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BRINGING DOWN the BANKING SYSTEM This Page Intentionally Left Blank Bringing Down the Banking System Lessons from Iceland BRINGING DOWN THE BANKING SYSTEM This page intentionally left blank Bringing Down the Banking System Lessons from Iceland Gudrun Johnsen BRINGING DOWN THE BANKING SYSTEM Copyright © Gudrun Johnsen, 2014. Softcover reprint of the hardcover 1st edition 2014 978-1-137-35819-6 All rights reserved. Grateful acknowledgment is made for the permissions to reprint the following previously published images: (1) Figure (10.2) and Front Cover—Cross-ownership of fi rms with more than 500 million ISK in assets (Icel. Eignatengsl fyrirt æ kja me ð yfi r 500 millj ó nir kr ó na í eignir), SIC report, Appendix 2, Figure 6, (2) Figure 10.3—Cross-ownership of fi rms with more than 500 million ISK in assets, 10% minimum cross-ownership (Icel. Eignatengsl fyrirt æ kja me ð yfi r 500 millj ó nir í eignir, 10% l á marks eignatengsl), SIC report, Appendix 2, Figure 7, (3) Figure 10.4—Related parties with Baugur Group hf as the main party (Icel. Hópur tengdra aðila þegar Baugur Group hf er aðalaðili), SIC report, Appendix 2, Figure 15, (4) Figure 11.6—Total Lending to Baugur Group and related parties as percentage of capital base shown as a function of 2007 year-end minimum shareholding (Icel. Hlutfall heildarútlána Baugur Group og tendra aðila sem hlutfall af eiginfjárgrunni og sem fall af lágmarkseignarhlut við áramótin 2007/2008), SIC report, Appendix 2, Figure 30, previously published in Bjarnadottir and Hansen, 2010, “Investigation into the cross ownership and bank credit to related parties,” SIC Report, Volume 9 (Title in Icelandic: Ranns ó kn á krosseignartengslum og ú tl á num bankanna til tengdra a ð ila), Special Investigation Commission, Reykavik. All quotations and illustrations from the Special Investigation Commission fall under the public domain and are not protected by copyrights. First published in 2014 by PALGRAVE MACMILLAN® in the United States—a division of St. Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978-1-349-47105-8 ISBN 978-1-137-34735-0 (eBook) DOI 10.1057/9781137347350 Library of Congress Cataloging-in-Publication Data Johnsen, Gudrun. Bringing down the banking system : lessons from Iceland / Gudrun Johnsen. pages cm 1. Bank failures—Iceland—History—21st century. 2. Banks and banking— Corrupt practices—Iceland—History—21st century. 3. Bank management— Iceland—History—21st century. I. Title. HG3154.J66 2013 332.1094912—dc23 2013025082 A catalogue record of the book is available from the British Library. Design by Newgen Knowledge Works (P) Ltd., Chennai, India. First edition: January 2014 10 9 8 7 6 5 4 3 2 1 To my mother Stefania Valdis Stefansdottir for her everlasting help, support, and encouragement and to my kindred spirit, husband, and editor in chief, Thorarinn R. Einarsson This page intentionally left blank Contents List of Figures ix List of Tables xiii Acknowledgments xv List of Characters xvii Timeline of Relevant Events xxi Part I From Prosperity to Panic Chapter 1 Illusion of Prosperity 3 Chapter 2 Collapse 13 Chapter 3 Panic 19 Chapter 4 Investigation 47 Part II How Did the Bankers Do It? Chapter 5 Financial Liberalization 59 Chapter 6 Funding the Banks 75 Chapter 7 The Geyser Crisis 83 viii CONTENTS Chapter 8 Love Letters to the Rescue 91 Chapter 9 Playing Tricks on the European Central Bank 97 Part III Why Did the Bankers Do It? Chapter 10 The Web of Ownership 109 Chapter 11 Tunneling Money through Related-Party Lending 119 Chapter 12 Market Manipulation and Falsification of Equity 137 Chapter 13 Wages of Failure 153 Part IV Why Didn’t Anybody Stop the Bankers? Chapter 14 Funded by the Ill-Informed 169 Chapter 15 A Debt-Free State; Isolated and without Credit 179 Chapter 16 Putting a Poodle on Watch 189 Chapter 17 What Have We Learned? 195 Notes 199 References 227 Index 233 Figures 4.1 Aggregate assets of the three banks 56 6.1 Deposits as share of banks’ total funding 76 6.2 Banks’ bond issues 79 7.1 CDS spreads of the Icelandic banks 2006–2008 86 7. 2 Bank deposits on consolidated basis 88 7. 3 Icesave deposits in Landsbanki’s branches abroad 88 7.4 Edge deposits in Kaupthing’s subsidiaries abroad 89 7. 5 Collateralized lending from central banks 89 8.1 Collateralized lending of the Central Bank of Iceland 92 8.2 Icebank’s collateral pledged into the Central Bank of Iceland 94 9.1 Collateralized lending of the ECB to Kaupthing, Glitnir, and Landsbanki 98 9.2 Icelandic bank bonds as collateral with the ECB 98 9.3 Collateralized lending of the European Central Bank (ECB) 99 9.4 Collateralized lending of the Banque Centrale du Luxembourg (BCL) 100 10.1 Example of cross-ownership structure of Icelandic fi rms in 2008 113 10.2 Cross-ownership structure of 1,307 fi rms in Iceland with balance sheet larger than USD 6 million (500 million ISK) in 2008 114 10.3 Cross-ownership structure of 453 fi rms in Iceland with balance sheet larger than USD 6 million (500 million ISK) in 2008 115 10.4 Cross-ownership structure of Baugur Group and related parties (184 fi rms) 116 11.1 Total lending by the three banks to Baugur Group and related parties 121 x FIGURES 11.2 Total lending by Glitnir to Baugur Group and related parties 122 11.3 Total lending by Kaupthing to Baugur Group and related parties 123 11.4 Total lending by Landsbanki to Baugur Group ehf. and related parties 124 11.5 Total lending of Glitnir to Fons and related parties 125 11.6 Total lending of the three banks to Baugur and related parties at year-end 2007 as percentage of capital base using ownership thresholds from 5–55% 125 11.7 Total lending by Landsbanki to Bjorgolfur Gudmundsson related parties 127 11.8 Total lending by Landsbanki to Bjorgolfur Thor Bjorgolfsson related parties 128 11.9 Total lending by Kaupthing to Exista and related parties 129 11.10 Total lending by Kaupthing to Olafur Olafsson related parties 129 11.11 Total lending by Kaupthing to Robert Tchenquiz related parties 130 11.12 Lending by the three banks, by type of borrower 132 11.13 Percentage of total lending of the three banks’ parent companies, by type of borrower 133 11.14 Percentage of total lending by Landsbanki’s parent company to Icelandic holding companies, by installment arrangement 135 12.1 Total value of blue chip stocks pledged to Glitnir as collateral 138 12.2 Total value of blue chip stocks pledged to Kaupthing as collateral 139 12.3 Total value of blue chip stocks pledged to Landsbanki as collateral 139 12.4 Percentage of outstanding shares of banks and holding companies pledged as collateral to listed banks 140 12.5 Percentage of outstanding company shares pledged as collateral to Kaupthing 140 12.6 Kaupthing’s buying and selling of its own shares as percentage of all its stock exchange turnover, by initiator, with share price (right scale) 142 FIGURES xi 12.7 Kaupthing’s monthly trading in its own shares, stock exchange and over-the-counter transactions 143 12.8 Landsbanki’s buying and selling of Kaupthing shares as percentage of all Kaupthing’s stock exchange turnover, by initiator, with share price (right scale) 143 12.9 Glitnir’s buying and selling of Kaupthing shares as percentage of all Kaupthing’s stock exchange turnover, by initiator, with share price (right scale) 144 12.10 Percentage of Icelandic listed shares pledged as bank collateral after 2004, with stock-market price index (right scale) 145 12.11 Glitnir’s buying and selling of its own shares as percentage of all its stock exchange turnover, by initiator, with share price (right scale) 147 12.12 Glitnir’s monthly net trading in its own shares, stock exchange and over-the-counter transactions 147 12.13 Kaupthing’s buying and selling of Glitnir shares as percentage of all Glitnir’s stock exchange turnover, by initiator, with share price (right scale) 148 12.14 Landsbanki’s buying and selling of its own shares as percentage of all its stock exchange turnover, by initiator, with share price (right scale) 149 12.15 Landsbanki’s monthly net trading in its own shares, stock exchange and over-the-counter transactions 149 12.16 Landsbanki’s capital adequacy (CAD) ratio, adjusted to exclude own-shares 151 12.17 Kaupthing’s capital adequacy (CAD) ratio, adjusted to exclude own-shares 151 12.18 Glitnir’s capital adequacy (CAD) ratio, adjusted to exclude own-shares 152 13.1 Percent of Landsbanki’s outstanding shares owned by limited liability companies owned by off-shore trusts 158 14.1 Deposits to Landsbanki’s branches in the UK (wholesale and retail) and the Netherlands 172 15.1 CDS spreads on fi ve-year Icelandic sovereign debt and bank debt, plus the ITraxx fi nancial index 180 15.2 Ratio of foreign reserves to quarterly imports 180 This page intentionally left blank Tables 1.1 Credit to the private sector by deposit money banks and other credit institutions as share of Iceland’s GDP 1990–2010 7 5.1 Landsbanki offers: Scores for knowledge and experience of fi nancial markets 65 5.2 Landsbanki offers: Evaluation of fi nancial terms of offer 66 5.3 Total scores for evaluation of Landsbanki offers 67 5.4 Bunadarbanki offers: Scores for knowledge and experience of fi nancial markets 68 5.5 Bunadarbanki offers: Evaluation of fi nancial terms of offer 69 5.6 Total scores for evaluation of Bunadarbanki offers 69 10.1 Year-end assets and organic growth (million ISK), sum of the three banks 110 13.1 Icelandic banks’ CEO compensation by year and bank, 2004–2008, USD thousands (nominal) 165 13.2 Icelandic banks’ CEOs’ dividend payments from the banks, by year, 2004–2008, USD thousands (nominal) 166 16.1 Write-downs of assets of the three banks from June to October 2008 (billion ISK) 192 This page intentionally left blank Acknowledgments Writing a book like this one requires the knowledge, experience, and hard work of many individuals.
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