Echoes of The ‘80s and The Collateral Damage of Fraud

By Sigrún Davíðsdóttir

Recently, I talked to the CEO of a very successful Icelandic company that has grown steadily over the decade it’s been operating. Every year, the CEO would go through the annual report, lean back and think with great satisfaction that his company was indeed showing a healthily steady growth. Then the banks and their satellite companies would come out with their annual accounts – and the CEO’s heart would sink, questioning what on earth was he was doing: compared to these companies his company’s growth was pitiful. Now, anno 2010, his company is still doing well and even hiring people. The three main Icelandic banks collapsed in October 2008 and most of the companies owned by those favoured by the banks are now bankrupt.*

This conversation came to mind as I read ‘Den of Thieves’ by WSJ journalist James B. Stewart, on the insider trading involving the arbitrageur king of the 1980s, Ivan Boesky and junk bond emperor Michael Milken. Their apparent success became a gold standard everyone else tried to achieve. But as it was based on questionable business practices and outright fraud this measure proved an unhealthy standard. Their success was also a measurement in remuneration, again not a healthy measure. The same happened in Iceland: the banks rapidly raised salaries after they had become entirely privatised in 2003. With hindsight, their success can now be doubted and their rising remuneration levels affected the whole business community.

In his book Stewart points out that the ‘arrival of the big-money ‘star’ system in the eighties had made national celebrities’ out of people like Milken, Boesky and others who were condemned for fraud and doomed old-fashioned investment bankers that earlier had dominated the financial world. There is no need to be unduly nostalgic about the old way of banking but one of the great but too little noticed harm of fraudsters like Milken ed al. is the unhealthy standards they created in terms of growth rates and remuneration.
We still do not know the extent of fraud within the Icelandic banking bubble. The Icelandic FME, comparable to the UK Financial Services Authorities, has already sent several extensive cases of alleged market manipulation to the Office of Special Prosecutor, set up to deal with possible cases of criminal activity connected to the collapse of the banks. The Special Prosecutor is both conducting his own investigations and working on specific cases that have been sent to him from i.a. the FME and the resolution committees of the collapsed banks.
Apart from the general damage of fraud by creating harmful standards it feels as if some of those who led the Icelandic banking bubble had reopened the tool kit of the prolific fraudsters that Stewart writes about. The difference is of course that Milken was working for his own benefit, often at the cost of the bank where he worked, whereas the Icelandic banks, in cahoots with major shareholders seemed to favour certain clients more than others and possibly worked against the interest of other shareholders.
In the Icelandic context, two of the counts to which Milken pleaded guilty are of particular interest. Milken pleaded guilty to selling stock without disclosing that included in the deal was the understanding that the purchaser would not lose money. The other count involves selling securities to a client and then buying those securities back at a real loss to the customer, but with an understanding that Milken would try to find a future profitable transaction to make up for any losses.

One of the peculiarities of Icelandic banking up until the collapse is that certain clients were sold stock with a kind of ‘no loss guarantee.’ This was particularly common among key staff at the banks: the staff would get a loan from the bank where they worked to buy shares in that same bank. In most cases these were bullet loans, the staff wasn’t expected to pay anything off the loans but had the shares at their disposal to reap the dividend. The benefit for the bank was that the shares would not be used for short-selling. This practice escalated in 2007 and 2008 as foreign banks made margin calls on some of their big Icelandic clients who had pledged Icelandic bank shares against foreign loans. In order to avoid dumping these shares into the market, causing further decline in the share price, the banks would ‘park’ them with their staff, lend against them, with the understanding that these arrangement wouldn’t harm the borrower.

A bank manager from one of the collapsed banks informed me recently that among the big favored clients there was an understanding that in deals where the client lost money the bank would then try to find a profitable transaction to make up the loss. There would be many ways of making this happen, i.a. buying assets at a price above market price. It’s difficult to ascertain if and when this happened but certain sales guarantees could be scrutinised.

The interesting thing is that Milken and others convicted at the end of the ‘80s were rogues in the financial markets who defrauded clients and the banks they worked for. The Icelandic example suggests that the banks’ management, together with their main shareholders, were operating like the rogue bankers of the ‘80s bubble. It is still early day, no big cases of fraud have so far been brought to court and when that happens it will take a while until the first cases are brought to closure. So far, the possibility of a certain echo of the ’80s’ financial fraudsters remains only an intriguing thought based on striking but so far unproven parallels.

* For more on various aspects of the collapse of the Icelandic banks and connections with international banking see Icelog, my blog at

3 responses to “Echoes of The ‘80s and The Collateral Damage of Fraud

  1. The moral to the story is fraud pays…As late as 2004 Michael Milken was still listed in Fortune's "Top 400 Wealthiest Americans" with assets over $800 million.. So in other words he was permitted to keep the booty from raiding retirement funds, ruining healthy companies/creating unemployment etc. So he becomes a "philanthropist" and throws out crumbs to sugarcoat his image & that of Wall Street as well..The Phoney upper class White Collar version of "reform" .. No doubt key players like Timothy Geithner (soon to be rich after his stint with the U.S. treasury),Henry Paulson, Robert Rubin, Zoellick and others can feel his pain & would welcome him a a fraternal brother in one of their many homes which span the globe.

  2. How long did it take to get Madoff into jail, and what's holding Icelanders up?Could it be just the lack of jail space – or possibly the fact that the prosecutors all have a family member on the suspect list?I never felt that Iceland was such a small country until now, and I feel so sorry for them.It's such a beautiful country and the people are so open, but for many of them this must be like discovering that your boyfriend is a serial killer – it hurts.

  3. The two counts that you note Milken pleaded guilty to, selling securities with the understanding the purchaser won't lose money and buying back to give the customer a loss while promising to try to find a profitable transaction to make up the loss, are not in themselves fraudulent or illegal.Both practices could be used in fraud or illegal activities. both may be used for legitimate purposes as well. The Icelandic banks' case that you note, to block short-selling, is a legitimate use.Short-selling is manipulation of shares. When it succeeds the short-seller's "profit" comes from someone, usually who is responsible to maintain the manipulated shares' market value. In banking, where currencies are the "shares", exchange rate variations are speculated, sometimes speculator-driven. Currency "shares", that banks trade in, trade for goods in all market transactions, and so spread speculator induced changes rapidly and significantly. Banks must balanced them and damp their oscillations, especially rumour-driven ones, which may be worsened by speculative manipulations. Most banks do the best they are able to control manipulations, to prevent shortings in one that may induce longing in others, which could produce speculation runs.When funds must be "parked" with someone the someone will always be someone close, known and known to be trustworthy: The party will, after all, have discretionary access to the parked funds in his possession. The holding party should profit to some extent for the holding, and should be insured against losses and liabilities that might accrue to them on paper, but that are not theirsFor the need for trust in these circumstances it may appear, or be possible to make appear, that nepotism, cosy-dealing or special perqs are involved.Responsible investigation requires caution, abeyance of accusation, determination of the purpose served, to determine if it is legitimate or fraudulent in an instance. As in the 1980s, when traditional bankers were hard put to stay abreast, and had also to avoid becoming victims of frauds, in the early 21st century honest bankers had similar troubles. Entities, especially American, that were sold wonderful "investments" by con-artists who corsaired under colours of respected institutional names sought loans, especially of European banks, to "invest" in those "iinvestments", or to replace operating funds they had tied up in those "fantastic investments", usually derivatives. In addition they had to try to maintain exchange balances while the "hot" market in "hot" derivatives was inflating everything.The activities bankers engaged in then, like snatching up a child and running with it, could be criminal, or protective, to abduct, or to save from hazard. What is needed is investigation, and patience, as you note, and a certain amount of self-control, to not, ourselves, become guilty, in this case of falsely accusing and over-hasty judging.