Euromoney Magazine

Euromoney Magazine http://www.euromoney.com/Print.aspx?ArticleID=2406144 The failed state of Iceland Elliot Wilson Friday, March 05, 2010 The full horror of the country’s bank-led collapse is still emerging. A new generation of regulators is trying to sort out the mess as prosecutors attempt to bring the perpetrators to justice but, as Elliot Wilson discovers in Reykjavik, there’s a long road ahead to recovery. IN A WORLD where international reputations seem to topple like dominoes every few months – Greece being the latest casualty – it’s worth stepping back in time to the mother of all financial disasters. When Iceland’s banking sector disintegrated in autumn 2008 it spelled the end for the nation’s big three lenders – Kaupthing, Glitnir and Landsbanki – creating the greatest banking collapse relative to economic size in history. But it did much more. It shredded a tiny nation’s hard-won economic reputation in a heartbeat. It bankrupted hundreds of Icelandic firms, many of which had grown fat and rich with cheap loans from local banks. Worst of all it impoverished tens of thousands of poorly advised (and often greedy) consumers, who are now deeply in debt and bitter towards everyone – bankers, politicians, regulators and the entire global financial system that allowed Iceland to fly so high before burning up and falling to Earth. While the eyes of the world are elsewhere, it’s interesting to see how a new generation of politicians and regulators in Reykjavik, backed by a coterie of teak-tough international advisers, are seeking to scrape the country’s tattered economy off the floor. First, a quick trip to the recent past. For most of the 2000s Iceland’s bank expansion knew literally no bounds. By 2008 the economy – sustained outside the financial sector by 320,000 people engaged in tourism, steel production and fish exports – was worth IKr1.47 trillion ($11.4 billion). The same year assets at the big three banks had reached nearly IKr15 trillion, with borrowings of IKr6.35 trillion. The ratio of foreign liabilities of the leading banks to GDP had topped nine times in Iceland – higher than the ratio in Switzerland, a nation built on banking and with a robust currency of its own. Between 2000 and 2007 GDP grew by 130% How big is big? – a rate that nearly equalled China’s rapid growth, according to figures from Iceland’s Failure of three largest Icelandic banks stock regulator, the Financial Supervisory superimposed on the largest US corporate Authority (FME). Housing prices jumped 75% bankruptcies between 2004 and 2008, while disposable Rank Firm Year Type Assets income rose 73% between 2000 and 2007. ($bln) Everything rested on the strength – or lack 1Lehman 2008 Investment bank 691 thereof – of the nation’s banks: when they Brothers went kaput, so did the entire Icelandic 2 Washington 2008 Savings and loans 328 economy. Kaupthing’s bankruptcy alone Mutual would have placed number five on the list of the largest US corporate failures in history; 3 WorldCom 2002 Telecommunications 104 added together, the failure of Iceland’s 4 General 2009 Auto manufacturing 91 biggest banks was equivalent to the third- Motors largest bankruptcy in US history, behind only 5 Kaupthing 2008 Commercial/investment 83 Lehman Brothers and Washington Mutual. Bank bank Invisible regulation 6 CIT Group 2009 Bank holding company 80 Who, then, was regulating Iceland’s out-of-control banks? Simply 7 Enron 2001 Energy trading 66 put, the answer is no one – or at least, no one worth mentioning. By late 2007 Iceland had essentially become a financial banana 8 Conseco 2002 Financial services 61 republic. The FME had long been a cipher, offering empty platitudes about financial supervision. Its offices sit in the distant 9 Landsbanki 2008 Commercial/investment 50 outskirts of Iceland’s capital, anonymously nestled at the back of a Islands bank ramshackle office building and above a Chinese noodle shop. They could not be farther – literally or metaphorically – from the 10 Glitnir Bank 2008 Commercial/investment 49 gleaming steel-and-glass waterfront real estate chosen by leading bank local banks, most based a stone’s throw from government offices and Reykjavik’s retail centres. Source: FME There was a good reason for this distance. For one, Iceland’s bank chairmen and chief executives resented what one former senior banking official still describes as "unnecessary meddling" by people who knew "next to nothing" about the brave new world carved out by gung-ho lenders. During the boom years, anyone with an ounce of financial nous was swiftly hired out of the FME by one of the big lenders. That left behind largely the halt, the lame and the clueless, headed by a man overly interested in palling around with bank executives. The bonhomie between Kaupthing’s ex-chief executive, Sigurdur Einarsson, and the former FME director general, Jónas Fr Jónsson, was too cosy even for some of the latter’s staffers. According to one, Jónsson would settle down on the sofa when entering Einarsson’s office and chat about the weather, sports, foreign travel – 1 of 5 25.3.2010 14:34 Euromoney Magazine http://www.euromoney.com/Print.aspx?ArticleID=2406144 anything but high finance. "Jónsson was a chinless wonder," says a state official insider. "He was best friends with most of the top bank execs – his was a rather ceremonial role, involving cheerleading for the banks, rather than supervising them." Gunnar Andersen, the current FME director general, appointed in April 2009, is far harder nosed than his passive predecessor. A former managing director of international banking and treasury at Landsbanki, Andersen left his post in late 2002, just days after the Icelandic government’s executive committee on privatization sold its 45.8% stake in Landsbanki to Samson Holding, a little-known investment group headed by three enormously wealthy Icelanders who had made their fortunes in Russia’s cut-throat brewing industry. "It’s a story of incompetence. It’s a story of That group was headed by Björgólfur Thor Björgólfsson and his father Björgólfur Gudmundsson, hillbillyism and delusions of grandeur. It’s a a man connected to two corporate scandals that rocked Iceland in the mid-1980s involving the story of babes in the woods and narrow- shipping line Hafskip and the near-collapse of Utvegsbanki, Iceland’s fisheries bank. To that list minded country bumpkins. And it’s a story of he can now add West Ham United, the English football club Gudmundsson bought, then brought disastrous management and alleged serious to the brink, and Landsbanki – the septuagenarian was chairman of the board of the Icelandic criminality" lender when it filed for a $50 billion bankruptcy in October 2008. Gunnar Andersen, FME Many now connect that sale – which placed control of a venerable 124-year-old banking institution in the hands of a group of questionable investors – with the unfettered Icelandic financial expansion that followed, lasting just six years and culminating in the emergency renationalization of the entire first-tier banking sector. Yet the sale of Landsbanki eight years ago raised surprisingly few dissenting voices. One of the very few came from Euromoney, which in a November 2002 article questioned whether this father-and-son outfit was a "suitable choice" to control such an important component of the Icelandic economy (Questions over Landsbanki's new shareholder, Euromoney, November 2002). Delusions of grandeur Sat in his brightly lit, somewhat Spartan offices, the intense and driven FME chief – who many believe left Landsbanki in protest at the Samson sale – doesn’t mince words when asked to describe the torrid tale of his country’s failed banking sector. "It’s a story of incompetence," Andersen says. "It’s a story of hillbillyism and delusions of grandeur. It’s a story of babes in the woods and narrow-minded country bumpkins. And at the tail end it’s a story of disastrous management and alleged serious criminality. "The collapse of the banks revealed serious weaknesses in their information systems. Their management was... a shambles. They seem often to have financed the deals they were doing with little or no equity components, thus assuming enormous risk but with little protection for any downside. One assumes that the bank CEOs and chairmen must have known the crash was coming for some years, but they carried on anyway." Andersen notes that in the six years to October 2008 the assets of banks supervised by the FME grew by 554% while the regulatory body’s staffing numbers less than doubled. Turnover soared as quality personnel were headhunted by banks: in 2005 fully one-quarter of FME staff left the body. "The image of the FME was damaged by this and we haven’t recovered yet," he says. Yet such gloom seems a deliberate undersell by the studiedly pragmatic Andersen, who is clearly determined to boost both headcount and budgets. For now the Althing, Iceland’s parliament, seems only too happy to accommodate most demands, even as state spending on health, education and national security plummets. The FME budget jumped 25% in 2010 over 2009 figures and is widely expected to rise further. Bigger budgets are justified in part by higher supervisory fees imposed on regulated entities by the FME, which rose 49% year on year in 2010. So far Andersen has invested wisely. Auditors Deloitte and international consultants Oliver Wyman were hired to deliver a no-holds-barred report highlighting FME deficiencies. A forensic accounting (FA) division was established in late 2009, employing public accountants and, Andersen hopes, former policemen all blessed with "a healthy degree of scepticism". A group leader, most probably a financial forensics expert, is soon set to join the five-strong team, seen internally as something akin to a CSI: Reykjavik.

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