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.

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.

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.