Not only does politics make for strange bedfellows, but so does desperation. Iceland is looking to borrow over $5 billion from Russia to shore up its banks. Um, Iceland is a member of NATO, or at least is now. As reader Jørgen commented,
Russia backstopping Iceland? What is the pay-back? Keflavik?
I guess this resembles blackmail of EU: If you don’t rescue us, Putin will.
Reading the Reuters story on this surprising turn of events, it appears that Iceland is not willing to seek assistance from the IMF, since in the Asian crisis, it imposed reforms that were seen as draconian (and many believe contained counterproductive elements).
Update 7:15 PM. I thought Jørgen was kidding. Even if he was, he was spot on. The Spectator confirms the idea (hat tip reader RB):
But what price will the Russians demand for their bailout? A highly-placed source in Reykjavik tells Coffee House that Iceland might look kindly on requests from Russia’s military to use America’s former military base in Iceland. America closed its Naval Air Station at Keflavik Airport two years ago, handing back the Nato facility to the Icelandic government.
From Reuters:
Iceland took over its second largest bank, propped up a battered currency and sought on Tuesday a 4 billion euro ($5.44 billion) loan from Russia to help tackle a crisis threatening to overwhelm the island nation.
Russian Finance Minister Alexei Kudrin said Moscow viewed positively the request from Iceland, whose premier said it had faced a risk of “national bankruptcy.”
“The result will be announced after negotiations,” Kudrin said.
Prime Minister Geir Haarde said Icelandic officials would travel to Moscow on Tuesday or Wednesday to discuss terms for the loan to bolster the country’s foreign reserves.
“With this, like everything else, nothing is certain until it’s certain,” Haarde told a news conference.
He said Iceland would not default on its sovereign debt…..
Yves here. If you believe that, I have a bridge I’d like to sell you.
So volatile was the currency that Iceland’s central bank was forced to introduce a currency peg at a value of 131 per euro. It was last trading around 150.
An International Monetary Fund spokesman said an IMF staff team was in Iceland and Norway said it was ready to discuss help but had heard nothing from Reykjavik.
Its reluctance to ask for IMF help was also noted when G7 deputy finance ministers discussed its situation during a conference call on Monday evening, according to a government official from one of the Group of Seven industrial nations.
“Japan proposed using an IMF facility to help Iceland, but Iceland did not want to ask the IMF for money,” the official, who was familiar with the content of the phone consultations, told Reuters, speaking on condition of anonymity.
“Iceland does not want to be singled out as a country that needs IMF help. Even last summer, Iceland preferred to ask the central banks of some Nordic countries for help rather than go to the IMF for money.”….
The central bank said a Russian loan would substantially strengthen Iceland’s foreign reserves and support the crown, which Haarde predicted would should strengthen significantly when more normal trading conditions resumed.
“Four billion euros would be more or less what Iceland needs to cover the whole banking system assets with their reserves,” said Elisabeth Gruie, currency strategist at BNP Paribas.
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We can’t let that domino fall!
Russian expansionism must be contained!
Increase the strategic herring reserve now!
Is Bjork safe?
GDL
You have to admire the efficiency of the Russians. Bush spends 700 billion in Iraq for nothing. Russia spends 5 billion and gets control of the North Atlantic shipping lanes. Putin sure can play the game.
I suspect that Russia simply wants to reestablish a working relationship with the West. It also re-entered the discussion on Iran last week after the decision (irrationally in my view) to have G7 as opposed to G8 discussions on how to handle the financial crisis caused it to pull out.
There has recently been some evidence that Russia wants closer integration with Europe, while resigning themselves to an arms-length relationship with the US. It seems that certain elements in Europe are tempted, including Berlin, if you take the statements at the Petersburger Dialog last Friday seriously … and perhaps their response to the crisis as well.
Reinsurance Treaty II, perhaps.
Matt Dubuque
The big push is on for strategic access to Arctic oil.
Plus Russia has actually salted away a little cash. By contrast, the USA has not.
Matt Dubuque
nospammdubuque@yahoo.com
Bloomberg version, with Haarde’s comment about Iceland’s friends:
Prime Minister Geir Haarde said at a press conference he was “disappointed” that “we have not received the kind of support we requested from our friends.” He declined to name countries Iceland may have approached for a loan, adding that the nation “will absolutely not default on its foreign debt.”
If you missed this story, it has some interesting thoughts:
$5 Trillion Cash Pool Needed to Stop Rout, Ohmae Says
By Bei Hu
Ohmae, nicknamed “Mr. Strategy'' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion “international facility'' to be made available to financial institutions. The system could be modeled on one used by Sweden during its banking crisis in the early 1990s, he said.
“This is a liquidity crisis,'' Ohmae said at an investor forum hosted by CLSA Asia-Pacific Markets, the regional broking arm of Credit Agricole SA, in Hong Kong yesterday. “The liquidity has to be so big that people won't get panicky.''
http://jessescrossroadscafe.blogspot.com/2008_09_01_archive.html
Don’t know if it’s been report abroad but the Icelandic minister of Industry told the Icelandic news media today that the US had given Iceland the finger when Iceland asked for assistance. Iceland has turned to Russia before (during the cod war with the UK) and we’ll do it again.
The Wall Street Journal is reporting the Treasury may finance investors who buy the assets the Treasury eventually sells off.
http://online.wsj.com/article/SB122342388130313375.html
So, is the Plan for the Treasury to overpay in purchasing assets, then underprice (possibly through cheap credit or retaining some of the risk) when it sells? This is so roundabout and time consuming, how can it possibly be about global solvency instead of enrichment at taxpayer expense?
You can’t run an empire when you’re broke. Any major U.S. financial collapse must inevitably be followed by a global military collapse.
We must put things in perspective. Iceland borrowed $16k per capita. It is unknowable what is their GDP per capita as of recently because of the demise of the currency but my Economist’s “Pocket World in Figures 2007” shows $41k per year. So, now, very speculatively with kruna halved it should be $20k.
US for that year was $39k per capita but also has $9tril. federal debt, which ends up being $30k per capita.
Iceland is probably better; and being smaller probably more organized and will accept sacrifices.
–petar
FairEconomist said…
You have to admire the efficiency of the Russians. Bush spends 700 billion in Iraq for nothing. Russia spends 5 billion and gets control of the North Atlantic shipping lanes. Putin sure can play the game.
An old Russian joke goes, that after NASA developed a miracle pen that can write in the absense of gravity – at the cost of one million dollars, the Soviet space agency responded with a one-cent solution – a pencil.
The CHinese also stiking out in editorial in the People’s Daily today re the US inflating its way out at expense of debt holders. THe next decade will be more fascinating than the ’80s. The USSA is the USSR circa 1980. What does the US look like without dollar hegemony…
Here’s what I don’t get. No one has yet asked the Icelandic Prime Minister why no one in government sought to protect the people of Iceland.
The record salaries at the newly privatized banks, the ridiculous housing boom in a country of only 300,000 people, world sales record for most LandRovers …. It was very clear that Iceland was headed for a cliff. Surely the government was in a position to say, no, especially given the country’s history of destitution under foreign interests as a Danish colony.
Yves,
I love this blog. I have been heavily involved in subprime over the last six months.
I have been having a debate with a co-worker:
He believes that the bank failures are a result of a liquidy problem.
I believe that these banks have on their books tier-three assets such as CDO’s which are falling in value.
I am wondering if you could clarify what is at the heart of the failure of banks in the U.S. and EU.
Thanks
Right. some say Liquidity, some say Solvency.
The Liquidity case (from above post) :
“This is a liquidity crisis,” Ohmae said at an investor forum hosted by CLSA Asia-Pacific Markets, the regional broking arm of Credit Agricole SA, in Hong Kong yesterday. “The liquidity has to be so big that people won’t get panicky.”
The Solvency Case (from Richard Kline, yesterday).
“This isn’t a crisis of confidence, it’s a crisis of solvency, and that isn’t addressed at all by bloating liquidity. The Fed keeps stacking bricks o’ bills on the Liquidity Wall, while the Solvency Wall has collapsed and the zombies are inside the City.”
I think “solvency” wins easily, especially when one considers style and presentation.
Anon of 10:15 PM,
You asked a big question, and I am afraid I can give only a short answer,
It is true that illiquidity can lead banks and companies to fail, But there is strong evidence to suggest this is a solvency problem, bigger than the CDO problem you mention, although that is an important piece.
As you know, banks carry only a small amount of equity. 8% is a good rule of thumb. European banks carry even less (some are geared as much as 50 times).
Banks (and we can include investment banks) engaged in riskier and riskier lending. Just look at how the profile of credit card borrowers has changed. Banks have been out to create heavily indebted, chronic borrowers, though the use of teaser introductory offers. Before, they used to price their products so they made money off everyone (in fact, in the old days, the best customer was someone who paid the annual fee but used the card little or not at all); now their profits depend on the heavy borrowers.
Since the early 1990s, but at a greatly accelerated pace, consumers have taken on more debt relative to income. The ratio of consumer debt to income rose by 50% from 2000 to 2007. That is simply stunning.
Banks were also discouraged from building up loss reserves in good years. It was seen as a way to smooth earnings and frowned up on by regulators (talk about perverse).
So we have a lot of deadbeat borrowers, due to over leverage. Some were destined not to make it, some might have but will be taken down by bad luck or a deteriorating economy.
European banks didn’t have as much latitude to take risk, but were brought down by buying US product and also by exposure to the markets where consumers went wild (England, Ireland, Spain, the Baltics).
Does that help?
Yves, I think McCain is right when he points to the GSEs as culprits. Mortgage originators would have been far more cautious if they were buying debt for their own account, instead of laundering it as AAA agency-backed fudge. What worries me most at this point is state and local deficits and an avalanche of muni defaults.
Seems almost like a setup for President Jindahl to Invade, er, liberate Iceland to show that we’re back after the malaise of the Obama years, er to free the medical students/depose the illegitimate regime/end the the suffering. Knocking off small regimes was almost elevated to an art form in the Reagan/Bush I years. Bush II, sadly enough, was no artist. It’s not hard to imagine a reprise (gives the proles something to think about besides the economy).
So Matt, you hit most of the nail’s head with your remark: This intervention in Iceland is very much about control of the Arctic, which is very, very high on the Agenda of Russia. It’s not _just_ about oil, or even just about shipping lanes through an ice free Arctic, though the latter will be very important with Iceland a key location in that. Getting Iceland into a partnership with Russian on ‘Arctic exploitation’ locks out the US of a huge region. I’m sure that Russia has the angle of repairing bridges with the EU in this, too, but that’s just a sugar plum on the pie. This will be the best $5B Russia spent in our lifetime—for them. Putin is a nasty piece of work, but he absolutely understands how to play geopolitics unlike Dickie and Dufus who can’t even win a game of Stratego without knocking the board over.
I’m sorry for the Icelanders. Some of their problems are their own creation; they’ve had their own little bubblete. But it’s tough to manage a small country with limited resources in a world with big financial dogs. Don’t lease that genetic base folks, some things aren’t for sale.
There may be a brief day when the net worth of Sigur Ros and Bjork together exceeds that of their country. *eeekk*
Re liquidity vs. solvency, isn’t the biggest problem that no one really knows for sure which is the case (‘no one’ here including quite possibly the banks themselves)?
Certainly there will be some outright losses, but it seems (at least to my non-expert eye) that the greatest concern is that, with all the complex derivatives and various counterparties, no one really knows what the result of unwinding would be. And even a bank may not be able to determine its own result, as such is dependent upon other parties, whose results are dependent upon still other parties, and so on.
But one possible result of unwinding everthing could be losses that are manageable by at least the majority of financial institutions. Of course, it is also possible that such is not the case, and there are gigantic losses waiting to wipe out large numbers of financial institution. But it seems that there is insufficient information for a compelling argument either way.
Xinhua just reported: “ING Groep NV, the biggest Dutch financial-services firm, agreed to buy more than 3 billion pounds of retail deposits held by UK customers of two Icelandic banks for an undisclosed amount.”