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Iceland fends off hedge fund attacks

By David Ibison in Stockholm

Published: April 18 2008 03:00 | Last updated: April 18 2008 03:00

Iceland's aggressive moves to fend off an alleged speculative attack by international hedge funds on its currency, banks and stock market seem to be working.

The cost of insuring the debt of the country's banks in the credit default swap market fell sharply this month, indicating that hedge funds were taking flight, analysts said.

The Icelandic Financial Supervisory Authority is investigating an alleged speculative attack involving manipulation of the CDS market and distribution of misleading information.

The announcement of the investigation was co-ordinated with an emergency interest rate increase by the central bank and measures to inject liquidity into the financial system.

Geir Haarde, prime minister, made clear he would defend the financial system with all the tools in his armoury, including issuing government bonds to boost foreign exchange reserves and co-ordinated action with other Nordic central banks.

According to Glitnir Research, an arm of Iceland's Glitnir Bank, since the authorities started to fight back CDS spreads on the country's three main banks have dropped from their peaks at the end of last month.

It said the five-year CDS level for Kaupthing was 710 basis points, down 340 basis points from its peak; Glitnir's had fallen by 280 basis points to 720 basis points; and Landsbanki's by 400 basis points from 800 basis points.

Spreads on the debt of Iceland itself have fallen to 260 basis points, compared with 410 basis points at the beginning of April.

"It is clear that, if this turnaround is permanent, the Icelandic government may enjoy acceptable credit terms before long," said Glitnir Research.

But while Iceland declared, in effect, an end to the speculative attack, Standard & Poor's, the credit rating agency, cut its sovereign rating for the country.

It reduced its long-term foreign currency rating to A from A+ and put it on negative outlook, citing concerns over banks' reliance on external funding.

"The banks' higher funding costs, combined with the recent 27 per cent depreciation of the Icelandic krona, increase the chances that the economy will contract more and for a longer period than we had foreseen," S&P said in a statement.

Fitch and Moody's have placed Iceland's sovereign rating on "negative", but all three agencies have been criticised for putting the country on a "ratings rollercoaster" by consistently changing their outlooks.

Iceland has the highest interest rates in Europe after the central bank raised them by 0.5 percentage points to a record 15.5 per cent last week as it strove to restore confidence in the struggling currency and quash fears of a banking crisis.

Copyright The Financial Times Limited 2008

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Do not be alarmed by Icelandic whispers

By Wolfgang MĂźnchau

Published: March 30 2008 18:55 | Last updated: March 30 2008 18:55

Some report elsewhere whatever is told them; the measure of fiction always increases, and each fresh narrator adds something to what he has heard. (Ovid, Metamorphoses)

Vicious rumours recently almost drove a British bank off a cliff. Could that happen to a country? Probably not to the US, the UK or Germany. But it could happen to a small country of which most of us know little. In fact, last week it almost did happen to one when Iceland’s krona once again came under speculative attack, prompting the country’s central bank to raise interest rates by 1.25 percentage points to 15 per cent.

Iceland has been subject to periodic crises, one in February 2006 and another one recently, after Moody’s downgraded its sovereign rating from stable to negative. Yet this is the same agency that lifted the ratings of Icelandic banks by several grades to AAA, on the spurious grounds that they enjoy an explicit bail-out guarantee by the central bank.

An important element of the latest speculative attack was a massive rise in credit default swaps of Iceland’s largest banks – to more than 1,000 basis points in one case. This means that you pay $1m per year to insure a corporate bond of $10m. If these ratings were even remotely justified, then surely Iceland’s banks should be considered as effectively insolvent.

Are they justified? Let us look at some facts. Iceland is a very small country with 300,000 inhabitants and an economy 0.1 per cent the size of the US. But relative to its size, it has a large banking sector, whose assets are about eight times its gross domestic product last year. Iceland’s current account deficit peaked at 25.5 per cent of GDP in 2006, but fell back to about 16 per cent last year, according to the latest figures from its central bank. As of the end of 2007, Iceland’s net international investment position – a snapshot showing the difference between external financial assets and liabilities – was a negative 125 per cent of GDP, which is very large by international standards. Iceland has had a bigger housing boom than that of the US or Spain. In 2005 alone, according to the latest country report by the Organisation of Economic Co-operation and Development, Icelandic house prices rose by 30 per cent. Annual inflation stood at 8.7 per cent in March, compared with an inflation target of 2.5 per cent.

So clearly, if your attention span extends to headline figures only, you could easily panic. But there is other evidence that might put those statistics in context. As Professor Richard Portes from the London Business School and Professor Friorik MĂĄr Baldursson at Reykjavik University* found out, Iceland’s three largest banks – Glitnir, Kaupthing and Landesbanki – are healthy compared with many European counterparts. Two of them do not own any of the toxic mortgage products that have forced write downs at other banks; in the other case the holding is relatively modest. The capital structure of the banks is sound and so is the maturity profile of their debt.

Iceland’s real problem is not the financial sector but macroeconomic imbalances. Here the issue is whether these are being corrected. The current account deficit fell significantly in 2007, though it picked up again in the fourth quarter due to falling returns from equity investments.

Profs Portes and Baldursson also argue official accounts probably overstate the size of the current account deficit and the international investment position. Their point is that the Icelandic economy is extremely highly leveraged – and thus very sensitive to valuation conventions. A mind-boggling statistic is that the country’s net foreign debt was 210 per cent of GDP (mostly private) at the end of 2004, while equity investment abroad was 88 per cent, both among the highest rates in the world. So the country has huge foreign liabilities and foreign assets: how you value them is absolutely crucial for the balance of payments.

On many structural indicators, Iceland is a sound economy. It has a modern and flexible labour force, high employment and no pension problem. But there are structural weaknesses that render monetary policy ineffective. It relies heavily on a state-owned mortgage company to provide mortgages, effectively crowding out the private sector. There is extensive price indexation for savings and other financial contracts, which has contributed significantly to the persistence of inflation. Once inflation rises, it stays high.

But judged on this evidence, the speculative run is hardly justifiable. Of course, this tiny country is susceptible to such attacks. But global investors should ask themselves whether the prospect of a dramatic rise in US inflation or a collapse in UK growth are not more serious and real threats to worry about than a collapse of Iceland’s financial sector.

* The Internationalisation of Iceland’s Financial Sector, Nov. 2007, www.chamber.is

Send your comments to munchau@eurointelligence.com

More columns at www.ft.com/munchau

Copyright The Financial Times Limited 2008

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Cool under fire: Iceland takes the fight back to finance

By David Ibison in Reykjavik

Published: April 8 2008 19:10 | Last updated: April 8 2008 19:10

On a gloomy North Atlantic evening in January, a group of international hedge fund managers gathered in the stylish bar of 101 Hotel in downtown Reykjavik at 8pm for a drink before dinner. They had been flown to Iceland by Bear Stearns, the US investment bank that two months later had to be rescued. Bear had organised the excursion to discuss the bizarre state of Iceland’s economy. What transpired at this dinner has entered into legend within Iceland’s close-knit financial community.

An executive who works with a big Icelandic bank recalls: “Upon entering the bar I was approached by one of the hedge fund managers. He informed me that all people in this party – except for him, of course – were shorting Iceland.” The executive says the fund manager described Iceland’s profit-making potential as the “second coming of Christ”.
EDITOR’S CHOICE
In depth: Icelandic economy - Mar-27
Iceland threatens direct markets intervention - Apr-02
Iceland counters alleged attacks - Mar-30
Wolfgang MĂźnchau: Do not fear Icelandic whispers - Mar-30
Iceland inflation at six-year high - Mar-29
Analysis: Iceland’s problem of perception - Mar-26

“As dinner progressed – some people actually decided not to eat at all but just sit at the bar – and more drinks were downed, the conversation and questions started to get more hostile and short positions openly declared,” the executive says.

What started as an alcohol-fuelled evening has become a full-blown investigation by Iceland’s Financial Supervisory Authority into an alleged speculative attack by hedge funds on Iceland’s currency, banking system and stock market. Jonas Jonsson, director-general of Iceland’s FSA, says the authorities are “searching whether some parties have systematically been distributing negative and false rumours about the Icelandic banks and financial system in order to profit from it”.

Mr Jonsson admits such cases are “difficult to ascertain and prove” but adds that “we would not be using our time if we didn’t think there was a good reason to investigate”. He is concerned that funds may have been “front-running” – taking trading positions on the basis of privileged information, in this case their own forthcoming negative reports.

The stock exchange is also examining its trading records and will send anything suspicious to the FSA. “There is nothing wrong with taking short positions. But if false rumours have been spread around the markets, that, in my view, is a clear case of market manipulation,” says Thordur Fridjonsson, president of the exchange.

Details of the investigation are confidential, but the authorities are expected to pay close attention to movements in the credit default swap markets for Iceland’s banks. Spreads in these markets – a proxy for investors’ fears the banks will collapse – have ballooned from about 50 last August to more than 1,000, indicating a very high level of fear about their viability.

The suspicion is that speculators exerted undue pressure on the illiquid CDS market in the knowledge that the wider the spread went, the more fear of a banking collapse would contaminate the stock and currency markets. There are also concerns about the way rumours were spread about the alleged reliance of Iceland’s banks on internet deposits, which triggered reports in UK newspapers that such deposits could be withdrawn rapidly.

Icelandic economy

The chief executives of the three main banks, Landsbanki, Glitnir and Kaupthing, made clear in interviews last week there is no evidence this is the case, despite the negative publicity about Iceland. They firmly believe such rumours were started deliberately in order to spark fears of a run on their overseas deposits.

Iceland’s most senior officials have declared open war on the speculators. David Oddsson, governor of the central bank and former prime minister, says: “There is an unpleasant odour of unscrupulous dealers who have decided to make a last stab at breaking down the Icelandic financial system.”

Concern that hedge funds are profiting from spreading malicious rumours is not limited to Iceland. In recent weeks, the Financial Services Authority in the UK stated that it would not tolerate market abuses after rumours of liquidity problems at HBOS’s hit the British bank’s stock price. Ireland’s financial regulator is also examining unusual trading patterns in its market, while Lehman Brothers, the US bank, told the Securities and Exchange Commission it had been the target of malicious rumours after its shares plunged on speculation that it faced a cash shortage.

Sympathy for US investment banks may be hard to find these days but the image of tiny Iceland, with a population of just 313,000, battling to protect its economy against the sharpest minds in global capitalism has captivated the local population and global market practitioners alike.

Fame of a sort was achieved when Ben Bernanke, chairman of the US Federal Reserve, was asked about the alleged attacks on Iceland during testimony to Congress, a development greeted with bewildered pride in Reykjavik. “We’ve made it,” commented one senior Icelandic banker ironically.

These events serve as a testament to Iceland’s transformation from fishing-based backwater to northern European tiger economy. Icelanders have certainly grown richer. Its economy may be the smallest in the Organisation for Economic Co-operation and Development, with a gross domestic product of about $20bn (£10bn, €13bn) but GDP per capita income is approximately $60,000, among the highest. Private jets swoop into Reykjavik’s airport bearing home-grown billionaires, while black Range Rovers purr through the capital’s streets amid a forest of cranes.

Significantly, the fishing industry’s share of GDP has declined from 16 per cent in 1980 to 6 per cent in 2006, replaced largely by finance, insurance and property, whose combined share of GDP rose from 17 per cent in 1998 to 26 per cent in 2006. However, banking sector assets have grown from about 96 per cent of GDP in 2000 to about 10 times today – the main source of concern about the country.

Perhaps more fundamentally, there has been a profound shift in attitude. Icelandic entrepreneurs have developed a reputation for aggressiveness, snapping up assets in the UK and shocking their consensus-driven Nordic neighbours with an almost American attitude to acquisitions and risk. For a country that was for more than 500 years under the control of Denmark, these developments have unleashed a dormant sense of national pride.

But growth has not been without its costs. Iceland reported a current account deficit of 16 per cent of GDP in 2007, while inflation stood at 8.7 per cent in March – well over its central bank’s target of 2.5 per cent. Iceland’s new rich are feeling the heat. “A Toyota Land Cruiser that cost IKr10m ($140,000, £70,000, €90,000) in January is now IKr13.8m,” says Ulfar Steindorsson, president of Toyota Iceland.

Such factors have undermined investor confidence, sending the stock market lower by nearly 16 per cent this year. The currency has fallen more than a fifth over the same period, further stoking inflation. In response, the central bank this month imposed an emergency interest rate increase of 1.25 percentage points to a record 15 per cent.

Such numbers make for uneasy comparisons and help explain hedge fund interest in Iceland. The country has the second highest interest rates in Europe after Turkey’s 15.25 per cent and its current account deficit puts it in the same league as volatile, high-growth economies in the Baltic and central and eastern Europe. Banking-sector borrowing is also high by international standards.

But these outwardly negative numbers, as Halldor Kristjansson, chief executive of Landsbanki, points out, require further analysis. The current account deficit, for example, is set to contract sharply once exports from new aluminium smelters start in the next few months. This will alleviate pressure on the krona and bring inflation back to within the central bank’s target range next year, it is forecast. Interest rates are expected nearly to halve to about 8 per cent in 2009 as economic growth slows to under 4 per cent.

As for the banks, they have responded to criticism by diversifying funding away from wholesale markets and relying more on deposits. Speaking for the industry, Larus Welding, chief executive of Glitnir, points out they have all diversified geographically and generate more income from a wider range of products, boosting fee and commission income. All are well capitalised by international standards and have survived various stress tests devised by the FSA with flying colours.

Speaking from the modest prime ministerial residence close to the waterfront in Reykjavik, Geir Haarde does not deny the country faces serious hurdles. But he does have a problem with these hurdles being raised artificially by the alleged actions of speculators. “We would like to see these off our backs,” he says. He has made it clear that he is prepared to intervene in the markets.

It is widely expected that Iceland’s central bank will announce – possibly on Thursday – a tie-up with other Nordic central banks to provide support for the banking sector. Mr Haarde also stated that the government, which runs a budget surplus, can easily issue bonds to bolster foreign exchange reserves of just $2.6bn. These moves will ensure the Icelandic central bank can be a lender of last resort in both Icelandic krona and foreign currencies, reducing the risk of a systemic collapse.

All indications are that the measures taken so far are working. The currency is strengthening, spreads in the credit default markets have narrowed and there has been no run on bank deposits. Whether this proves enduring will depend upon the soon-to-be-announced package from the central bank and the government.

But the dust is unlikely to settle quickly. Experts now expect a renewal of a long and tempestuous debate about whether Iceland should pursue membership of the European Union and the eurozone. It is already a European Free Trade Association member, but has shied away from deeper participation, saying it needs an independent monetary policy. This may now have to change. “If Iceland wants to play a role in the wider world then it can’t do it as an independent operation,” says one well-placed commentator.

Significantly, a recent poll revealed for the first time that a majority of people thought EU membership was a good thing and the business community has stepped up its support. Insiders say debate in government on the issue is “at a completely different level” now compared with a few years ago, but that internal party sensitivities make any public discussion tricky.

In the meantime, the economy is gradually tying itself to the eurozone as more companies adopt the euro. Fridrik Mar Baldursson, a professor at Reykjavik University, cautions against this gradual “euroisation”. “The more this happens the smaller the effect of [domestic] monetary policy on prices, wages, demand etc, and that equals more and more instability,” he says.

The undeniable fact is that Iceland is now more internationalised than at any time in its past. While alleged financial speculation is being rightly investigated, the solution to its challenges does not lie in blaming foreigners. In the words of Toyota’s Mr Steindorsson: “Some say ‘Those bastards’. Others say we shouldn’t blame other people for our own problems.”

Copyright The Financial Times Limited 2008

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Indignant Iceland faces a problem of perception

By Gillian Tett

Published: March 26 2008 19:37 | Last updated: March 26 2008 19:37

In recent weeks Geir Haarde, Iceland’s prime minister, has been engaged in an unusual sales mission. As his tiny country has been battered by the markets, Mr Haarde has flown to places such as New York, intent on convincing investors that Icelandic assets remain a good bet – notwithstanding recent falls in the krona or a sharp rise in the cost of insuring its banks’ bonds against default.

The movements in credit markets “are totally out of line and not justified”, Mr Haarde recently told the Financial Times, adding that the cost of protecting Iceland’s sovereign debt is also “totally unjustified”.
EDITOR’S CHOICE
In depth: Icelandic economy - Mar-27
Iceland inflation at six-year high - Mar-29
Editorial comment: Icelandic saga - Mar-25
Baugur insists its empire is not unravelling - Mar-26
Concern for Iceland grows after rate rise - Mar-25
Icelandic whispers shake faith in boom - Mar-25

A cynic might suggest that such comments have a familiar ring. Over the past year, numerous hedge funds caught up in the global financial turmoil have also complained about “irrational” or “unfair” investor behaviour. Similar sentiments have been voiced by many Wall Street banks in recent weeks as they faced mounting liquidity pressures.

But at least some outside economists fear that the market judgment on Iceland has become too extreme. Richard Portes, a London Business School professor who recently co-authored a report on the country, says “slander” is now a driving force. “The data just don’t fit the rumours,” says Prof Portes, who believes both investors and credit rating agencies are acting irrationally.

But slander or not, the sense of dĂŠjà vu points to a much bigger trend in global markets. To a casual observer, the country of Iceland might seem to have little in common with a Wall Street bank or a Mayfair hedge fund. But in reality, its predicament reflects a problem besetting many financial groups. At the core of Mr Haarde’s public relations battle is the issue of leverage – and, above all, the changing attitude of investors to debt.

During the first seven years of this decade Iceland enjoyed a boom partly driven by the fact that its banks and companies have been able to borrow cheaply to engage in an overseas expansion drive. One expert on the Icelandic economy recently remarked that the nation had turned into “the world’s first country run like a hedge fund”.

Until recently, this strategy seemed to have delivered wonderful benefits – in much the same way that high levels of leverage were previously producing fat returns for hedge funds. Iceland’s 300,000 citizens are now ranked as some of the richest in the western world. Moreover, global investors who bought Icelandic assets this decade have enjoyed strong returns, many earned via a so-called “carry trade” strategy – borrowing in low-yielding assets (such as the euro) to invest in the krona and other high-yielding currencies.

But the spreading credit crisis has turned “leverage” into a dirty word – and that is hurting Iceland in several ways.

On the one hand, international investors who borrowed to purchase Icelandic assets earlier this decade are seeing their own funding costs soar, forcing them to abandon the carry trade. At the same time, the leverage that fuelled Iceland’s recent overseas expansion is also provoking growing alarm – and concern that the pattern is unsustainable.

Having enjoyed the benefits of acting like a hedge fund when markets were benign, in other words, Iceland is now reaping the costs of high gearing as the credit cycle turns – in ways that seem as unfair to Mr Haarde as to many western banks.

The data illuminate the perception problem. The classic way that economists measure the debt burden of a country is to look at the ratio of debt to gross domestic product. On this metric, Iceland’s position does not necessarily look alarming: gross debt is currently just 24 per cent of GDP, better than most other western nations, and the country has a fiscal surplus.

However, Iceland – together with many eastern European countries – is bedevilled by a large current account deficit, running at 16 per cent of GDP in 2007 according to official statistics. More striking still, this decade the country’s banking assets have grown at a speed rarely seen in the modern world.

In 2000, the combined assets of Icelandic banks – mostly centred on Glitnir, Kaupthing and Landsbanki – were just below a year’s GDP. By 2006 they had risen to eight times GDP and the ratio is now thought to be near 10 times.

The Icelandic banks vehemently deny that this explosion in activity has created any risk and say they have made strenuous efforts to put their operations on a solid footing. Most notably, the level of funding they receive from retail deposits – as opposed to money markets – has risen sharply. They have also boosted their capital base to high levels by international standards.

But such measures have not allayed investor concerns: last week Moody’s, the rating agency, placed the Icelandic banking sector on negative watch and the banks’ credit default swaps, which measure the cost of insuring against default, have soared.

Notwithstanding the growth of retail deposits, Iceland’s banks still need to raise a hefty chunk of debt in the global markets. While this finance used to be freely available, fundraising costs have soared this year, since CDS spreads are typically used to set the price of bonds.

Chart

Most pernicious of all, the speed at which Iceland’s banking assets have grown relative to GDP has left investors worrying whether the government would have sufficient firepower to bail out the banking system if it did tip into full crisis. Or, as Prof Portes has observed: “The question arises whether the banks are not just too big to fail but also too big to rescue.”

Prof Portes, for his part, insists that the answer to this question is actually very reassuring: if Iceland’s banking system faced a crisis, the government could either use its existing resources to rescue the banks or borrow more funds from the markets. Indeed, the government has already agreed steps to bolster the system: in addition to a 1.25 percentage point interest rate rise this week, the Treasury will conduct a special bond auction to enhance short-term market liquidity.

Yet Icelandic officials know only too well that in times of stress, market rumours have a nasty habit of becoming self-fulfilling. Mr Haarde, however, has a perception challenge on his hands that many investment bankers might recognise. Or as Thor Herbertsson, an economist who is an expert on Iceland, notes carefully: “Let’s say that Iceland is not in more danger than Wall Street banks.”

With additional reporting by David Ibisonn

Aleks

Dziekuje za umieszczenie tych tekstow Smile

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rangurmadur · Gość

No i co? - Czy dobry kolega Rangurmadur nie podal tego tekstu na forum 25 czerwca ??
Jest w nim to wszystko o czym teraz sie pisze...

Mam nadzieje ze znalezli sie tacy, ktorzy przeczytali i cos im to pomoglo.

KO

WielkiBialyKrolik

no to mam stawiac twĂłj pomnik w koncu czy nie? czekam na szybka odpowiedz, bo zaprawa troche wazy, a mam plecy garbate.

<krolik chyli wĹochate czoĹo>
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"NajczÄĹciej nadmierne wymagania w stosunku do kobiet majÄ Äwokowate oblechy. "

rangurmadur · Gość

Pomnik to by siÄ przydaĹ twĂłrcy tej islandzkiej ekonomicznej potÄgi gospodarczej Smile

I islandzkiemu ministerstwu finansĂłw, oni widaÄ teĹź tego tekstu nie czytali lol

KO

Dobra teĹź mam coĹ fajnego, dĹugiego i po ensku

http://anapologyfromicelanders.blogspot.com/
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Konieczko · Gość

Pasjonaci ekonomii maja tutaj mozliwosc porownania publicznie dostepnych informacji i opinii sprzed 1,5 roku ze stanem obecnym.

zatroskany · ILOĹÄ OSTRZEĹťEĹ: 2

Iceland’s credit risk may rise “considerably” as the island faces the threat of a shelved emergency bailout and a government collapse, Standard & Poor’s said.
“The risk is there that the program will fall apart and with that, the downside risks would increase very considerably,”

“We were not encouraged by the statement of the president because it also made it clear that predictability of policy implementation in Iceland is not what we thought it would be,” Kraemer said. “The political process has turned out to be even more cumbersome than we had anticipated.”

The cost of protecting Iceland’s sovereign bonds from non- payment increased last week, according to CMA DataVision prices in New York. Credit-default swaps on the nation’s debt rose 37 basis points last week to 543.58 basis points. A basis point is 0.01 percentage point.

Government Collapse?

“The increasing sovereign risk in countries such as Iceland and Greece in Europe will very likely impact the European-based lenders and I could also see it having a spillover effect on some of the U.S. banks,”