Escher’s Bank

The incredible story of the Icelandic banking crisis

The Icelandic Special Investigation Committee (SIC) yesterday (April 12th, 2010) delivered its report on the collapse of the three main banks in Iceland. It makes shocking reading.

It can be downloaded here.

At Vox Sapiens, our initial vision was of a couple Escher’s masterpieces.

“Ascending and Descending” depicts a monastery where half the monks are forever walking upstairs and half are forever walking downstairs.

“Waterfall” depicts a perpetual motion machine in which water runs forever downhill.

The business empires of the owners of the three large Icelandic banks – Landsbanki, Glitnir and Kaupthing – allegedly demonstrate similar features.

The banks’ owners are alleged to have borrowed money from their own banks, and to have used some of this money to buy shares in the banks, resulting in an increase in the share price. The SIC refers to this as “weak equity” and it grew to represent more than 25% of the banks’ capital base.

These shares were also used as collateral against loans, further leveraging the banks’ positions.

And the growth of the banks was out of all proportion when compared to the Icelandic economy and the ability of its officers to supervise the banks.

In seven years the banks grew to twenty times their size until their debt issuance exceeded the GDP of Iceland and grossly distorted the requirement for foreign currency reserves. The writedown in the value of the banks’ loans in 2008 was the equivalent of five years GDP.

At the same time, a country of only 320 000 people was not able to provide a sufficiently large and experienced banking oversight regime to handle three large banks.

Finally, there appears to have been insufficiently long arms when lending contracts were established. Not only were loans provided to the banks’ owners, but also to the owners’ other businesses. These other businesses also pledged icelandic shares when borrowing from foreign banks. As the icelandic share prices fell, the icelandic businesses had to repay the foreign banks, and the icelandic banks stepped in to replace this debt, further leveraging the icelandic economy. The SIC summary presentation at the press conference states that “these investment companies had an abnormally easy access to loans in the banks in the capacity of their ownership and influence within them.”

A sorry state indeed.

Note: These images are available for commercial reuse.
Ascending and Descending search
Waterfall search

They can be obtained from:
Waterfall: http://picasaweb.google.com/lh/photo/36X8UHueP5H6pycVt_JBEA and
Ascending and Descending: http://picasaweb.google.com/lh/photo/gwkazaD_DWA9EyY3W0LyfA

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