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)

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)