreign Affairs

Sigurdur Einarsson former chairmand of the board, Kaupthing

Larus Welding former CEO Glitnir

Stefan Svavarsson chief accountant CBI and member of the board, FME

Halldor Kristjansson former CEO Landsbanki

Sigurjon Arnason former CEO Landsbanki

Bjorgolfur Gudmundsson former chairman of the board, Landsbanki

Tueday March 13:

Tryggvi Palsson former head of financial stability, CBI

Gudmundur Jonsson head of lending, FME

Jon Thorsteinn Oddleifsson former head of treasury, Landsbanki

Sverrir Haukur Gunnlaugsson former Icelandic ambassador, UK

Arni M Mathiesen former Minister of Finance

Sigridur Benediktsdottir member of the SIC

Tryggvi Gunnarsson member of the SIC

Atli Gislason member of Althing

Birgitta Jonsdottir member of Althing

Eyglo Hardardottir member of Althing

Lilja Rafney Magnusdottir member of Althing

Magnus Orri Schram member of Althing

Oddny Gudbjorg Hardardottir member of Althing

Steingrimur Sigfusson member of Althing

As this list show, both Prime Minister Johanna Sigurdardottir and Minister of Economic Affairs Steingrimur Sigfusson will appear before the court. It’s also an intriguing thought that bankers Sigurdur Einarsson, Hreidar Mar Sigurdsson and Larus Welding have already been indicted by the Office of the Special Prosecutor. The two CEOs of Landsbanki have been sued by the bank’s WUB and will most likely, at some point, be indicted by the OSP. The first OSP case ruled on by the High Court was against Baldur Gudlaugsson who recently was sentenced to two years in prison for insider trading.

Last but not least, Bjorgolfur Gudmundsson might have a flash back when he takes place before the court: it was in this same hall that Gudmundsson, together with his son Bjorgolfur Thor Bjorgolfsson and their business partner from St Petersburg Magnus Thorsteinsson, signed the agreement to buy 42% of Landsbanki in January 2003.

*The consultative group was comprised of civil servants from the Prime Minister’s Office, the Ministry of Finance, the Ministry of Business Affairs, the FME and the CBI. It was founded with a written agreement on February 21 2008. Its remit was financial stability and contingency planning. On its purpose and work see the executive summary of the SIC report. – I will be following the trial, unfortunately from abroad, but will try to bring a short digest of interesting testimonies.

**The charges have been updated from an earlier version.

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The Landsbanki Winding-Up Board writ against managers and board members of Landsbanki contains further insight into ownership and the bank’s status just before its demise. Here are some excerpts from the writ:

* The assets of father and son, Bjorgolfur Gudmundsson and his son Bjorgolfur Thor, were convoluted and not clearly separated. They had, according to the writ, joint ownership of Grettir, Eimskip and Icelandic Group. As a consequence of Landsbanki’s collapse both father and son became insolvent. Gudmundsson later went bankrupt but his son managed to renegotiate with his creditors.

* This connected ownership led the Icelandic FME to look at the bank’s risk assessment in April 2005. Things moved slowly, FME was even softer than the FSA in the UK, but in February 2008 FME concluded that Bjorgolfsson’s exposure to the bank was not 16.1% as the bank itself claimed but 42.1%, far above the legal limit of 20%. – Interestingly, the bank’s own rules were clear but they were not followed when it came to risk assessment of the bank’s major shareholders.

* According to the WUB, by September 30 2008, father and son did not only control the 41.85% they owned in the bank but had in reality control over 73.38% through shares owned by Landsbanki and Straumur, the investment bank where father and son were also the largest shareholders and where Bjorgolfsson was the chairman.

* The writ claims that Landsbanki was insolvent by October 3 2008, “if not earlier” (an interesting point and whole saga in itself) thus making it illegal for the managers to dispose of money to three entities on October 6.

* The WUB is suing CEOs Halldor Kristjansson and Sigurjon Arnason, Jon Thorsteinn Oddleifsson head of treasury and board members Andri Sveinsson, Kjartan Gunnarsson, Svafa Gronfeldt and Thorgeir Baldursson, in addition to 25 insurers.

* These seven are claimed to have caused damages of total ISK35bn (€219m) to the bank by allowing or not hindering three payments on October 6 when the WUB claims the bank was already insolvent. In addition, ISK11bn is sought from the insurers.

* And who were these three entities that the Landsbanki managers were so hell-bent on paying out large sums of money when it seemed clear that the bank was destined only for a moratorium? These three were the above-mentioned Straumur, a Landsbanki’s money-market fund Landsvaki and MP Bank.

* Half an hour before the Prime Minister Geir Haarde addressed the nation in the afternoon of Oct 6 2008, Straumur asked to draw on a loan line of ISK7.2bn (€44.7m). This loan line had been negotiated in January 2007, as part of a deal where Straumur took on to finance Landsbanki’s off shore companies that apparently were set up for employees’ option though never used. – These offshore companies are an interesting story: controlled by the bank, increasing the two major shareholders’ control. –  According to the loan agreement Straumur could only draw on the loan line on the same day if a request was made before 13:30. Even though the request came much later in the day, Landsbanki paid out the money. The payment was made after the time of the day banks were allowed to make large payments.

* Landsbanki bought bonds, hugely above market price in the preceding days and weeks – on a day where there was literally no market. For some reason, the managers felt a pressing need for these purchases, in total ISK20bn.

* MP Bank demanded to draw on a loan, related to previously negotiated loans, just over ISK7bn (€44m). Landsbanki legal adviser denied the request but an hour later had a change of mind and the loan was paid out at the same time as the Straumur loan.

* Everyone who runs a company knows that an insolvent company is prohibited by law to pay out money. For some reason, the Landsbanki managers thought it vital to pay out money to Straumur, Landsvaki (even more irregular since it was paying way above market price) and MP Bank. There are no doubt still untold stories from Landsbanki’s last hour.

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New political fault lines seem to have opened up in Icelandic politics. The reason only ex- PM Geir Haarde will be charged and not the three other ministers named in a recent Althing report on ministers’ responsibility for the collapse of the banks is because four social democratic MPs chose to vote for charging Haarde and against charging the other three. Consequently, only Haarde is seen by Althing to carry the political responsibility for the fate of the banks and consequently the Icelandic economy.

The Independence Party and the Left Greens are clear on the issue. The former unanimously voted against any charges. The latter were equally of one mind for the charges. The fault lines run through the social democrats, now leading a coalition government with the Left Greens. The question is if this will have any further political repercussions. The feeling among Icelandic political pundits is that this issue hasn’t left the debate and that things are a bit up in the political air.

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After the informative and insightful report by the Althingi Investigative Commission a parliamentary commission was to review the report, picking out things that the political class needed to ponder on and draw lessons from. The commission was also to come to conclusion if any ministers should be charged for recklessness or negligence, wilful or otherwise, in office related to the collapse of the banks. Should they or could they have done more to prevent what happened?

September 11 the MPs published their report and it unleashed a political tempest that is still raging. The commission was split regarding eventual charges against former ministers but the majority wanted to charge four ex-ministers: PM Geir Haarde and minister of finance Arni Matthiesen, both from the Independence Party and minister of foreign affairs and leader of the Social democrats Ingibjorg Solrun Gisladottir and minister of trade Bjorgvin Sigurdsson. All of them have left politics.

According to the Icelandic constitution Althingi can convene a court (based on a Danish court, ‘Landsdom’; a similar court is found in many countries) where ministers can be charged for misconduct in office.

This caused quite a fury for many different reasons. The Investigative Commission had let Gisladottir off the hook since she wasn’t directly involved with business and finance. The MPs commission came to the conclusion that she should be charged because she had been a leader in government and should have had an insight into what was going on. This came no doubt as a huge shock to her.

Last Monday evening, PM Johanna Sigurdardottir (social democrat) gave a speech where she effectively undermined the report saying that no minister should be charged. This added yet another dimension to the already tense debate and there are those who talk about a new election.

For the time being the matter still rests with Althingi but a conclusion has to be reached by Oct. 1 since that was the time Althingi set itself to settle the issue.

One of the many interesting aspects of the dispute is that Althingi set itself the task to review the report and i.a. solve the issue on ministers’ responsibility. Should the court be convened or not? Should the ministers be charged? Now that this process is about to be brought to a close it seems that Althingi is unable to close the matter. It is bucking under the weight of confronting the ministers’ responsibility and the individuals in question.

The parties directly involved in government in the years before the collapse – the Independence Party, the social democrats and the progressives – point out that none of these four ex-ministers are now in politics and shouldn’t that be enough of a punishment that they have to live with the disgrace of having failed in office? A tricky question: if someone has broken the law it’s normally not possible to escape the law just by changing track.

Others point out that those who were in power in 2006 should be prosecuted because that’s when something should have been done to tie down the banks. That has brought the names of Halldor Asgrimsson from the progressives and Independence Party leader David Oddsson into the debate.

There is anger in society towards politicians for what happened and there will no doubt be anger if Althingi is found to escape its responsibility by ducking a process it itself set in motion. Althingi finds itself resting in the proverbial place between a rock and a hard place – and the outcome is wholly unpredictable.

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