STOCK MARKET WATCH - Wednesday, 11 January 2012

[Demeter]

3. Iceland’s New Bank Disaster FROM NOVEMBER

http://www.nakedcapitalism.com/2011/11/iceland%E2%80%99s-new-bank-disaster.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

The problem of bank loans gone bad, especially those with government-guarantees such as U.S. student loans and Fannie Mae mortgages, has thrown into question just what should be a “fair value” for these debt obligations. Should “fair value” reflect what debtors can pay – that is, pay without going bankrupt? Or is it fair for banks and even vulture funds to get whatever they can squeeze out of debtors? The answer will depend largely on the degree to which governments back the claims of creditors. The legal definition of how much can be squeezed out is becoming a political issue pulling national governments, the IMF, ECB and other financial agencies into a conflict pitting banks, vulture funds and debt-strapped populations against each other. This polarizing issue has now broken out especially in Iceland. The country is now suffering a second round of economic and financial distress stemming from the collapse of its banking system in October 2008. That crisis caused a huge loss of savings not only for domestic citizens but also for international creditors such as Deutsche Bank, Barclay’s and their institutional clients.

Stuck with bad loans and bonds from bankrupt issuers, foreign investors in the old banks sold their bonds and other claims for pennies on the dollar to buyers whose web sites described themselves as “specializing in distressed assets,” commonly known as vulture funds. (Persistent rumors suggest that some of these are working with the previous owners of the failed Icelandic banks, operating out of offshore banking and tax havens and currently under investigation by a Special Prosecutor.) At the time when those bonds were sold in the market, Iceland’s government owned 100% of all three new banks. Representing the national interest, it intended for the banks to pass on to the debtors the write-downs at which they discounted the assets they bought from the old banks. This was supposed to be what “fair value” meant: the low market valuation at that time. It was supposed to take account of the reasonable ability of households and businesses to pay back loans that had become unpayable as the currency had collapsed and import prices had risen accordingly.

The IMF entered the picture in November 2008, advising the government to reconstruct the banking system in a way that “includes measures to ensure fair valuation of assets and maximize asset recovery.” The government created three “good” new banks from the ruins of its failed banks, transferring loans from the old to the new banks at a discount of up to 70 percent to reflect their fair value, based on independent third party valuation. The vultures became owners of two out of three new Icelandic banks. On IMF advice the government negotiated an agreement so loose as to give them a hunting license on Icelandic households and businesses. The new banks acted much as U.S. collection agencies do when they buy bad credit-card debts, bank loans or unpaid bills from retailers at 30% of face value and then hound the debtors to squeeze out as much as they can, by hook or by crook. These scavengers of the financial system are the bane of many states. But there is now a danger of their rising to the top of the international legal pyramid, to a point where they are in a position to oppress entire national economies.

Iceland’s case has a special twist. By law Icelandic mortgages and many other consumer loans are linked to the country’s soaring consumer price index. Owners of these loans not only can demand 100% of face value, but also can add on the increase in debt principal from the indexing. Thousands of households face poverty and loss of property because of loans that, in some cases, have more than doubled as a result of the currency crash and subsequent price inflation. But the IMF and Iceland’s Government and Supreme Court have affirmed the price-indexation of loan principal and usurious interest rates, lest the restructured banking system come to grief. This is not what was expected. In 2009 the incoming “leftist” government negotiated an agreement with creditors to relate loan payments to the discounted transfer value. On IMF advice, the government handed over controlling interest in the new banks to creditors of the old banks. The aim was to minimize the cost of refinancing the banking system – but not to destroy the economy. Loans that were transferred from the old banks to the new after the 2008 crash at a discount of up to 70% to reflect their depreciated market value. This discount was to be passed on to borrowers (households and small businesses) faced with ballooning principal and payments due to CPI indexing of loans. But the economy’s survival is not of paramount interest to the aggressive hedge funds that have replaced the established banks that originally lent to the Icelandic banks. Instead of passing on the debt write-downs to households and other debtors, the new banks are revaluing these loan principals upward. Their demands are keeping the economy in a straight jacket. Instead of debt restructuring taking place as originally hoped for, the scene is being set for a new banking crisis. Something has to give. But so far it is Iceland’s economy, not the vulture funds. With the IMF insisting that the government abstain from intervention, the government’s approval rating has plunged to just 10% of Icelanders for floundering so badly while the new owners call the shots...The New Banks have written off claims on major corporate debtors, whose continued operations have ensured their role as cash cows for the banks’ new vulture owners. But household debts acquired at 30 to 50 percent of face value have been re-valued at up to 100 percent. The value of owners’ share equity has soared. The Government has not intervened, accepting the banks’ assertion that they lack the resources to grant meaningful debt relief to households. So unpayably high debts are kept on the books, at transfer prices that afford a windfall to financial predators, dooming debtors to a decade or more of negative equity...

BUT WAIT, THERE'S MORE, AND IT GETS WORSE!