It is still unclear to me at least how Iceland’s banking sector became so exposed to global currents that its collapse is threatening the whole of Iceland. While the global financial crisis is having reprecussions across all corners of the world, no where is the pain being felt harder across an entire nation than in Iceland. Iceland is a small country that in the last 30 years became quite wealthy and as Iceland became wealthier, its banks grew. But Iceland has 250,000 or so people. It’s a tiny market and so Icelandic banks in order to grow more expanded overseas and they expanded aggressively into the British Isles. Therein probably lies their downfall. But the issue now is that the collapse of the Iceland’s banks, the three largest have failed, is threatening to subsume the whole of the Icelandic economy and the people of Iceland with it.
Let’s start with the background as noted Simon Watkins in the Financial Mail who noted back in March 2008 that the Credit Default Swaps premiums on Icelandic bank were astronomical.
CDSs are quite simple. They are contracts that allow someone who owns bonds issued by a company to insure themselves against it defaulting. The price of CDSs is measured in percentage points and is essentially a price for insuring debt.
For example, CDSs on Lloyds TSB are priced at about 1.33%, or 133 basis points. That means anyone with £10m of Lloyds TSB bonds could insure against it defaulting for £133,000 a year.
These prices move constantly because there is a market in CDS contracts, so watching the figures gives an idea of just how risky the market thinks a bank or any other company is. The higher the figure, the higher the risk.
Lloyds TSB has low exposure to US mortgage market toxicity and its 133-point figure is one of the lowest among banks. Most are in the same ballpark. Barclays, for example, is at about 170 basis points and HSBC 145.
To get a sense of what is a bad figure, let us take Bear Stearns, the bank that needed an emergency bailout last week. In the days and hours before the crisis hit Bear Stearns, its CDS price hit 720 points.
The message being sent out by the credit markets was clear – the bank’s debt is very high risk.
So what are the other interesting figures? In the UK it is worth noting HBOS (Halifax Bank of Scotland). Its CDS price was about 235 points last week, a long way from seriously worrying but markedly higher than most other British banks.
This reflects its high mortgage exposure in the UK, its relatively high exposure to certain types of near-prime mortgages in the US and its slightly higher dependence on financial markets to fund lending.
More risky is Alliance & Leicester, whose price was about 342 points last week, again reflecting its high dependence on wholesale financial markets, which have become frozen in recent months. But the real horrors are in Iceland.
Credit insurance for debts at Iceland’s biggest bank, Landsbanki, is priced at 610 points while that for Kaupthing is priced at a hair-raising 856. Given that these two have taken billions in UK retail deposits, it may be a sobering thought for savers to consider where they are putting their cash. These banks are now seen as the most unsafe in the developed world.
That was in March 2008. Landsbanki, Kaupthing and Glitnir have now all failed. Below the fold a few more reports on how far-reaching the crisis is in Iceland and the lengths to which Iceland is going to save itself from a total economic collapse.
Reykjavik Battles to Save Economy
By David Teather in the UK Guardian.
The Icelandic government last night presented an emergency bill giving it sweeping powers over the nation’s banks, to save the country from financial ruin.
In an address broadcast on Icelandic television, prime minister Geir Haarde said the bill, supported by opposition parties, would allow the government to push through mergers between the battered banks or force them into bankruptcy.
The fate of Iceland, which has extensive interests in the UK, has been seen as a warning sign for the rest of the world, after a long boom fuelled by debt, a dependence on its banking industry and a buoyant housing market.
Haarde, who had spent the weekend in intensive talks, made it clear how urgent the need for action now was. “As recently as last night, it looked like the banks could continue operations for a while,” he said. “This morning and today, things have totally changed for the worse.” Time appeared to be running out for Iceland to deliver a solution to the financial crisis yesterday as its currency, the krona, slumped 30% against the euro.
The emergency bill, which parliament was due to adopt last night, would also allow the government to take over housing loans held by the banks.
The financial regulator had earlier suspended shares in Iceland’s main banks to prevent panic selling. The government also followed Ireland and Germany by guaranteeing all domestic deposits in Icelandic savings accounts, although UK savers in the popular Icesave and Kaupthing Edge accounts run by the Icelandic banks will not be covered.
Concerns about the Icelandic economy grew stronger last week after the government seized control of the third largest bank Glitnir, taking a 75% stake in return for €600m (£466m) – Haarde warning Icelanders at the time of “the inevitable cut in living standards” to come.
Financial Crisis: Iceland’s Dreams Go Up in Smoke
By Andrew Pierce in UK Telegraph.
Iceland had ousted Norway from the head of the UN’s league table of 177 countries that compared per-capita income, education, health care and life expectancy – which, at 80.55 years for males, was third highest in the world.
This was only one in a string of glowing assessments of a country (population 313,000) which had pulled off a modern-day economic miracle. No wonder they are also said to be the happiest people on the planet. The inhabitants of this newly discovered Utopia, with its much-admired free health and education systems, bought the most books, owned most mobile telephones per head, and included the highest proportion of working women in the world.
Iceland had also presided over the fastest expansion of a banking system anywhere in the world. Little did anyone know that the expansion once so admired would go on to saddle the country with liabilities in excess of $100 billion – liabilities that now dwarf its gross domestic product of $14 billion.
Iceland overreached itself in spectacular fashion, and the party is coming to a messy end.
Iceland Government Seizes Control of Landsbanki
By David Teather in the UK Guardian.
The Icelandic government this morning seized control of Landsbanki, the second-largest bank in the country, and sought to secure a €4bn loan from Russia as it worked to avert a financial meltdown.
The government moved quickly to use sweeping powers over the country’s banks granted in the Reykjavik parliament last night. The board of directors at Landsbanki has been dismissed and the bank put into receivership. The government has also loaned €500m to Kaupthing, the biggest bank in Iceland.
UK savers trying to access their Landsbanki-run Icesave accounts this morning were faced with a message telling them the bank was unable to process requests for deposits or withdrawals. Icesave offered competitive rates and has more than 200,000 accounts in the UK. The first €22,000 (roughly £17,000) held in the accounts is secured under an Icelandic compensation scheme, and the remainder up to £50,000 is guaranteed by the British government.
On state radio, commerce and banking minister Bjorgvin Sigurdsson sought to reassure people in Iceland that the bank would remain open and continue to run as normal.
Iceland Seeks Emergency Loan From Russia
By Julia Werdigier in the New York Times.
Iceland said Tuesday that it was seeking a $5.4 billion emergency loan from Russia, had pegged its currency to an index and had taken control of one of its largest banks as the North Atlantic island struggled to keep its economy afloat.
Iceland’s prime minister said the talks about a loan began “some months ago.” But the situation of the country’s banks and economy deteriorated so rapidly over the last two days that a loan agreement became urgently needed.
Details of the loan discussions remained unclear on Tuesday as Iceland’s central bank said it had a confirmation from Prime Minister Vladimir V. Putin of Russia that a loan would be granted while a deputy Russian finance minister, Dmitri Pankin, told the Interfax news agency that no decision had been made.
Iceland said Russia, home to some branches of Icelandic banks, would grant the loan for the next three to four years with an interest rate of up to half a percentage point above the interbank lending rate.
For Iceland, the loan is necessary to strengthen foreign exchange reserves and support its currency, the krona, which dropped more than 30 percent against the dollar in the last month alone. For Russia, a loan would be a way to show its financial power and willingness to help distressed economies.
All this is nothing but stunning. I have plans to be in Iceland in 2009, it will mark my third trip to the country.