Sigrún Davíðsdóttir's Icelog

Today, the Winding-up Board of Glitnir is paying out the whole of its priority claims, in total about £500m. About half is being payed out at once, the rest are claims that are still disputed. The disputed sum now goes to an escrow account, which will collect interest rates as of today. The happy recipients of the pay-out are 55 UK local councils and universities.

After taking over the failed bank, the ResCom of Glitnir (contrary to Kaupthing) never brought its foreign currency to Iceland which means that the currency controls in Iceland don’t affect its currency holdings. The Glitnir currency holdings cover about 80% of the priority claims now paid out. The remaining 20% are paid out in Icelandic krona. Because of the currency control, this 20%, in Icelandic krona, is being held on an account with the Central Bank of Iceland. The owners of these krona can participate in the CBI’s auction – or if they are adventurous they could of course use their krona to invest in Iceland, buy goods there etc. The bids for the next CBI auction have to be in by March 28, see the CBI’s announcement here.

They payout has been widely covered in the UK press (I’ve been on three BBC interviews) and has obviously raised hopes for more money to return. Icesave depositors have been paid by the UK Government so there are no angry depositors camping outside the Icelandic Embassy – now it’s the UK Government waiting for the Icesave money from the Landsbanki WuB. Then there is of course this small matter of unpaid interest and the ESA case – yet another collapse saga.

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Iceland is not only on track but is actually ahead in paying off its loans to the IMF, as this press release today indicates:

“Iceland announced today that it repaid, ahead of schedule, obligations to the IMF amounting to some SDR 288.8 million (US$ 443.4 million). The payment was made on March 12.

The early repayment is about one fifth of the SDR 1.4 billion (US$2.15 billion) that Iceland borrowed from the IMF under its Stand-By Arrangement (SBA) (see Press Release 08/296). The amounts repaid early are the obligations falling due in 2013 under the original repayment schedule.

Together with a scheduled payment made in February 2012, this early repayment will reduce Iceland’s outstanding obligation to the IMF to SDR 1.041 billion (about US$1.60 billion). This outstanding balance is projected to be repaid during 2012-16.

After this early repayment, and taking into account a similar early repayment of Iceland’s Nordic loans, reserve adequacy—as measured by the ratio of reserves-to-short term debt—will remain above the standard benchmark of 100 percent.”

The recovery in Iceland has, in many ways been remarkably good and quick, considering the sharp fall, following the collapse of its three main banks in October 2008.

Richard Barley, WJS, recently compared the Icelandic and the Irish crisis – who had a better crisis? There are striking similarities:

The costs of dealing with banking failure have been similar. Bank recapitalization cost about 45% of GDP in Iceland and 40% in Ireland. Both saw deep economic declines of 12%-13% of GDP. And both ended up with budget deficits in the double digits, as a percentage of annual GDP, which have required stiff fiscal tightening. Government debt is lower in Iceland, but not by much, reaching 100% of GDP in 2011. The difference is that Iceland grew 3% in 2011, Fitch estimates, versus 1% for Ireland.

The growth in Iceland is promising but Barley points out that Ireland is doing strikingly better in one aspect:

Longer-term, euro membership should help Ireland lure investment and boost exports: Even in 2011, there was a 30% increase in companies investing in Ireland for the first time. Over time, that may prove the deciding factor.

Barley singles out the deterring effect of the currency controls to Iceland – it’s difficult to lure foreign investors over the sky-high barriers of the currency controls. Unfortunately, the problem of luring foreign investors is both deeper, longer-running and more severe than just the currency controls, in place since post-collapse 2008.

Historically seen, it’s always been difficult to attract foreign investors to Iceland. In this respect, Italy and Iceland are similar. Foreigners often sense in Iceland that things are done in some specific Icelandic ways that foreigners find hard to understand and penetrate. Personal relationships matter everywhere but in Iceland it’s very difficult to get anywhere at all without the right Icelandic personal relationships. Ad hoc decisions and opacity cloud the island.

Who are investing in Iceland? David Rowland has invested in a small bank, MP Bank. Rowland bought the Kaupthing Luxembourg operation in the summer of 2009. He was chosen to be treasurer for the British Conservative Party but after the Daily Mail published a series of rather unflattering articles on him Rowland realised he didn’t have the time to dedicate himself to the unpaid honorary but extremely influential job. Mike Ashley, owner of Newcastle United football club, is another investor in MP Bank. He was a client of Kaupthing and an intimate friend of Kaupthing Singer & Friedlander’s CEO Armann Thorvaldsson, according to Thorvaldson’s book, Frozen Assets.

Iceland and Ireland are small countries and there is quite a bit of cronyism in both countries. In Ireland, the cronyism is heavily connected to the building sector, which collapsed spectacularly in 2008 and brought down the three main banks. Other sectors, like high-tech and bio-tech, seem to be outside the cronyism sphere and are healthily attracting foreign investors. For some reason, Iceland is struggling in this respect. The feeling is that it’s not just because of the currency controls and not being members of the eurozone.

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State prosecutor Sigridur Fridjonsdottir has now summed up her reasoning in the case against ex-PM Geir Haarde. She points out that Haarde is not on trial for not preventing the collapse but for not taking action. She has listed a whole raft of warnings, meetings and other interaction that Haarde did not act upon. She also points out that there were plenty of warnings, ia from the CBI and Haarde as an economist and minister should have been able both to understand the warnings and take action. Maximum sentence is two years imprisonment. The prosecutor stated that the seriousness of the offence could constitute extenuating circumstances.  In contrast, a clean criminal record and the time, which has elapsed since the offence was committed, might be alleviating circumstances.  The sentence can be up to two years’ imprisonment.

Haarde’s defense lawyer will be speaking tomorrow.

One of the witnesses, Tryggvi Palsson former head of financial stability at the CBI, pointed out in his testimony that CBI’s reports from 2003 indicated that financial stability never improved. In May 2008 it said: “Present circumstances will test the banks’ resistance.” – Testing indeed. This is central bank speak for an unmitigated and colossal catastrophe.

Both Palsson and other CBI staff pointed out that there were signs of grave problems in the banks already in 2005. – It’s still a mystery why rating agencies and others who sounded warnings in 2006 seemed to retract these warnings. Many of the witnesses spoke of the mini crisis in 2006, which almost led to the collapse of the banks. They did recover in the sense that they saved themselves but they were in a bad shape. Instead of selling assets and strengthen the operations bad loans and loans to buy their own shares escalated. Bad assets replaced good ones.

The central question is if the Government had the tools to do anything. There was abundant evidence at the trial that yes, the Government could have taken action but didn’t. And interesting example of how indirect action could be used is the Government’s opposition to Kaupthing’s acquisition of NIBC. When the Kaupthing management sensed the political opposition it backed off. – If the acquisition had gone through with it, it would most surely have spelled an earlier demise of Kaupthing but that’s another story.

Former Minister of Finance Arni Mathiesen indicated the lack of implementing policy when he said it was the Government’s policy to reduce the size of the banking sector. It’s difficult to find any indication of implementation. The bankers have said that they didn’t sense that there was any ongoing action in this direction. It was at most mentioned or loosely indicated. Nothing more. In general, the banks led the way, the Government followed.

The ongoing question through the trial is: what could have been done? David Oddsson former Governor of the CBI said that something could always be done. If the meaning behind this question is: could the banks be saved? No, not from 2005 or so. The state and the banks were like a mouse and an elephant. The mouse can’t lift the elephant. In addition to size, the banks were in reality Siamese triplets – if one failed, they would all fail.

Moving the banks abroad was vaguely discussed. Kaupthing had a plan to move. The question is how realistic this was. It would have taken 1-2 years, by 2008 it was too late as a solution for an imminent problem. Was there any country that would have wanted the banks to register there? And what would the due diligence, taken by any FSA have shown? The fact that the Winding-Up Boards of Landsbanki and Glitnir have now sued the auditors, incidentally PwC for both banks, for the audits of 2007 and 2008 makes this plan of moving dubious if not wholly unrealistic.

At the end of 2007 the banks were way beyond what the state could shoulder and save. At that point, with a catastrophe in sight – for anyone who was in the position to see it – the Government should have prepared for the banks’ end. There were some tentative actions such as a draft by mid 2008 for an Emergency Bill, passed on October 6 2008. Another tentative action was the consultative group, which never functioned properly.

Tryggvi Palsson said that the testimonies of the bankers at the Haarde trial showed they were still in denial of what happened. Kaupthing’s former chairman of the board Sigurdur Einarsson said that one reason for the bank’s fate was CBI’s high interest policy. – That’s one way of seeing it but banks were truly good at exploiting it, ia by selling forex loans and by selling the Glacier bonds – and all of this strengthened the krona, which influenced the CBI rates. The question is: where the banks perpetrators or victims? The understanding from the many witnesses is that the banks really ruled, not the Government.

The trial finishes tomorrow. The court’s ruling is expected in 4-6 weeks.

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Today, Greg Smith, a Goldman Sachs employee in London, suddenly shot to fame, at least in the banking world. He is leaving Goldman because he thinks its environment is “toxic and destructive.” But instead of just leaving in silence he penned a resignation letter as an Op Ed piece for the New York Times, published today, on his last day at work. It might well have been the most read serious piece in the media today.

He’s uncomfortable with the bank’s business ethics: Goldman sees nothing wrong in selling junk and rubbish to its clients, making the clients lose while the bank makes money. A lot of it. In the infamous Abacus case, Goldman actually ended up paying $550m to settle claims – without admitting it did anything wrong – when it failed to disclose that the product sold was designed to fail. A favoured Goldman client was allowed to make money on it, with the bank. Everyone else was magnanimously allowed to lose on it. But this case and other similar haven’t taught Goldman’s managers any humility, according to Smith. “Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail.”

Now, it’s normal in business that some lose, others gain. But, as Smith points out, it’s interesting if there is a pattern to it and if a bank thinks nothing of clients’ predictable losses. One of the striking thing about the Icelandic banks is to consider who lost and who profited. Or, in the Goldman thinking, who were the muppets?

There were quite a number of muppets among the clients of the Icelandic banks. There were for example plenty of ordinary people who trusted the banks with their savings and invested in the banks’ money market funds, not knowing that these funds were used to buy bonds and shares in failing holding companies. These clients didn’t know that the Icelandic banks ran their money market funds quite a bit differently from what is the acknowledged banking practice (even with Goldman). This is one of the many bad banking practices stories in the SIC report – a story the Special Prosecutor might one day show an interest in.

Then there are those who put some savings into shares in the banks – Kaupthing had some 33.000 shareholders. These people didn’t know that the banks were buying shares off some shareholders shortly before the collapse. These people were just allowed to lose the savings they put into the shares.

The most striking muppets were possibly the pension funds. They lost heavily because they could be led to manage their investments against the interest of the funds and their owners but in the interest of the banks and their largest shareholders. This is particularly clear from the fact that the funds invested in unlisted companies – and from the fact that the funds hedged their foreign assets (that in themselves hedge the funds’ domestic assets) with the banks. A report* from February on the pension funds concludes that after mid 2007 currency hedges turned very risky, the pension funds should have sought advice – and the banks should have warned the funds. But they didn’t. Losses from currency hedges are about 12-15% of the total losses – some have yet to be settled with the banks’ Winding-Up Boards.

It’s safe to conclude that much of the funds’ losses were incurred because the banks gave the pension funds (as others) wrong or misleading information. In a recent report (only in Icelandic) by an expert group, on behalf of VR, one of the biggest Icelandic pension funds, the experts conclude that VR “and other pension funds should consider suing those who possibly played a role in giving wrong information to shareholders, bondholders and others with an interest. Those who could possibly be sued are the managers of the banks and companies and their auditors. … It can be critcised that the pension funds haven’t taken the initiative here or shown any interest in doing so.”

The pension funds report shows close personal relationships between the banks and the funds though more work could have be done on that issue. The banks are no longer pullings strings – but perhaps personal relations and the wish to move on and away makes some people behave as if the strings, holding the muppets, were still in place.

*The English summary starts on p. 29. See here for an earlier Icelog on the report.

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The previous list of witnesses due to appear tomorrow at the Haarde trial has been changed. Those who now have been called in are Tryggvi Palsson previous head of financial stability at the Central Bank of Iceland, Joh Thorsteinn Oddleifsson former head of treasure, Landsbanki, Steingrimur Sigfusson member of Parliament (and now Minister for Economic Development) and Arni Mathiesen former Minister of Finance. It is also expected that Geir Haarde will again be questioned tomorrow.

The link to the charges, in Icelandic, is here.

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“In Praise of Folly” is a book published by Erasmus of Rotterdam in 1509. Happily, businessmen of all sorts are still committing the folly of chasing each other in court, thus exposing their dirty linen in public. The most spectacular recent case of this folly was the clash of the oligarchs Boris Berezovsky and Roman Abramovitch. If it hadn’t been so outrageously offensive to hear the two recounting tales of corruption – as if it all was business as usual – in an English courtroom, it would have been utterly hilarious.

But the two oligarchs aren’t the only billionaires willing to stage a public fight at the Royal Courts of Justice. Simon Bower at the Guardian has unearthed some interesting stories from an ongoing court case involving Vincent Tchenguiz and his countryman, confidante, childhood friend and employee Keyvan Rahimian. Rahimian was so close to Tchenguiz that while he worked for him he also lived in his house. In late 2008 they fell out bitterly. Rahimian claims his former friend owes him £6.7m – Tchenguiz claims that Rahimian stole from his and is suing him for £2m.

But there is more to this case. In court, Tchenguiz has accused Rahimian of taking consultancy fees of almost €791,000 from a company called Carule, in undisclosed ownership, while Rahimian was working for him. Lawyers for Tchenguiz seem to have an idea where the money came from. They asked Rahimian if the oligarch Alisher Usmanov had paid him or a Pakistani millionaire, Alshair Fiyaz, recently in the UK news after abandoning a bid to buy a fashion chain, Peacock.

Rahimian only admitted that the payment was for financial research, though not disclosing who paid him. He says Usmanov is a friend but that he has never traded for him. Rahimian admits that he later got €388,000 to buy a Mercedes Benz in Paris and then passed the car on to Fiyaz.

All sorts of interesting pieces of information have popped up in this case, according to the Guardian:

“In angry exchanges, Rahimian accused Tchenguiz’s lawyers of raising irrelevant matters in the hope of embarrassing him in court. The property tycoon’s counsel made similar accusations about the evidence that Rahimian has sought to include. They claim that Rahimian is making “irrelevant” allegations that money transfers had been made, using his account, to pay for “eastern European models to come to the UK”. They characterise this as a threat and say Rahimian is hoping to embarrass Tchenguiz into a settlement of an otherwise “ridiculous” claim.”

Rahimian seems to be claiming that his accounts were used to pay for Eastern European girls, apparently for Tchenguiz. Why Tchenguiz is so touchy about this matter is difficult to understand since every article on him is almost invariably with photos of him with more than one lady. Perhaps he and Dominque Strauss Kahn see eye to eye on this: that any hint of money being paid for female company is abhorrent to them.

The question is still why this stream of money was going through the accounts of Rahimian, while he was working for Tchenguiz.

But the names of Tchenguiz, Usmanov and Fiyaz are not only united in the protocols of the Royal Court of Justice. Their names are to be found in Kaupthing loan books – they are all mentioned on the Kaupthing overview of larger than €45m exposures, presented to the Kaupthing management on September 25, 2008 (and later leaked to Wikileaks: Tchenguiz p62; Fiyaz p67; see here on Usmanov and Kaupthing) – the loans to these three allegedly had questionable collaterals.

This case is a further reminder that it’s not only in the present court case that there are untold stories. The feeling is that there are untold stories about the connections between some of the Kaupthing clients and why they all ended up being Kaupthing clients.

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The Glitnir Winding-Up Board has sued not only PwC Iceland but also PwC UK, according to Ruv. This case is further in the process than an identical case that Landsbanki WUB is pursuing against the bank’s external auditors, incidentally PwC, due in court in June. The Glitnir case will come up in the Reykjavik District Court April 12.

Glitnir seems to be suing PwC for the 2007 accounts, which wrongly reflected risk assessment, loans to related parties (the weak point in all three banks according to the SIC report) and evaluation of the bank’s assets. All of this made the bank appear in a much better shape than it really was and caused damages of tens of billions of krona, possibly as much as ISK100bn, according to the WUB. The writ was presented to PwC on January 31. Following this action, PwC UK was presented with a writ from the Glitnir WUB.

As pointed out earlier, it seems logical that the auditors of all the banks will be presented with similar cases since the SIP report indicates similar shortcomings in all the banks. The really interesting question is if the Office of the Special Prosecutor will take action against the banks’ external auditors.

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The Winding-Up Board of Landsbanki has sued the bank’s external auditor, PriceWaterhouseCooper, apparently for hundreds of millions of kronas in damages. The SIC report makes it abundantly clear that with so much wrong in the banks, their annual accounts were not much to rely on. And that raises serious questions regarding the auditors. Questions that the Landsbanki WUB has now formulated in a writ of 90 pages. It seems certain that other cases will follow. The question is if the Office of the Special Prosecutor will follow suit, bringing criminal charges against auditors.

The WUB clearly is of the opinion that already by the end of 2007 PwC knew the bank’s position was a lot more precarious than the accounts showed. According to a presentation to a Landsbanki creditors’ meeting in December 2010 the bank’s capital had fallen below the legal limit before its collapse in October 2008 – probably already before the end of 2007. The bank’s definition of “related parties” wasn’t correct, ia leading to over-risky loans to the bank’s largest shareholders, Bjorgolfur Gudmundsson and his son Bjorgolfur Thor. The presentation implied that the managers had given the auditors wrong information. Landbanki’s two CEOs have already been sued for damages caused to the bank.

According to Ruv, the WUB has now gone a step further, suing the auditors. The role of the banks’ auditors is scrutinised in the SIC report with many examples of highly questionable actions. It also raises questions, raised with international banks, on the relationship between banks and auditors.

By the end of 2007 Landsbanki had issued loans to father & son related companies and companies related to Jon Asgeir Johannesson, almost ISK200bn, now €120m. The WUB claims the auditors knew these loans either had no or insufficient collaterals. In spite of this and knowing that the bank was insufficiently capitalised the auditors went along with the managers in signing misleading and wrong annual and quarterly accounts.

If the accounts had been truthful the bank would have failed in 2007. Consequently, there would have been less losses resulting from Icesave UK, the Icesave in Netherlands would never have been opened and the over-all losses would have been less.

This case will no doubt be followed with great interest, not only in Iceland but also abroad. New York Attorney General is pursuing a case against Lehman’s auditors, Ernst & Young, for an alleged fraud involving a so-called Repo 105 transaction. Considering the evidence in the SIC report, the auditors for the two other Icelandic banks, Glitnir and Kaupthing, must already be pouring over their auditing and their relationship with the banks during the last years of the banks.

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

The charges against Haarde are the following:*

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

*Revised from an earlier blog.

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