mánudagur, febrúar 02, 2009

grand unified theory

I was listening to the BBC's "World Have Your Say" program tonight. It was broadcast live from a kitchen table in Reykjavík, where (in a funny, clueless, all-too-common twist on the general lack of surnames in Iceland) the host was interviewing what he called "the Jónsson family" about their dismal experiences post-economic collapse. I have been mulling a grand unified theory about what went down here this decade, and that sad interview made me finally set it onto paper. So here goes:

  • Iceland floated its currency, the króna, back in 2001. Suddenly the world had a new floating currency that was the smallest pool of independently controlled money in the world.
  • Iceland has a history of high inflation, and so the new currency carried an interest rate higher than other currencies of the West. Some outsiders might say that made it "attractive".
  • At around the same time, to try to bolster the US economy in a "post 9/11 world", Alan Greenspan's Fed began slashing interest rates on the dollar to some of their lowest levels ever.
  • The interest differential between the dollar (with interest rates as low as 1% at one point), the still-ailing Yen (interest rates near 0%), other major currencies such as the Swiss Franc and the ISK was quite large.
  • This meant one or two worldly American savers might say to themselves, "Hey, I'm sick of this CD paying me 1%. Why don't I change that into ISK and get 10%? (Or later, 15%)"
  • So they did.
  • This being a new, shiny globalized world, anyone and everyone who wanted to could put their money in the ISK and get big yields. Japanese housewives could go into their local bank branches and buy ISK savings. Americans could open ISK accounts at Everbank. And they did.
  • Not only savings, but people who wanted to take more of a gamble could borrow Yen or dollars for almost free, and turn around and invest those dollars in an ISK account and make big free money. (It's called the "carry trade" but never you mind about that.)
  • So they did.
  • And what to the world is just a few bucks from a handful of savers, just a couple Japanese housewives and a clown-car full of wacky Americans trolling the Everbank site at 11:00 at night, long after their wives have gone to bed, was, when compared to a tiny economy of 300,000 souls, quite a bit of money in the Land of Fire and Ice.
  • And the money poured in. Where did it go?
  • It gushed into investment accounts and into the stock market. The stock market posted 60% years for more than one year in a row. Every company was a winner!
  • And still the money poured in.
  • It filled up money market funds, which doubled, and then tripled, and then sextupled. Some of them were growing by orders of magnitude per year.
  • But money market funds have to invest in something. What could they invest in?
  • Well, they could buy bonds from the banks. So the banks issued bonds. Every time they issued a new bond, they had a buyer in the money market funds. So they issued more bonds. They issued about as many as they wanted.
  • "We're rich!" said the banks. "Rich = smart. What do we do with this cash? Let's fit out some longships and go raiding in Europe."
  • And they did. And they came back to Iceland with chests full of minor brokerage houses and second-tier banks and mortgage companies.
  • [And the banks also said, "Wow, this buying up other banks is great fun! And loans are so cheap in dollars and Euros. Let's do more of this buyin'. Let's set up funding desks and borrow some money and then use that money to buy more foreign subsidiaries. Luxembourg sounds nice!"]
  • And every time a dollar, or a Euro, or a Yen came into the Land, it had to be exchanged for a króna. As the money poured in, all that buying of krónur meant the little Icelandic currency just kept getting stronger! It went from 100 to the dollar to 90 and then 80 and then 70 and then 60!
  • And still the money poured in. Who else could use it, besides those banks? Why, every company in Iceland!
  • So the oligarchs of Iceland got busy doing what they do best: creating shell companies that they bought with other shell companies, that they registered in Ísafjörður and hoped nobody would look. They built castles in the sky, shares in those castles exchanged for other shares, capitalized and re-capped and interlinked like a bad circuit diagram.
  • But the money wasn't just for the oligarchs. Every two-bit builder who wanted to throw up a couple ugly concrete apartment blocks in the wilderness of 203 Kópavogur could go in to his local bank branch, fill out a couple of forms, and get his hands on some of that money.
  • So they did. And they built. All around Reykjavík, ugly neighborhoods sprang up overnight.
  • But there was more money still. It had to go somewhere. It filled up the coffers of local self-styled buyout/raider firms like Baugur Group and FL Group, which went on buying sprees. Not in Iceland, because there was nothing left to buy, but in Europe and North America.
  • Baugur bought up half of the stores on the British high street, and rubbed the Danes' haughty noses in the purchase of their local Macy's equivalent. FL Group bought 10% of American Airlines and bought and sold Danish airline Sterling a handful of times, just because they could.
  • All this money coming in meant there was plenty of money to go around. And when there is plenty of money to go around, well, there's usually plenty of inflation.
  • So there was.
  • Inflation was huge, sometimes 8%, a few years later 14%. The Icelandic Central Bank kept boosting its rate, trying to tame it. But those new, high rates still looked pretty great to the Japanese housewives. So they bought some more!
  • And there was still more money coming in. What else to do? Why not lend it out to some consumers?
  • And the Icelandic people, with their newfound riches and rapidly increasing salaries, lived out their own little version of the American dream: they bought up the new ugly houses, and expensively jacked-up Land Cruisers they called "jeeps" to park in front of them, and flat-screen TVs to go inside them. Then they bought big stainless grills to go on the decks. And kids' rooms so full of toys, they had to make them other rooms. And with what was left over they chartered airplanes and went on ski vacations and two-week summer trips to Mallorca. And the ones who stayed home went salmon fishing for $1000 a day and hoped to run into their favorite Hollywood celebs in the ice-cold streams.
  • Sometimes, though, the people didn't like borrowing at the high interest rates in their own currency. "No problem!" said the shifty advisors at the banks, "We'll lend you some money in another currency! Any one you choose! USD, JPY, CHF? What about a basket of all 3? You'll pay much less interest, and you take all the exchange-rate risk, but what the hell? The króna always goes up!"
  • So the Icelandic people took more loans, in all kinds of faraway currencies. They flew 7 hours direct to Minneapolis just to spend two days buying clothes for their kids in the Mall of America. They flew to Boston and ran roughshod over the Cambridgeside Galleria. A sales clerk at the Apple store there said, "Yep, we know all about Icelanders! They buy 5 iPods at a time! They make our month!"
  • So with the backdrop of the largest credit expansion in the history of the world, one small population with a free-floating and high-yielding currency saw mind-boggling increases in the cash their country had on hand. And there were plenty of iPods to buy.
  • But every "largest expansion in history" must eventually stop expanding, if only so it can be measured. This one started to unwind in early 2007. A handful of homeowners in equally ugly southern California suburbs realized they couldn't make their mortgage payments.
  • So they stopped.
  • Suddenly lending money to anyone, anywhere in the world started to seem like less of a good idea. And thus the great unwinding of lending began.
  • The people who had borrowed Yen or dollars decided maybe it was just about time to pay those loans back.
  • So they called up their banks and sold their ISK and bought back their dollars and paid off their loans.
  • The ISK lost a little bit of power. Fewer people wanted it.
  • The fianciers who had looked at Icelandic banks and thought, "Yeah! Great business plan!" a year or two before suddenly said, "Hmmmm... not sure about rolling that loan over, pal."
  • And so what was first a trickle became a stream. The currency started to lose its value, slowly, steadily. Every day, down a little bit.
  • Icelanders felt a little less rich by the day, bought less expensive bottles of wine in their Swiss ski hotels, and still the currency continued to fall.
  • The banking system and the stockmarkets of the US and Europe kept having bad months, followed by other bad months. The ISK kept falling.
  • Then Lehman Brothers was bankrupt with no bailout on a Monday morning and there was panic. A rush for the exits.
  • People with ISK, both inside and outside Iceland, bought back their Euros or dollars, or took refuge in these currencies. The ISK entered free-fall.
  • The Icelandic banks, which had been having trouble renewing their loans, now found it impossible to get new ones. The balloon was burst and air was gushing out far faster than it had come in.
  • All that money was just racing to get out. The banks, unable to finance themselves for even a day or two ahead, went belly-up. The currency hit levels nobody had imagined just a few months before, then stopped trading.
  • The price of everything Iceland imported was suddenly double what it had been. Inflation hit again, even uglier than before.
  • And that rush of money out the double doors meant that, for a new economy built for almost a decade on the promise of endless and cheap money, life couldn't go on as before. There suddenly just wasn't enough money to go around.
  • And so companies started to fold. And people lost their jobs. And then more companies. And so here we are. And nobody is sure how far there is to fall from here.

Did I leave anything out?


Anonymous Nafnlaus said...

Informative, amusing, and sad.

Do America next!


Blogger Farbror Willy said...

I needed a good bedtime story with a happy ending to ease me into sleep, thanks skipstjóri :).

Blogger howdoyoulikeiceland said...

Really well written article. I think it explains the situation really well. Thanks for posting.

Blogger don said...

Excellent and informative.

I recall reading an article by a Professor Portes of the London Business School in early 2008 where he stated that the Icelandic banking system was sound, as in no toxic assets ( as in sub-prime loans) on the books.

Did Iceland implode as it did because of the sudden credit freeze up worldwide, with the failure of Lehman, or did they have their own version of toxic assets on the books?

It is great to read IR again.

Thanks, Jared

Anonymous Nafnlaus said...

I think you left out the Icesave adventure.

Blogger JB said...

Thanks, kids.

Don: Indeed, the Icelandic banking system had no toxic assets. But that wasn't the issue. The issue was that the system itself was built on the premise of easy money. Banks financed themselves on the "wholesale" market. That means they went out and got 1-3 year loans and used that borrowed money to support their business and expand. The loans had to be "rolled over" (paid off with new loans) when they came due. Once the credit markets started to slow down, guess who suddenly looked like a really risky bet for the lenders? Our friends the Icelandic banks.

Skúli: The Icesave adventure is a little bit of a sideshow/symptom, so I intentionally left it out. But if I were to have included it, it would go like this:

- In March 2006, some annoying analysts from Merrill Lynch wrote a sharply critical report on Icelandic finance. They pointed to the banks' reliance on only wholesale funding (see above) plus the Icelandic deposit base. They thought this was a flimsy way to build a banking system with pan-European reach. In response, the two biggest banks started UK online savings programs. One was called Icesave. It was shoddily set up, in that the deposits went straight into the parent bank in Reykjavík, instead of a UK subsidiary. So when the parent bank in Iceland (Landsbanki) collapsed, the British widows' and orphans' money was frozen.

You can see why I left it out. It's a bit of a distraction from my central theme, which was that cheap money inflated a boom here that was impossible to sustain.

To paraphrase a friend, we're not in a kreppa, we're back in reality.

Blogger Helgi Briem said...

Thanks JB for this very concise account of our follies.

I just wish I'd taken advantage of that easy credit and high interest to make a few easy millions along the way. Alas I am too cheap and careful ever to be rich.

Blogger Unknown said...

Easy comes,easy goes, emphasis on "easy"
The LOVE of money is the root of all evil

Blogger Unknown said...

Very interesting post, JB. Long but interesting. As a nation, yes, we did spend more than we had and made a lot of stupid mistakes. My personal favorite is taking loans in a foreign currency when all of our income was/is in ISK.

BUT not every family participated in "the party". For example, the working-class families didn't join in. Nonetheless they are paying for the party. The bankers who were making ISK 500.000 or more every month: I do not feel sorry for them at all. They should have been smart enough to save some of their money instead of spending it all, and then borrowing some more. That only added to the problem.

My thoughts go out to the people making minimum wage, not going on expensive vacations abroad because they could not afford it, not buying a "jeppi" because they could not afford it, and not buying a new apartment or house because they could not afford it. Yet they have now lost their jobs, they are behind on their mortgages because they are indexed to our wacky inflation rates, and putting food on the table for their children is becoming more challenging every week because with the ISK so weak prices of imported foods are just going up and up.

Where it all will end, I do not have a clue. Therefore I fear the unknown.

Anonymous Nafnlaus said...

Takk kærlega. Very informative. I have now officially bookmarked you.

Blogger JB said...

Whoa. Coming up on 300 readers today. Not sure quite how that compares to the Iceland Report "glory days" of 2005-2006, but I think this might be a new one-day readership record.


Anonymous Nafnlaus said...


Now you have a mission!

Blogger RS said...

Sounds like a few icelandic waingros maybe coming along in this economy.

"What about Waingro?"

John in boston

Blogger JB said...

Totally Teen Waingro sez: "Look man, I hadta get it on!"

Stan, what's my mission? I am looking for one of those, funnily enough.

Biskupinn: You know what they say about the "Rime of the Bishop's Bookmark"!

...and for those of you following along at home, ding ding! 326 readers yesterday. That's big-time for the IR. That's a number equivalent to 0,1% of Iceland's population (although many of the hits are from outside Iceland). Here we have a word for that kind of following, though: kjördæmi!

Anonymous Nafnlaus said...


This is the single simplest and most informative thing I've read about the Icelandic economic mess (and much of it applies to the overall world economic mess as well).

Blogger Michele said...

Great reading. Thanks!

Blogger JB said...

Thanks Alex, that's quite a compliment.

In general, the news media doesn't do a great job on economic news, probably because the average reporter is just as confused on economics as the layman.

I was waiting for someone to come out and tell this story, then realized that person should probably be me.

Anonymous Nafnlaus said...

We could all appreciate the values expressed by Laxness in "Independent People" in these times. Bjartur extols his cultivation of sheep in The Land and on his small holding as a religion, refusing indebtedness to anyone for any reason, living and raising a family on his own and their own gruesomly hard work. In the backdrop of the early 1900's, the sheep herder's cooperatives overtake the merchant classes in Iceland and people's lives slowly improve, partly also due to the spike of prices for Icelandic products from WW1. The character of the Icelandic people is very tough and durable. We will not get on track again until the huge debt mounted on our shoulders at all levels of society is rung down to the point that intake is no longer paying primarily for what we owe. Then we have to learn to put aside some of what we make/earn for that rainy day that is certain to come. Those who have saved and those who have lived modestly and within 'their means' will make out best in the long run. Tend the sheep that you have and encourage them to multiply. FB

Anonymous Nafnlaus said...

Number 328 and counting. MB

Anonymous Nafnlaus said...

An excellent summary, thanks.
Someday someone will write a multivolume treatise on the History of Stupidity. Iceland will get an entire volume for itself.
I don't blame ordinary Icelanders, they were just going along with the Bubble Mentality (as the Americans have done). But the Icelandic government - what incredible, mind-boggling stupidity.
The Icelandic government violated numerous basic principles - don't borrow money at rates higher than you have to, don't borrow any more money than you need unless the lender can't force you to pay it back (as is the case with the USA, who will never pay its debt back), only big counties can run huge deficits, all assets end badly and revert to the mean, don't drink your own free-market ideology Kool-Aid, and so on and so on.
One thing you didn't mention is that the Icelandic banks were insolvent as early as 2006 (i.e. zero net assets), that's why they started the Icesave-type accounts. So the game was really over then. Icesave and what happened after that was a double-down, all or nothing bet by a desperate gambler (the banks), using borrowed money.
If you had deliberately planned to ruin a country, to destroy it forever, you could not have done a better job than what the Independence Party has done. Iceland would be in a better position now if the IP had bought dynamite with the money and blown up every building in Iceland.

- Superman007

Blogger JB said...


Interesting on the banks' insolvency in 2006. Do you have a reference on this? Or perhaps you were CFO of one of them?

I couldn't agree with you more on the incompetence of Sjálfstæðisflokkurinn (the "Independence Party" just sounds so lame when translated) lo these many years. These guys treated Iceland like their own little fiefdom, like an ATM from which they could regularly withdraw cash.

We should form a Truth & Reconciliation Commission (but one run by outsiders, say a team of lawyers, forensic accountants, and retired/respected politicians from the USA and Europe, people who capable and competent but unconnected here) here to get to the bottom of political corruption in Iceland, and all of the multifaceted causes of the 00s bubble. Then prosecute any wrongdoing to the fullest extent of (what I fear is not yet well-enough developed) Icelandic law.

I was thinking about a post on Sjálfstæðismenn. What do you think? Where does one even begin?

Anonymous Nafnlaus said...

On the banks' insolvency in 2006 - that is well-known, I think.
"The banks started having problems borrowing in wholesale markets, and decided that opening up high interest savings accounts in the UK and elsewhere in Europe was a good idea. The Icelandic banks, with government permission, used European savers to provide the liquidity they could not obtain from the better-informed banking system."
Jon Danielsson & Gylfi Zoega
In other words, the Icelandic couldn't borrow any more from real banks because the real banks had looked at their books and saw there was no more value left as collateral - i.e. they were broke.
Foeign hedge funds knew this too and started to pile on this point.

A Truth & Reconciliation Commission would be a good idea, but, honestly, the situation really requires a full-criminal investigation plus prosecution, involving the Icelandic FSE, British FSE, and Interpol. What the top executives did were not moral lapses, but white-collar crime.
This is another amazing aspect of the Icelandic bank calamity. In the US businessmen have to work very very hard to steal money. No money transfers to their own accounts or their friends', no incestuous business deals, no fake subsidiaries, no stock market manipulations, no offshore accounts. They can only steal money by giving themselves back-dated stock options or inflated bonuses. But Iceland - Iceland was an unguarded candystore. These executives, Olafur Olafsson, Finnur Ingolfsson, the Bjorgulfs, etc., they just raided the safe - taking the money from the banks, transferring it to the subsidiaries they own through fake business deals, then to Luxembourg accounts and on and out to the Caymans and Turcos. Very simple and direct, three or four steps perhaps.
This was possible of course because of the toothless FSE and a wholly inadequate, undeveloped set of financial fraud laws and a mechanism to enforce them. You can fill a very large room with American securities and fraud lawbooks. And a stadium with lawyers ready to file class-action lawsuits. The corresponding Icelandic laws? You could put them under your arm, probably no bigger than the last three or four unreadable Gore Vidal novels.
A post on Sjálfstæðismenn for an English-speaking would be welcome and very interesting. I wouldn't know where to start since they have such a long and complicated history in Icelandic politics, starting as a Nazi-sympathiser party. You would have to read up on abnormal psychology beforehand. Perhaps you know this already - psychologists have done studies on stupid people and discovered that one of their main characterics is their inability or unwillingness to recognize that they are stupid. They make mistakes but can't or won't see them. That's certainly true of the IP.
- Superman007


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