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Markets call time on Iceland

Robert Peston | 12:35 UK time, Saturday, 4 October 2008

The best way of seeing Iceland is as a country that turned itself into a giant hedge fund.

For years it paid higher interest rates than in many parts of the world, so its financial institutions borrowed a ton of hot money from abroad, which they then re-cycled into investments all over northern Europe, including the UK.

The Icelandic banking boom was an economic phenomenon created by what's known as the carry trade - whereby colossal sums of money were borrowed in places like Japan, where interest rates were effectively zero, for lending to institutions in high-interest-paying economies, such as Iceland.

This, for years, seemed to be a no-lose arbitrage on differential interest rates in a globalised economy.

But it was just another manifestation of the pumping up of the credit bubble, which is now deflating and hurting us all.

Here are the lethal statistics about Iceland: the value of its economic output, its GDP, is about $20bn; but its big banks have borrowed some $120bn in foreign currencies.

Now that's what I call leverage - and remember that's just the overseas liabilities of its commercial banks.

If this were a business, and if it had no other borrowings (which of course Iceland does have), this would be a debt-to-ebitda ratio of 6.

Or to put it another way, Iceland simply doesn't have the domestic earnings to service this kind of debt.

Which is why if the Icelandic government were to formally underwrite all these liabilities - which it might just have to do, given that other banks and financial institutions no longer want to touch Iceland with the longest barge-pole ever constructed - well its national-debt-to-GDP ratio would be at a level that make the UK in the 1970s look like a model of prudence.

And if Icelandic taxpayers actually had to service all that debt, well there wouldn't be a lot left over for even the basics of life.

It's a proper old mess.

Of course I'm being a tad unfair, in that the banks that have foolishly borrowed all this wonga have invested in tanker-loads of offshore assets.

Much of the British high street, a load of property and the Hammers have been financed or are owned by Icelandic banks and financiers.

And those that have borrowed from Icelandic banks have frequently borrowed too much. Which means they will have to start looking for alternative sources of working capital and debt at a time when over-leveraged outfits aren't flavour of the month with our banks. Ouch.

So Iceland's problems have a direct knock-on for the British economy - and goodness alone knows how exposed our banks are to Icelandic ones through the interbank market or derivatives market. One British bank with a reasonable name and a long history, Singer & Friedlander, is owned by the Icelandic bank, Kaupthing.

That'll be making the City watchdog, the Financial Services Authority, a tad uncomfortable, because Kaupthing - which is no minnow, with gross assets of $73bn - has the worst case of financial BO I've encountered in some time.

On Friday, had anyone wished to take out insurance in the credit default swaps market to guarantee repayment of debt issued by Kaupthing, he or she would have had to pay a premium of £625,000 to guarantee the return of £1m.

Which is simply to say that Kaupthing couldn't issue new debt, even if it wanted to.

And even the Icelandic government is classed by the markets as a lousy credit risk. On Friday, the cost of insuring $10m of Icelandic debt was $1.5m up front and $500,000 a year - a cripplingly large premium.

So what'll happen to poor indebted Iceland?

Well, although its central bank has fairly substantial reserves - enough according to the central bank governor to cover imports for eight to nine months - it's difficult to see how it can re-float without international help.

Comments

  • Comment number 1.

    Don't be shocked if you sudenly find that the Icelandic government do a "South America" and sell of cheaply to China some of it's emerging mineral wealths to guarantee the debt. Rather ironic realy that the most pollutting country in the world should benefit from the damage that does to the Iceland eco system.

  • Comment number 2.

    But this is not sovereign debt so if the Icelandic banks go into liquidation, their creditors lose (almost) everything, another bank would scavenge the remaining assets and they can start again. The Government of Iceland would have to certifiable to guarantee these liabilities.

  • Comment number 3.

    Islands are sinking as the sea level rises. It's a natural process.

  • Comment number 4.

    There must be a sense of sad irony for the 320,000 inhabitants of Iceland. The facts are that in the 2007 UN Human Development Index they ranked in 1st place, whilst taking 4th place (behind Denmark, Sweden and Austria) in a University of Leicester international study looking at subjective well-being (happiness) published in 2007. One wonders in light of the events reported by Robert, how Icelanders would report their feelings if they were to be asked to participate in a similar study today.

  • Comment number 5.

    #2 - the alternative ? allow every depositor in an Icelandic bank to be wiped out and all the loans that can be made on demand called ?

    Damned if they do damned if they dont - just like Ireland, Iceland have no choice but tp stand behind the banks/economy.

    The problem is either way we are facing a potential sovereign default in Europe - who would be next etc.

    An international bailout is a certainty. These are frightening times.

  • Comment number 6.

    The EU should annexe Iceland to make use of it's free geothermal energy to make hydrogen for fuel cell vehicles from seawater. Pretty good hedge against oil prices long term and green too.

  • Comment number 7.

    err...I don't think the Uk is that different. We have no idea how badly exposed our banks our because they won't tell us. HSBC could have easily $50 billion more of exposure.

    Could we and the US follow Iceland?

    the markets think so....

  • Comment number 8.

    Would Europe really allow a close sovereign nation to collapse? Even a non-EU one? Likely a deal is done to rescue the economy and Icelandic banks, as it's relatively cheap for the EU or Scandinavian friends to help. Perhaps Iceland will adopt a Scandinavian currency (at a level which burns currency short-sellers) or kaupthing bank is force-sold to a bigger bank. The Bank also has huge customer deposits all round Europe which would need covering if it defaulted, so it's just too messy, Scandinavians and the UK government have to rescue it to avoid a public outrage. Perhaps a deal is announced after the Paris meeting today...

  • Comment number 9.

    Time gentlemen please...time.

    For the last 2-3 years the market has been calling time on Iceland. The fact that Icelandic authorities froze or at least were ineffective in covering the looming risk to that nation is a bit more than a disgrace...it's a disaster.

    I guess they didn't know what to do. They had no exerience to draw on. easy to know when something is wrong, a lot hjarder to figure out a solution. (Good luck to Ireland and Greece in this respect....they're trying!).

    Expect national level defaults (whether actual nations or their main commercial banks) in the next few weeks as contracts are not renewed, positions are called and not rolled over.

    The real bite of this crisis will be on the main street. Today it is in the financial district and leaking into the corporate treasuries...tomorrow it will hit hard the individual mom and pop operations.

    Iceland is perhaps the worst example - but other nations will be hit. Look out for the smaller ones in Europe - cracks will appear quicker in the smaller sophisticated nations than the bigger economies. However, all sizes of economies will be under great stress in the next month or so.

    Worse before better.

  • Comment number 10.

    Iceland's days outside the European Union are numbered. So long ISK, but thanks for all the fish!

  • Comment number 11.

    The way things are going no one is safe. There will not be any money to pay depositors, nothing left, as write downs mount.

    Probably high inflation for few years is the only hope as all the bobbles will disappear with that.

  • Comment number 12.

    Mr Peston, Perhaps you care to comment and explain further the 'trials and tribulations' of the Irish move into this area.

    Also what would happen if the 'eurozone' banks were to 'guarantee' large deposits and a lot of 'hot sterling' would zip across the channel ?

    One suspects that the 'carry trade' might not work because the 'exchange rate' would then eventually alter to compensate - but at the moment, of course, the Bank Of England shows no sign of slashing interest rates to avoid a recession.

  • Comment number 13.

    Robert Peston: The best way of seeing Iceland is as a country that turned itself into a giant hedge fund.

    What is the best way of seeing the UK, Robert? A hedge fund? A bank? An insurance company? An asset management firm? All of those things? We too have high leverage and are putting banks onto the public balance sheet.

    And a disproportionate share of our income comes from financial operations, not fish and aluminium. So our earnings are derived from the very things going wrong. What is the future of a business with exposure like that?

  • Comment number 14.

    I think Iceland is more like a sovreign private equity fund given the nature of its investments, rather than a true hedge fund. Mere pedantry, perhaps?

    Anyway, Iceland will have to join the EU (it's already part of the EEA so this isn't a major issue), and adopt the Euro from day 1 in order to gain currency stability. There's only 320,000 people live there, so this won't impact the EU in any material way.

    The correction will be very painful for Icelanders. Although interest rates will come down if they adopt the Euro, on the flip side there will have to be big tax hikes and public expenditure cuts to cover the depositor bailout.

  • Comment number 15.

    Unbelievable ... but, hell, it's true. What an ocean going mess. For the past 12 - 18 months I, and others like me who have been watching this storm brew and unfold, have been of the opinion that this situation is hugely (like, hugely) worse than it looks to the ordinary guy on the street. I fear that many (most?) people have no inclination to dissect this crisis beyond the prima facie news reports. Sure, the British people are starting to worry and change their behaviours, but do we really know the most likely outcome of all this?

    I wish the BBC (Robert Peston?) would come clean and provide a thoroughgoing analysis of where this is heading, but using a comprehensive approach. In other words, rather than reacting to each news story as it emerges, why not sweep the whole subject and tell us just how bad this is. Moreover, tell us the most likely economic and social scenario over, say, the next 3 - 5 years as a result of the global financial system (as we currently experience it) collapsing ... because it does seem to me to be, er, collapsing!

    There's no chance of a politician telling us the truth, that's for sure: they're all far too busy looking after their own skins (as usual).

  • Comment number 16.

    The move to Euro would be an interesting one. That of course would tie Iceland to a macro economic plicy which might not be in line with their needs....but it would allow them to operate.

    Whereas a run on their currency would force Europe as well as Iceland to commit to supporting ISK at a time when reserves are needed to keep markets liquid.

    This risk could also tip economies such as Sweden and Denmark. I not saying it will, but there could be pressure if a few of their banks collapsed. The prospect of raising SEK or DKK interest rates (much less so the latter which is de facto tied to EUR already), would be damaging to their economies. The prospect could be to devalue....not a good idea. So they would have to rely on EMU support and burn their own reserves. What price now stying out of the EURO project?

  • Comment number 17.

    #12

    Re the Irish move, by which I assume you mean guaranteeing all deposits etc). You're right to see Ireland as being in a similar mess to Iceland. The banks here (in Ireland) are all very exposed to a similar toxic combination of excessive domestic mortgage lending, excessive lending to support domestic buy-to-let (actually, in some cases buy-not-to-let: people just sat on property waiting for a price rise before selling on), lending to support overseas speculative property investment (eg Bulgarian apartments that either weren't built or did not have permission to be built) and, finally, lending to domestic property developers to build all the other stuff that the banks then lent on.

    Things came to a head last Monday, when the best performing Irish bank stock that day saw an 18% share price fall. The worst was over 40%. I work in the finance sector, and was confident I'd wake up on Tuesday to find the entire Irish banking sector nationalised overnight. I posted a blog response that evening along those lines, so it's not just hindsight. Effectively, that's what the Irish government did via the blanket guarantee.

    The alternative was that all interbank funding to Irish banks would have dried up in days. The banks were called to see the Finance Minister at 10pm on Monday. Shotgun marriages between them were discussed but rejected. Hence the guarantee. You can assume that all the banks will be sold off to foreign ones well before the end of the guarantee period (2 years). The guarantee is simply a way of buying time to allow a more orderly consolidation of the industry.

    The problem for Ireland comes if other countries now adopt the same guarantee policy. Just as some money may well have switched into Irish banks on the back of the guarantee, it can quite easily switch out again if the UK/French/German etc governments provide equivalent guarantees. In that case, Ireland will again face the fact that its banks are in the weakest position in the EU, and will quickly lose external interbank funding (which was the reason the guarantee was required in the first place).

  • Comment number 18.

    #9 and #16: Smaller European countries face challenging times, that much is now certain. Those that relied on financing for a shortcut to economic miracles - Ireland is already feeling the squeeze, Spain, but particularly new EU entrants such as the Baltic states - they will find it difficult to stand alone. Their reserves are tiny and currency market intervention is a labour of Sisyphus if ever there was one. And we have already seen how it took three countries to prop up Fortis, proof that banks have outgrown their host countries.

    How that was allowed to happen will be an interesting debate one day. The company greater than the nation state represents regulatory failure by definition.

    Since UK plc (or at least its banks) was an important participant in financing such things, I expect by the time our turn comes, we will have had to dig deep into our pockets a few times.

  • Comment number 19.

    Now I know why I have never wanted to bank with banks with the sort of name Kaup Thing has. Or the Abyss Thing Bank.

  • Comment number 20.

    I'm a little at unease about Peston's reasoning here.

    In particular, he seems to be implying Iceland's central bank has been keeping interest rates high to attract capital. In fact, the reason interest rates have been high is that Iceland has a high rate of inflation. The real interest rates achieved in Iceland have not been particularly high.

    If a knock on effect has been for people to engage in carry trades by borrowing in countries with low interest rates and invest in those with high interest rates, that's hardly the fault of the Icelandic government or central bank.

  • Comment number 21.

    the most acute part of iceland's problem is the currency issue. this is the same thing that sunk e.g. brazil in 1997 and argentina in 2001.

    if a country borrows a lot in foreign currency, its debt ratios may look perfectly healthy so long as the currency remains strong. but the moment there is a loss of confidence, this leads to a catastrophic fall in the currency, in turn leading to massive worsening of of the debt ratio. remember, iceland's gdp is isk-denominated, whereas most of its debt is not.

    the isk has devalued 50% to produce a (private) debt/gdp ratio of 600%. but before the devaluation, that ratio would have been closer to 300% (i.e. in line with the 350% debt/gdp ratio in the usa for example).

    ireland's case is not comparable because it is inside the euro and its banks borrow mainly in euros. similarly, uk banks borrow mainly in gbp and us banks in usd. so devaluations of their respective currencies would not lead to a significant worsening of debt ratios.

    about 4 years ago i was working at an investment bank where one of the traders was making an absolute killing in iceland. the currency was strong then, it was aaa/aa rated (god knows why - probably the ratings agencies just gave the ratings then forgot the country was there). investors, especially less sophisticated german funds, absolutely loved icelandic government bonds because the yield on them was so high compared to their rating. of course the inflow of foreign investors pushed the currency up even more - it doesn't take much inflow to push up such a small and illiquid currency. so it was a classic bubble. i believe the same trader also helped securitise a large part of the icelandic mortgage market as well - somewhat ironic now.

    iceland will undoubtedly get bailed out by norway if need be. norway has masses of oil wealth and feels a strong kindred spirit towards iceland. interestingly i believe the norwegian public are also coming round to eu membership - maybe they can join at the same time?

  • Comment number 22.

    #1 stuartgeorgethopmson said

    "Don't be shocked if you sudenly find that the Icelandic government do a "South America" and sell of cheaply to China some of it's emerging mineral wealths to guarantee the debt. "

    I wouldn't be surprised at all. China is buying mineral rights all over the place. Even Zimbabwe, supporting Robert Mugabe with arms in return.

    China see economics as them against the rest of the world. They are right. We should see it the same way (although protectionism should be limited).

    Can we buy Icelandic resources? A few years ago there was talk of Iceland providing 10% of our electricity from waterfalls. I don't know what happened to that (does anyone) but we need it now. Can't we do a deal? Now, not in two years time.

    Yes I know we are skint. But can't the masters of the universe in the City dream up some funny money in a way that noone understands and get us some resources? Isn't that what they are meant to be good at? We need the resources, Iceland needs the money and if we don't do it China probably will.

    Where's a Sovereign Wealth Fund when you need one? (Oh forgot, Prudence didn't set one up, he spent the money on Civil Servants paper pushing instead).

    Now he's at Business and Enterprise isn't this Mandy's responsibility?

  • Comment number 23.

    here is an interesting observation:

    banks wanted to extend more and more credit in order to grow more quickly. however, the amount of debt they could take on themselves directly was limited because they can only support so much debt with their limited capital base. so instead they relied on spvs, which brought borrows and investors directly together without creating any formal obligation on the banks. however, when the crisis hit, these spvs ran into serious liquidity problems. although the banks could technically have let the spvs go bust and the investors in those spvs take the loss, in reality the banks felt obliged to bail out the spvs. a failure of the spvs would have been catastrophic for the banks because it would have destroyed trust and confidence in the banks that set them up. in any case, the banks did not imagine that the financial crisis would grow so big. so what the banks did was to buy up the spvs and take on the spvs' dodgy assets directly. the banks funded these bailouts by borrowing a lot of money from the markets. but as the crisis got worse, it was this additional borrowing by the banks that most laid them open to the credit crisis themselves. the problems at the spvs proved more than the banks could deal with, and soon the markets lost confidence in the banks themselves. the result was that the banks found they were no longer able to refinance the excessive debt they had taken on, and pretty soon some of the banks were going insolvent as well.

    okay, now take the entire paragraph above, but replace the following words:

    banks => government
    spvs => banks
    capital base => tax base

    will history repeat itself?

  • Comment number 24.

    This post makes me very glad I didn't take up one of the tempting high-street interest rates Icelandic banks were offering recently.

    If an Icelandic bank fails, you cannot go to the FSA compensation scheme! You have to go to the Icelandic one first, and on the basis of what Robert was written, you could be whistling for your cash. Whether you would then be covered by the FSCS wasn't clear to me when I looked into it, but I didn't fancy taking a chance.

  • Comment number 25.

    Surely the only way out if for Iceland to let the banks fail?

    This will transfer the losses to the foreign banks etc that invested in the banks. And after that Iceland can ask Norway for help in rebuilding a very much smaller banking system to finance their domestic and international needs.

    By the way, many other small countries are also regarded as off shore banking centres that have drawn huge amounts of funding from other countries. Are any of them equally vulnerable or are they much safer than Iceland because they use the US dollar, Euro or sterling as their domestic currency?

  • Comment number 26.

    Very interesting blog from Paul Mason on the announcement from the Prime Minister on the creation of a National Economic Council.

    It looks like we may see a Labour government behaving more in the mould of Harold Wilson than Tony Blair.

    Essentially an end to 'tweaking' by government of an economy which is believed to be fundamentally able to look after itself - instead wholesale management of the economy by government.

    We are living in interesting times!

  • Comment number 27.

    Perhaps Ielanders could craft a few longboats, sail west, and colonize Greenland and Newfoundland. According to the global warming gurus, those islands should be a good future investment in beach front property.

    The interdependency of the world economy means that one governmnet, such as that of Iceland, the Cayman Islands, etc., can act irresponsibly for its advantage but the potential negative fallout is spread around the globe. It's up to prudent western governmnets not to accept such practices in future but to ostracize such banking vultures.

  • Comment number 28.

    #18 - More nationalistic jingoism ?? FYI HSBC is actually a Burmudan bank with a large chunk of Far Eastern ownership !! Citigroup (reportedly the largest banking group in the world) is partly owned by Dubai and partly by Singapore. Standard Chartered is a South African bank masquerading as a British one !! And Banco Abbey....

    For those who stridently call for the lowering of the BoE interest rate, this will instantly drive what little liquidity available here straight into the arms of those offering higher interest rate and, thereby, dooming the British banks faster that ever !!

    #4 This is the starkest example of living beyond their means. The Icelanders borrowed to finance their standard of living and lived high off the hog for a few years. Now is the payback time !!

    #6 Your idea will result in an instant devaluation of *ALL* properties in all the ports designated as the landing points for the hydrogen. Since gaseous hydrogen leaks even from the tightest containers, one spark and *BOOM* !! Truly a hydrogen bomb, if ever there was one !! Liquid hydrogen cost more to transport than its calorific content can sell for !!

    The only viable means of using Icelandic energy is to turn it into "canned energy"; using it in energy-intensive processes. One well known and already exploited means is the refining of Aluminium from its ore !! Since energy costs are rising worldwide, the Icelanders may capitalise on this means !! And there's still a great deal of Icelandic cod in our supermarkets !!

    Anyway, since the Icelanders are indebted to the Japanese and the Japanese, themselves, are feeling the pinch, they may sell on the debts to stronger, more liquid third party Asian economies. Unfortunately, this time, the Chinese, who have the biggest pile of cash, may not be too happy to help out ever since Bjork stood up in Beijing and demanded that Tibet should be independent !! However, some Chinese billionaire might be interested in buying out Hammers from the Icelanders !!

  • Comment number 29.

    #22

    We wouldn't need Sovereign Wealth Funds had the 'City' not been spending so much time dreaming up all those schemes to generate 'funny money'...

    Blame were blame is due, please!

  • Comment number 30.

    Norway will only help out the Icelandic banks *IF* Iceland becomes part of Norway !! This has been their dream for more than a millennium !!

    BTW, a little known fact. Iceland is the Northernmost banana growing country in the world !! They do it in greenhouses warmed by their geothermal hot springs !! Visit Iceland and have a locally produced banana split !! Taste the same as any other but it's the bragging rights that count !!

  • Comment number 31.

    #23

    Ben,

    I think what stops it repeating itself is that governments can always increase their funding base via printing more money. It might be inflationary, but it solves the immediate problem of insufficient bank funding. It's pretty much what the UK did in its (smaller) banking crisis in 1973-74. I say smaller, but to put in context, NatWest bank was thought to be on the verge of collapse at the time, so it wasn't that small.

    The impact of the above was that the UK had worse inflation than most post-the first oil crisis. It remained manageable, though.

    The way things are heading, we may well find ourselves in a deflationary spiral if monetary authorities aren't careful. I suspect they've seen this risk in the last week or two. Otherwise Trichet would not have gone from inflation hawk to promising us rate cuts in the space of under a week! Anyway, if this is now seen as a risk, a bit of inflationary monetary expansion might be more widely acceptable than would normally be the case. I see Gordon B is putting the case for a €12 billion European fund to assist small businesses that can't get bank credit. Maybe this is the way they're going to put more credit into the economy, and not wait for the banks to sort themselves out?

    Would be interested on your thoughts.

  • Comment number 32.

    I can't see anybody galloping to help Iceland in view of the problems rife everywhere. The rules of the game are you don't do anything unless it threatens your sovereign state, the same as the rules that apply, or should apply in war. Even if there is interactivity between the economies of countries it becomes a damage balance. There are already signs of disunity in the EU on common intervention throughout the EU. If countries have different vulnerbilities in a threat situation it is difficult to get unity in action. Another lame duck joining the EU helps Iceland but there is hostility amongst the public in the founding countries to expansion. A White Knight for Iceland has got to see an inescapable strategic reason to help, or feel severely threatened.

  • Comment number 33.

    Maybe we are all awaiting the arrival of E.T. to sort out this sorry mess, (perhaps that's why the Vatican has a deep space telescope on Mount Graham - Mount Graham International Observatory). E.T. may be our last best hope because, as it stands, while our banking brethern have been building an enormous and unsustainable bubble with which to 'blow us all up, (in the financial sense), it now seems our governments are busy digging an enourmously deep hole to bury us all in, (figuratively speaking)!

  • Comment number 34.

    #28, my use of written English is no indicator of identity. Is there generic jingoism? I call it as I see it, and smaller countries, especially those outside the Eurozone who tried to leapfrog legacy issues with financial alchemy will have a harder time of it. And openly or covertly, we will probably help them whether or not it makes long term sense, because we have dominos of our own further down the chain.

    It also matters little who owns what bank's equity or debt. I am aware who does, I have been keeping up with SWF injections, but actions taken here and in the US have undermined any confidence anyone has had in the capital structure being sacrosanct. Preferred is wiped out in the US and UK equity holders get something instead of the zero they should. Loan books are placed in sovereign SPVs instead of being sold, or sold with "the terms of the deal have not been disclosed" to avoid creating a market mark someone may find unhelpful. This exposes the taxpayer to losses irrespective of the company's original ownership structure. We have not seen a single textbook bankruptcy, everything financial is declared an exception.

    If you have a different assessment, please share it.

  • Comment number 35.

    #5 - I was really thinking of the foreign loans. Iceland may well be able to guarantee domestic deposits but the Government obviously can't repay the banks' overseas debt this millemium. How about US / UK pulling his trick too?

  • Comment number 36.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 37.

    re 19: Understand totally - but Kaupthing Edge in UK is Kaupthing Singer and Friedlander - so what ? Well, it is covered by the FSCS just to the same extent as any other "Bank Incorporated In The United Kingdom" [Unsuitable/Broken URL removed by Moderator]so I guess that if it goes bust (which is probably no more or less likely than any other bank at the moment) you would be just as well covered to the 35000 / 50000 come tuesday, limit. Agreed, being Icelanic, right now, I'll re-phrase my comment above - it IS probably more likely to go bust - but you're covered. OR ARE YOU ? The domino theory - if one goes many may go - the FSCS may be unable to cover you anyway. Like I said before in some postings - I no longer care - I just watch in wonder and amazement at the daily revelations of total financial incompetency. I'm a saver, not an investor, and I am astonished, amazed and totally GOBSMACKED to learn that the people I have trusted my savings with are no more than spotty youths who've never seen hard times and have been acting like card sharps and gamblers at the roulette table. Maybe a good idea is to get them all on a reality TV show to play Russian Roulette (the real version)

  • Comment number 38.

    It is scary to how many here know little of Iceland. And some do not even know how the financial system works.

    #24 lordJimBowman and #35 chivalrousStephenG think for example that people that have deposited to either IceSave or KaupthingEdge saving accounts are not covered by the UK scheme. That is so totally wrong and can be very harmful. All depositors in UK have the same coverage that is at the moment GBP 50,000. So why not get a hefty interest and be covered versus getting low interest plus the coverage?

    The current crisis in Iceland is mostly do to the fact that money are not available and that some self-fulfilling prophets have been talking up the credit default swaps for the banks. How come that Reykjavik Utilities can get a big loan with CDS of 9.8 points! when the government has CDS of 650. If these CDS's had been moderate there would be no problem. So actually the CDS market is killing the banks not the risk of their operation. I am sure if RBS would face a CDS of 750 for 1 year it would run into difficulties. Or if the UK government would get a CDS of 350. This is the Icelandic situation. The unregulated CDS market is deciding who will survive and who will collapse. If the Icelandic banks and the Icelandic government would be offered a CDS that is in line with what Irish banks get, we would not have any problem. None at all.

    Did you know that all the Icelandic banks have been showing a healthy profit for the past year? None has had to write of anything because of the subprime loans. Sure people invested but most of those investments are making it.

    The latest incident, that the Icelandic government decided to buy 75% stake in Glitnir bank started something that is actually the core problem in the banking regulation system. I am here talking about the New Basel Capital Accord. In the system a bank has to maintain a certain standard of the portfolio to keep their rating. If a debtor is relegated in rating the bank has to call in the loan or other wise the bank it self could face relegation in rating. Why do I mention this as being a problem? This should be a good risk management. Yes, it is. But this is the reason why a BBB housing loans in US went through the rating agencies' laundry and came out as AAA. This was the only way to sell the package. This was a fraud that the whole world is suffering for and Iceland worst of all. Because when the government took over the bank all of Iceland was relegated in rating triggering the bail out closes in all financing contracts (loan-lines). If this does not get turned around in the next few days we are facing a major catastrophe and that could cause a domino effect influencing all our neighbouring countries.

    The situation we are facing is very serious. Not only for Iceland, for very bank in Europe and US. We have already seen 17 banks in US gone under, been rescued by the government or been taken over by a competitor. The UK government has bailed out at least two banks. The Dutch government has bailed out two of Europes biggest banks. What is needed in Iceland is petite compared to all these bail outs but with CDS of 650 - 5500 all roads are blocked at the moment. We that live here in Iceland are watching the progress of this matter as a very important football match. We are 4 - 0 down with not much time to play but we've just made a very important substitution, a super striker. If this does not work I guess we will do a Derby! As they say in the football.

  • Comment number 39.

    Journalists love inflammatory, sensationalist language: lethal, toxic etc and Peston, though he writes for the BBC is no exception. Off the leash, although unfortunately not off the record, in the long grass of his own blog - and heaven knows why his blog should be directly linked to the home page of the BBC - he grudgingly admits to being a "tad unfair", but only mid-gibe.

    The facts are simply that savings accounts with Kaupthing Edge in the UK are operated by a subsidiary called Kaupthing, Singer and Friedlander. Any account with Kaupthing in the UK is therefore fully protected by the Financial Services Compensation Scheme (FSCS) up to the new limit of £50,000. Kaupthing Edge is therefore protected to the same degree as any other British savings bank.

    Ultimately, who should back up Kaupthing and the nation state of Iceland ? First, the bulk of the assets of Kaupthing are in fact international assets, outside of Iceland - hence the large balance sheet size relative to the Icelandic economy. Second, well, Iceland is a small nation and has always been potentially vulnerable to credit squeeze. Let us simply hope that it has enough international friends who wish to include it in their own collusive bail out plans.

    In the meantime, as Britain rumbles to a halt in our winter of discontent, book your flights to what is rapidly becoming the cheapest winter holiday destination in Europe !

  • Comment number 40.

    This bog is certainly an interesting reading, particularly for an Icelander like myself. However, there are several additional things that could be mentioned. I do not maintain to posses any secrets, but would like to mention a few things that pop to mind.

    First of all, it is important to remember that the Icelandic banks are owned by international investors and not by Icelanders alone. For example just ten days ago, Sjeik Mohammed Bin Khalifa Al-Thani from Qatar bought 5% of Kaupthing shares. He is brother to the ruling Emir Sheikh Hamad bin Khalifa Al-Thani. Therefore the banks are not only backed by the Icelandic government and the Central Bank of Iceland.

    Second, the balance sheets of the Icelandic banks are solid. As an example, Kaupthing's Ownership Equity would be sufficient for two years of government spending. The problem is not bad management, but the international cash shortage.

    Third, the banks are private enterprises. The government of Iceland has no obligations to protect them, only their customer's deposits, up to a certain limit. If Iceland does not find international solidarity, failing banks will surely be allowed to go into liquidation.

    Fourth, the Icelandic government has certainly not acted in irresponsible manner. The Icelandic treasury has no debt at all. On the contrary, it owns large amounts in foreign currencies. Admittingly it could not buy all the banks at the same time.

    Fifth, Icelandic pension funds are wealthy. Abroad they own assets that is similar in size to Kaupthing's Ownership Equity. These assets would therefore be sufficient for two years of Icelandic Government's spending.

    Sixth, I would like to add the strategic location of Iceland. If I were head of the Icelandic Government, I would start discussions with the Russians about location of Russian military bases in Iceland. If Western governments are going to strangle Iceland's economy, we will surely take appropriate measures.

  • Comment number 41.

    Dear Robert Peston,

    Your story about Iceland and Kaupthing Bank reminds me of an American colleague of yours, David Faber, at CNBC. In one fateful week last March, his comments on TV were instumental in causing a drain of funds from Bear Stearns in a matter of days. In the beginning of that week there were rumours about Bear having a liquidity problem but these hadn't resulted in a run on the bank. CNBC started repeating those comments even though nobody knew the factual situation (as we now know Bear actually had ample liquidity, more than USD 15 bln). On Wednesday, David Faber interviewed Bear's CEO, Alan Schwartz, live on TV. His introducory remark to Schwartz was that he had direct knowledge of a counterparty where the credit dept had held up a trade with Bear. That is a death sentence. The statement wasn't true, Faber later retracted it but the damage was done. It fell on fertile ground with the market being nervous. Three days later Bear was dead.
    What are you trying to achieve with your remarks about Iceland ? How good is your information ? Is it the usual case where you have a source that you have known for years and who has proved to be correct (i.e. has good intuition, unless he works at Kaupthing) most of the time ? If you consider that a good enough basis for creating a scare, I would suggest next time you think again before you commit to this blog. I am fairly sure the BBC would not allow this kind of rumour mongering on its official website or broadcasts, because it fails a few basic tests. In short, it is irresponsible journalism. In fairness, I have not seen this in your comments about the City although you came very close to it on 3rd October (putting out a later correction about HBOS; a bit reminiscent of David Faber).
    PS: For the record, I am not an Icelander nor do I live there.

  • Comment number 42.

    Hi Robert,

    Iceland can recover quickly, within 2 years, if they do things correctly.

    (You're forgetting what the Russians, South Koreans and Argentinians did) They simply, allow the banks to default on their debt. The creditors who were foolish enough to extend these large lines of credit to Iceland, and the insurance houses who insured the debt will get their fingers singed and they will learn a valuable, if costly lesson in prudential money management.

    Iceland will then renegotiate their debt to cents in the dollar, clean out the dirty shop, and rebuild.

    Simple as one, two three. No long drawn out saga like we are seeing in the US and Europe and continue to see in Japan. (after 15 agonising years)

    Short, sharp and clinical.

  • Comment number 43.

    #36 IceGate: Your comment looks like a shameless plug to promote your own website. For those who are interested the IceGate website is not hosted in Iceland and is not registered by an Icelander. So it is NOT "Iceland's largest centralized database containing economic, financial, and demographic information. Its purpose is to service institutional investors, government, and media locally and overseas" as it promotes itself to be. It is registered to a person in the US and likewise hosted there.
    The company that is supposedly to be running the site is not registered in Iceland and furthermore no fellow Icelander has ever heard of this website until I mentioned it to them. And reading this blog was the first time I heard about it. So basically the above claims of the website look like quite a bit of non-truths. And sadly, also looks somewhat unprofessional for the type of services it claims to provide.
    As for the crisis. Icelandic people have been living "high" since we got our independence. We have been quick to assimilate new technology into our culture and we always spend too much money - which should be obvious by the amount of shops we have in the captial area alone. And we do shop alot when we go abroad. This is all because we had nothing before, we didn't really exist in the world as such until the last century and in the last few decades we have wanted to have all things everyone else has - alot of catching up to do. As it is now, we even seem to have surpassed a few larger nations in this respect.

  • Comment number 44.

    My partner and I are Brits living in NL.
    We were tempted by Icelandic banks offering one to one and a half % above the going rate.
    But, if it's too good to be true, it ain't true (we understand these things, she's a psychologist, I'm an historian.
    There must be (tens) of thousands of small. or less than small savers who were tempted.
    I hope my pension fund wasn't too exposed, though I must admit, naked bathing in hot springs at midnight was very pleasant.
    Thanks for the confirmation of my feelings.
    Maybe one might call it "The Cod Liver Oil Bubble".
    Would that I had an hour or four to PhotoShop an appropriate Hogarth etching.

  • Comment number 45.

    Only §38, §40 and §42 seem to be talking any sense here. And I fear Robert that you are being far too reactionary.

    Firstly you have to remember that the Icelandic Banks are medium sized European banks who just happen to be headquartered in a tiny country. 80% of their revenues and operations are outside Europe. Why should they be restricted in size based on the size of Iceland?

    Next, Robert, what you say about the CDS levels is irrelevant. Kaupthing has shown in the past it can access much cheaper funding through private placements and the latest capital injection from Qatar shown they also will seek other forms of cheap funding.

    Also what you say about reserves is not true. Their reserves are big enough for the economy excluding the banks, but with them they are totally inadequate. This is why the central bank was seeking to double the size of current reserves. Even then it would not be enough to help the banks mainly foreign debts. This is why the central bank has entered into a number of conditional swap agreements with the other nordic banks and the ECB stands ready to provide liquidity to the banks in order to avert contagion though the rest of europe.

    Finally as §42 says, Iceland will recover quickly. Iceland has shown in previous cycles that it has a very sharp but short recession and then rebounds given inward investment in geothermal and aluminum smelting. The housing market has already shown signs of stabilization and a decline in consumption has slowed.

    Iceland has always gotten battered by the financial markets given investors, punters and journalists who not knowing anything about the country and just know some headline figures about the size of the banks and the current account. There are risk yes but they should not be exaggerated and a number of different liquidity measures the continued profitability of the banks businesses and their phenomenal build up of deposits will all act as buffers. Icelanders are a tough people and will weather this... just!

  • Comment number 46.

    Altice #40, Ally Iceland with Russia? LOL Good luck.

  • Comment number 47.

    #44 Donald42, your money is as save with the Icelandic banks as with any Dutch bank. So why did Mr. Peston not mention the Dutch bail out and warn about that, I don't know. He decided to plant a fear into everybody that have deposited money to the Icelandic banks. This is just the way many hedge funds work and short sellers.

    I have no interest in Kaupthing. Don't owe them anything and don't have money in any of their branches. But I am Icelandic and I am getting fed up with all the nonsense that has been written about the Icelandic banks for the past years undermining their strength for no other reason than people in this industry is afraid that the Icelandic banks will out smart them.

  • Comment number 48.

    How does one say 'Stupid' in Icelandic?

    We can adopt it as an epithet to use as we describe the US Congress.

    Or we can create a verb:

    I kaupthing, you kaupthing, he/she/it kaupthings, etc.

    We have been kaupthinged all along...

    All we can do at a moment like this is laugh, because black humor is the only means of describing this ridiculous time in history.

  • Comment number 49.

    Ahm... has anyone hear of Switzerland? The good people at the FT seem to have... http://www.ft.com/cms/s/0/61d7e148-8f15-11dd-946c-0000779fd18c.html
    And nobody is worried about UBS and Credit Suisse. The size of Iceland, number of inhabitants and GDP aren't relevant, as the banks aren't Icelandic, but international just as the Swiss banks.

  • Comment number 50.

    Peculiar. I am not an economist, but this does make the red "this does not add up" flags go up like a Nigerian lottery email.

    The blog states that Icelandic banks have a debt of 120 bl, which seems quite large, being six times Icelands national income.

    However, the loans were used for investmets, and it mentions later that -one single bank- holds 73 bl in assets!

    How much does the other banks hold? If it is anywhere near that amount, it seems Iceland is quite far in the black.

  • Comment number 51.

    A few comments from 'the giant hedge fund. All monetary figures are expressed in EUR in the text below as using that currency makes more sense than USD. Monetary conversion to EUR is based on today's rate.

    First, OldSouth: "How does one say 'Stupid' in Icelandic?"

    Vitleysingur (singular), vitleysingar (plural). To sound really Icelandic, use 'snillingur (plural), or snillingar (plural). Means wise@$$.

    AdamFrost: "How much does the other banks hold?"

    Total banking system assets as of August 2008: 83,719 bl. Foreign assets are half of that.

    Robert Peston: "Well, although its central bank has fairly substantial reserves - enough according to the central bank governor to cover imports for eight to nine months - it's difficult to see how it can re-float without international help."

    As of August, Banking system reserves were EUR 792 bl. As of July, Imports total FOB clocked in at EUR 338 bl and exports total FOB 223 bl, which makes the balance -115 bl. The exchange rate index (ISK TWI) July 31 was 158.95; August 29 158.9, and October 3 206.72.

    Pension fund assets as of July were 12,557 bl.

    toughkardinal: "In particular, he seems to be implying Iceland's central bank has been keeping interest rates high to attract capital. In fact, the reason interest rates have been high is that Iceland has a high rate of inflation. The real interest rates achieved in Iceland have not been particularly high."

    You bet it is to attract capital. I really wish I could post charts here to show inflation against the interest rates, but since that's impossible a few bullets will have to do:

    Dec 31 2003: Inflation 2.4%, Interest on indexed loans 6.10%; non-indexed loans 8.50%.

    Dec 31 2004: Inflation 3.9%, Interest on indexed loans 4.20%; non-indexed loans 9.00%. Inflation rises and interest rates on indexed loans go DOWN.

    Dec 31 2005: Inflation 4.1%, Interest on indexed loans 4.15%; non-indexed loans 12.00%. Again inflation rises and interest rates on indexed loans go DOWN.

    Dec 31 2006: Inflation 7.0%, Interest on indexed loans 4.85%; non-indexed loans 15.50% (!!!).

    Dec 31 2007: Inflation 5.9%, Interest on indexed loans 6.30%; non-indexed loans 16.50%. Observe that inflation now goes DOWN while interest rates on indexed loans go UP. So indexed loans at this point carry a double shock.

    Dec 31 2008: Inflation 13.6% (!!!), Interest on indexed loans 6.05%; non-indexed loans 18.50%.

    And now for some trivia:

    Current CPI inflation (August): 14.0%
    Inflation on bread and cereals: 14.0%
    Inflation on fruit: 46.3% (!!!)

    Building cost index inflation level: 18.5%
    Producer price index: 34.3% (!!!)
    Wage index: 9.1%

    There you got something to speculate upon.

  • Comment number 52.

    Small countries like Iceland can and do play hardball in situations like this, and often manage very well. Iceland need not join the EU or borrow from Norway or become part of Norway, let alone invite Russia to establish bases in Iceland. Iceland has other options.

    For example, because Iceland's government has plenty of foreign currency, and because the banking trouble is entirely due to foreign transactions, Iceland is a good candidate for help from the IMF, which usually imposes painful conditions on its help, but which can restore normality.

    Alternatively, Iceland could make the Krona inconvertible, and require gov't permission for *anyone* to move *any* funds in *any* currency out of Iceland. Isn't that, in effect, what the UK did for a number of years after World War II? As for the imbalance of imports and exports, when I lived in Brazil in the 1960s it was illegal to import a wide variety of consumer goods that were deemed nonessential, and although there were some ways around the ban, for the most part it worked as intended; Iceland could do likewise.

    No doubt Iceland will go through hard times for a while, but the country is basically sound, although the big Icelandic banks are not, so the country should be able to cope without undue hardship to its people. And, if I were a citizen of Iceland, I wouldn't want to be part of the EU or adopt the Euro,
    and evidently most of the citizens of Iceland don't want to be swallowed by some huge bureaucratic regime; they have demonstrated that repeatedly for 1000 years.

  • Comment number 53.

    The question about bank assets anywhere, not just in Iceland, is how much of these assets are tied up in bad debt. Or how much they are really worth after the likely repayment defaults and loss of value in property, businesses, etc. Again, this is the question everybody is asking for all banks, but there are no clear answers... the same for Iceland. So, maybe the assets are enough to outweigh liabilities, or maybe not.

    True that bank debt is not the same as the government debt, and one should not compare the size of Iceland's economy to bank debt... unless the government starts guaranteeing debt. However, the banks are probably providing significant employment and tax revenue to the country, and if they get in trouble, this will affect the standard of living and flow through all aspects of life. It is equally wrong to suggest that bank failure will have no effect on society simply because the government does not hold the debt.

  • Comment number 54.

    JayPee28bpr @ 31

    yes, i agree that printing money is always an option, provided that your debts are denominated in your own currency (so does not help iceland much!)

    i don't think inflation is a cheap option (particularly the loss of credibility, plus the cost of getting it under control again), but like you suggest, you can get away with printing money if your economy is stuck in a liquidity trap (i.e. the vicious circle of everyone hoarding cash => very weak demand => zero or negative inflation). this is what japan did.

    but i think there is a big difference between our case and japan's. we (and the usa) are big net importers. if there was a threat of falling into a liquidity trap, interest rates would be cut to zero and the pound / dollar would plummet, pushing up import prices significantly. unless of course the chinese decided to intervene..

    btw that small businesses fund is a big red herring imo, although no doubt it will help out a lot of companies that really need the help.

  • Comment number 55.

    hmmmm.....the banks and governent created a spending culture based on credit-after all, why not copy the American model for creating wealth?! A cry of 'we want to be as big as them'! Oh woops....can't pay your mortgage/credit cards? The banks and government spank anyone in this situation-credit defaults, reposessions etc. All the while assuming we trust them to look after pensions and savings. They cane us all with exhorbitant interest rates for short term lending, bank charges for banking (captive audience-they know we need to have bank accounts so do what they like!). They rub their hands with glee as they make more and more money from hard working folk-they acted without conscience to line their pockets!

    Now they're caught with their hands in the cookie jar-they are guilty of far greater excesses of living beyond their means than any small company or us average joe-public. I can't see any world leader standing on my doorstep if I couldn't pay my mortgage or credit card!

    Robert, a great suggestion-protect pensions and savings, and help those with a mortgage. The banks should be penalised-they forgot who they serve while their greed ran away with them! If I treated my clients to the same level of customer service I would go bust!

    I left banking many years ago when customer service became sales (we had targets to sell insurances and were in trouble if we didn't meet them). It's time banks learned about customer care again in the real sense of the word!

    One last thing-My mortgage is not so-called 'sub-prime' yet i've been sold on twice-now on my 3rd lender-no choice in the matter-the credit crunch has meant that with arrangement fees and tighter lending protocols I am not able able to source an alternative. I'm sure this is the case for thousands of other people.

    If my lender goes bust, my mortgage should be written off!

    Time to spank the banks I say!

  • Comment number 56.

    sorry all-my last post should have gone on a different blog of Roberts!

  • Comment number 57.

    #51, IceGate, I think you are experiencing a decimal problem in your numbers. Please take a closer look at your conversion ratio and correct your use of comma (,) and period (.) do indicate decimal places. I think that almost all your figures are wrong (a bit inflated).

    The banks assets might be 83.719 bl EUR that is a far cry from 83,719 bl EUR. The banks reserves are definitely not 792 bl. EUR and the pension funds are rich but they do not hold 12,557 bl. EUR. It is more like 12.557 bl. EUR.

    To explain to readers we indicate decimal places with comma (,) in Iceland while most other countries use period (.).

  • Comment number 58.

    #57: Right, decimals are off in the monetary figures. Copied it directly from an Icelandic formatted spreadsheet and forgot the change the decimals in the monetary section. Entered the inflation figures manually, hence correct notation on those. All monetary figures are indeed inflated (wishful thinking?).

    Good catch. :o)

  • Comment number 59.

    On top of all the bad news that keeps bubbling up everywhere, I would love to know what position the world's auditing firms consider themselves in - why haven't they chirped up about some of the incredibly dangerous positions taken on by various collapsing banks?
    After the Enron debacle, you'd think they would be far more critical and actually "useful" to shareholders, and thus to the public at large - the public is ending up having to pay for this global party that no one anywhere warned us about its cost...
    Secondly - I'm used to the concept of internal audit and internal risk management departments, certainly in major corporate structures, let alone in genaral. Were there such in these collapsing titans, and if so, were they aware of dangerous practices? If so, were they just ignored?
    Let's not lose sight of the fact that there is always a responsibility attached to one or more people, and that, if we are STILL coming across "new" calamities, there are STILL people hiding from their responsibility to shareholders/the public. At this point in time, hiding problems is no longer something that should be tolerated, by legislation, by auditors, by anyone who is aware of what is going on in their company. Isn't that, after all, why no institution trusts another?

 

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