Friday 1 May 2009

Viking accounting

Just before last weekend’s election, the FME (Iceland’s Financial Supervisory Authority) received two reports on the health of to “New” banks (New Kaupthing, NBI and Íslandsbanki), one from accountant Deloitte and the other from management consultants Oliver Wyman. The reports have not been made public, but were leaked to Morgunblaðið, whose article has been translated by Anya. Apparently, 40% of the assets of the new banks are “non-performing”: ie, they consist of loans which are not being paid back.

While 40% of worthless assets may seem a lot, it is actually far less than the FME's initial estimates. These were not made public either, although we know some details thanks to the IMF. The FME wanted to write off 66% of Kaupthing’s Icelandic loan book and 50% of Landsbanki’s (later upped to 55%). The FME didn’t dare give an exact figure for Glitnir, but crossing the FME's figures with Glitnir's 2008Q2 financial statement suggests that they were working on a 75% write-off! “We do not intend to pay the debts of banks that have been a little heedless” toned central bank chairman and former Prime Minister Davíð Oddsson on 7 October, in comments that are widely suspected of having prompted the UK government to freeze the British assets of Landsbanki. For a while, it appeared that the Icelandic authorities didn’t expect individual Icelanders and Icelandic companies to pay their debts either.

Icelanders built up household debts of more than twice their disposable income in a credit frenzy fuelled by their banks’ foreign borrowings, making Americans, with household debts of “only” 134% of disposable income, seem positively virtuous in comparison. Iceland’s companies went even further: corporate debt is more than three times GDP, compared to 77% in the eurozone. An old British adage runs that if you owe the bank a thousand pounds you have a problem, but if you owe the bank a million pounds then the bank has a problem. If so, Iceland’s new banks have a very big problem.

The new banks were set up to take on the assets and liabilities in Iceland, and the assets (mostly loans) far outweigh the liabilities (mostly deposits), at least in book value. But how much are those assets actually worth? The question is doubly important because the new banks have to compensate their predecessors for the net value of the assets. That money will then help pay the old banks’ overseas creditors. The larger the provisions, the lower the net value of the new banks’ assets and the less they will have to pay out to their predecessors. The FME’s provisions amounted to a 4000 billion krónur loss for the foreign creditors of the old banks; the leaked report would put these provisions at nearer 2500 billion krónur. The difference – roughly the size of Iceland's GDP – would have to made up in part by increasing the capital of the new banks.

The valuation of the assets of the new banks was supposed to be completed with ninety days: it has dragged on for more than twice as long. Yet it is absolutely fundamental to any recovery plan for the Icelandic economy. Until the initial balance sheet is known, there can be no capital injection into the new banks, no restructuring of loans, and no sale of assets to pay off the debts. One can only hope that the new government will move swiftly to publish the relevant parts of the reports after the holiday weekend: to do so might be politically painful within Iceland, but it is essential for regaining Iceland's international credibility.

***UPDATE*** (Saturday 2 May)
See also this press release from the Ministry of Business Affairs and this article in today's Iceland Review.

Thursday 30 April 2009

Order of the Puffin - lundisorða


The Order of the Falcon (fálkaorða) is Iceland's highest honour. The Order of the Puffin (lundisorða) is this blog's highest honour. Both are quite difficult to get – especially the former, as U.S. Ambassador Carol Von Voorst found out this month.

Now in the world of world diplomacy, handing round a few gongs here and there is nothing particularly unusual. The British, always the experts in the finer distinctions of relative snobbery, have even created an entire order of knighthood, the Order of St Michael and St George, which is only given to diplomats. So it can't have been too much of a surprise to Ms Von Voorst when the President's office rang earlier this month to say that she would be awarded the Order of the Falcon on the occasion of her moving on from Reykjavík to a new posting: three previous U.S. ambassadors to Iceland had been similarly honoured.

The surprise came last Friday, as she was on her way to the Presidential residence at Bessastaðir to pick up her medal. It was all a terrible mistake, apparently, and she wouldn't be getting it after all! But she was welcome to come in anyway for a cup of tea and a chat with Ólafur Ragnar Grímsson if she wanted too. "Grímsson allegedly explained to her that only those who were deemed worthy were honored this way." according to Iceland Review. The Order of the Falcon, or tea and a chat with Óli and Dorrit?

Now Ólafur Ragnar is no stranger to controversy. Last November, he allegedly tried singlehandedly to sell the Keflavík naval air base (and international airport) to the Russians – the Russians politely declined the offer – before lashing out at virtually every other country with an embassy in Reykjavík, especially the British (no surprise there). It's really quite hard to take him seriously when there are so many accumulated speeches from before last October in which he claimed that Iceland's bankers were financial wizards rather than the deluded psychotics they turned out to be. But with this latest incident, he seems to have stooped to new lows of ridicule.

Ambassador Von Voorst might not be the best U.S. ambassador to Iceland in the short history of diplomatic relations between the two countries. She was only in the job for three years, and presided over the somewhat muddled announcement of the withdrawal of U.S. Navy aviators from Keflavík. The commentators at the Iceland Weather Report don't seem to think much of her. But that's no reason to snub the woman, it's only a medal after all all: if she'd been told she was going to get it, she should have got it, and tough if a few people felt she wasn't "worthy" enough. After all, there are plenty of people who think that Ólafur Ragnar is hardly worthy of being President of the Republic and hence ex officio Grand Master of the Order of the Falcon! So, in a belated attempt to set things right, I've whipped off an email to the U.S. Embassy in Reykjavík bestowing the Order of the Puffin on Ambassador Von Voorst for her services to the Icelandic people in proving that their Presidency really couldn't organise a piss-up in a brewery.

If you have any other suggestions for worthy – or unworthy, I don't care – recipients of the Order of the Puffin, the comments box is below!

Get this man a job!


Thanks once again to Anya the eyes for finding exactly the sort of absurd news stories which appeal to the Ministry of Puffins. Apparently a certain Halldór J. Kristjánsson is thinking of leaving Iceland to try to find gainful employment abroad. Sadly, there's nothing unusual about that these days, with unemployment up 650% in the last twelve months. Halldór says he wants to work in the financial sector, so I guess it makes sense to look for work in a country which actually has a financial sector – somewhere like Albania, for example, which this week managed to apply for EU membership, a feat which seems beyond Iceland's political class.

Does Halldór have any experience in this type of work? Well, that depends what you count as "experience". Until 8 October 2008, Halldór was chief executive of Landsbanki: he lost his job when the Icelandic government had to take over the bank. His disastrous scheme of taking deposits in Britain and Holland and lending them to Icelanders without the means to repay them has cost the country thousands of billions of krónur. Unsurprisingly, he has been unable to find steady employment in Iceland since he bankrupted the country (with a little help from his friends), hence his search abroad.

Still, it pains me to think of Halldór sitting doing nothing in Reykjavík, using social security benefits which could go to more deserving causes, so the Ministry of Puffins is making this appeal: if you know of a job, preferably a long way from Iceland, that Halldór could do, please let us know, and I'll do my best to pass on the information.

I'll start the ball rolling with a job offer I found from a company at 41/42 London Wall, in the heart of the City of London (postcode EC2M 5TB, telephone +44 20 7638 7787): Halldór can even apply online herei'm lovin' it®

Monday 27 April 2009

Today is Monday

Back to work it is. And Saturday's election results send a clear sign to Iceland's government as to what the People want that work to be.

Samfylkingin (the Social Democratic Alliance) was the most voted party (29.8%, 20 seats). Together with Vinstrihreyfingin – grænt framboð (Left-Green Movement, 21.7%, 14 seats) they now have a majority in the 63-seat Althing. Borgarahreyfingin (the Citizens' Movement, or Civic Movement depending on how you translate it) came from literally nothing – it was only "formed" nine weeks ago, and had a campaign budget of about a million krónur – to gain 7.2% of the vote and four seats. And perhaps the great surprise of the night was the showing of Framsóknarflokkurinn (the Progressive Party), which won 14.8% and nine seats (more on that later).

Sjálfstæðisflokkurinn (the "Independence" Party) was clearly punished for being the architect of the economic bubble that burst with such dire consequences, although it still polled 23.7% and won 16 seats. Many bloggers have been surprised at how many voters could still bring themselves to vote for this heap of crap: 23.7% represents 44,369 votes, less than the 50,000 members that Sjálfstæðisflokkurinn boasts about on its website. It really is that much of an institution in Iceland: hopefully in a couple of years' time, we will be able to write that sentence in the past tense.

Other losers were Frjálslyndi flokkurinn (the Liberal Party), which was wiped off the political map; the newish Lýðræðishreyfingin (Democracy Movement), which gained the votes of its candidates and some of their close family members; and L-listinn, which was doing so badly that it didn't even bother to stand in the elections.

Ironically, the Left-Greens are also on many lists of election losers. Education minister Katrín Jakobsdóttir – the Left-Green's one woman charm offensive – looked incredibly glum on Saturday night for someone whose party was scoring a historic victory, with more than 50% more votes that at the last election. While the results were the best in the Left-Green's ten-year history, opinion polls just a week before the election were predicting them 26–28% of the vote, instead of 21.7% which they ended up with. Left-Green environment minister Kolbrún Halldórsdóttir lost her seat in the Althing: that's right, Iceland's first green environment minister lasted twelve weeks…

So what divides the winners from the losers in Saturday's election? The Social Democrats, the Progressives and the Citizens' Movement all support negotiations to join the European Union: they were the winners on Saturday. The "Independence" Party, the Liberals and the Left-Greens all oppose membership negotiations with varying degrees of vehemence: they were the losers on Saturday, even if the "loss" of the Left-Greens is only relative.

Let's be clear that the idea of a referendum to approve the start of negotiations is just a manoeuvre to prevent negotiations starting at all. What is there for people to vote about? It is frighteningly obvious that most of Iceland's politicians don't understand what EU membership negotiations entail, let alone the rest of the population. That includes Iceland's foreign minister, which is truly worrying, but more on that another time. A referendum before negotiations start would be a vote on peoples fears and prejudices, and we all know which way that one would fall.

All the same, Icelanders have voted in representatives who are favorable to starting negotiations on behalf of the nation. The government should do so without delay. Like today. OK, maybe wait until the first Cabinet meeting, but that meeting should not just discuss negotiations, it should agree how to move forward. Too much time has been wasted already.

Sunday 26 April 2009

And the (early) results from the Icelandic jury…

22:23 UTC
Projections from state broadcaster RÚV, based on about 40% of votes counted:
  • Progressive Party: 9 seats (+2)
  • Independence Party: 15 seats (–10)
  • Liberal Party: 0 seats (–4)
  • Civic Movement: 4 seats (+4)
  • Democracy Movement: 0 seats (–)
  • Social Democratic Alliance: 22 seats (+4)
  • Left-Green Movement: 13 seats (+4)
The international observers from the OSCE have declared the elections to be "of the highest standard": they certainly seem to be giving a reasonable result so far.

22:36 UTC
Those predictions seem to be based on rather less than 40% of the vote counted: thanks to the team at The Reykjavík Grapevine, whose Icelandic is far better than mine is, for the correction!

23:44 UTC
No real movement in the projected figures, except maybe the Civic Movement will gain an extra seat at the expense of the Social Democratic Alliance.
Apparently "thousands" of ballot papers have candidate's names struck out, perfectly legitimate in Iceland's "open list" system. The speculation is that the candidates concerned are those that were named as having received campaign donations from corporations during the 2007 elections. The striking out of candidates does not affect the number of seats for each party, although it might affect the individuals who are elected from certain lists and will slow down the count.

01:00 UTC
These projections are from Morgunblaðið, based on 53.6% of votes counted:
  • Progressive Party: 13.2% (+1.5%), 9 seats (+2)
  • Independence Party: 23.4% (–13.2%), 15 seats (–10)
  • Liberal Party: 1.9% (–5.4%), 0 seats (–4)
  • Civic Movement: 8.0% (+8.0%), 5 seats (+5)
  • Democracy Movement: 0.5% (+0.5%), 0 seats (–)
  • Social Democratic Alliance: 32.2% (+5.4%), 21 seats (+3)
  • Left-Green Movement: 20.9% (+6.6%), 13 seats (+4)

01:50 UTC
Anya at NewsFrettir passes on a warning from the National Electoral Commission that the large number of strike-out ballots may mean that the current figures are "giving off the wrong image" of the final result. The reason is that struck out ballots are counted last, and there are clear differences between the parties as to the proportion of ballots having names struck out.

Saturday 25 April 2009

Election special

A small country goes to the polls this weekend to elect a new parliament after a very hectic six months. A country with a thousand-year history and an innate sense of independence, but which has nevertheless been repeatedly bullied into submission and poverty by its more powerful neighbours. A country which thought it had found riches, only to have the recent global crisis brutally expose the weakness of its economic model: a model which, at times, seemed to be based entirely on banking and shopping.

The last opinion polls predict a historic victory for the social democrats, after decades of hegemony by a centre-right party far too cosy with the nation's bankers. In recent years, it has seemed that the banks were supporting the state, not the other way round.

Everyone agrees that some sort of change is needed. The social democrats support EU membership, while the centre-right wants simply to revise the current agreements. Nobody seems to have a clear idea of what sort of deal they would be able to get from Brussels or (at least as importantly) from Frankfurt and the City of London.

The population are understandably worried. What will be the cost of unraveling the excesses of recent years? How can the prosperity of the nation's children be assured? Or will it all just end up with yet more of the stunning wilderness concreted over by foreign "investors" who couldn't even find the country on a map? Those foreign "investors" are already trying to impose their own terms, with varying degrees of tact and diplomacy, yet surely their "solutions" are just more of the same, exactly what got the nation into its current problems…

The polls are open from 09:00 to 19:00 Central European Summer Time on Sunday 26 April. The country is Andorra, not Iceland. Plus ça change, plus c'est la même chose, but I'll let you know the results when I get them ;)

On glacier bonds and Frankfurters


On the eve of today's elections the newspaper Morgunblaðið (linked to Sjálfstæðisflokkurinn, the "Independence" Party, as are many of the Icelandic media) published a report, translated at NewsFrettir, on the glacier bond problem. See "More euro madness" and "How much is a króna worth?" for the Ministry of Puffins' take on the issue.

Morgunblaðið claims (quite plausibly in my opinion) that the European Central Bank has been left holding 100 billion krónur in these once-cool financial instruments, money which is now trapped behind behind Iceland's currency controls. That's about one-fifth of the total outstanding value of the glacier bonds, according to several estimates seen by the MoP. The ECB accepted the bonds – 57 billion krónur in Íbúðalánasjóður (Housing Finance Fund) bonds, 28 billion krónur in Iceland treasury bills and 15 billion in króna-denominated bonds issed by Dutch bank RaboBank – as collateral for a euro loan to Landsbanki Luxembourg S.A., a subsidiary of Landsbanki h.f. which is now in suspension of payments.

Less plausibly, Morgunblaðið also claims that the interest payments on glacier bonds are driving down the króna exchange rate. Foreign investors are allowed to convert króna interest payments into hard currency under the currency controls; only the principal (capital) is locked into Iceland. But with some 500 billion krónur in glacier bonds, even the interest payments are a significant drain on Iceland's foreign currency. Significant, yes, but nothing compared to Icelandic domestic debt – 4827 billion krónur according to the latest available figures, of which a whopping 60% is denominated in foreign currencies according to the IMF. Although the foreign-currency loans to households (with no foreign-currency income) represent the pinnacle of stupidity, these are only a small proportion of the total: most of these loans are to Icelandic businesses. The hard currency which goes on paying off these loans can't be used for other things, like paying for imports, so the businesses have to buy more hard currency for squidgy-soft krónur, which pushes the value of the króna down.

Don't expect to hear any of this from Sjálfstæðisflokkurinn in the foreseeable future: it's simply more than they could humanly bear, to admit that sold the independence that they pretend to cherish so dearly, all for a fist full of euros (no less!).

Friday 24 April 2009

Jekyll and Hyde


There were a couple of bits of good news from Kreppaland this week. Firstly, the assets of Kaupþing banki h.f. are reckoned to be enough to pay off German depositors in Kaupthing Edge. The Kaupthing Edge accounts in Germany were operated under the disastrous "branch" model chosen by Landsbanki for its Icesave accounts, rather than the more conservative "subsidiary" model that Kaupþing chose for most of its overseas retail markets. The news from Kaupþing's Icelandic administrators is equivalent to €1.2 billion that the Icelandic state will not now have to take on in short term loans: Prime Minister Jóhanna Sigurðardóttir was justifiably pleased at last week's annual meeting of the Central Bank.

A second piece of good news came from the United Kingdom. The administrators of Landsbanki's Scottish subsidiary Heritable Bank plc reckon that uninsured depositors (mostly UK local councils) will get 70–80% of their money back. As a spokesman for Kent County Council put it, they'd have lost more money had they invested their reserves on the London Stock Exchange.

The news about Heritable Bank didn't cause many ripples in Reykjavík, for reasons I'll come to in a moment. However Iceland's finance minister and tireless promoter of relations with Norway, Steingrímur J. Sigfússon, was ready with a comment: "It is very positive that there are valuables at hand but it does matter how they are disbursed of the interest of the nation."

The problem for Steingrímur Jóhann is that these "valuables" are not available to be disbursed "of the interest of the nation". Heritable Bank was a subsidiary of Landsbanki h.f., or to put it another way, Landsbanki was Heritable's shareholder. Shareholders are always the last to get paid in a liquidation and, if depositors are only getting 70–80%, it seems very unlikely there will be anything left afterwards. As a Scottish company, Heritable Bank was a full member of the UK Financial Services Compensation Scheme, which picked up the £500 million deposit insurance bill but which will also be reimbursed at "70–80%". The only benefit to Iceland is a bit of good press, and a reminder that the banks had (and have) assets as well as debts, but even that is welcome these days with all sorts of ludicrous claims being exchanged in multiple fora.

Now Steingrímur Jóhann is a geologist, not a lawyer, but one would hope that he understands the principle of limited liability corporations, especially given his current job. Icelandic Wikipedia doesn't have an article on them, but I found this one in Nynorsk if it helps him at all… After all, it's hardly the first time he's put his foot in it in less than three months as finance minister, a job that one would think is pretty important (not to say hellishly difficult) in today's Iceland.

On the other hand, like the character from the Robert Louis Stevenson novella, Steingrímur Jóhann has another side to his (political) personality. As well as being finance minister, he is also minister of fisheries and agriculture, a subject dear to puffins!

Steingrímur Jóhann's party, the Vinstrihreyfingin–grænt framboð (Left–Green Movement) were long ridiculed by "those who decide[d]" for Iceland: until, that is, the kreppa came and people started to realise that the old decisions were not as sensible as had been claimed. Steingrímur Jóhann was born on a sheep farm in Northeast Iceland, and already had experience as agriculture minister (1988–91), but was still taking on one of the more conservative sectors of any society from the position of leader of the "loony left". And, despite all the anxiety which surrounded his appointment, he has done remarkably well at the helm.

His predecessor in the fisheries ministry left a poisoned chalice in the form of a controversial set of fishing quotas, especially for the section devoted to commercial whaling. Steingrímur Jóhann sensibly decided not to take on the powerful fishing lobbies in a head-to-head, saying that there were probably more important things for the nation to be arguing about, but neither did he simply dodge the argument. In one of his last acts before tomorrow's election, he has commissioned a study of the contribution of whaling to the Icelandic economy, which many believe to be zero if not negative. He has calmly cooperated with the European Commission in their review of the EU Common Fisheries Policy – possibly a far more effective way to insure the future of 8% of the Icelandic workforce than any hypothetical hardball negotiation.

The last opinion polls suggest a clear victory for the parties of the current coalition government, and hence a clear break with the hegemony of Sjálfstæðisflokkurinn (Independence Party). But as Heilög Jóhanna prepares her new government, she will still have to take account of grubby little demands like "another job for one of ours!" or "the best job for me!" I can only hope that she manages to place as many ministers as possible with portfolios that they will do well. That means removing finance from Steingrímur Jóhann, but keeping him as fisheries and agriculture minister. The next few days will really show the commitment of Iceland's political class to move ahead together for the good of the country – or not as the case may be.

IgNobel nominations (3)

(continued from this morning's post)


Mr. Sigurður Einarsson, former Chairman of Kaupþing banki h.f., Reykjavík, Mr. Björgólfur Guðmundsson, former Chairman of Landsbanki h.f., Reykjavík, and Mr. Þorsteinn Már Baldvinsson, former Chairman of Glitnir banki h.f., Reykjavík, for their studies on high-leverage banking in a small economy.

This nomination is for a long-term study whose pertinence is only now becoming apparent. It began around 2003, with the deregulation of the Icelandic banking sector under the government of Davíð Oddsson (see separate nomination). It is useful to recall some “vital statistics” from that period:
  • Bank lending to the domestic sector: ISK 698.3bn
  • Credit system total lending: ISK 1,970.9bn
  • Króna M3: ISK 393.6bn
  • Central Bank of Iceland policy rate: 5.8%
  • Króna exchange rate index: 126.6
  • Estimated labor force: 154,600

The small size of Iceland’s economy was an obvious handicap to the three commercial banks in their plans for expansion. All three decided that would have to set up operations in places where there were more people if they ever wanted to earn more money (and who doesn’t?). But, for the very same reason that they wanted to expand abroad, they didn’t have the money to do so: so they borrowed it.

The three banks set up, bought or maintained operations in at least ten jurisdictions of the European Economic Area, as well as in Switzerland, the Isle of Man, Guernsey, Canada, the USA and Japan. These operated either as branches or as subsidiaries, and offered the normal range of banking services, especially (but far from exclusively) to Icelandic companies. However the range of lending opportunities was somewhat limited in these mature banking markets, so much of the money was lent instead in the ‘captive’ Icelandic market, as can be seen from the “vital statistics” at the end of 2007:
  • Bank lending to the domestic sector: ISK 3,004.5bn
  • Credit system total lending: ISK 5,386.4bn
  • Króna M3: ISK 1,145.2bn
  • Central Bank of Iceland policy rate: 13.75%
  • Króna exchange rate index: 121.8
  • Estimated labor force: 169,600

Such a business strategy creates obvious exchange rate risks – the banks were buying króna assets (loans) with liabilities in euros and dollars. Fortunately the banks were able to use two devices that they did not themselves invent: lending at index-linked interest rates and lending in foreign currencies. The latter obviously transfers the entire exchange rate risk to the bank’s client. To understand the former, it is sufficient to note that the Icelandic consumer price index is approximately half-composed of imported products: hence, in this case, half the exchange rate risk is transferred to the client. It should also be mentioned that the króna remained strong throughout most of the study, thanks to the high nominal interest rates imposed by the central bank in an attempt to stem the inflation caused by the commercial banks’ lending.

Nevertheless, the commercial banks felt obliged, from 2006 onwards, to seek alternative funding sources, and so started taking deposits in their overseas markets. Again, they were helped in this by the high nominal interest rates in Iceland that they themselves were maintaining by their business strategy. The Icelandic banks could offer extremely competitive interest rates to depositors in the rest of Europe because they were using the money to lend in Iceland. At the end of 2007, the three commercial banks had deposits of ISK 3,465bn and borrowings of ISK 5,198bn: these figures are 268% and 402% (respectively) of Iceland’s 2007 gross domestic product.

As the interbank lending market dried up in 2008, the banks found it increasing difficult to roll over their borrowings. They continued to expand their overseas deposit-taking operations – the last such operation was set up by Landsbanki in Austria on September 4th, 2008 – but were increasingly dependent on the fickle confidence of their overseas clients. The króna as well seemed to lose the confidence of international investors, along with 35% of its value, between January and September 2008. Our final snapshot of the “vital statistics” is from just before the collapse of the Icelandic economy:
  • Bank lending to the domestic sector: ISK 4,827.4bn
  • Credit system total lending: ISK 6,731.4bn
  • Króna M3: ISK 1,230.3bn
  • Central Bank of Iceland policy rate: 15.5%
  • Króna exchange rate index: 151.8
  • Estimated labor force: 148,600

All three commercial banks collapsed within the space of less than a week in early October 2008. Their Icelandic operations were ring-fenced off in an attempt to preserve some semblance of a domestic banking system: the domestic assets (ie, loans) of the banks exceeded their domestic liabilities (ie, deposits) by at least ISK 3,714bn, or 287% of Iceland’s 2007 GDP. The new banks were forced to provision against the non-repayment of between half and two-thirds of the value of these loans. All the same, the Icelandic government has had to supply capital equivalent to 30% of GDP, while the new (state-owned) banks start life with liabilities to their predecessors’ (mostly foreign) creditors of 90% of GDP. Deposit insurance liabilities in the UK, the Netherlands and Germany are estimated at €3.8bn: given the current uncertain value of the Icelandic króna, it is impossible to express this figure as a proportion of GDP, but it is at least half Iceland’s 2007 output. Another €2bn is trapped in “glacier bonds” – private, króna-denominated debt sold to offshore investors attracted by the high nominal interest rates – waiting for currency controls to be relaxed.

It could be said that any Ig Nobel Prize should be shared more widely. Perhaps an Ig Nobel Special Mention could go to the anonymous managers at Glitnir who allegedly engineered an unauthorized loan of €47 million for their bank from the Norwegian government; or the anonymous manager at Landsbanki who allegedly transferred €695,000 into his personal account in order to “save deposits”: but these cases are currently before the courts where they belong. I could nominate Mr. Geir H. Haarde, Prime Minister of Iceland 2006–2009 and finance minister 1998–2005; Mr. Björgvin G. Sigurðsson, minister of “business affairs” (with responsibility for banking) from 2007 until January 2009 or his predecessor Mr. Jón Sigurðsson… but an Ig Nobel Prize is traditionally reserved for “achievements”, and so it seems inappropriate to honor these people for simple inactivity, no matter how essential that inactivity was to the pursuit of the studies in question.

I shall rest my case, believing that I have shown that the nominees have indeed made “achievements that cannot or should not be reproduced” in their field (even if the exact field were not their chosen one) and hoping that the Distinguished Members and the random passer-by will agree with me.

(data from the Central Bank of Iceland, the International Monetary Fund and the 2007 Annual Reports of Kaupþing banki h.f., Landsbanki h.f. and Glitnir banki h.f.)

IgNobel nominations (2)

(continued from yesterday's post)


Mr. Davíð Oddsson, former Chairman of the Board of Governors of the Central Bank of Iceland, former Prime Minister of Iceland, for his study of the effects of increasing money supply while keeping interest rates high.

The Central Bank of Iceland, like many central banks in Europe, operates its monetary policy by inflation targeting. The target rate for Icelandic inflation is 2.5%: since Davíð took over the helm of the CBI in October 2005, the target has only been met in 2 months out of 29 (it was met in 37 out of the previous 55 months). As is normal in such circumstances, and according to the Taylor rule, the central bank has steadily increased interest rates in an attempt to control inflation, up to 15.5% in September 2008.

However high interest rates tend to restrain economic activity, and so are unpopular with politicians such as Davíð. In order to support the Icelandic economy, the Central Bank of Iceland decided to increase the number of krónur in circulation. It did this by lending money to Icelandic banks on the basis of “newly-issued uncovered securities”, the financial equivalent of IOU notes. (see para. 19 of Iceland's Letter of Intent to the IMF)

In classical economic theory, the effects of an increasing money supply and of high interest rates should cancel each other out. However Davíð discovered that, if the money supply is increased sufficiently – the Icelandic króna M3 increased by 52.7% in the twelve months to September 2008, compared to a GDP growth of 5.0% – it will outweigh the effects of high interest rates. At such levels, the study shows, one finds the classical economic response to “printing money”: that is, inflation, currency devaluation and, eventually, systemic economic collapse.

The study has now been halted at the request of the International Monetary Fund, as there are already sufficient data to include in the new editions of undergraduate economics textbooks.

(data from Statistics Iceland, Central Bank of Iceland)

(to be continued)

Thursday 23 April 2009

Video from the Wall Street Journal

This video is 21 minutes long: I won't pretend to agree with all of it, but it's one of the better (and more balanced) free videos I've found.

IgNobel nominations (1)

To the Distinguished Members of the Ig Nobel Board of Governors, and the random passer-by who is traditionally invited to assist them in their deliberations.

Distinguished Members, random passer-by,

Each year since 1991, the Ig Nobel Prizes have honored research that cannot or should not be repeated. It is something of a tradition that one of the Prizes should be awarded for achievements in the field of economics.

In the past, the Distinguished Members and the random passer-by have chosen to honor the Vatican (2004, for outsourcing prayers to India), Karl Schwärzler and the nation of Liechtenstein (2003, for making it possible to rent the entire country for corporate conventions, weddings, bar mitzvahs, and other gatherings) and of course the team of economists from the University of New Mexico, USA, for discovering that professional lap dancers earn higher tips when they are ovulating.

They have also chosen to honor Enron and 27 other financial companies for adapting the mathematical concept of imaginary numbers for use in the business world (2002), Nick Leeson for using the calculus of derivatives to demonstrate that every financial institution has its limits (1995) and Juan Pablo Dávila for managing to lose 0.5% of Chile’s gross national product by typing “buy” instead of “sell” (1993). It is in the spirit of these latter awards that I wish to make two nominations for the 18th First Annual Ig Nobel Prizes, for achievements in the field of economics whose transcendence was not fully apparent at the date of last year’s awards ceremony on October 2nd.

(to be continued)

Central Bank translation service

Thanks to Mike the UK Nordic Analyst (whatever one of those is) over at IceNews for providing this translation of the main points from the speech of Central Bank Governor Svein Harald Øygard last Friday. It made me laugh out load, so I thought I'd share it with my readership (hi Mum!)

He said
“All efforts should be made to avoid further socialisation of private sector debt”

Which means
“If you think that the Central Bank and Government are going to help you Icelanders pay back, reschedule or even write off, your mortgages, indexed car loans or corporate debts … well you can forget it! We’ve got enough on our plate already with depositor guarantee schemes and ISK bonds due.”

He said
“The negotiation processes in the financial sector and the restructuring and recapitalisation of the banks must therefore be pursued according to plan.”

Which means
“Plan!! Plan? We’re just blundering along being told what to do. As for restructuring the banks it looks as if they will need to come to terms with their creditors. Who cares about the division between “new” and “old” banks? Our foreign bondholders certainly don’t. Let’s hope for the best!”

He said
“As part of this, the foreign exchange exposure and indexed loan exposure of the new banks must be addressed.”

Which means
“I have no idea how the banks are going to pay back their debts, especially those that need to be paid back in foreign currencies! But hell, it’s not my problem – it’s the banks!”

He said
“With declining domestic demand, there will be resources available to service the country’s accumulated debt.”

Which means
“All income from our productive output will be used to pay our foreigner creditors. So frankly we’re not going to have anything to spend on ourselves. Domestic demand? Don’t make me laugh! Bread and water if you’re lucky!”

He said
“The Central Bank also reviews selected measures that may allow the most impatient investors locked in by the capital controls to convert their holdings of ISK, in a way that does maintain the currency reserves of the Bank.”

Which means
“Impatient investors? Why are they impatient? Because their bonds have matured and they want their money back – NOW! If we did pay them it would wipe out our currency reserves. Does anyone have any ideas?”

He said
“Negotiations for bilateral loans, other negotiation processes, and the IMF review should be completed shortly.”

Which means
”The IMF et al are holding back the latest tranche. We need money. We’re descending into poverty. HELP!”

Wednesday 22 April 2009

Dreamland (1)

Draumalandið ("Dreamland" in English) opened in Reykjavík a couple of weeks ago. It's not a fashion store (who'd open one of them in Iceland these days?), it's a film based on the book of the same name by Andri Snær Magnason. The book is available in English, translated by Nicholas Jones and published by Citizen Press, ISBN 978-0955136320.

Both the book and the film tell the story of the Kárahnjúkavirkjun power plant in East Iceland, a 690 MW hydroelectric power station built to serve a new aluminium smelter in Reyðarfjörður… at a huge cost. You can find English comments about the film at the Iceland Weather Report and at Economic Disaster Area. Alda in particular claims it to be "quite possibly the most important Icelandic film ever made".

So what is all the fuss about this documentary (whose subtitled trailer you can find here)? Well the project was (and is) very controversial in Iceland. It has been hailed as the biggest single civil engineering project ever attempted in the country, and lambasted as a pointless destruction of the natural environment. It is far from clear that it will ever make a single króna in profit. But also it has been claimed that it is one of the causes of the kreppa. Aluminium smelting in Iceland is a topic which deserves its own post, so I shall concentrate on the third of these points for today.

The hydroelectric plant was built with immigrant labour and foreign money. It is good for Iceland that it was built with immigrant labour: it would have cost even more had the contractors been obliged to hire Icelanders at the then-going rates! The 2005 estimate of its cost was 90 billion krónur (roughly €1 billion, at the going exchange rates of the time).

Now readers of this blog might see a sign here. 90 billion krónur is a lot of money, but it is far less than many of the sums described here. The glacier bond problem is something like 500 billion krónur; the Icesave "problem" is even larger, roughly 800 billion krónur, but hopefully less serious in the short term as there seem to be agreements not to make too much of a fuss about it.

Let's take the example of Landsbanki. At 30 June 2008, it had:
  • 345 billion krónur in ISK deposits, but 1372 billion krónur in loans in Iceland;
  • 989 billion krónur in sterling deposits, but only 528 billion krónur in loans in Britain and Ireland.

There are many honest and honourable reasons to object to the expansion of aluminium smelting in Iceland, but the idea that it was responsible for the kreppa is not one of them. The kreppa was created by Iceland's commercial banks sucking money into Iceland, regardless of such schemes as Kárahnjúkavirkjun. White elephants are often born during economic bubbles, and they never help, but it goes too far to accuse this one of having caused the whole financial meltdown.

Tuesday 21 April 2009

How much is a króna worth?


A couple of days ago, I commented on Sjálfstæðisflokkurinn's crackpot idea to unilaterally adopt the euro as Iceland's currency. Nobody has pointed out the flaw in my argument, so I will come clean and admit it myself! Iceland can't adopt the euro on its own, at least not yet and not at the current exchange rate.

Today's Central Bank of Iceland selling rate is 168.09 krónur per euro, down 12% since 1 February. On the other hand, if you look at Yahoo! Finance, they quote a rate of 290.66 krónur per euro… The European Central Bank hasn't quoted a ISK exchange rate since 3 December, when it was 290 krónur to the euro. How much is a króna really worth?

Entire textbooks have been written about exchange rate theory: fortunately, we only need to consider a very simple definition here. You'll just have to trust me that we would reach the same results through more complicated theory, but we can just consider that a currency is worth what people are willing to pay for it. This leads to two important conclusions, neither of which you are likely to hear from the mouths of Icelandic politicians.

Firstly, in reality, the króna is worth less than 168 to the euro. It must be, because 168 to the euro is the rate it "trades" at within Iceland, where there are strict controls on selling krónur. If the currency controls didn't exist, more people would want to sell krónur – that's only logical, otherwise there'd be no need for the controls! If more people are selling krónur, it's exchange rate will go down. Hence the CBI exchange rate is artificially high.

Secondly, the króna must be worth more than 290 to the euro. To see why, we need to look at where this exchange rate comes from. Imagine you are a foreign investor who bought a million krónur's worth of Icelandic government bonds when times were good (you would have paid about €11,000 for them). As things stand at the moment, you can't get any of your money out of Iceland. because of the currency controls. You have two choices: either you can be patient and wait for the currency controls to be lifted, or you can sell the bonds onto someone who's more patient than you are. If you sell the bonds, you have to agree a price for them, which is equivalent to setting an exchange rate for the Icelandic króna. The 290 krónur to the euro rate means that people outside of Iceland are selling a million krónur's of glacier bonds for about €3500 (once you've factored out interest payments, etc). Now the people who are buying these glacier bonds don't know when they're going to be able to get their money out of Iceland, so they apply a risk premium: they want to make a profit from their patience, so they buy krónur at an artificially low exchange rate.

In other words, we don't know how much a króna is worth and we won't know until the glacier bond problem is sorted out. We can say that the króna is not worthless. Jokes like "What's the capital of Iceland?"—"About twenty euros and a couple of dried cod." are exactly that: just jokes. The offshore exchange rate, as quoted by the ECB, reached a high of 200 krónur to the euro last November: that's about as good a guess as you're going to get for the real exchange rate, but it's only a guess.

Last week, Finance Minister Steingrímur J. Sigfússon predicted that "it is possible that there will be news about the arrangements of the glacier bonds at the annual meeting of the Central Bank of Iceland" last Friday. I've heard more reassuring politicians… Governor Svein Harald Øygard did indeed speak of the problem: apparently "the Central Bank also reviews selected measures that may allow the most impatient investors locked in by the capital controls to convert their holdings of ISK, in a way that does maintain the currency reserves of the Bank."

Hints of these "selected measures" came out over the weekend. Apparently Norðurál is looking at financing the new aluminium smelter at Helguvík with "glacier bonds". In effect, they propose to exchange ISK-denominated securities for Norðurál bonds denominated in US dollars. An interesting proposal, but the devil is in the details. What will be the exchange rate proposed to holders of glacier bonds? Will it even be made public? Or will this just be another deal between friends of the type which has made Icelandic business infamous over the last few months? In any case, the Helguvík smelter will cost 80–90 billion krónur, less than a fifth of the total value of the glacier bonds: at best, the Norðurál solution will only be a partial one.

A better bet would be to set up currency auctions to allow holders of glacier bonds to liquidate their króna capital. If, at the moment, the Central Bank of Iceland can only afford to pay back, say, €500 million euros to glacier bond holders, it should organise an auction. Investors could offer their bonds to the Central Bank at a given exchange rate and, once the pot of euros is used up, the CBI stops buying. The sellers (ie, bond holders) determine the exchange rate at which they wish to bid, and those who bid the most krónur for each euro get their bonds bought off them. Auctions could be organised every few months until the problem is resolved. That way, the Central Bank gets the benefit of the current offshore speculation on the króna and overseas investors get to put a cash price on their impatience. Don't expect this idea to become reality though – it would require too many people to face up to difficult realities as to the true value of Iceland's currency.

Monday 20 April 2009

The £200 million question

Like a mosquito on a summer's night, one question keeps buzzing back into the collective consciousness just as we try to think of something else. Did the UK authorities offer to take Landsbanki under British jurisdiction in return for the Central Bank of Iceland granting one last liquidity loan (of GBP 200 million, all the same, hardly small change even in the City of London)? If so, the refusal of the CBI would weigh heavily on its responsibility for the meltdown of Iceland's banking system. Or is this just a delusion (for not to say an outright lie) of Björgólfur Thor Björgólfsson, one of the former owners of Landsbanki? After all, as I pointed out on Wikipedia back in October, the whole thing sounds more like "I know a few guys in London who'll solve all our problems, but they need 200 million GBP to do it…" rather than a serious business proposition worthy of backing with large quantities of public money. Both the British and Icelandic authorities have denied the existence of any agreement, although neither set of clowns enjoys much confidence in either country these days.

One thing everyone admits is that there were talks between British and Icelandic officials in Reykjavík over the weekend of 4–5 October 2008 concerning the position of Icelandic banks operating in the UK. These talks led to a formal letter from the Icelandic government to its British counterpart on Sunday 5 October, explaining Iceland's position regarding deposit insurance. Apart from formalities, the letter reads:
If needed the Icelandic Government will support the Depositors' and Investors' Guarantee Fund in raising the necessary funds, so that the Fund would be able to meet the minimum compensation limits in the event of a failure of Landsbanki and its UK branch.
There's no mention here of the UK Financial Services Compensation Scheme taking over responsibility for Icesave deposits: indeed the letter assumes that Iceland's Tryggingarsjóður would retain responsibility for insuring the first tranche of deposits (the first €20,887 of each account, in practice more than half the total amount insured).

On the other hand, both governments were aware of the need for liquidity in Landsbanki's London branch, responsible for the Icesave accounts. It is mentioned in the now-famous telephone conversation between British Chancellor of the Exchequer Alistair Darling and Icelandic Minister of Finance Árni M. Mathiessen on Tuesday 7 October, after Landsbanki had been intervened in Iceland but before its UK assets were frozen:
AD: What I… I take it therefore that the promise Landsbanki gave to us that it was going to get £200 million of liquidity back into it has gone as well.


ÁMM: Yes, they didn’t get that liquidity.

This exchange is from near the end of the conversation, but it is notable that AD refers to "the promise Landsbanki gave to us", not to any agreement between the two governments (despite the talks of the previous weekend). The promise to which AD presumably refers was leaked to the Icelandic press last month, just after Björgólfur Thor had repeated his claims on the influential Kastljós television programme (see Alda's blog about the emission). It takes the form of an email from Landsbanki to the UK Financial Services Authority, sent in the early hours of the morning of Monday 6 October, and reads:
I have been informed by my CEOs that a transfer of the amount of GBP 200 million in favour of Landsbanki London branch is required tomorrow morning to meet potential further Icesave outflows and the amount of GBP 53 million in favour of Heritable bank by end of tomorrow. We have been working on arrangements, including a repo transaction with the Central Bank and have submitted to them our pool of assets for those purposes. We understand that the Central Bank will deal with this tomorrow. As soon as the repo transaction has been completed we will transfer the required funds as discussed. I trust this meets the requirements discussed earlier tonight with you and Mr. Hector Sants.
Before I enter into the textual analysis of the email, let's take another look at the sums involved. Two hundred million pounds is a lot of money in anyone's terms – Icelanders might like to think of it as 40 billion krónur (at the exchange rates of the time), while Brits should consider it as £600 from each and every Icelander. Yet it is small change compared to the (then potential) liabilities of Landsbanki failing. Landsbanki had £6.26 billion in sterling deposits from customers at the end of June 2008, according to its interim financial statement, of which most was presumably from the United Kingdom. Not all of those deposits were covered by EEA deposit insurance schemes: initial estimates spoke of £4 billion in insured deposits in the UK, although more recent estimates I've seen put the figure slightly lower.

Björgólfur Thor is alleging that the UK authorities were willing to take on the deposit insurance liabilities of Landsbanki's London branch for a "price" of 5% of the total risk. That's a lot more than the 1% that Tryggingarsjóður (the Icelandic deposit insurance scheme) requires, but it would be a remarkably generous offer for a bank in the middle of a run on its deposits and which could not obtain the necessary liquidity from the private markets or its own central bank. A bank, in short, which was already in the middle of failing (or are we supposed to believe that high-level weekend meetings between British and Icelandic officials are normal, run-of-the-mill events?)

The email leaked to the Icelandic media (in this case, visir.is) makes no mention of Landsbanki's London branch becoming a full member of the UK Financial Services Compensation Scheme. In fact, it was quite specific: the £200 million was "to meet potential further Icesave outflows". That the London branch needed liquidity is not really in question: even once the Icesave liabilities had been set aside, it still needed a loan of £100 million from the Bank of England (formally guaranteed by HM Treasury) to restart its UK operations.

The leaked email gives us another clue to the nature of the discussions in referring to a separate £53 million needed by Heritable Bank. Had Landsbanki wanted to place its UK Icesave liabilities under British jurisdiction, it could have transferred them (with sufficient assets to cover them) to its wholly owned Scottish subsidiary, Heritable Bank. Such a move would have required the approval of the UK authorities, but would have been much simpler than setting up a new subsidiary. However, and unlike Kaupthing, Landsbanki chose to keep its UK retail deposits within a structure governed by Icelandic law. Why we can only imagine, but the decision has turned out very expensive for Icelandic taxpayers. I could mention the relative rates of capital gains tax – 18% in the UK, 10% in Iceland – but I doubt this is the whole reason.

To conclude, Björgólfur Thor's allegations have to be dismissed on the evidence available, without wanting to suggest that he doesn't believe them himself. History is full of deluded people who think they can dig themselves out of financial holes with one last try at the same game, from King Midas onwards.

Nevertheless, had Landsbanki wanted its Icesave deposits guaranteed by the UK compensation scheme, there were many ways they could have done it, and much earlier than the weekend that those very deposits were dragging the whole bank under. But Landsbanki wanted to stay with the Tryggingarsjóður, and hit out strongly this time last year at suggestions that other EEA schemes might not be as rapid at repaying depositors than the UK FSCS: this was a "falsehood", and the mere suggestion was a violation of EEA law, in Landsbanki's eyes. With the benefit of hindsight, the Icelandic scheme proved not only slow but incapable of paying out, and the attitude of Landsbanki has proved remarkably damaging to Iceland.

***UPDATE (Wednesday 22 April)***
I should have credited freelance journalist Friðrik Þór Guðmundsson (blog in Icelandic here), who went to the trouble of demanding detailed responses from the UK authorities (HM Treasury and the Financial Services Authority) under the UK Freedom of Information Act 2000. He has been kind enough to forward one of the responses to me, which basically confirms that the UK FSA regarded the £200 million as a regulatory issue (the FSA is not obliged to go any further under the FoIA). In other words, this money was connected with Landsbanki's current status in the UK, not with any possible change of status.

Sunday 19 April 2009

More euro madness


So now Sjálfstæðisflokkurinn (the Independence Party to English speakers) have decided they want Iceland to adopt the euro after all… Not to join the European Union, at least not when they answered the questionnaire posed by the Reykjavík Grapevine (maybe they've changed their minds on that one as well…), but simply to decree that the euro will henceforth be the currency of Iceland.

The idea isn't a new one – indeed it dates from long before the current financial crisis. The response from the European Commission and the European Central Bank has been a consistent "no", most recently from Commissioner for Enlargement Olli Rehn in January 2009 and from ECB board member Jürgen Stark in February 2008. Before the kreppa, it was usually the bankers who were keen to adopt the euro, which makes it all the stranger that Sjálfstæðisflokkurinn should choose to put aside its traditional reticence just now, with less than a week to go until the parliamentary elections. Perhaps they think it will somehow make them sound "pro-European", or perhaps they just think it's more sensible than talking about adopting the Norwegian krona. It is more sensible than talking about adopting the Norwegian krona, but not by much.

How would this currency changeover come about? Well let's imagine that a Sjálfstæðisflokkurinn government were to decide to change the króna, not for the euro but for gold: one króna being worth a couple of thousandths of a gram of gold. It's not a silly as it sounds: it is the equivalent of the gold standard used by most major economies from 1946 to 1971. First the government buys enough gold to compensate the holders of all the króna banknotes in circulation, some 22 billion krónur. Then it simply insists on selling all Icelandic exports for gold – that would make the fish market in my native Grimsby a much more glamorous place! – and offers to pay for imports in gold. Not everyone would accept gold in return for sending goods to Iceland but, so long as imports were roughly equivalent to exports, the Central Bank of Iceland could sell some of the gold to buy dollars or euros or Thai bahts or whatever to pay for imports.

At first sight, it looks feasible to change the króna for another currency, based on that analysis. After all, the international reserves of the Central Bank of Iceland amount to some 383 billion krónur, more than enough to buy back all the krónur banknotes and still have plenty left over. But it ignores the fact that the "money" in circulation is much more than physical notes and coins, and, in the case of Iceland, not all of it is held by residents who can easily be subjected to exchange controls.

Accurate figures are hard to come by, but most estimates I've seen of the "glacier bond" problem put it at around 500 billion krónur. These are foreign investors who have lent money (in krónur) to the Icelandic government, the Íbúðalánasjóður (Housing Finance Fund) or the Central Bank of Iceland. They are being paid back in krónur when the bonds or certificates of deposits mature but, since last November, they cannot convert those krónur into foreign currencies, only reinvest the money within Iceland. If Iceland were to adopt the euro, these bonds and certificates of deposit would have to be repaid in euros, and the CBI simply doesn't have that much foreign currency at the moment.

No country has unilaterally adopted the euro in the way that Sjálfstæðisflokkurinn proposes. Several countries outside the EU use the euro as their currency, but this was because they didn't have their own currency when the euro was introduced. Take Andorra for an example: before 1999, it used both the French franc and the Spanish peseta. When those currencies were abolished in 1999, all Andorran assets and liabilities in France and in Spain were automatically converted into euros; when euro notes and coins were introduced in 2002, the French and Spanish notes and coins circulating in Andorra were exchanged for euros at the respective central banks. On the other hand, Andorran banks cannot turn to the European Central Bank if they get into difficulties, as Andorra is not a member of the EU or the eurozone.

Sjálfstæðisflokkurinn's idea is not just unworkable, it is sheer intellectual dishonesty. This party – whose membership is around 25% of the Icelandic electorate and which has been the most voted party for most of the last century – seems to believe that the nation belongs to them and that they have a god-given right to govern. I can only hope that ordinary Icelanders will take the opprotunity to send it to the outer reaches of the political wilderness next Saturday.

***UPDATE*** (Tuesday 21 April)
  • NewsFrettir reports the comments of Professor Kristjan Vigfusson, saying that Sjálfstæðisflokkurinn's proposal is unrealistic.
  • Economic Disaster Area reports that Sjálfstæðisflokkurinn is plastering Reykjavík with posters announcing their mad idea.

***UPDATE*** (Friday 24 April)
  • J. Halldór in Morgunblaðið seems more optimistic about Sjálfstæðisflokkurinn with this cartoon. Only time will tell.

Saturday 18 April 2009

Where did all the money go?


More than six months on from the spectacular collapse of the less-important bits of the Icelandic economy, most mere mortals are still at a loss to answer the simple question of "where did all the money go?"

To remind readers who don't share my love of the absurd, three Icelandic banks had borrowed the equivalent of more than seven times Iceland's GDP, only to find that they couldn't pay the money back. The Central Bank of Iceland had been running the printing presses on overtime, with the number of krónur in circulation increasing by 56.5 per cent, while the economy was growing at a healthy but somewhat more conservative 5 per cent. The result was financial meltdown in this ancient nation of 340,000 souls (who themselves had an average personal debt of more than twice their annual disposable income). Apparently, it was all the fault of the British, but more of that later! Journalist Mica Allan described it as "Free Money" and "chasing rainbows", in probably the most sensible description of events I've yet to read.

All the same, 50 billion euros is an awful lot of money to lose, even for a bank. Madoff seems to have managed it, but it took him more than thirty years and even now there are plenty of people who don't believe that the money is really lost. The three Icelandic banks and their political accomplices managed to sink the Icelandic economy in less than a decade following their deregulation.

The image on this post is Smáralind, the biggest shopping centre in Iceland, better known to followers of Alda's excellent blog as "Penis Mall", for obvious reasons. Now Reykjavík has another, older shopping centre called Kringlan, as well as city centre shops in what is, after all, the capital of the country and home to more than half the national population. "Penis Mall" opened in 2001 and claims more than eighty stores, along with a cinema and restaurants. Why build it? Why spend all the money on expensive imported construction materials and even more expensive local architects to have a third large shopping centre in the space of a few kilometres? Who was going to shop there, and hence allow the stores to pay the rent which pays for the construction?

I've been trying to find out how much "Penis Mall" cost to build. The 2007 annual accounts are here, if any kind soul can make sense of them for me. Did it cost 6 billion krónur, or 15 billion krónur, or some other figure? It certainly cost a lot of money, money which was lent by Iceland's commercial banks, which they themselves had borrowed from abroad. The rent from the shops in Penis Mall goes to pay off this debt, so long as people actually shop there. To ensure that people shopped there, the same Icelandic banks lent money to the shoppers in the form of personal loans: again, this money had been borrowed by the banks from abroad. So the money which was being used to pay off the constructions debts of Penis Mall was itself money that had been lent by the very same commercial banks. All of this was fine while there were still people willing to lend money to Icelandic banks, greedy enough to take advantage of the 15 per cent interest rates without asking themselves why rates had to be so high. But in fact, it was just one big pyramid scheme, with the money of new depositors being used to pay off the older debts. No new wealth was being generated, except by the Polish builders who sweated to construct the damn thing: all the rest was financial scam, with Iceland playing the role of the Emperor in Kejserens nye Klæder, the one who never actually got his wonderful new clothes.