Iceland the absurd

I mentioned Iceland a few times only on this blog – because it was sort of well known in the hedge fund community – a crowded trade even.  Paul Krugman did an (incorrect) anti-hedge fund piece where he happily swallowed the dogma about hedge funds of conspiring against Iceland.  You didn’t need to conspire against Iceland – it was obvious once you read the balance sheet of any of the banks or any of the major corporates.

The first time I mentioned Iceland on this blog was in my list of current account deficit countries with potential banking problems.

Later I mentioned – but only in the comments – the raid on the UK savings market done by IceSavings and Kaupthing.  These were high interest rate deposits that seemed to be insured by a combination of the Icelandic and UK government if you read the documentation.

I wrote a post about high rate deposits (Wachovia will walk over you) and I confess that I had an ulterior motive – I was looking for someone to tell me how much the Icelandic banks were raiding the deposit market of Norway.  I got a few nice helpers amongst my readers (thank you). 

But this post is an ex-post analysis of just how absurd Iceland became – and some speculations from there.

Firstly the Russian loan (5.4 billion) is really big.  The population of Iceland is about 320 thousand people.   This translates to almost 17 thousand per person.  That is a real bailout – none of this small stuff that America is doing. 

It is pretty hard to see how an economy that has functionally destroyed itself is going to pay that back.  Whatever it looks like a darn big loan to a very dodgy credit – and I presume that there is a non-financial motive for granting it.

In my quick post on Iceland (done at JFK airport with a beer whilst waiting for a plane and not adequately fact checked) I linked to Andrew Neil who thought that the ulterior motive was Russian access to Iceland as a military base – or at least as a military refuelling depot – an unsinkable aircraft carrier if you will.

That is plausible because there is no obvious financial motive for this loan.  But there is an alternative theory doing the rounds – which is that one of the Icelandic banks was closely tied to the Russian Mafia – and the loan by the Russian Government is just make-good.  [The implication being that the Russian Government is just another arm of the Russian Mafia.]  Again I have no proof for that hypothesis – however as you need a non-commercial explanation of the loan its as good as most.  [Access to military bases however looks more likely…]

But you got to realise just how big the Icelandic problem is relative to the Icelandic economy.  Kaupthing Edge and IceSavings raided the UK deposit market as noted above and raised 3 billion pounds in deposits.  That is another 20 thousand dollars per person in Iceland.  Iceland as I need not remind readers cannot print pounds or dollars.  It is small wonder the Icelandic government is not going to meet its deposit insurance liabilities.  We have the Sovereign Default of a democracy at hand.  That is rare… I always thought it was populist dictators that defaulted.   Now I guess it is just populist democracies.

So Iceland is going to default at the national level and the level of every bank.  Lets have a look at its corporates.  I did this – there are about 20 companies listed on the Icelandic stock exchange.  I went and read the annual reports of about 5 and they were mostly similar – over-levered global acquisition conglomerates with Kaupthing as the major investment bank. 

Bakkavör Group sticks in mind – just because it was so levered in such an ordinary business – processed fresh food.  The five year summary is as follows:

(Click for detail...)

Yes – it does have quick ratios of less than one, current ratios of less than one and ebit of only about a ninth of outstanding debt. 

It might be possible to survive that – but it will be tough.

And whilst the investment bank is Kaupthing with whom it shares multiple board members – the list of “principal bankers” contains more usual suspects – they are Barclays, RBOS, Rabobank, Mizuho,  Fortis, ABN Amro, Bank of America Securities and HSBC.

Oh Iceland the international.  What happens in Iceland does not entirely stay in Iceland.

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It is also worth considering what happens to Iceland in the absence of new funding...  It has no banking system left.  There is nobody much willing to take Icelandic Kroner.  The country has no reserves of hard cash that matter.  Its winter coming.

They can sell fish and energy intensive manufactures (their main exports) for hard currency.  But this is not like Australia - when the going got really tough in Australia in the depression you gave up and went and hunted (feral) rabbits for food.  

Iceland is a little colder.

My guess - and it said only half in cynicism - the women are beautiful in Iceland - the place just pushes out Miss World winners.  Its almost as close to NYC as Vegas.  Sex Tourism for hard cash will be their next export industry.

If they adopt the Vegas slogan will it work for financial crisis as well?  What happens in Iceland/Vegas ...

J

The Bronte Capital thesis breaks down

This blog has an over-arching thesis – which is that current account deficit countries are going to have bad banking systems – but current account surplus countries are going to be sort-of-OK.

This post was outlined in the second substantive post on this blog in which I said:

America is a land with little in deposits and considerable lending. There are similar lands – such as Spain, the UK, Australia, New Zealand and Iceland.

But I was pretty happy with the banks in current account surplus countries – although their profitability was limited.

Well – the facts on the ground look much uglier than that.

Sure the failure in Germany (Hypo Real Estate) was largely caused by its dumb Irish subsidiary (Depfa).  And the banks in Iceland and the UK have essentially imploded – as have several in the US.

But my problem is that the banks in current account surplus countries are behaving very badly.  The relatively well run Chiba bank in Japan has halved.  Ditto DNB Nor – in oil rich current account surplus Norway.  

This is significant and signifies either irrational panic or the thesis being wrong.

Thoughts please.

Geopolitics and financial crisis

Dopeyness warning.  Whilst I was familiar with the Icelandic bank balance sheets relative to GDP (Iceland is the second most bank revenue to GDP in the world after Switzerland which tells you something) I was simply sure - and wrong - about Iceland being an EU member state.  

They are not - as many comments have pointed out.  My mistake.

I was also familar with Kauthing Edge and Ice Savings - and indeed had mentioned them in the comments - and was concerned about the effect of the Icelandic banks on the Norwegian deposit market.  (If you look back at past posts I found some Norwegian readers to confirm to me what DNB Nor management was saying).  

I am a dope.  I thought that there was no way the UK would allow the Icelandic banks to raise 5 billion pounds plus in deposits at high rates in the UK unless they were forced to under EU rules.  

Something else went wrong with UK policy here.  Either way its very problematic.

J

I am short Swedbank.  It’s a call on the collapse of the Baltic States – something I regard as almost inevitable.

The risk with that short is a bail-out because the Baltic States are geopolitically significant.

But then I am wondering how dumb American foreign policy is becoming.  Russia is now lending Iceland 4 billion euro.  A lot of money to be sure – but the Spectator is speculating (probably with reason) that the quid-pro-quo is allowing Russia to use the former US military bases in Iceland.

The Spectator also reports that the US were asked for the loan first and declined.

Some questions: what is political union in Europe if Europe will let a member state have an Argentina type default event?  Where is the Committee to Save the World?

Who is in charge here? 

Is it an enormous geopolitical decision to allow Russia to have a refuelling base in the middle of the Atlantic?  Hey – a failed adventure in Iraq is a 1000 billion plus experiment.  This one is cheap.

I have a question for the conservatives: would Ronald Reagan have allowed it?

Sir Fred not quitting

I have a British passport.

I am considering sending it back.  Sir Fred Goodwin is not quitting.

http://www.thisislondon.co.uk/standard/article-23566426-details/City+cautiously+welcomes+‘positive,+sensible+move’/article.do

Hey - this is a guy who ran cap-in-hand to the UK government asking for money for the bank he destroyed.

In the US the Government had the decency to sack the CEO of the companies they nationalised.

Come on Her Majesty - your government is better than that!

Sir Fred Goodwin deathwatch - hopefully final edition

The press is reporting the sacking of Sir Fred Goodwin before the bank has announced it.

http://www.thisislondon.co.uk/standard-business/article-23566287-details/Banking+bailout+claims+scalps+of+top+pair+at+RBS/article.do

Three cheers for common decency.

Now deny him the termination payment.  

Dumb things I did not do for real

I wrote out a model portfolio for a hedge fund in January this year.  I also wrote a draft note explaining every position - part of a due diligence package if you will.  

The longs did awful (eg GE), the shorts did really awful (Bear and Lehman) - but the portfolio would still be down as there were more longs than shorts.

The "model portfolio" had a very small position (minus 1 percent) short Fortis.  I wrote a small note on the stock:

Fortis

This is a place-holder position.  But they paid way too much for ABN Amro and got the worst end of the deal (RBS got the better stuff!). 

They also have an undisclosed amount of subprime in the insurance company on which they have refused to take charges because they are “going to hold the assets to maturity”.  [This is an exact quote.]

They are capital constrained from the ABN Amro deal and refuse to take losses because (at best) they require a large capital raising.  

There are rumours about them needing to lean on the European Central Bank.

They are not particularly cheap and my experience of individual operations is that they are poorly run.

This however is not a sufficient case for a large position. 

Further work

Plenty.  Main thing is to work out the size of the raising and whether it is doable.  With work it might wind up as a core position.

Anyway - this little note - which I dug up again yesterday - looks fantastic now. 

Pity though - I did not do the further work and I never put the position on for myself.  

Execution is everything John and don't forget it.

Royal Bank of Scotland – some comments

One of the first posts I made on this blog was about Royal Bank of Scotland.  In it I described Sir Fred Goodwin as "the worst CEO of any big bank anywhere".

I promised a Sir Fred Goodwin Death Watch part II and III and had articles written – but the stock got ahead of me – and I didn’t much feel like picking the wings off butterflies.

Besides I thought I was just being vindictive.  My worst ever day at work was provided by Sir Fred.  I was short a very large amount of Charter One (a Midwest Bank) and Sir Fred purchased the company for a substantial premium.  I cost my clients many tens of millions of dollars.

In my history of US Finance note I drolly noted that the (then) universal acceptance that the acquisition of Charter One was dramatically overpriced provided “thin consolation, but no refund”.  My motives for going after Sir Fred were not entirely pure – so I decided to steer clear.  (Sir Fred - the refund would be nice...)

Besides – in the scheme of things Sir Fred raised a lot of capital.  Enough to cover a multitude of sins.  I thought RBS would survive.  I thought (incorrectly) that long RBS short Barclays was probably a good pair.  Thankfully I never put it on. 

Now RBS is at the edge.  It looks like it is failing.  It might survive – so I don’t want to fan the fire too much.  However the stock price is plenty fanning the fire.

At year end RBS had the biggest balance sheet of any bank anywhere in the world.  This balance sheet was inflated as it consolidated Fortis’s position in ABN Amro for instance.  Even net of this however RBS really matters.

I thought the expression “too big to fail” meant something – however this cycle has proved me wrong. 

RBS could provide the alternative test – too big and too global to bail out.  RBS is heavily integrated in the United States where it is one of the top ten banks.   The UK end is large relative to the UK economy and sterling is falling on the panic – the UK Government cannot do RBS alone – and the US end will need a US backstop.  RBS has large operations in many countries (including for instance a deposit base in Switzerland and a lending business in my home country of Australia).  I have no idea how the various governments will be involved – but I would seriously doubt that Australia would contribute. 

But for the time being I will take you back to one of the best – but most un-noticed business articles in the world this year.  It was by Bethany McLean in Fortune in Mid February. 

In it Bethany starts with the prophetic line:

 Could Royal Bank of Scotland be the new AIG?

For the rest of this article I just pass you to Fortune.   

Bethany told me once that this article generated almost no feedback – to which I say to the magazine readers – shame on you.

The Sheila Bair disgrace sequence

1).  Sheila Bair rings Jamie Dimon and suggests to him that she might confiscate the assets of Washington Mutual.  She says that Jamie should prepare a bid. 

2).  One week later the Office of Thrift Supervision signs a memorandum of understanding with WaMu saying that WaMu does not need to raise capital or increase liquidity.

3).  Sheila Bair forces WaMu to get investment bankers in who will do due diligence.

4).  The investment bankers talk down WaMu for weeks in press and cause a minor run. 

5).  The OTS seizes WaMu without any real indication to the management that this was going to happen and sells it to her hand-picked banker (Jamie Dimon).  The deal is irrevocable.  In the process she puts the fear-of-government in all the intermediate holders of US Bank finance.  This exacerbates the crisis.

6).  The WaMu deal causes a panic at Wachovia.  There was no panic at Wachovia prior to this – though Wachovia stock is justifiably weak.

7).  On Sheila’s timetable a deal has to be done for Wachovia in three days.

8).  Sheila decides that no deal can be done without government support and she offers that support.  Wells Fargo has simply told her they need more time.  Having done due diligence on a small bank I can assure you three days is not enough for a large bank unless the Government is going to give you large warranties.  Sheila created a timetable that forced the government into a deal that was potentially bad for taxpayers.

9).  A few more days and the deal turns up that doesn’t cost taxpayers anything.  Sheila however has staked her reputation on the prior deal and defends her prior behaviour.

I have argued that Sheila should be sacked.  I think that is pretty obvious now.

But someone on Wall Street has a better idea.  It is in this photo:

 

 

 

John Hempton

Its amazing how bad Sheila Bair looks now

Sheila Bair - without giving anyone time to do due diligence - forced Wachovia into a merger with Citigroup in which she warranted that the taxpayers would pick up the losses (beyond a certain point well below the book value of the deal she did).

Now she is defending that deal - and her tattered reputation - 

http://blogs.wsj.com/economics/2008/10/03/fdics-bair-statement-on-wachovia-deal/

Then she says not to assume the FDIC is opposed to Wells/Wachovia...  

This is the way a bad public servant makes a sausage.

Sheila - do us a favour and resign.

John Hempton

Did Sheila Bair force the confiscation of a solvent bank?

Well - yes.  If Sheila had not acted Wachovia would not have been in play.  She basically forced a deal whereby Wachovia banking operations were purchased by Citigroup.

Wachovia had 70 billion in net worth.

Now Wells is prepared to buy the lot.  No government assistance required.

I stand by my assertion that WaMu was solvent too - and if left alone would have survived.  But Sheila never gave it a chance.  

Sack Sheila Bair now!