Spend to save: The excuses are invalid

The good times were 2004-2006 when the banks lent freely to homeowners and those who would be. It had only been 1-2 years since privatization and of course they were going to enter that market. Why wouldn’t a private Northen European bank with 20%+ market share (as all the Icelandic banks were at the time) offer home loans? Icelandic businessmen went wild, purchasing retailers in the UK, hotels and airlines in Europe.

The banks received criticism from abroad for cross-ownership and an unusually low rate of customers savings vs. loans. They consistently scored high with the ratings agencies, such as Moody’s so the alarm bells were relatively quiet.

In the second half of  2006 the banks rolled out their autumn campaigns which revolved around customer savings. “Spend to save” was Landsbankinn’s motto, the most catchy of them all. The branches and call centers contacted customers and brought personal savings to their attention.


There was a tug-of war inside the banks, between the retail division which wanted the savings to be directed into old-fashioned savings accounts and the assets management divisons that wanted to promote their funds. Where I am familiar it was decided that both options would be presented and the customer would decide.

The reason behind these marketing campaigns were not hidden from anyone. The banks’ managers were honest about the need to finance their institutions through savings instead of through the markets where they were facing higher rates every week. The basic principle in economics which says that when your borrowing options become more expensive then it is a sign that you should slow down was forgotten in Iceland. By the banks, their customers and the government which seemed extatic that Wall Street had come to Iceland at last.

Billions came into the banks through these campaigns. But the savings of ordinary Icelanders were never going to be enough for the banks so Landsbankinn entered the UK market with IceSave, an internet account with marginally higher rates than the British banks were offering. It was genius, as CEO Sigurjon Arnason told the media as he described how he just watched the money roll in at the end of the day.

At the other banks, people were envious and sceptical. Landsbankinn had found a brilliant way to finance itself. But questions were asked and specifically one that seemed important. Are they really indicating that IceSave is backed by the Icelandic Authorities?

As months passed and the banks were facing more closed doors in the markets, Kaupthing and Glitnir followed suit with Kaupthing Edge and Glitnir’s Save&Save in Scandinavia and Europe. But dark clouds were forming in the world financial markets. In the autumn of 2007, the message was clear at loan-meetings in the banks. Don’t lend out more money! And then again shortly afterwards, “Didn’t you get the message? Don’t lend out more money! A CEO’s forecast for the Icelandic economy in 2008 at one of those meetings was mindblowing and eventually the prophecy turned real.

If you worked inside the banks in 2006-2008 then you could hear the alarm bells grow louder. As the Central Bank, the Government and the owners of the banks scramble to blame each other and tell everyone that they foresaw what was happening, why was so little done to prevent it before it was too late?

Carsten Valgreen, economist at Danske Bank shared his thoughts with the Financial Times in the beginning of October 2008:

With my team at Danske Bank I was responsible for a piece on Iceland in March 2006 called “Geyser Crisis” (can be googled). The unsustainable leverage of the Icelandic Banking sector in foreign currency was plain to see back then. Indeed we included a scary chart on foreign currency reserves to bank assets. We also took the liberty to argue that an Emerging Market style currency crisis/currency run and a sovereign default could happen.

As a result I had to go to Reykjavik back then and got a pretty hot reception. The Prime Minister publicly denounced our research piece, ans banks issued denials. Also Frederick Mishkin was paid(?) by the Icelandic chamber of commerce to write a piece on Icelandic Financial Stability in May 2006 refuting our conclusions + arguing that there might be weaknesses but that they could be addressed. I still wonder why Mishkin would lay name to that.

In essense 2½ years ago all these problems were in the open. Yet Icelandic authorities has not acted and the banks were not reigned in (enough).

Iceland is hardly to blame for the credit crisis, and I dont think the country deserve what is now happening. But the risks have been plain to see for years (you have also written on then previously), and the mini crisis in the spring of 2006 now looks like a missed opportunity for decisive political action against the banks expansion of balance sheets in foreign currency.

Moreover, the almost comic events over the last week do not make Icelandic authorities look good:

1. Glitnir first nationalized and now not but in receivership, so that the State can avoid the liabilities which it cannot pay.

2. Icelandic authorities announce Russian deal. Then Russia says its not done

3. Iceland announce peg. Then does not defend it. Complain that market makers doesnt defend it (!). Then abandon peg.

4. Iceland complain that other countries don’t support

I truely regret the fate of the ordinary Icelandic taxpayer. But the truth is that a closeknit high flying Icelandic elite has been playing risky leverage games using his balance sheet as indirect guarantee for years.

This is partly understood publicly in most Nordic countries. Denmark and Danish tax payers ended up paying about $1bn for a similar but smaller leverage game on the Faroe Islands 10 years ago.

Iceland has had a wildly inflationary history over the past 50 years, partly because domestic politicians and the elite has always had a hard time staying within budget constrains. Using the inflationary route as a way out has always been a habit and the economy remains widely inflation indexed. Although I hold the staff at Sedlabanki in high regard, institutions are generally weaker than in many other developed countries, partly due to the smallness of the country and the close ties in the community. The central bank Governor is a former prime minister just to make an example.

In this context it should be no surprise that no Politician in the Nordic countries will or can shoulder a bail out. It would be political suicide.

Therefore complaining that no one now comes to the rescue is strange.

Btw. $10bn might not sound a lot. But it is like the US asking for a $10trn loan. That is a loan the size of the entire US household mortgage debt stock.

The warning signs grew in numbers and the alarm bells sounded louder every month of every year. Therefore the excuses that Iceland’s plight was unforeseeable or because of turmoil in international markets are absolutely invalid.


1 Response to “Spend to save: The excuses are invalid”

  1. 1 balance sheet problems | Finance Blogg Trackback on January 6, 2009 at 5:30 am

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