Tag Archives: Iceland

The Icelandic Chutzpah Prize is Retired: Portes and Baldursson Win by Losing

By William K. Black
(Cross posted at Benzinga.com)

Portes as the poster child for the failure of econometrics and neoclassical dogma

Richard Portes is the economist that the U.K.’s neoclassical economists chose to be their representative.  They consider him to represent the greatest strengths of neoclassical economists in general and econometricians in particular.  “Econometricians” is a fancy term for economists whose specialty is statistics.  Economics is unique in that one can receive exceptional honors from fellow-neoclassical economists for proving catastrophically wrong – repeatedly and causing immense human suffering.  Wesley Marshall and I are doing a book that illustrates this point by focusing on Nobel Laureates in economics, and explains the underlying pathology that has so twisted the field.  Portes has not been made a Laureate, but he is a global leader among neoclassical economists.  Portes’ pronouncements on Iceland have proven so wrong, so often, that they serve a similar purpose in illustrating these crippling pathologies.

Continue reading

Neo-Liberals’ Dismissal of Latin Americans as “Idiots”

By William K. Black
(Cross posted at Benzinga.com)

Alvaro Vargas Llosa (AVL) co-authored the Guide to the Perfect Latin American Idiot with two other journalistsHe revisited the subject with an article in 2007 entitled “The Return of the Idiot.”

“The ‘Idiot’ species, we suggested, bore responsibility for Latin America’s underdevelopment. Its beliefs — revolution, economic nationalism, hatred of the United States, faith in the government as an agent of social justice, a passion for strongman rule over the rule of law — derived, in our opinion, from an inferiority complex. In the late 1990s, it seemed as if the Idiot were finally retreating. But the retreat was short lived. Today, the species is back in force in the form of populist heads of state who are reenacting the failed policies of the past, opinion leaders from around the world who are lending new credence to them, and supporters who are giving new life to ideas that seemed extinct.” Continue reading

Iceland’s New Bank Disaster

By OlafurArnarson, Michael Hudson and Gunnar Tomasson*

Theproblem of bank loans gone bad, especially those with government-guaranteessuch as U.S. student loans and Fannie Mae mortgages, has thrown into questionjust what should be a “fair value” for these debt obligations. Should “fairvalue” reflect what debtors can pay – that is, pay without going bankrupt? Oris it fair for banks and even vulture funds to get whatever they can squeezeout of debtors? 

Theanswer will depend largely on the degree to which governments back the claimsof creditors. The legal definition of how much can be squeezed out is becominga political issue pulling national governments, the IMF, ECB and otherfinancial agencies into a conflict pitting banks, vulture funds anddebt-strapped populations against each other.
Thispolarizing issue has now broken out especially in Iceland. The country is nowsuffering a second round of economic and financial distress stemming from thecollapse of its banking system in October 2008. That crisis caused a huge lossof savings not only for domestic citizens but also for international creditorssuch as Deutsche Bank, Barclay’s and their institutional clients.
Stuckwith bad loans and bonds from bankrupt issuers, foreign investors in the old bankssold their bonds and other claims for pennies on the dollar to buyers whose websites described themselves as “specializing in distressed assets,” commonlyknown as vulture funds. (Persistent rumors suggest that some of these areworking with the previous owners of thefailed Icelandic banks, operating out of offshore banking and tax havens and currentlyunder investigation by a Special Prosecutor.)
Atthe time when those bonds were sold in the market, Iceland’s government owned100% of all three new banks. Representing the national interest, it intendedfor the banks to pass on to the debtorsthe write-downs at which they discounted the assets they bought from the oldbanks. This was supposed to be what “fair value” meant: the low marketvaluation at that time. It was supposed to take account of the reasonableability of households and businesses to pay back loans that had becomeunpayable as the currency had collapsed and import prices had risenaccordingly.
TheIMF entered the picture in November 2008, advising the government toreconstruct the banking system in a way that “includes measures to ensure fairvaluation of assets [and] maximize asset recovery.” The government createdthree “good” new banks from the ruins of its failed banks, transferring loansfrom the old to the new banks at a discount of up to 70 percent to reflecttheir fair value, based on independent third party valuation.
Thevultures became owners of two out of three new Icelandic banks. On IMF advicethe government negotiated an agreement so loose as to give them a huntinglicense on Icelandic households and businesses. The new banks acted much asU.S. collection agencies do when they buy bad credit-card debts, bank loans orunpaid bills from retailers at 30% offace value and then hound the debtors to squeeze out as much as they can, byhook or by crook.
These scavengers of the financial system arethe bane of many states. But there is now a danger of their rising to the topof the international legal pyramid, to a point where they are in a position tooppress entire national economies.
Iceland’s case has a special twist. By lawIcelandic mortgages and many other consumer loans are linked to the country’ssoaring consumer price index. Owners of these loans not only can demand 100% offace value, but also can add on the increase in debt principal from theindexing. Thousands of households face poverty and loss of propertybecause of loans that, in some cases, have more than doubled as a result of thecurrency crash and subsequent price inflation. But the IMF and Iceland’sGovernment and Supreme Court have affirmed the price-indexation of loan principaland usurious interest rates, lest the restructured banking system come togrief.
Thisis not what was expected. In 2009 the incoming “leftist” government negotiatedan agreement with creditors to relate loan payments to the discounted transfervalue. On IMF advice, the government handedover controlling interest in the new banks to creditors of the old banks. Theaim was to minimize the cost of refinancing the banking system – but not todestroy the economy. Loans that were transferred from the old banks to the newafter the 2008 crash at a discount of up to 70% to reflect their depreciatedmarket value. This discount was to be passed on to borrowers (households and smallbusinesses) faced with ballooning principal and payments due to CPI indexing ofloans.
Butthe economy’s survival is not of paramount interest to the aggressive hedgefunds that have replaced the established banks that originally lent to theIcelandic banks. Instead of passing on the debt write-downs to households andother debtors, the new banks are revaluing these loan principals upward. Theirdemands are keeping the economy in a straight jacket. Instead of debtrestructuring taking place as originally hoped for, the scene is being set fora new banking crisis.
Somethinghas to give. But so far it is Iceland’s economy, not the vulture funds. With theIMF insisting that the government abstain from intervention, the government’sapproval rating has plunged to just 10% of Icelanders for floundering so badlywhile the new owners call the shots.
TheNew Banks have written off claims on major corporate debtors, whose continuedoperations have ensured their role as cash cows for the banks’ new vultureowners. But household debts acquired at 30 to 50 percent of face value havebeen re-valued at up to 100 percent. The value of owners’ share equity hassoared. The Government has not intervened, accepting the banks’ assertion that theylack the resources to grant meaningful debt relief to households. So unpayablyhigh debts are kept on the books, at transfer prices that afford a windfall tofinancial predators, dooming debtors to a decade or more of negative equity.
Withthe preparatory work done, the time has come for the Vultures to cash inthrough re-sale of New Bank equity shares by yearend. The New Banks have kepttheir corporate cash cows afloat while window-dressing owners’ equity withunrealistic valuations of consumer debts that cannot be paid, except at thecost of bankrupting the economy.
Thereis a feeling that Iceland’s government has been disabled from acting as anhonest broker, as bank lobbyists have worked with Althing insiders – now backedby the IMF – to provide a windfall for creditors.
Theproblem becoming a global one. Many European countries and the United States facecollapsed banks and derailed banking systems. How are the IMF and ECB torespond? Will they prescribe the Icelandic-type model of collaboration betweenGovernment and hedge funds? Or should the government be given power to resist driveby vulture funds to profiteer on an international scale, backed byinternational sanctions against their prey?
The policy danger now facing Europe

Aneconomic crisis is the financial equivalent of military conquest. It is anopportunity for financial elites to make their property grab as ForeclosureTime arrives. It also becomes a political grab to make real the financialclaims that had become uncollectible and hence largely fictitious“mark-to-model” accounting. Populist rhetoric is crafted to mobilize thewidespread financial distress and general discontent as an opportunity to turnlosers against each other rather than at the creditors.
This is the point at which all the years offinancial propaganda pay off. Neoliberals have persuaded the public to believethat banks are needed to “oil the wheels of commerce” – that is, provide the creditbloodstream that brings nourishment to the economy’s moving parts. Only undersuch crisis conditions can banks collect what has become a fictitious buildupof debt claims. The overgrowth of mortgage debt, corporate debt, student loans,credit-card debt and other debts are fictitious because under normalcircumstances there is no way for them to be paid.
ForeclosureTime is not sufficient, because much property has fallen into negative equity –about a quarter of U.S. real estate. And for Ireland, market value of realestate covers only about 30% of the face value of mortgages. So Bailout Timebecomes necessary. The banks turn over their bad loans to the government inexchange for government debt. The Federal Reserve has arranged over $2 trillionof such bank-friendly swaps. Banks receive government bonds or central bankdeposits in exchange for their bad debts, accepted at face value rather than at“mark-to-market” prices.
Atleast in the United States and Britain, the central bank can print as much domesticcurrency as is necessary to pay interest and keep these government bondsliquid. Public agencies then take on the position of creditor vis-à-vis debtorsthat can’t pay.
Thesepublic agencies then have a choice. They may seek to collect the full amount(or at least, as much as they can get), as in the case of Fannie Mae andFreddie Mac in the United States. Or, the government may sell the bad debts tovulture funds, for a fraction of their face value.
After the September 2008 crash, Iceland’s governmenttook over the old, collapsed, banks and created new ones in their place.Original bondholders of the old banks off-loaded the Icelandic bank bonds inthe market for pennies on the dollar. The buyers were vulture funds. Thesebondholders became the owners of the old banks, as all shareholders were wipedout. In October, the government’s monetary authority appointed new boards tocontrol the banks. Three new banks were set up, and all the deposits, mortgagesand other bank loans were transferred to these new, healthier banks – at asteep discount. These new banks received 80 percent of the assets, the oldbanks 20 percent.
Then,owners of the old banks were given control over two of the new banks (87% and95% respectively). The owners of these new banks were called vultures not onlybecause of the steep discount at which the financial assets and claims of theold banks were transferred, but mainly because they already had bought controlof the old banks at pennies on the dollar.
Theresult is that instead of the government keeping the banks and simply wipingthem out in bankruptcy, the government kept aside and let vulture investorsreap a giant windfall – that now threatens to plunge Iceland’s economy intochronic financial austerity. In retrospect, none of this was necessary. Thequestion is, what can the government do to clean up the mess that it hascreated by so gullibly taking bad IMF advice?
Inthe United States, banks receiving TARP bailout money were supposed tonegotiate with mortgage debtors to write down the debts to market prices and/orthe ability to pay. This was not done. Likewise in Iceland, the vulture fundsthat bought the bad “old bank” loans were supposed to pass on the debtwrite-downs to the debtors. This was not done either. In fact, the loanprincipals continued to be revalued upward in keeping with Iceland’s uniqueindexing designed to save banks from taking a loss – that is, to make sure thatthe economy as a whole suffers, even suffering a fatal austerity attack, sothat bankers will be “made whole.” This means making a windfall fortune for thevultures who buy bad loans on the cheap.
Isthis the future of Europe as well? If so, the present financial crisis willbecome the great windfall for vulture banks, and for banks in general. Whereasthe past few centuries have seen financial crashes wipe out the savings andcreditor claims (bonds, bank loans, etc.) that are the counterpart to baddebts, today we are seeing the bad debts kept on the books, but the banks andbondholders that provided the bad loans being made whole at taxpayer expense.
Thisis not how economic democracy was expected to work during the 19th-centurydrive for Parliamentary reform. And by the early 20th century,social democratic and labor parties were supposed to take the lead in movingbanking and credit along with other basic infrastructure into the publicdomain. But today, from Greece to Iceland, governments are acting as enforcersor even as collection agents on behalf of the financial sector – as the OccupyWall Street movement expresses it, the top “1%,” not the bottom 99%.
Icelandstands as a dress rehearsal for this power grab. The IMF and Iceland’sgovernment held a conference in Reykjavik on October 27 to celebrate theostensible success in their reconstruction of Iceland’s economy and bankingsystem.
Inthe United States, the crisis that Obama Chief of Staff Rahm Emanuel celebratedas “too good to let go to waste” will be capped by scaling back Social Securityand Medicare as soon as the autumn Doomsday Clock runs down and theCongressional Super-Committee of 12 (with President Obama holding the 13thvote in case of a tie) gets to agree to make the working population pay WallStreet for its bad loans. The Greek austerity plan thus serves as a dressrehearsal for the U.S. – with the Democratic Party playing the role ascounterparts to Greece’s Socialist Party that is sponsoring austerity, andexpelling labor union leaders from its ranks if they object to the granddouble-cross.

*Olafur Arnarson is an author and columnist atPressan.is. Michael Hudson is Prof. of Economics at UMKC. Gunnar Tomasson is aretired IMF advisor.

Why Iceland Voted “No”

By Michael Hudson

About 75% of Iceland’s voters turned out on Saturday to reject the Social Democratic-Green government’s proposal to pay $5.2 billion to the British and Dutch bank insurance agencies for the Landsbanki-Icesave collapse. Every one of Iceland’s six electoral districts voted in the “No” column – by a national margin of 60% (down from 93% in January 2010).

The vote reflected widespread belief that government negotiators had not been vigorous in pleading Iceland’s legal case. The situation is reminiscent of World War I’s Inter-Ally war debt tangle. Lloyd George described the negotiations between U.S. Treasury Secretary Andrew Mellon and Stanley Baldwin regarding Britain’s arms debt as “a negotiation between a weasel and its quarry. The result was a bargain which has brought international debt collection into disrepute … the Treasury officials were not exactly bluffing, but they put forward their full demand as a start in the conversations, and to their surprise Dr. Baldwin said he thought the terms were fair, and accepted them. … this crude job, jocularly called a ‘settlement,’ was to have a disastrous effect upon the whole further course of negotiations …”

And so it was with Iceland’s negotiation with Britain. True, they got a longer payment period for the Icesave payout. But how is Iceland to obtain the pounds sterling and Euros in the face of its shrinking economy. This is the major payment risk that is still unaddressed. It threatens to plunge the krona’s exchange rate.

Furthermore, the settlement included running interest charges on the bailout since 2008, even the extra-high interest charges that led depositors to put their funds in Icesave in the first place. Icelanders viewed these interest premiums as compensation for risks – that were taken and should be lost by the high-interest Internet depositors.

So the Icesave problem will now go to the courts. The relevant EU directive states “that the cost of financing such schemes must be borne, in principle, by credit institutions themselves.” As priority claimants Britain and the Netherlands will indeed get the lion’s share of what is left from the Landsbanki corpse. That was not the issue before Iceland’s voters. They simply aimed at saving Iceland from an open-ended obligation to take the bank’s losses onto the public balance sheet without a clear plan of just how Iceland is to get the money to pay.

Prime Minister Johanna Sigurdardottir warns that the vote may trigger “political and economic chaos.” But trying to pay also threatens this. The past year has seen the disastrous experience of Greece, Ireland and now Portugal in taking reckless private sector bank debts onto the public balance sheet. It is hard to expect any sovereign nation to impose a decade or more of deep depression on its economy inasmuch as international law permits every nation to act in its own vital interests.

Attempts by creditors to persuade nations to bail out their banks at public expense thus is ultimately an exercise in public relations. Icelanders have seen how successful Argentina has been since it imposed a crew haircut on its creditors. They also have seen the economic and political disruption in Ireland and Greece resulting from trying to pay beyond their means.

Creditors did not give accurate advice when they told Ireland that it could pay for its bank failures without plunging the economy into depression. Ireland’s experience stands as a warning to other countries about trusting overly optimistic forecasts by central bankers. In Iceland’s case, in November 2008 the IMF staff projected yearend-2009 gross external public and private debt at 160% of GDP – but observed that an exchange rate depreciation of 30% would push the ratio to 240% of GDP, which would be “clearly unsustainable.” But the most recent IMF staff report (January 14, 2011) shows end-2009 gross external debt at 308% of GDP, and estimates end-2010 gross external debt at 333% – even before taking the Icesave and other debts into account!

The main problem with Iceland’s obligation to Britain and the Netherlands is that foreign debt is not paid out of GDP. Apart from what is recovered from Landsbanki (now with the help of Britain’s Serious Fraud Office), the money must be paid in exports. But there has been no negotiation with Britain and Holland over just what Icelandic goods and services these countries would be willing to take in payment. Already in the 1920s, John Maynard Keynes pointed out that the Allied creditor nation had to take some responsibility just how Germany could pay its reparations, if not by exporting more to these countries. In practice, German cities borrowed in New York, turned the dollars over to the Reichsbank, which paid Britain and France, which paid the money back to the U.S. Government for their Inter-Ally Arms debts. In other words, Germany tried to “borrow its way out of debt.” It never works over time.

The normal practice would be for Iceland to appoint a Group of Experts to lay out the strongest possible case. No sovereign nation can be expected to acquiesce in imposing a generation of financial austerity, economic shrinkage and forced emigration of labor to pay for the failed neoliberal experiment that has dragged down so many other European economies.