How Iceland bankers tried to trick the regulators as crisis struck in 2008..

A very interesting piece by Friðrik Már Baldursson (Reykjavik University) and , Richard Portes (LBS).

There has been this huge criticism on how no banker has been punished for the mis-deeds that led to the recent crisis. Apparently, Iceland is a lone example where senior bankers were thrown to the gallows. What they did was very interesting (and shocking) as they tried to use tricks to postpone financial troubles. As the crisis struck share prices of banks tumbled. It seems these banks then gave money to the owners/investors to buy the shares and boost prices!:

The demise of the three large Icelandic banks, just after the fall of Lehman Brothers, was a key event in the spread of the financial crisis. A couple of weeks before its collapse in October 2008, Kaupthing bank announced that the Qatari investor Sheikh Mohammed Bin Khalifa Bin Hamad al-Thani had bought a 5.01% stake. This briefly boosted market confidence in Kaupthing (Financial Times 2008). What market participants did not know was that Kaupthing illegally financed the deal, which was without risk to al-Thani.

Recently, four former top bankers at Kaupthing – including the CEO and the chairman of the board – were sentenced to jail for three to five-and-a-half years for fraud and for abusing and misleading markets by this trade (Financial Times 2013b). So far, these are the heaviest sentences handed out to bankers in Iceland. This was just one of many instances where Kaupthing financed purchases of its shares in private deals.

There are many historical precedents for banks trying to boost their share prices by covert financing of purchases. In writing l’Argent (1891), Emile Zola consulted records of the 1882 fall of Union Générale, whose CEO Paul Bontoux had done just that. It was illegal even then, and he was tried and convicted. Zola’s fictional character Aristide Saccard followed the same path. And in 2008, there was apparently similar behaviour outside Iceland. Thus “Barclays said the FCA [Financial Conduct Authority] has concluded that the main purpose of two advisory services agreements made between the bank and investment vehicle Qatar Holding LLC in June and October of that year [2008] ‘was not to obtain advisory services but to make additional payments [£322 million], which would not be disclosed, for the Qatari participation in the capital raisings.’” The Financial Conduct Authority has proposed a fine of £50 million, but as yet, no prosecutions (Wall Street Journal 2013).

In recent work, we study the rise and fall of the Icelandic banks, in the domestic and global macroeconomic context (Baldursson and Portes 2013). Kaupthing’s culpable strategy was a part of a large gamble for resurrection by Kaupthing and the others during the last year of their existence. A bank whose managers believe it to be insolvent may decide to conceal this from the regulator and carry on, doubling down with further risky bets, hoping for a good outcome (‘resurrection’) in the near future (e.g. Dewatripont and Tirole 1994).

Nice case study. It is amazing really how they managed these tricks at the peak of the crisis..