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Iceland’s special investigation: The plot thickens

What brought down Iceland’s banks? This column examines the revelations from the latest report from the Icelandic parliament, raising the possibility that the collapse of Iceland’s three largest banks is the result of “control fraud” where shareholders stole from their own bank in the same way as those convicted of looting from the American saving and loan banks in the late 1980s.

The recently published nine-volume, 2,400-page report from the Icelandic Parliament‘s Special Investigation Commission (SIC, appropriately pronounced sick) is not an attempt at whitewash as many had feared. Those fears arose from the government’s unwillingness to appoint an international commission of enquiry as proposed by Professor Robert Aliber (see Aliber and Zoega, forthcoming) and others, including myself. Rather, the report confirms, and documents in detail, what many of us thought we already knew (Gylfason et al., 2010, Ch. 7). The report states: “Explanations for the collapse of Glitnir..., Kaupthing …, and Landsbanki … are first and foremost to be found in their rapid expansion and their subsequent size when they tumbled in October 2008.“ Further, the report states (see the report’s English version Special Investigation Commission 2010):

  • “The largest owners of all the big banks had abnormally easy access to credit at the banks they owned, apparently in their capacity as owners. ... in all of the banks, their principal owners were among the largest borrowers.”
  • “When the bank [Glitnir] collapsed, its outstanding loans to Baugur and affiliated companies amounted to ... 70% of the bank’s equity base.”
  • “When Landsbanki collapsed, Björgólfur Thor Björgólfsson and companies affiliated to him were the bank’s largest debtors. Björgólfur Guðmundsson [his father] was the bank’s third largest debtor. In total, their obligations to the bank ... [were] higher than Landsbanki Group’s equity.”
  • “During a hearing, an owner of one of the banks [Mr. Guðmundsson], who also had been a board member of the bank [Chairman of the Board, in fact], said he believed that the bank “had been very happy to have [him] as a borrower”.” (I am not making this up.)
  • “The operations of the Icelandic banks were, in many ways, characterised by their maximising the interests of the larger shareholders, who managed the banks, rather than running solid banks with the interests of all shareholders in mind, where due responsibility was demonstrated towards their creditors.”
  • “In 2008 the banks were buyers on average in 45% of cases of automatically matched trades in their own shares. In comparison they were sellers in less than 2% of cases of automatically matched trades during the same period. ... all the banks in this manner attempted to elicit abnormal demand for their own shares.”
  • “At the beginning of 2006, ... all the prerequisites for a financial crisis were in place.”
  • “It has been established that until just before the collapse of the banks [in October 2008] there was little discussion within the Icelandic government of the bank’s standing and of the liquidity crisis which began towards the end of summer 2007.”
  • “When the ministers intended to improve the image of the banking system by partaking in public discussions, mainly abroad, it was done without any assessment of the financial capability of the state to come to the banks’ assistance and without information being available on the cost of a possible financial shock.”
  • “… when the banks collapsed there was no joint governmental contingency plan available.”
  • “In a letter to the Investigation Commission, Stefan Ingves, Governor of the Central Bank of Sweden, makes it clear that unclear ownership, along with the banks’ rapid balance sheet growth had led to a dangerous situation and that the Icelandic government did neither seem to fully grasp nor understand how to deal with it.”

The report concludes by identifying three former ministers and three former central bank governors as well as the erstwhile director of the Financial Supervision Authority who “showed neglect” in the exercise in their duties.

Control fraud?

The language of the SIC report is guarded. It uses the gentle word “neglect” to refer to what might more accurately be called gross dereliction of duties. Let us not forget what happened on the authorities’ watch. Not only did Iceland’s three main banks accounting for 85% of the country’s banking system collapse within a week, but much of the remaining 15% of the banking system went the same way as did other important concerns that had to be propped up at taxpayers’ expense. Assets equivalent to seven times Iceland’s GDP went up in smoke, including foreign creditors’ claims equivalent to five times GDP. Foreign shareholders and some foreign depositors also took a hit. Icelandic residents lost the equivalent of two times GDP. No other country has ever caused such damage relative to its own size, at least not in peacetime.
At this stage it must be left to the reader and ultimately to the courts to determine whether the facts reported by the SIC suggest that the Icelandic banks were brought down by control fraud as defined by Black (2005) or by their “their rapid expansion and their subsequent size” per se. If the banks were looted by their owners with the assistance of politicians, there would be no mystery about how they did it: they would have used the same methods as the convicted criminals who looted the American saving and loan banks in the late 1980s. More than 1,000 elite white-collar criminals (not counting tellers and minor players) were convicted of felonies arising from the S&L debacle. Their methods are described in Akerlof and Romer (1993) and Black (2005).

Smörgasbord of the shareholders

The SIC chose to focus its attention on the role and responsibility of the government in the events leading to the crash and to steer around the question of the banks’ “possible criminal conduct.” Even so, the report clearly states that the banks broke laws. The Danish bank director Jørn Astrup Hansen writes (vol. 2, p. 313, my translation): “The banks not only broke the law but they also exceeded their own limits, or moved the limits as needed.”
Mr. Hansen goes on to add (pp. 317-318): “Three relatively large banks could easily have serviced even the largest firms in the country without breaking the most important rule of the banking legislation stipulating that the individual loan obligations must not exceed 25% of the bank’s risk capital. … The Icelandic banks broke this rule. … All three banks applied especially unhealthy methods involving loans to finance purchases of their own equities with the equities themselves as sole collateral. The method and scope of such loans to finance purchases of the banks’ own equities after October 2007 became such that they must be presumed to have constituted a violation of the law. … The five largest shareholders in the banks were also their five largest customers. Largest by far! As if that were not enough, they also sat on the banks’ boards or had representatives there. This arrangement seemed, to say the least, dubious. The danger of favouritism and self-dealing looms large.”

More gold, anyone?

The SIC was granted full access to the records of the banks. Thus, it was able to report that, of 63 Members of Parliament, ten owed the failed banks €1 million or more each at the pre-crash exchange rate of the króna; their personal debts range from €1 million to €40 million. The average debt of the ten MPs, including the leader of the Independence Party, his deputy, and five other party comrades, was €9 million. (This is not a misprint.) The Independence Party has been in government 90% of the time since 1944. Most of these loans were heads-I-win-tails-you lose as they were granted mostly to finance equity purchases with the equities themselves as sole collateral. Besides, the banks and affiliated companies had paid the political parties and candidates large sums before the crash.

Further, to understand what happened in Iceland, it helps to know the following (some of this information is not included in the SIC report, but has been reported in the Icelandic press):

  • Two Icelandic brothers who produced TV dinners for export became bank shareholders, and went on to buy themselves a yacht that used to belong to Giorgio Armani.
  • Another bank owner bought himself a penthouse in Manhattan, but – this is actually in the SIC report – the bank “forgot” to ask for collateral.
  • At a small dinner party for favoured bank clients on the Riviera, where Tina Turner stood for the music, the main course was sprinkled with – you couldn’t possibly have guessed this one – gold flakes.
  • And then there was the dinner party in Reykjavik where singer George Michael had been scheduled to land on the glass roof in a roaring helicopter, but to the great embarrassment of the bank’s director of entertainment the plan fell through.
  • One of the bank owners, the afore-mentioned Mr. Guðmundsson, declared bankruptcy in 2009 to the tune of $750 million, of which $500 million is owed to the bank he owned and directed. Not even Texas has seen a personal bankruptcy of such proportions.

What happens next?

The SIC has referred a number of cases or issues to the Special Prosecutor’s Office where an independent assessment will be made as to whether charges will be brought against the bankers and the four civil servants. Parliament will decide whether to press charges against the ministers; if it does, it must convene Landsdómur, a special court designed to determine whether ministers have broken the law. If Landsdómur is convened, as appears likely, it will be the first time in the 66-year history of the republic. If some or all suspects are found guilty, the constitution permits the President of Iceland to pardon the bankers and the public officials, but a presidential pardon of ministers found guilty by Landsdómur would have to be affirmed by Parliament. We are not in Kansas anymore.


Akerlof, George A, and Paul M Romer (1993), “Looting: The Economic Underworld of Bankruptcy for Profit“, Brookings Papers on Economic Activity 2:1-73.
Aliber, Robert Z, and Gylfi Zoega (eds.) (forthcoming), Preludes to the Icelandic Financial Crisis, Palgrave, London.
Black, William K (2005), The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry, University of Texas Press, Austin, Texas.
Gylfason, Thorvaldur, Bengt Holmström, Sixten Korkman, Hans Tson Söderström, and Vesa Vihriälä (2010), Nordics in Global Crisis, The Research Institute of the Finnish Economy (ETLA), Helsinki, Finland.
Special Investigation Commission (SIC) (2010), “Report of the Special Investigation Commission (SIC)”, report delivered to Althingi, the Icelandic Parliament, on 12 April.

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