jännäri

Karlo Jännäri, former bank regulator of Finland, was invited last fall to Iceland to draft a report on the Icelandic financial sector and the causes of the banking collapse of October 2008. That report was published yesterday. The report gives some excellent (and very readable) history on the development of the Icelandic crisis, and the steps taken to mitigate problem areas like ICESAVE before they exploded. This report is the first time I have read detailed discussion of the steps taken by the Icelandic authorities to mitigate the banking crisis before it hit, and I found this very enlightening. The report then goes into more detailed discussion of issues affecting the banking system, such as credit risk, liquidity management, and FX risk.

A few paragraphs from the section discussing the history of the crisis jumped out at me:

[CBI = Icelandic Central Bank, Seðlabanki Íslands
FME = Financial Supervisory Authority, Fjármálaeftirlitið
HFF = Housing Finance Fund, Íbúalánasjóður]

Privatization: The privatisation process of the banking system at the beginning of this decade was another milestone in this development. This is also where the first potentially “wrong decisions” or mistakes were made. Instead of spreading ownership among several institutional investors and private households, with no one holding a controlling interest, as was the original intention, the government then in power decided in 2002 to allow one investor group, Samson, to have a de facto controlling interest of 45% in Landsbanki, then the country’s largest bank. This was largely a political decision. The FME, for instance, was dissatisfied with the result and, in early 2003, gave its approval to the holding by Samson only after lengthy deliberations. The same applied to the acquisition of Búnadarbanki by the “S-group” when that bank was privatised. Some efforts were made to have reputed foreign financial institutions invest in the Icelandic banking system, but with limited success. This is not surprising, as the Icelandic financial market was (and to a large degree, still is) difficult for foreign financial professionals to assess because of the high degree of indexation, the role of the HFF, the small currency and market size, and the volatility of the economy. Even so, it appears that at least one reputable bank was showing interest in entering the Icelandic market, but it was turned down in the end, probably for protectionist reasons.

The Boom: At the time, the global financial market was flush with liquidity; moreover, due to historically low real interest rates, funds were readily available for the international expansion of the Icelandic banks, as investors were hungry for higher returns. The Icelandic banks also enjoyed favourable ratings from the international rating agencies, which greatly facilitated their access to the international bond markets. At the same time, the domestic economy overheated due to lax monetary and fiscal policies. Large-scale aluminium and power projects, large salary and wage increases combined with a reduction in both direct and indirect taxes led to a boost in domestic demand that resulted in wide current account deficits. At the same time, the HFF started to relax conditions in the mortgage market in order to increase its market share, and the banks joined in to compete aggressively in this rapidly growing market. In many cases, loan-to-value ratios neared 100%, and because real estate prices rose at unprecedented rates, households used the opportunity to raise money by using their homes as collateral to fund their consumption spree. This led to high household indebtedness. Firms also expanded by borrowing.

Ineffective Interest Rates: Most mortgages remain in ISK and are indexed, as are term deposits. In my opinion, this state of affairs renders the CBI’s interest rate policy rather toothless, as the Central Bank’s interest rate decisions affect only a small portion of the domestic money and capital markets. Contrary to traditional theory, increases in ISK interest rates accelerated the boom in consumption due to increased inflows of capital through so-called carry trade and Glacier bonds (Eurobonds denominated in ISK). It should be noted, however, that the CBI strongly disagrees with the above analysis, and admittedly, economists have widely differing views on this.

Foreign Loans: Households normally have no way to hedge against foreign exchange risks; therefore, lending to them in foreign currencies is not very prudent from a risk point of view. This is why there are restrictions on such lending in many countries. This might have been advisable in Iceland also, although the EEA and EU legal framework would have made it difficult to enforce such rules.

Rules Meant to be Thwarted: The banking community and the business community at large had a tendency to consider the letter rather than the spirit of the law as setting the boundaries for their actions. Here they were helped by a fair number of diligent legal advisors and international financial consultants. Complicated legal structures and webs of holding companies were established to circumvent many of the restrictions in banking and company law.

Global Context: When judging the reasons for the Icelandic banking crisis and the events leading to it, one should not forget the international setting in which it happened and which made it possible. It would not have been possible without the overall laxity in the global financial markets and the bubbles it produced, which were bound to burst at some point in time. When greed gave way to fear and the bubbles started bursting, there was no way the Icelandic banks could have been saved. This is not to say that Icelandic banks were innocent victims of the circumstances. They made the gravest mistakes themselves by going along with the global euphoria and forgetting that conquering the world is not possible without a strong home base and own resources. The nation, up to its highest echelons, supported and admired the banks, and many are still in a state of denial regarding their own part in this tragedy. The CBI and the FME tried to raise words of caution, but it was too little and too late, and it is doubtful whether they could have stopped these developments even if they had had the power to do it.

The report ends with recommendations, including:

• Solve the problem of inflation-indexed loans
• Reduce or eliminate the influence of HFF
  
• Decrease the number of government ministries involved in regulating the financial market
• Create a credit reporting agency to score creditworthiness and overall exposure of individuals and businesses
• Give more discretion to the FME
• Actively cooperate with other international banking regulators and central banks

You can read a PDF of the report here.

inflation

Ask an Icelander on the street (or in my office) what the inflation number is so far in 2009, and they'll quote you something in the range of 15-20%. That's because the most-often quoted inflation number is for the trailing 12 months. The current number quoted by Hagstofan (or "Statistics Iceland" as they call themselves somewhat demeaningly in English) is 15.2% for the 12 months through March 2009.

However, dig a little deeper and a quite different picture emerges. That 15.2% headline number includes the October-December 2008 period when Icelandic inflation was roaring like a mighty lion. The Icelandic króna lost much of its value in October and that meant that the prices of everything Iceland imported (a lot of what it consumes) went through the roof overnight.

However, Iceland is in a serious recession and recessions are almost always deflationary. Meaning, prices tend to go down. This only makes sense: clothing stores put jeans on sale to clear out inventories (sometimes even at a loss), out-of-work painters suddenly want to come do your whole house for less than they would have charged last summer, and even movie theaters start having special 2-for-1 ticket deals. All of these things are happening in Iceland: at long last prices are coming down.

So, looking at just the first 3 months of 2009, the annualized inflation is a meagre 1.94%. This is far below what Icelanders have become accustomed to in recent years, and is also under the Central Bank's inflation target of 2.5%. Not only that, but between the months of February and March, prices actually fell by 6.9% at an annual rate! I say this with the caveat that annualizing (and thus extrapolating) short periods is fraught with danger, and whether this trend continues into the summer is anyone's guess. However, deflation is the watchword in America and Europe these days, so the prices of goods Iceland imports could continue to fall, adding to the pressure on struggling Icelandic merchants to mark down their prices.

So, contrary to orðið á götunni ("the word on the street"), I believe that Iceland is in for a period of noticeable deflation, or at the very least, price stability. And this would at last be some good news for those holding inflation-indexed króna loans.

Play with the data yourself here and tell me what you think. Also, more info on the March numbers is here and a good FAQ on the Icelandic CPI, including recent changes to the way cars and package holidays are priced, can be found here.

michael lewis

...recently wrote a fairly "incendiary" piece on Iceland for Vanity Fair magazine, in which he said, among other poorly researched misstatements, that Icelanders were routinely blowing up Range Rovers on the downtown streets. Apparently they were doing this to their own cars to collect insurance money, a scenario that doesn't really make all that much sense after a few moments of reflection. Maybe he deduced this when a kid set off a firecracker (fairly common) outside the downtown bar he was drinking at and someone next to him wryly joked that it was a high-end car getting the torch. He took the man seriously, and built the first section of his article around a falsehood.

The Range Rover story that started out as a cynical Icelandic joke has however taken on a life of its own in the American media. Now Fox News is warning that Iceland is a dangerous place to travel, and even staid old NPR is in on the action, apparently repeating the meme without any further reporting of their own. My dad quoted the NR story to me as though it were fact. Meanwhile, there have not been any cars, overpriced/ugly British SUVs or otherwise, set alight on the quiet streets of the village that is downtown Reykjavík.

Why would a guy like Michael Lewis, an author who I respected for Moneyball - and who does indeed have some good insights in this piece as well, start off his article by painting such a distorted picture of the country he came to report about? Is it perhaps that he came to the place expecting to see a certain level of panic, destruction, and despair, and in fact found nothing of the kind? Did he or his editor feel the urge to invent violence where there was none to be found, perhaps to draw the American audience in to what might otherwise have been a fairly boring piece? Or was it just hard for an American to visit a country that is facing exponentially bigger economic woe than his native land, and yet in which people are managing to live their daily lives with a level of calmness and grace that American society doesn't possess in the best of times?

And if this much out-and-out untruth is being spun out in the world about Iceland, a Western country that is easy to access from both the U.S. and Europe, how can I really believe much of what the news media reports on more far-flung corners of the world?

two great tastes that go great together

Wow. I have just stumbled into greatness. Part of our evening meal plan tonight was fiskibollur (literally, fish-balls), the homemade-tasting kind that seem to only be available at weekend Kolaportið. These are made of tiny fish molecules blended with some kind of meal, usually white flour, and then deep-fried before they are frozen. I split the bollur into halves and then pan-fried them in their own oily juices. They got nice and brown and crispy on both the outside and the moist inside.

When I sat down at the table with a bowl of these fresh-fried delicacies and smelled their intricate wafting flavors, the thunderbolt struck. Something about the way they smelled reminded me of potato pancakes. And, since you can take the man out of New England but you can't take the New England out of the man, well the next step was logical. And by that I of course mean maple syrup.

We have a huge plastic jug of Massachusetts Maple in the fridge, and after the standard de-thread-locking under the hot water tap, I was good to go. I brought the whole gallon jug over to my plate and poured a nice little pool next to the golden-brown and gently oily fiskibollur. I mopped syrup onto the little pancake with the ease and skill borne of more than 30 years of American breakfast-eating practice.

On the first bite, I was in heaven. These two tastes have probably been waiting 1000 years to be brought together on the same plate, on the same fork, in the same mouth. It was brilliant. It was sweet and salty, all in one. It was home fries, Iceland style. It was the first item on the menu of that longstanding diner of dreams. Breakfast may never be the same.

Now go try it.

the putative red sox fan

There's a guy I see almost every day at the school where I work. He's a student, but unlike the other Icelandic students around him, he's always attired in 90s-era American college gear: baggy plaid shirt, jeans, and a baseball cap. And the cap is always a blue cotton "B" hat with the "hanging sox" logo stitched on the back.

Now, it's not often in Iceland that one sees the good ole "B" hat, the uniform of many a modern MBTA rider. Just like everywhere else in the world, in Iceland the "NY" swastika is ubiquitously stitched onto caps and jackets: that marquee of a dying club sported by clueless locals who, when pressed, thought that they were just supporting "New York" in general. Much like a lot of that team's in-city support, these people aren't remotely fans of baseball, the game. And that team logo has been printed so much it's lost most of its value. Kind of the Icelandic króna of sports graphics.

But on the other hand, the "B" logo: now that's the mark of quality. That's the mark of a person who knows who he is and where he is in life. The wearer of the "B" hat belongs to a select group, an inner circle that can recognize its own members the world over.

After months of not having a good shot to talk to my Icelandic twin, I finally ran into this guy in the hall today. I was ready to make the connection. I smiled and said, "Great to have another Sox fan in the building."

"Huh?"

"The Boston Red Sox, the baseball team?"

"I'm not a baseball fan, no."

"So how come you're always wearing their hat?"

"This is just a comfortable hat."

So much for the tight-knit international brotherhood.

...but he did tell me he's tried three times to see a game at Fenway, but the boys haven't been in town when he has. So there is some hope yet.

Also, this isn't the first time I have written about the Olde Town Team. Related posts from the IR archives: nation expands 2004 fan promise

first beer

Today is the 20th anniversary of a special day in Icelandic history. Twenty years ago today, on the first of March, 1989, just months before the fall of the Berlin Wall, Iceland legalized the sale of beer. Before that, in keeping with its schizophrenic policies on alcohol, the country did not allow any regular beer to be sold. The reasoning seems to have been that, if beer was legal, people would just sit around drunk 100% of the days and no fishing or aluminum smelting would ever get done.*

Hard alcohol was allowed, because apparently people couldn't drink so much of this as to get drunk. Because it was just too strong, I guess. Of course they did. They also took shots of this hard booze and mixed it with the Utah-style low-alcohol beer that was legal for sale here (locally referred to as "pilsner", in an unintentional insult to the Czechs and their best-í-heimi beer making mastery) to make a sort of beer-like concoction. This, also, was legal. In fact, one downtown bar (don't look for it, it's not there anymore) called Gaukur á stöng made its name selling this reconstituted near-beer-vodka-combo. It tasted about as good as it sounds, apparently.

Of course, twenty years on the populace doesn't sit around drunk 100% of the days. In fact, with the legalization of beer, the consumption of hard liquor dropped appreciably. (Around 30%, according to tonight's "remember when" TV special.) And of course, the consumption of beer did go up: it really couldn't do any less. And now, after another 20 years, microbreweries have started to spring up and Icelanders are at long last beginning to make the next transition: the one from "any beer" to "tasty beer".

*But before you laugh at the naive Icelanders and their irrational fears, think for a minute. Isn't this the same reasoning for pot and cocaine still being illegal in many places?

first flight

Now, for something completely different: Yesterday marked the beginning of the paragliding season for me. This is a sport that, although is pretty much undisputably the best way to spend time outside of the bedroom, has only become really popular in Alpine Europe and some other pockets around the world.* That is probably because it is a new sport, having been developed in the 1980s and with advances in equipment this decade that have made it safer and more accessible.

Iceland has a small following of just about everything one could imagine, and this includes the sport of paragliding. We have around 30 local pilots, and (but of course) an Icelandic-language name for the sport, svifvængjaflug. The Land is itself somewhat of an untapped paragliding paradise, what with treeless landing areas almost every way you look, and mountain launch sites and soaring ridges leading off in all directions.

I am new to the sport, having taken my first lessons here last summer. After a few evenings of struggling with the wing (which when not inflated basically amounts to a big floppy bag of high-tech cloth) on level ground, I was able to take some small runs down a training hill, gaining a few feet of altitude. It doesn't take long to learn the basics. Then it's off to one of the foothills that surrounds Reykjavík for the first flights of more than a few seconds.

The group that met yesterday on top of Hafrafell, the local flying site, were some of the "young bloods": a handful of pilots with a few months to a few years of flying experience. Some of them had already been over at Bláfjöll, one of the local ski areas, where they had epic winter soaring flights. When that taller mountain clouded over, the party moved north a few clicks to Hafrafell. There was the usual top-of-mountain wind-measuring, cloud-scrutinizing, and smack-talking. And then one by one we unpacked our wings and flew down.

My flight was a classic "sled ride", meaning a straight, smooth glide to the landing area. There was no wind blowing up the slope to provide any ridge lift that would keep me aloft. So gliding down through 145 meters (475 feet) of clear, still air took me all of 2 minutes. Leaning from side to side in the seat makes the wing overhead steer in big lazy turns, and I was practicing this weight shifting in my new harness. A couple of these slow turns, a straight final approach, and the wing set my feet gently down among frozen clumps of pasture grass. It was like stepping out of the sky into a winter field. The whole thing lasted only 120 seconds or so, but I will be savoring that string of mental snapshots long into the week.

*Americans, as an example, seem to hear the word "paragliding" and imagine getting dragged around by a motorboat, floating under a WWII Army surplus parachute. Sorry, not the same thing, fellas. (That's "parasailing.") But the sport is practiced there too, see for example this site.