Iceland Proves Ireland Did `Wrong Things' Sacrificing Taxpayers

"With the economy projected to grow 3 percent this year, Iceland’s  
decision to let the banks fail is looking smart -- and may prove to be  
a model for others."

regards,
-Lance

-------------------
http://www.bloomberg.com/news/2011-02-01/iceland-proves-ireland-did-wrong-things-saving-banks-instead-of-taxpayer.html

Iceland Proves Ireland Did `Wrong Things' Sacrificing Taxpayers
By Yalman Onaran - Jan 31, 2011 6:01 PM CT

On his second day as head of Iceland’s third-largest bank, Arni  
Tomasson faced a crisis: The firm he had been asked by regulators to  
run was out of cash.
It was Oct. 8, 2008, at the height of the global financial meltdown,  
and Iceland’s bank assets in the U.K. had been frozen, Bloomberg  
Markets magazine reports in its March issue. Customers flocked to  
branches of Tomasson’s Glitnir Banki hf to withdraw money, even though  
the government had guaranteed their deposits. By the end of the day,  
the vaults were empty, says Tomasson, recalling the drama two years  
later.

The only way Glitnir and other lenders could avoid a panic the next  
morning was to get more cash, which they were having trouble doing. A  
container of crisp kronur sat on the tarmac at Reykjavik’s airport  
awaiting payment, Tomasson says. The British company that printed the  
bills, De La Rue Plc, was demanding sterling, and the central bank  
couldn’t access its U.K. account.

“Everybody was panicked -- depositors, creditors, banks around the  
world,” Tomasson says. “The effort by all of us at the time was to  
make sure life could go on as normal.”

Tomasson, 55, got the cash he needed that night after the central bank  
managed to open an emergency line of credit with a European lender.  
Now, he’s sitting in an office in Reykjavik, handling about $24  
billion of claims by creditors as life in Iceland’s capital returns to  
normal.

Unlike other nations, including the U.S. and Ireland, which injected  
billions of dollars of capital into their financial institutions to  
keep them afloat, Iceland placed its biggest lenders in receivership.  
It chose not to protect creditors of the country’s banks, whose assets  
had ballooned to $209 billion, 11 times gross domestic product.

Krona Devaluation

The crisis almost sank the country. The krona lost 58 percent of its  
value by the end of November 2008, inflation spiked to 19 percent in  
January 2009 and GDP contracted by 7 percent that year. Prime Minister  
Geir H. Haarde resigned after nationwide protests. With the economy  
projected to grow 3 percent this year, Iceland’s decision to let the  
banks fail is looking smart -- and may prove to be a model for others.

“Iceland did the right thing by making sure its payment systems  
continued to function while creditors, not the taxpayers, shouldered  
the losses of banks,” says Nobel laureate Joseph Stiglitz, an  
economics professor at Columbia University in New York. “Ireland’s  
done all the wrong things, on the other hand. That’s probably the  
worst model.”

Ireland guaranteed all the liabilities of its banks when they ran into  
trouble and has been injecting capital -- 37 billion euros ($50  
billion) so far -- to prop them up. That brought the country to the  
brink of ruin, forcing it to accept a rescue package from the European  
Union in December.

New Banks

Ireland’s banks had more than 10 times the assets of Iceland’s  
lenders, making their collapse more dangerous for the European  
financial system. Ireland also couldn’t devalue its currency because  
it is part of the euro zone. Still, countries with larger banking  
systems can follow Iceland’s example, says Adriaan van der Knaap, a  
managing director at UBS AG.

“It wouldn’t upset the financial system,” says Van der Knaap, who has  
advised Iceland’s bank resolution committees. “Even Irish banks aren’t  
too big to fail.”

Under an emergency act of Iceland’s parliament on Oct. 6, 2008, the  
assets and liabilities of the three biggest banks -- Kaupthing Bank  
hf, Landsbanki Islands hf and Glitnir -- were divided based on whether  
they were originated at home or abroad. The act created three new  
banks that were given the deposits and loans made to Icelandic  
companies and consumers. Resolution committees were set up to manage  
and liquidate what the old banks were left with: the overseas  
borrowing and lending that fueled a sevenfold increase in assets from  
2000 to 2008.

Saving the Future

Arni Pall Arnason, 44, Iceland’s minister of economic affairs, says  
the decision to make debt holders share the pain saved the country’s  
future.

“If we’d guaranteed all the banks’ liabilities, we’d be in the same  
situation as Ireland,” says Arnason, whose Social Democratic Alliance  
was a junior coalition partner in the Haarde government.

By guaranteeing bank liabilities, Ireland faces a public debt burden  
as high as 12 times the country’s GDP. Iceland’s is about 85 percent.

“Our future isn’t as bleak because our public debt isn’t as high,”  
says Hoskuldur Olafsson, chief executive officer of Arion Banki hf,  
the new bank formed to take over Kaupthing’s domestic assets.

‘Disappeared Overnight’

Today, Iceland is recovering. The three new banks had combined profit  
of $309 million in the first nine months of 2010. GDP grew for the  
first time in two years in the third quarter, by 1.2 percent,  
inflation is down to 1.8 percent and the cost of insuring government  
debt has tumbled 80 percent. Stores in Reykjavik were filled with  
Christmas shoppers in early December, and bank branches were crowded  
with customers.

Half a mile from where Tomasson runs Glitnir’s resolution committee,  
the bank’s former headquarters glitters against Reykjavik’s dark  
winter skies. The building, one of the largest in Iceland, is lit in  
red neon with the logo of the company that emerged from its  
wreckage:Islandsbanki hf.

“We had built trust over 100 years, but it disappeared overnight,”  
says CEO Birna Einarsdottir, 49, who was executive vice president of  
commercial banking when Glitnir collapsed. Einarsdottir, who spent  
five years working for Edinburgh-based Royal Bank of Scotland Group  
Plc, says, “It will take more than two years to regain that trust.”

Banking Boom

Iceland’s banking boom began in 2001, after the U.S. Federal Reserve  
began cutting interest rates, pumping cheap money into the global  
economy. The next year, Iceland sold its majority stakes in Landsbanki  
and a predecessor of Kaupthing. The new owners, along with those of  
Glitnir, which was already in private hands, expanded lending at home  
and overseas.

Kaupthing’s income surged 100-fold from 2000 to 2006, reaching 100  
billion kronur ($850 million). Banking’s share of national output  
almost doubled to 9 percent, while that of fishing, the traditional  
backbone of Iceland’s economy, halved to 4 percent. More homes were  
built from 2004 to 2008 than in the entire previous decade, fueled by  
a government decision in 2003 to lower down payments on mortgages to  
10 percent from 30 percent. The 367 Range Rovers sold in Iceland in  
2007 exceeded the number in Denmark and Sweden, which combined have  
almost 50 times Iceland’s population of 318,000.

Tchenguiz Loans

The banks were particularly aggressive in the U.K., where loans were  
made to developers of the NoHo Square complex in the Fitzrovia section  
of London and to All Saints, a retail chain. Many of the borrowers had  
insufficient or low-quality collateral, according to investigations  
launched by the Icelandic government since the crisis.

“Our banks found their own subprime borrowers,” says Magnus Arni  
Skulason, founder of Reykjavik Economics ehf, a financial consulting  
firm.

Loans were also made to companies in which bank executives and owners  
had stakes or which were controlled by their friends, according to  
dozens of lawsuits initiated by regulators and resolution committees.  
Kaupthing lent 1.5 trillion kronur to such related parties, often  
without collateral, Prime Minister Johanna Sigurdardottir said in  
2009. In 2008, lending to U.K. entrepreneur Robert Tchenguiz, chairman  
of R20 Ltd., and related parties accounted for more than 25 percent of  
Kaupthing’s equity, according to a 2010 report by a parliament- 
appointed special investigative commission.

Tchenguiz, 50, Kaupthing’s biggest retail borrower, was also a board  
member in Exista hf, one of the bank’s owners. His spokesman said  
Tchenguiz wasn’t available to comment.

Red Flags

“It’s hard to see where the lines between bad decisions and violating  
the law were crossed,” says Gunnar Andersen, director general of  
Iceland’s Financial Supervisory Authority.

Andersen says that before his arrival in April 2009, the agency was  
understaffed and failed to see the red flags being raised as the banks  
grew through risky lending. So did auditors and credit-rating firms,  
he says. Moody’s Investors Service gave the Icelandic banks its fourth- 
highest rating of Aa3 in 2007, even though the central bank had long  
since lost its ability to be lender of last resort if those firms ran  
short of cash, Andersen says. Abbas Qasim, a spokesman for Moody’s in  
New York, declined to comment.

David Oddsson, who became chairman of the central bank in 2005 after a  
14-year stint as prime minister, says he relayed his concerns about  
surging growth of the industry to government leaders.

‘Party Was On’

The three banks had become the largest companies in Iceland, creating  
thousands of well-paid positions and controlling the top trade  
associations, says Oddsson, who oversaw the privatization of Iceland’s  
state-owned lenders as prime minister. Their headquarters were the  
largest buildings in Reykjavik, dwarfing the parliament.

“Nobody wanted to listen when the party was on,” says Oddsson, 63, now  
editor of Morgunbladid, one of the largest dailies in the country,  
with a circulation of about 50,000.

It was Oddsson’s decision not to build up the central bank’s foreign  
currency reserves from 2005 to 2008 that made a bailout impossible.

“They were collecting debt in such a fast pace, it would be stupid for  
us to build a mountain they could lean on if they failed,” Oddsson  
says. “The creditors that were lending to the banks recklessly had to  
face the losses.”

After the three lenders were seized by regulators, the government  
negotiated with the creditors, almost all of them outside the country,  
including mutual funds and hedge funds in the U.S. and the U.K. and  
European banks and pension funds.

Glitnir Creditors

Kaupthing’s creditors agreed to take an 87 percent stake in Arion, and  
Glitnir’s creditors now own 95 percent of Islandsbanki. Glitnir’s  
biggest creditor as of June was Dublin- based Burlington Loan  
Management Ltd., followed by Royal Bank of Scotland and DekaBank  
Deutsche Girozentrale, the fund manager for Germany’s state-owned  
savings banks.

Glitnir’s 8,500 creditors and Kaupthing’s 28,000 expect to get about  
30 cents on the dollar for their claims, based on secondary-market  
prices of the banks’ debt and asset valuations by the resolution  
committees. About half of Kaupthing’s creditors are German depositors  
who had Internet accounts, have gotten their principal back and are  
seeking interest payments.

Landsbanki’s creditors opted for a promissory note from successor NBI  
hf instead of a stake in the new bank. Landsbanki had collected about  
$5 billion of overseas deposits through branches in the U.K. and the  
Netherlands. Iceland didn’t guarantee those deposits at the time it  
seized the bank, as it did for domestic customers, leading to a  
dispute with the British and Dutch governments.

Icesave Depositors

In December, Iceland agreed to compensate the U.K. and the Netherlands  
in full for their payments to Icesave depositors, as the Landsbanki  
accounts were known. Payment, including interest of about 3 percent,  
will be made over 35 years.

The U.K. and Dutch governments are claiming priority over other  
creditors so they can recoup funds from Landsbanki to cover the  
payments, based on a hierarchy created by the 2008 emergency act. If  
they succeed, other creditors would get nothing from the sale of  
Landsbanki’s assets. The priority of depositors is being challenged by  
creditors in court.

“The German banks and pension funds that loaned to Landsbanki in the  
early 2000s argue that their investments were made well before the law  
was changed,” says Heidar Asberg Atlason, a partner at Logos Legal  
Services in Reykjavik, which represents about 100 creditors of the 3  
lenders.

Suspended by Cables

Claims against the three banks add up to $107 billion, and it may take  
years to resolve them in court, even after the resolution committees  
finish their work.

At Kaupthing’s offices, housed on the seventh floor of a building with  
floor-to-ceiling windows overlooking the Atlantic Ocean, a half dozen  
asset managers huddle over computer monitors watching market prices  
for stocks and bonds the bank owns. They and their counterparts at  
Landsbanki and Glitnir are in no hurry to sell.

“Some things, like our subsidiary in Norway, we sold really fast  
because we had good offers,” says Tomasson, the Glitnir resolution  
committee chairman. “Others we resisted selling immediately because we  
wouldn’t get a good price. Creditors are telling us not to hurry, not  
to do fire sales.”

At Arion headquarters, visible from Kaupthing’s resolution office, CEO  
Olafsson sits in a meeting room that’s suspended by steel cables and  
surrounded by see-through glass floors, talking about the challenges  
facing the new bank. Those include restructuring thousands of consumer  
loans, mortgages and debts of small Icelandic companies.

‘Just Can’t Pay’

While the bank got the loans from Kaupthing at steep discounts -- in  
some cases for nothing, if no recovery was expected -- it has to work  
with borrowers to make sure they can pay back, Olafsson says.

“Asset values and income in Iceland have gone down a lot, so people  
just can’t pay,” he says.

Iceland’s government, now led by the Social Democratic Alliance, has  
pushed laws through parliament that would require the new banks to  
write off $1.4 billion in consumer debt.

“There have been lots of interventions, which creates uncertainty,”  
Islandsbanki’s Einarsdottir says. “But hopefully those are all behind  
us, and we can complete all the restructuring by the end of 2011.”

Creditors have an interest in seeing Einarsdottir and Olafsson  
succeed. They stand to recover more if the new banks can be sold for a  
good price to strategic investors or in a public offering. Glitnir  
aims to do so in three years; Kaupthing is shooting for five.

Rebuilding Confidence

While the shattered trust of the public may take years to rebuild,  
there aren’t any alternatives for Icelanders, who have kept their  
deposits at the new banks.

“I lost all the confidence in the banks, but where else can we go?”  
says Jon Birgir Valsson, a customer at an Islandsbanki branch in  
downtown Reykjavik who was paying some bills for the government agency  
that employs him. “Life continues. We need to bank, and these are the  
banks we have.”

Rebuilding the confidence of international investors may take longer.  
Iceland’s banks won’t be able to access international markets until  
political and financial uncertainties are removed, say creditors and  
their representatives, who asked not to be identified.

Those include the agreement reached with the U.K. and the Netherlands,  
which has to be approved by President Olafur R. Grimsson. The  
politically independent head of state has said he’ll decide by  
February whether to put the issue to a referendum again. Voters  
rejected a previous arrangement last year that forced a higher  
interest rate on Iceland.

‘Grow Cautiously’

Einarsdottir agrees that settlement of these issues and completion of  
debt restructuring is required before the government and the banks can  
access international capital markets again.

“In the beginning, banks and other financial institutions in Europe  
were telling us, ‘Never again will we lend to you,’” Einarsdottir  
says. “Then it was 10 years, then 5. Now they say they might soon be  
ready to lend again.”

This time her bank won’t use foreign funds to go on a lending binge,  
she says.

“We will only focus on areas where we can bring on the nation’s  
expertise, such as fishing and geothermal energy,” says Einarsdottir.  
“We will grow cautiously.”

Fishing, Banking

Economy Minister Arnason wants more for Iceland than fishing and  
geothermal energy. He acknowledges that the nation got into banking  
without the right infrastructure or the know- how to do it well.  
Still, he doesn’t think Icelanders have to go back to fishing now that  
they’ve proven themselves inept at finance.

His government needs to find work for the 2,000 highly educated  
finance-sector employees who lost their jobs, he says. Otherwise,  
they’ll migrate, and a shrinking population is the biggest scourge for  
this small, isolated island nation.

“The choice isn’t between fishing and banking,” Arnason says. “The  
choice is building a healthy, diversified economy.”

Arnason will have a better chance of keeping his countrymen home if  
Iceland can resume growth as predicted. It would also help prove his  
predecessors were right to let the country’s banks fail: Ireland,  
which rescued its financial institutions, is on the way to shrinking  
for a fourth consecutive year.
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