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 http://uti.is/