Too-Big-To-Fail
Prevention Is Tested In Post-Crisis Iceland
Iceland
was brought to the brink of bankruptcy when its biggest banks failed
four years ago. Now, the site of the world’s most spectacular
financial collapse is becoming a pioneer in banking reform.
3
August, 2012
“We’ve
been burned by this and that’s why we have to look very closely at
what we need to do to prevent it happening again,” Economy
MinisterSteingrimur J. Sigfusson said in an interview. “Icelanders
are more interested in taking greater steps than small steps when it
comes to regulating banking.”
His
party, the junior member in Prime Minister Johanna Sigurdardottir’s
coalition, has submitted a motion to parliament to stop banks using
state-backed deposits to finance risky investments. The move puts
Iceland on course to become the first western nation since the global
financial crisis hit five years ago to force banking conglomerates to
split their business.
It’s
a proposal that’s gaining traction elsewhere. Even Sanford “Sandy”
Weill, whose 1998 creation of New York-based Citigroup Inc. (C)
triggered the Gramm-Leach-Bliley Act that paved the way for financial
behemoths, now says investment banks should be separated from
deposit-taking banks. Opponents including JPMorgan Chase & Co.
(JPM) Chief Executive Officer Jamie Dimon say diverse businesses are
needed to spread risk across divisions and stay competitive.
The
Icelandic lawmaker who presented the motion, Alfheidur Ingadottir,
says the best way to stop banks creating asset bubbles is to pass
laws akin to the 1933 Glass-Steagall Act, which separated commercial
and investment banking in the U.S. for more than six decades.
Forced
Breakup
The
law would force Arion Bank hf, Landsbankinn hf and Islandsbanki hf --
state-engineered successors to the banks that failed -- to break up
their operations. Investment banking now makes up less than 5 percent
of business at the banks, whose deposits are backed by the Icelandic
state. Before the crisis, the ratio was as high as 33 percent at
Iceland’s biggest lender, said David Stefansson, an economist at
Arion.
Sigfusson,
whose ministry oversees the financial industry, wants a “partial,
or even complete, separation of commercial and investment banking,”
he said. “It’s a way to prevent the riskier parts of banking
being mixed with regular day-to-day banking and shouldered by regular
customers or taxpayers,” he said.
The
government has found support inside Iceland’s banking industry. The
head of the island’s biggest investment bank says breaking up
financial conglomerates is the most effective crisis prevention tool
and one that would have prevented the nation’s meltdown.
Ruinous
“Giving
banks too much of a free ride with deposits -- money they don’t
need to repay if something goes wrong -- isn’t such a great idea,”
Straumur Investment Bank hf Chief Executive Officer Petur Einarsson
said in an interview.
Einarsson
says Europe should look to Iceland to get a sense of how much damage
an overgrown banking system can wreak.
“Europe
is today feeling the pain of the same disease Iceland caught in
2008,” he said. “The changes that need to be made should benefit
the depositors and businesses served by these financial institutions,
rather than the institutions themselves.”
The
excesses of Kaupthing Bank hf, Glitnir Bank hf and Landsbanki Islands
hf proved ruinous for Iceland’s economy. The banks grew to about 10
times the nation’s total economic output before defaulting on $85
billion in 2008, forcing the government to impose capital controls
and to resort to an international bailout.
Risks
Overlooked
Kaupthing’s
balance sheet ballooned by a factor of 85 between 2000 and 2007 to
peak at 5.3 trillion kronur ($44 billion), compared with Iceland’s
gross domestic product last year of $13.5 billion. The bank,
Iceland’s biggest before it was put under state control in October
2008, opened offices in Luxembourg, New York and Dubai. Its size and
complexity relative to the economy made proper risk analysis
difficult. Moody’s Investors Service rated the bank A1, its
fifth-highest grade, until the day the lender was seized by the
state.
The
financial regulator also missed the red flags. Iceland’s three
biggest banks all had capital adequacy ratios of more than 10 percent
of their risk-weighted assets as of the end of June 2008, the
Financial Supervisory Authority said in August the same year. All
three lenders passed FSA stress tests in a report published two
months before they failed.
Crisis
Pain
In
the years that followed the banks’ collapse, Iceland’s
unemployment rate jumped nine-fold and the economy was thrust into a
recession that lasted through the first half of 2010. An 80 percent
plunge in the krona against the euro offshore sent inflation soaring
to 19 percent. That bloated the debt burdens of a household sector
paying down inflation-linked mortgages.
Now,
the government wants to ensure that the new banks are never again
allowed to grow big enough to wreak such havoc. Preventing financial
conglomerates from dwarfing the economy is key, according to
Ingadottir.
“Running
a commercial bank isn’t really compatible with running an
investment bank, especially in regards to financial risk management,”
she said in an interview.
Iceland’s
economic reforms since the end of 2008 have so far proven successful.
The economy will outgrow the euro area this year and next, the
International Monetary Fund estimates. Iceland’s krona has
appreciated 14 percent against the euro since the end of March,
making it the best-performing emerging- market currency in the
period. The krona was little changed today at 147.67 per euro.
Greenspan
Weill,
who stepped down as Citigroup chairman in 2006, said in a July 25
interview with CNBC that the time has come to split investment and
commercial banking.
Weill
helped engineer the 1998 merger of Travelers Group Inc. and Citicorp,
a deal that required the repeal of the Depression-era Glass-Steagall
Act. Citigroup subsequently became the biggest bank in the world
before taking a $45 billion taxpayer bailout in 2008.
Even
former Federal Reserve Chairman Alan Greenspan, who had fought to
abolish Glass-Steagall, said in 2009 that breaking up the banks might
make them more valuable.
The
Volcker rule, part of the Dodd-Frank financial overhaul law, is
intended to limit transactions that put deposits insured by the U.S.
government at risk. Regulators have said they hope to finish the rule
by the end of the year and have given banks a July 2014 deadline,
provided they make a good-faith effort to comply.
In
the U.K., Bank of England Governor Mervyn King has said the scandal
surrounding the London interbank offered rate underlines the urgency
of implementing proposals in John Vickers’ Independent Commission
on Banking, which recommends banks separate their consumer and
investment units.
Crisis
Wasted
Corners
of Iceland’s bank industry remain apprehensive about a split. The
nation’s Financial Services Association and the bank regulator say
any overhaul should only take place after an analysis of the benefits
and drawbacks.
Parliament
may not want to wait that long.
“Lawmakers
in all parties agree on the necessity of separation,” Ingadottir
said. “So I’m confident that this will pass later this year.”
The
worst outcome of the global financial crisis would be if policy
makers and regulators fail to fix the mistakes of the past, according
to Einarsson.
“If
commercial and investment banking aren’t separated now, we might
have to wait a long while before such an opportunity presents itself
again,” he said. “This is going to be one of the defining issues
of the coming years.”
Capital
Punishment for Crimes Against Capital?
Max
Keiser interviews Birgitta Jonsdottir
We
discuss crimes against capital, financial blockades and hoax Op-eds.
They also suggest that Boris Johnson may be the illegitimate step
nephew of Louis XV and how all your financial opinions come from a
warped fortune cookie written by some guy that just dropped massive
tabs of acid. And they discuss this while minding their Second
Amendment right to bear a shoulder launch missile.
In
the second half, Max
interviews Birgitta Jonsdottir about the need to form Pirate
Parties around the world to protect privacy, democracy and stop
financial blockades of certain groups for their beliefs and
campaigns.
UPDATE:
Here is the Wall Street Journal editorial / blog:Should
Crimes of Capital Get Capital Punishment?
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