Iceland’s Freezeout

So how did the li’lest economy get frozen first?

So Iceland’s economy is facing an interesting shock, first banks failing and now foreign currency reserves running out.

How they got there is interesting, and also a pointer to how they’ll get out.
(this is my perspective, from the outside, I am not a financial analyst)

Iceland deregulated in the late 80s and 90s, moving from an economy hinged on a single line of export, to an aggressive modern anglo-american style post-industrial economy, tech heavy, and heavily leveraged making aggressive finanical investments in niche markets.

Iceland got very rich. Or some people did, wealth disparity increased to a level not seen since danish monopoly merchants strutted around Reykjavik.
There was also a lot of trophy investing – big name danish shops (like foreigners buying Harrod’s in the UK), UK football clubs – but the money continued to be made, even off the danish investments after some modern management was introduced and the work ethic improved ;-)

So… how did the Icelandic banks get trapped in the current crisis?
The underlying reason is high leveraging, the big investments were made with cheap money – the proximate reason, at least so far, is liquidity not solvency, the money was made but is not churning to serve the loans.
The money… it was reinvested (ok, sometimes in Surrey mansions and very fine bordeaux cellars) and kept out there, not cashed out. So the property and the profit is highly illiquid. The bills were paid, modern style, with rolling lines of credit, not cash reserves. The trigger for the current panic was Glitnir losing their short term lines when Lehmans went under, and because of the US crisis, nobody wants to lend.
So the Icelandic banks are solvent, they own assets, but they are illiquid, they can’t get cash to serve short term obligations.

There is an immediate solution, which is what seems to have been negotiated under the table, because the government just announced there would not be a formal bailout package this weekend beyond extending an individual depositor guarantee – everyone in Europe has to do that, because the Germans blinked and now everyone has to follow suit.
The solution is repatriation of assets to provide foreign currency and cash – in particular the pension funds, which are heavily over capitalized are selling assets and moving money back, and, it has also been suggested to the banks that they should pull back and liquidate assets.
To convince them to do this, which will cause losses because of distressed sales, I presume the government:
a) appealed to the companies patriotism and love of the greater good. Heh, just joking.
b) hinted at restoring 70s era currency controls and banning unnecessary or frivolous purchase of foreign currency
c) pointed out to them that the alternative was bankruptcy, seizure of their assets and eternal scorn of their cousins and neighbours, even if they stayed in the second home in Surrey

This will work, for now, and may work long term – there will be opportunity losses and real losses of profit, but the currency reserves will be restored and people out there will still buy fish, especially since everyone else has destroyed their stocks – so Iceland recapitalizes, with hard cash, over the next decade or two.

An alternative long term solution is to abandon the króna and go into the
eurozone – but, I think that window is closed, it was briefly open and Iceland wouldn’t join, for reasons that hold true. Basically asset owners, merchants and people living on unearned income in Iceland want the Euro adopted, but exporters and labourers would probably be better off without the Euro.
Point is moot though, the EU is not opening any doors, too much risk of those inside deciding to leave…

Comments

  1. #1 csrster
    October 6, 2008

    Colour me ignorant, but how do you liquefy assets during a global credit crunch when nobody has any money to buy them?

  2. #2 dane
    October 6, 2008

    “There was also a lot of trophy investing – big name danish shops (like foreigners buying Harrod’s in the UK), UK football clubs – but the money continued to be made, even off the danish investments after some modern management was introduced and the work ethic improved ;-)”

    I suppose this is the sort of delusional nonsence you like to believe. The reality is that icelandic investments in Denmark have been a story of disaster and incompetence. The pinnacle of stupidity was reached, when they tried to run a free add financed newspaper (Nyhedsavisen), at a time when no fever than four other papers were fighting for the same market.

    “This will work, for now, and may work long term – there will be opportunity losses and real losses of profit, but the currency reserves will be restored and people out there will still buy fish, especially since everyone else has destroyed their stocks – so Iceland recapitalizes, with hard cash, over the next decade or two.”

    Fishing boats need fuel, and you will pay for that how exactly? Not only are you broke, but your island is litterally a few months away from famine.

  3. #3 Alex
    October 6, 2008

    Jesus, things get weird.

    ISTR a major (but very rarely discussed) cause of the great influx of wholesale capital was the existence of a Soviet-era treaty with Iceland that provided Russian investors with tax advantages. Cyprus has a similar one, and also received tonnes of Russian ill gotten gains. Perhaps the Russians…actually, that’s a REALLY bad idea. (cranes neck into grey skies looking for Tu22M3s)

  4. #4 Andrew
    October 6, 2008

    With fish futures I imagine. Just like fishing companies and boats do now and just how the rest of the commodities market (mining, refining, agriculture etc) functions. :p

  5. #5 Eric Lund
    October 6, 2008

    @csrster: You can still sell assets to somebody who has cash. Of course, there aren’t many in that category, and they would probably make you accept a smaller price than you would like. But if the assets are truly worth having, there will be a buyer out there at some price.

    Lesson: Leverage is a great thing when asset prices are going up. When they’re going down, you get wiped out that much faster.

  6. #6 Brad
    October 6, 2008

    Amusingly, I just read the following on Iceland’s rescue package.

  7. #7 Steinn Sigurdsson
    October 6, 2008

    Oh boy.

    1) Grauniad has another good article on the situation at Reykjavik Battles

    2) Alex: any suggestion that loose oil rubles might have come through Iceland at critical times and encountered any soap and water enroute doe not lead to Tu22M3 visits, but rather squadrons of our learned friends wearing gowns and silly wigs, armed with the UKs finest ancient libel laws.

    3) If I were the head of a pension fund in Iceland, and I am not, and the government were to “suggest” (backed by the new draconian insta-financial regulation laws) that some foreign investments be repatriated, then I would sell my US Treasuries, first, people want to buy them, they earn no interest, and use the sale proceeds to buy short term Icelandic government bonds, currently earning about 15%.
    I’d then take a long hard look at Eurobonds.
    Equities I’d try to hold on to, since their planning horizon is ~ 20 years, but some could be sold if suitable vulture bidders could be found.
    Hang on to commercial paper and foreign muni bonds, for the income stream and hope there is not too much toxic crap mixed in that will default short term.

    That would bring back maybe $5 billion to the currency reserves on a time scale of days.

    The Icelandic investment banks just have to wait for the derivatives to unwind, then they’ll know if they are bankrupt or rich again – if they can roll short term credit and obligations through fast enough and for long enough.
    All the investment banks have this problem, not just the Icelandic ones.

    Note that the assets/obligations of the banks are ~ 10 times the Icelandic GDP, but the net obligation will be much smaller.
    And, the US banks, as I read it, have $62 trillion exposure just to credit default swaps, several times the US GDP. Their net exposure is thought to be 1-3% of the gross, so they are looking at potential losses of $600 billion to $2 trillion.
    On a per capita basis, the nationalization of Glitnir was about the same size as the current US bailout costs.

    4) Iceland won’t starve: a) us silly monkey know how to grow bananas
    b) I’d personally fly some spaghetti back home
    c) Iceland is a food exporter, we can live on haddock, lamb and sky, again. Most of the fish caught for domestic consumption is caught by shallow water small boats, not deep sea trawlers. Less than 10% of the annual catch would comfortable feed the whole country indefinitely. The fishing fleet uses a small fraction of the oil imports. I think we could scrape enough $ together to import 1-2% of the current oil imports, maybe Norway or Venezuela would give us credit.
    Oh, and we still know how to use sails, and enough boats could be converted to LH2 or NH3 boilers to keep us fed, if needed – at enormous cost of course.

    5) Nyhedsavisen – at one point the most widely read paper in Denmark – was set up by Baugur – they sunk about $10 million into it, and they sold their stake to Lund before it went bankrupt.
    Baugur have (had) shitloads of cash, and have been prone to “trophy investments” – they were in fact the example I had in mind.
    But not Nyhedsavisen, that was a risky venture into a crowded and lucrative field, note thar Lund reportedly tried to buy 24timer for $80 million, according to wiki anyway.
    Baugur bought Illum, and House of Fraser. That cost real money. It is also why they have cash flow problems – they invested aggressively and are asset rich but cash poor.

    Illum, by the way, was much nicer and more customer friendly after they bought it.
    Even had decent coffee.
    I am semi-reliably informed that the initial decision to purchase Illum was pure nostalgia and trophy shopping.

  8. #8 Emory Kimbrough
    October 7, 2008

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