Sigrún Davíðsdóttir's Icelog

I was a bit too quick concluding that the eruption in Grímsvötn this time would be like last time, in 2004, when air traffic wasn’t affected. This morning, the flights out of Iceland were on schedule whereafter the airports were closed. There is a lot of ash, it’s darkness at noon south of Vatnajökull.

The eruption is much stronger than in 2004, more akin to 1873, geologists gather. The fissure that’s opened up seems to be 500-800m long. However, it’s likely that the ash production is at its most forceful right  now but that it will only continue, at most, for a few days. There are already now signs of diminished ash. That, of course, doesn’t help the ca seven thousand passengers now stranded but it might mean that the disruption of flights won’t last.

Also, it seems that the ash isn’t travelling, so international flights will probably not be affected this time around. Or that’s what the experts are saying. Remains to be seen what nature will do.

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There is steam and ash rising up from Vatnajökull, Europe’s largest glacier, in the South East of Iceland. The eruption is in a place called Grímsvötn. Eruption happen at regular intervals under the glacier, the fire from below melts the ice, the water lifts the ice cap and ‘leaps’ onto the sands below the glacier. It’s now expected that the ‘leap,’ the floods, will start tomorrow morning. Usually, the floods start 10-12 hours after the eruption starts.

The world, in particular the air companies, doesn’t need to hyper ventilate in fear of the eruption endangering flights. This type of eruption happens frequently, with no particular disruption in the air. The floods, however, can often wash away roads and bridges but the infrastructure there is made with this in mind. Remains to be seen what forces are at large this time. The last eruption in Grímsvötn was in 2004 when the ‘leap’ was strong and destructive.

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Baugur, the investment company of Jon Asgeir Johannesson, his family and few others, started its life as a listed company that Johannesson later took off market. In 2002, while still a listed company Baugur was investigated for financial irregularities. Eventually, charges were brought against the company. As the case came to court, most of the charges, but not all, were thrown. Johannesson was finally sentenced to a three months conditional imprisonment in the summer of 2008. The sentence meant he had to leave the boards of several companies where he sat.

The demise of the Baugur case – Johannsson was sentenced but many of the claims were thrown out – is fresh in the memory of those now investigating not only Johannesson’s businesses but also other cases related to the collapsed banks. There are some intriguing parallels between the Baugur case and a recent case.

Glitnir, one of the three banks that collapsed in October 2008, is now bringing a case against Johannesson, his long-standing business partner Palmi Haraldsson, the Glitnir CEO Larus Welding, brought in when Haraldsson and Johannesson became major shareholders in Glitnir in spring of 2007 and three employees of Glitnir. The Glitnir case regards the sale of Aurum shares from one Haraldsson company to another Haraldsson company, a case Icelog has reported on earlier as a modern amorality tale.

The first Baugur charge to be thrown out by the Reykjavik County Court judge Arngrimur Isberg regarded a sale of shares in a company called Voruveltan by another company, Fjarfar, to Baugur, then a public company. According to the prosecutor Johannesson was guilty of fraud and breach of fiduciary duty for his part in this sale.

The judge saw it differently. To him, the charges merely described a business transaction. He did though acknowledge that the listed company Baugur had quite possibly lost ISK325m and Johannesson and his associates had profited by ISK200m but their cost, ia brought on as they tried to hide ownership and business relations, had been considerable. Consequently, it wasn’t a crime to trick Baugur and make ISK200m on the side.

The Aurum case rises from a Glitnir loan of ISK6bn related to sale of the Aurum shares. There is a significant difference between the Aurum case and the Baugur case: in the former case Glitnir is suing for damages, the latter was a criminal case brought on by the prosecutor (not the Office of the Special Prosecutor, which is a new office, set up to investigate cases related to the collapsed banks).

The Aurum sale was a classic deal in the Icelandic pre-collapse business environment: a sale between related entities. Glitnir’s employees valued the Aurum shares, at most, at ISK1.5bn. Johannesson and Haraldsson wanted a loan of ISK6bn where the Aurum shares should be worth at least ISK4bn.

Their evaluation was based on ‘Head of Terms’ from the Damas International, a big Dubai jewellery chain that in the summer of 2008, just at the time that the Aurum sale was being organised, had shown an interest in Aurum. It was a Kaupthing contact in the Middle East who brought Aurum and Damas together.

Johannesson and Haraldsson discredited Glitnir’s evaluation and convinced the bank to accept the Damas evaluation. Damas, by the way, never bought Aurum. Last year, three brothers who are Damas main shareholders and managers, were banned by the Dubai Financial Services Authority from the board of Damas International for 10 years and imposed penalty for having illegally withdrawn $165m from Damas, a public company.

The Aurum sale went through as Johannesson and Haraldsson wanted. Of the ISK6bn 4bn was used to pay off older loans, one billion went to Haraldsson’s Kaupthing Luxembourg account and a billion went into Johannesson’s private account with Glitnir. A loss of ISK6bn landed with Glitnir late 2008 because of a buy back clause obliging Glitnir to buy the 6bn indebted SPV for the royal sum of 1 krona.

In a report in the Aurum case, Johannesson’s lawyer Gestur Jonsson claims that Johannesson neither sat on the board of Glitnir nor was in any position to influence Glitnir. This echoes the defence in the Baugur case, where Jonsson was also acting on behalf of Johannesson. In an email published in the Glitnir charges Welding complains that the bank’s main shareholders treated him like a branch manager.

With the SIC report it became abundantly clear that Johannesson was diligent sending emails to Welding and other Glitnir managers and in general to managers in the three banks where he was among the biggest clients. Actually such a big client with all of them that the power was reversed: the banks had no power over him; he had all the power over the banks because on their books he was too big to fail. Consequently, he had to be saved, at all cost, with loans upon loans from late 2007 until the bitter end of the three banks. In addition, he and his business associates were closely involved with Byr, one of the small Icelandic savings banks.

The Aurum case has indirectly come up in a UK court. In relation to the Aurum case in Iceland, Glitnir asked for an international freezing order in a UK Court, confirmed last summer by Justice David Steel. Regarding the Aurum case, Justice Steel concluded that ‘even if Mr Johannesson has some prospect of answering the (Aurum) claim in Iceland, nonetheless the prospect of establishing that he had no control over the bank and/or that the loan was a bone fide commercial transaction looks somewhat forlorn.’

From the Voruvelta deal Johannesson profited at least ISK200m, a small sum compared to what was to come. Johannesson and Haraldsson got each a billion from the Aurum sale. From a third deal, the so-called Stytta deal, another remarkable 2008 loan story, Fons netted ISK2bn.

All this isn’t just an old story. The deals made with the bank’s favoured clients during 2008 secured them well beyond the collapse of the banks. And they are still profiting from these deals. In a recent interview, professor William Black said:  ‘If cheaters prosper, cheaters will dominate. It is like Gresham’s law: Bad money drives out the good. Well, bad behavior drives out good behavior, without good enforcement.’

This is what Iceland is wrestling with: to make sure that it’s not the unnatural, counter-market law of the cheaters that still rule the market.

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According to the last report from the Landsbanki Winding-Up Board, the recovery from the Landsbanki assets is now expected to cover 94% of the priority claims, using the currency rate end of last March. More interestingly, it covers 99% at the currency rate of 22.4. 2010. It’s the currency rate of that date against which the claims were sat in order to lessen the currency risk when it comes to settle with creditors. The value of the assets is now estimated to be ISK1.3bn, with the priority claims at 1.319bn.

Johannes Karl Sveinsson, who was on the negotiation committee, said to Ruv yesterday that he’s still worried about certain aspects of the eventual ESA process, the recovery won’t change anything re ESA though the improving recovery is good news. There is, says Sveinsson, still the risk that the UK and the Netherlands will bring Iceland to court since the two countries compensated Icesave depositors and claim Iceland owes them for it.

Minister of finance Steingrimur Sigfusson points out that the improved recovery is good news but won’t change anything regarding the dispute with the UK and the Netherlands nor ESA. He is referring to the fact that the countries claim they have an outstanding loan to Iceland. The ESA process regards whether Iceland has violated the deposit guarantee.

Sigfusson’s comments are interesting. After the referendum that rejected the Icesave agreement Sigfusson indicated that there was nothing to worry about, there was enough money to pay. That is, of course not the relevant point, as Sigfusson now indicates. Reality is slightly more complicated.

Landsbanki can’t start to pay out to creditors until the Icelandic High Court has confirmed that deposits are priority claims, as the Icelandic Government stipulated in October 2008. The ruling is expected in autumn. The Reykjavik County Court has already ruled that deposits are priority claims.

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Among the more memorable news events of last year were the US Senate Subcommittee on Investigations’ hearings into the financial crisis.* This April, the Subcommittee published its 650 pages report on the crisis, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, focusing on four aspects:

High Risk Lending

Regulatory Failure

Inflated Credit Ratings

Investment Bank Abuse

The report concludes that a severely compounding factor in the crisis was investment bank abuse. Case studies in the report relate to the cooperation between Goldman Sachs and Deutsche Bank. Quite interesting since I firmly believe that the contacts between Deutsche Bank and the Icelandic banks merit some attention (hope to clarify this on Icelog in the near future).

Summaring, the report points out:

The four causative factors examined in this Report are interconnected.  Lenders introduced new levels of risk into the U.S. financial system by selling and securitizing complex home loans with high risk features and poor underwriting.  The credit rating agencies labeled the resulting securities as safe investments, facilitating their purchase by institutional investors around the world.  Federal banking regulators failed to ensure safe and sound lending practices and risk management, and stood on the sidelines as large financial institutions active in U.S. financial markets purchased billions of dollars in mortgage related securities containing high risk, poor quality mortgages.  Investment banks magnified the risk to the system by engineering and promoting risky mortgage related structured finance products, and enabling investors to use naked credit default swaps and synthetic instruments to bet on the failure rather than the success of U.S. financial instruments.  Some investment banks also ignored the conflicts of interest created by their products, placed their financial interests before those of their clients, and even bet against the very securities they were recommending and marketing to their clients.  Together these factors produced a mortgage market saturated with high risk, poor quality mortgages and securities that, when they began incurring losses, caused financial institutions around the world to lose billions of dollars, produced rampant unemployment and foreclosures, and ruptured faith in U.S. capital markets. (P. 12.)

Professor William Black (the link is to an interview with Black on the S&L crisis vs now) and others have been calling out for criminal investigations into the role of the major banks during the crisis, comparing the situation now with investigations into the Savings & Loan crisis of the ‘80s when a number of lenders actually went to jail. An article in the latest issue of Rolling Stones Magazine, based on the Senate’s report argues that the report has laid out the evidence. Now the Justice Department should bring criminal charges against the bankers responsible for what the banks did.

As often pointed out earlier on Icelog, the Icelandic Special Investigative Committee outlined many cases in its report now being investigated in Iceland. The SIC informed the Office of the Special Prosecutor of findings it found to be suspicious. The UK Serious Fraud Office is conducting an investigation into Kaupthing’s operations.

*The hearings can still all be watched on C-Span, ideal to watch while you cook or do other things that leave your mind mostly free. Senator Carl Levin was the absolute star, some memorable moments when he was questioning the squinting Goldman Sachs CEO Lloyd Blankstein.

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Today, Fitch Ratings has raised its outlook on Iceland from negative to stable. This indicates that Fitch has concluded that the rejection of the Icesave agreement with the UK and the Netherlands will not stall the economic recovery. After steep contraction it now seems that the Icelandic economy is finding some stability, possibly even the forecasted growth of about 2% this year. Fitch affirmed its foreign and domestic issuer ratings at BB+ and BBB+ respectively.

Fitch’s Paul Rawkins, Senior Director in the Sovereign Rating Group, said in a statement that solving the Icesave issue was an important step towards the normalisation of relations with international creditors. “However, the capacity of this dispute to close off access to multilateral and bilateral funding for Iceland’s IMF financial rescue programme and put Iceland’s economic recovery at risk has clearly diminished,” Rawkins said.

Mar Gudmundsson Governor of the Central Bank of Iceland welcomed Fitch’s credit rating though he underlines that had the Icesave agreement gone through the rating wouldn’t have landed on stable but improved.

Gudmundsson was in Brussels today where he gave a talk at Center for European Policy Studies on Shocks, adjustment, recesson and recovery in Iceland.

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Today, Iceland’s Minister of Finance Steingrimur Sigfusson said to Dow Jones that Iceland is better off outside the European Union. This comes as no surprise: Sigfusson’s party, the Left Green, opposes Icelandic membership to the EU whereas the Social democrats, who lead the Icelandic Government, think Iceland should join. For the time being, polls indicate that the majority of Icelandic voters side with the Left Green.

As to Icesave, Sigfusson said: “The Icesave dispute is solely a problem between Iceland, the U.K. and the Netherlands and should not be mixed into anything else—be it the EU application process or our cooperation with the International Monetary Fund.” – The ESA might beg to differ here.

Sigfusson pointed out that Iceland isn’t in any immediate need for funding and the IMF’ fifth review of its Iceland programme is expected soon. The IMF programme, approved in November 2008, of emergency loans of up to $2.1 billion will help Iceland recover from the crisis following the collapse of the banking system in October 2008.

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The UK Financial Services Authority is working on a report into the collapse of the Royal Bank of Scotland. The report was due in March but the FSA is having some problems in coughing it up. Now it’s calling in Sir David Walker, a retired chairman of Morgan Stanley who recently wrote a Government report into failure in governance in the banking sector leading up the crisis.

It drew quite some criticism when the FSA announced in December that it had closed its probe into RBS and no one would be charged. Just keep in mind that the RBS was one of the most willing UK banks to lend to Icelandic business men such as Jon Asgeir Johannesson of Baugur fame and his Scottish business partner Sir Tom Hunter. Both of them ran into severe problems when there were no banks to keep their mills running. And like ia Kaupthing RBS grew at an insane rate from a small bank into one of the world’s largest. Since banks ideally should serve clients, not make them, the growth rate is indicative of a certain type of banking mechanism laid bare with the collapse of the Icelandic banks and the SIC report into the Icelandic banks.

According to the FT today:

“Lawyers for RBS are concerned that the draft as written could expose the bank to further litigation. The legal team representing Johnny Cameron, the former head of RBS’s investment banking arm, has also raised ­objections.”

If this wasn’t coming from the FT I would take it as a joke.

Who is writing the report, the FSA or RBS lawyers? Isn’t the FSA doing an independent probe into a bank where the state now owns 83%?

First the FSA completely and utterly fails to regulate the banks, to ask critical questions – and no change in management. Now, the FSA seems to be doing a similar job in probing the failures. To write a report that secures that no managers of RBS will be prosecuted won’t make anyone happy… except these same managers.

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Below is the summary of arguments from the Icelandic answer to ESA:

(i) The Government fully transposed the Directive into Icelandic law with the adoption of Act No. 98/1999 on Deposit Guarantees and an Investor Compensation Scheme, and following that, established a deposit-guarantee scheme (hereinafter also referred to as “TIF”) as stipulated in the Directive. That scheme is similar to that established by other EEA States and in accordance with the provisions of the Directive. Nothing in the Directive supports the Authority’s construction.

(ii)           The Government rejects the contention that the Directive imposes an obligation of result upon the Member States. This would lead inter alia to a de facto state guarantee for all deposits amounting to EUR 20,887 for each account in each and every bank. Such an unlimited obligation would be contrary to the EEA’s key objective of promoting competition within the internal market. Nor would it conform to EEA state-aid rules which prevent Member States from interfering with markets unless specifically authorised to do so.

(iii)          The so-called legal concept of obligation of result in EU law is unclear and does not suffice as legal basis for imposing a duty on Member States which would jeopardise their financial stability. Reference to the case law of the ECJ does not support the view that such unconditional principle of EEA law exists, nor that it would apply in this case. An obligation of result can only materialise – or deem to be breached – once it becomes clear that the actions of a Government did not suffice to ensure the minimum protection for deposits stipulated in the Directive. This is by no means evident.

(iv)          The Government ensured – to the extent possible while dealing with a complete collapse of a banking system – that all retail depositors in the failed Icelandic banks would receive compensation in a form of payments from the estates of those banks. Deposit claims were granted priority ranking when the collapse became unavoidable, thus making up for the obvious shortcomings of any Deposit-guarantee scheme in the event of a total banking system collapse.[1] This compensation in many instances far exceeds the minimum deposit guarantee in case of all the collapsed banks. If any obligation of result exists it has been discharged by these actions of the Government.

(v)           Should the Icelandic Government, contrary to expectations, be found to be in breach of the provisions of the said Directive, it maintains that such a breach should be considered justifiable in view of the fact that no deposit-guarantee scheme envisioned by the Directive could have dealt with a financial crisis of the magnitude experienced in Iceland in the autumn of 2008.

(vi)          Should the Government, contrary to expectations, be found to be in breach of the provisions of the said Directive, it maintains that such a breach is justifiable in view of the various unilateral actions undertaken by the United Kingdom and the Netherlands governments in breach of the EEA Agreement against Landsbanki, the Icelandic state, and other Icelandic interests and their effect on the Government’s reaction to the crisis. These actions obstructed the Icelandic Government’s efforts to efficiently reorganise and wind-up Landsbanki to facilitate payments under the deposit guarantee scheme, which efficiency under normal circumstances is now historically evident by the swift resolution of the Kaupthing Edge internet depositor’s payment from the estate undisturbed by the German Government.  These ill-advised and disproportionate actions justify any breach which the Government may have committed as a consequence.

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Today, minister of trade Arni Pall Arnason held a press conference to present Iceland’s answer to ESA. In the letter, the Icelandic Government emphasised its earlier position, ie that the EU deposit guarantee did not apply to the situation in Iceland in October 2008 because Iceland suffered a breakdown of its entire banking system. Consequently, Iceland had not other options but to treat deposits in Iceland and abroad differently. It also pointed out that the UK and the Dutch Governments had hampered economic revival in Iceland by its actions to delay the IMF programme.

The letter is quite long, over 30 pages. It remains to be seen what ESA will do but it seems that some of the Icelandic points are somewhat beside the point. ESA formulated precises complaints. Iceland’s answer offers more explanations than hard-nosed legal reasoning.

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