The North Atlantic conspiracy

Is Iceland the victim of a financial conspiracy?

Such things really do happen. During the 1997-1998 financial crisis there was, almost certainly, a financial conspiracy against Hong Kong. According to the Hong Kong Monetary Authority, several major hedge funds engaged in a “double play”, shorting both the city-state’s stock market and its currency. The alleged plan was to put the HKMA in a double bind: it would be forced either to raise interest rates to defend the Hong Kong dollar — driving stocks down — or to devalue the currency. Either way the hedge funds thought they’d make a killing. They were, however, caught in a bear trap when the HKMA did the unexpected and bought up a large fraction of the HK stock market.

There was also, according to Australian officials I talked to at the time, a deliberate effort to drive down the Aussie dollar.

Now, Iceland is making similar allegations:

The cost to protect the bonds of Iceland’s three biggest lenders from default rose after central bank Governor David Oddsson said “unscrupulous dealers” are trying to break the country’s financial system.

…

Oddsson called for an international investigation into attempts to drive Iceland’s economy “to its knees,” in a speech on March 28. The central bank was forced to raise its benchmark rate to a record 15 percent last week to defend the krona after a 30 percent slump against the euro this year.

…

Attacks on the country’s Reykjavik-based banks “give off an unpleasant odor of unscrupulous dealers who have decided to make a last stab at breaking down the Icelandic financial system,” Oddsson said at the central bank’s annual meeting in Reykjavik. “They will not get away with it.”

One interesting point: it appears that the Icelandic authorities particularly suspect Bear Stearns.

I’ll be keeping an eye on this.

Comments are no longer being accepted.

Bill March 31, 2008 · 10:55 am

Perhaps you should add that manipulation at this level affecting millions of people is not ethical, moral, or maybe legal. After all, a lot of people have been brain-washed since 1980 to think that the market can do no wrong.

Adam S March 31, 2008 · 12:00 pm

They’re going to take away your “reasonable-member-of -the-economic-establishment” card if you keep spouting off like this. To claim that a market entity would be so unscrupulous as to try to manipulate the market, why, that’s like saying the Hunts tried to corner the market on silver.

Speaking of which, it would be fascinating to see just how much capital one needs to mount this sort of attack vs. the size of the market for the security in question. Was it just that the Hunts were undercapitalized?

Richard Patten March 31, 2008 · 12:13 pm

Paul, I recall FDR hiring Joe Kennedy to write legislation to regulate market mabnipulation of the type you describe. I don’t recall the exact rules involved. Can you provide the details and suggest additional regulation to control hedge funds and this kind of manipulation? Please keep up with this topic. If not stopped, it could put the nail in the coffin of trading in the U.S. market.

RennieB March 31, 2008 · 1:27 pm

Not just Iceland, all E.U. countries.
And it’s not a conspiracy, it’s the “ingenuity of the markets”…

William Smith March 31, 2008 · 3:57 pm

Prof Krugman,
People have been speculating rampantly at the almost-instantaneous time it took the Fed to force Bear Stearns to agree to a buy-out at 1/85th its peak share price. This could rightly add fuel to that fire.
However, Bear Stearns also alleged that its decline was the result on market manipulators shorting it for massive gain.
The plot thickens and this mystery may involve bankers and economics wonks as detectives.

Icelander March 31, 2008 · 4:14 pm

Yes – the bad American Bear (with the surname Stearns). Ough! Actually the Icelandic banks are now considered having higher default risk than banks in countries like Zimbabwe! C’mon guys – that is a bit weird. However, if the krona (ISK) is fine and based on a strong economy (as our poet, former PM and current Central Bank Governor Mr. Oddsson argues) we shall prevail. And you should all instantly convert your wealth (what’s left of it) to ISK and get 15% risk free fresh arctic interest. Instead of keeping the increasingly devaluating pathetic USD on the laughable rate offered by the FED & friends. As you all should know, the famous cliché is of course true; Iceland is Niceland!

Greg March 31, 2008 · 4:40 pm

What exactly are the positions of the traders? Are they short the currency? If so, it is an expensive position to maintain with interest rates at 15%.

If they are long credit default swaps, then all they need is to spread rumors of a default to make their profit, so there is not really any intention to bring the country to “its knees.”

ee March 31, 2008 · 4:48 pm

To me, manipulation, no doubt.

It feels like, “if you are not with me you are against me” combat attitude.

To RennieB: No, I am sorry to say that it was only Iceland this time. Anyway it is easy to check.

Todd Ryder March 31, 2008 · 8:12 pm

Obviously, by Bear Stearns’ standards, the Hunts were not so much under capitalized as under-leveraged! Debt is king — until it’s not. If not happens I wouldn’t want to be within 500 miles of the New York metro area.

argh March 31, 2008 · 8:35 pm

Hmmm.

You write:

…the hedge funds thought they’d make a killing. They were, however, caught in a bear trap when the HKMA did the unexpected and bought up a large fraction of the HK stock market….

They write:

From the Telegraph:

The US Federal Reserve is examining the Nordic bank nationalisations of the 1990s as a possible interim solution to the US financial crisis.

—————

Same thing, basically?

marino March 31, 2008 · 9:05 pm

Greg said:

“If they are long credit default swaps, then all they need is to spread rumor of a default to make their profit”

Well that is exactly what they have done. The Sunday Times published news yesterday saying that people in England were closing their account they had in the Icelandic banks in England. It turn out to be fabrication. News have been circulating for the past weeks that the banks would not been able to refinance their loans, when it turns out that none of the banks need refinancing until at earliest late next year. The CDS for the Icelandic government jumped 400 points last Friday despite the fact the government has no foreign loans. Everything points to the fact that what mr. Krugman is saying is actually happening and it is scary that Bear Stearns that was recently saved by the US federal Bank

Marino March 31, 2008 · 9:09 pm

Sorry my comment did not end correctly:

I was saying it is scary that Bear Stearns, that was recently saved from bankruptcy by the US Federal Bank, seems to be behind this attack on an independent nation. I hope the people behind this spend a good part of the rest of their life behind bars because that is where they belong.

Jón Frímann March 31, 2008 · 11:14 pm

Being an Icelander I find this allegations of an ex-prime minster (how did not do a good job in my opinion and isn’t doing a good job) are bit strange. Mostly for the reason that the Icelandic banks have over invested abroad with short term loans in long term investments, at least that is what I understand as the common man on the street.

The Icelandic krona is weak on it’s own, mostly for the reason that foreign banks (mostly) have been issuing krona notes to make profit on the huge percent difference between Iceland and the rest of Europe. That has been keeping the krona strong, until about one or two months ago. When this papers did start to flow out and flow out they did. In the aftermath of this flow out the krona did start to get weaker, but the main problem is that this flow out is not over yet. There is much more left in this debt notes or whatever you call them in English.

The fall of the Icelandic krona isn’t over, it is just starting in my opinion. As a common man in Iceland.

Randolph Fritz March 31, 2008 · 11:48 pm

We need international banking regulation. The chances that we will get anything other than giving the banks the keys to the vaults seems, at this point, vanishingly small.

halbhh April 1, 2008 · 12:49 am

“Fitch said countries that run current account deficits above 10pc of GDP for any length time almost always come to grief. East Asia’s debt crisis in 1997 erupted before any state reached double digits. Iceland’s deficit is now 16pc of GDP….”
says Ambrose Evans-Pritchard at the Telegraph.

I chanced across this while reading at the Telegraph for the first time, on another subject.

Many of the British papers seem rather plain spoken I’ve noticed in the last week. They make us over here sound like we are hiding something in comparison.

RennieB April 1, 2008 · 3:56 am

To ee; My point is that the bizar growth of the derivate markets in only 4 years to almost 550 triljon has layed a financial nukular (GWB) bomb beneath Western Liberal Capitalism. That’s the ingenuity of the markets.

Now the carry-trade with Japan seems to unravel these poisitions need to unwind…

With the fact in mind that the us government holds approx. half of these derivates, the fact is that government has an unfair advantage to all players.

With Keynes in mind:

“The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

It’s a conspiracy all right, but played on all chessboards simultaneously… By the way, what’s that with chess and Iceland?

Icelander April 1, 2008 · 4:09 am

“I want to be known as the man who bankrupted Iceland”
– Hugh Hendry, of Eclectica Asset Management, 2006.
//business.timesonline.co.uk/tol/business/columnists/article684587.ece

Liv April 1, 2008 · 5:49 am

Short? Long? This post seems interesting, but as a novice, I certainly don’t know the lingo. Would anyone have a not-to-complex explanation of the basic mechanisms involved here?

Unsympathetic April 1, 2008 · 8:37 am

Just because I’m curious, and Tuesday morning is slow.. How, exactly, would one go about determining the origin of the currency/market shorting? Furthermore, what would one do with that information once the IT work has been done?

Penalize BS.. er, JPM.. a round figure to dissuade future attacks of this sort. Say, $29 billion?

Another Icelander April 1, 2008 · 11:08 am

Well, everyone knew the Icelandic currency was way, way overvalued, and it was not a matter of whether it would drop 20-30% – only a question of when.

The government, the national bank and the local banks had all predicted the currency would fall – it just happened earlier and quicker than than expected.

The same applied to the stock market – Last summer it was showing all the symptoms of a bubble – only a matter of time when it would burst. The smart people got out in time, of course.

The point? You really didn’t have to be a financial genius to try to profit from this with a short position – there was no need for a conspiracy – we just saw a bubble burst – nothing more, nothing less.

l.rodrigues April 1, 2008 · 11:58 am

If we all play Eve does it help? Their in-game currency is called ISK..
(Eve is a Massive Multiplayer Online Game, developed and based in Iceland, for those outside the gaming scene).

frankenduf April 1, 2008 · 1:25 pm

I’m with Bill- call a crime a crime- isn’t this the same financial negligence that led to the collapse of the peso in the 90s?

Nordic watcher April 1, 2008 · 4:40 pm

This isn’t a crime. The Icelanders have been pretty happy to work the markets when they were going up. They have leveraged like mad. When markets go up, leverage is great. When they fall, it kills you! This Central Bank governor says exactly this in the same speech last week. He said (translated)
“It cannot be denied that the Icelandic economy’s total debt is too high, which can be traced to the decisions made by financial institutions and other companies in the market.” Exactly. The Icelandic banks Kaupthing and Glitnir, and financial companies Exista, FL and Baugur have created the scenario where they can be exploited. We shouldn’t have any sympathy for these people. Greedy on the way up, they are paying on the way down! Now they are crying “foul”. There are conspiracies and there is the truth.

Here is an Icelandic story – An Icelandic driver is driving too fast on snow covered roads. He hits a patch of ice, goes off the road – big smash! His reaction – If it hadn’t been for that ice I would have been fine!

Marino April 1, 2008 · 6:44 pm

It looks like not many people understand or know of the reason for the current account deficit (CAD) of the past years. They are basically three fold:

1. Iceland’s biggest hydro plant and Iceland’s biggest aluminum smelter were under construction during these years. Giant projects that caused great deal of the CAD. One was build by the National Power Company, the other by ALCOA so both are a result of foreign investment in Iceland. The power plant is of course on the responsibility of Icelanders but long term contracts are in place with ALCOA that will pay up the construction cost during the next 20 – 25 years. The smelter is on the responsibility of ALCOA an American company and the CAD does not show the foreign capital investment made by the company as CAD does not measure capital investments.

2. The Icelandic krona has for many reasons been very strong lately. The USD has been as low as 55 IKR in the last few years compared to 110 IKR in November 2001. For that reason imports have been cheap and people and companies have been using the opportunity to shop/invest more than usually. It has been like a months and months of clearance sales.

3. Many of the Icelandic investment companies have moved abroad to countries with lower taxes but are still collecting dividends from their investment in Iceland. The money they get have then been used to reinvest in Iceland. The problem with CAD is that it only measures the money flowing out of Iceland as dividends but not the money going back again in the form of investment. Just this alone shews the calculations by some 10 – 15%.

Here we have three big factors that have influenced the CAD but only small part of these factors are negative for the economy. Item 1 and 3 are contributing a great deal in strengthening the economy and most of item 2 did that too. Sure there has been some over investment and we had our version of dot com stock fiasco. But our banks are strong. Our economy is strong. There is no reason why the CDSs have been rising. None at all. Our banks are better financed than most American banks. Our banks have not had to write off debts (at least not yet). Why does an Icelandic bank have CDS of 1002 while a Danish bank that has had to write off US loans has CDS of 72 when both have similar base? Why does the Icelandic government have a CDS of around 500 when the third biggest town in Iceland gets a big loan today with CDS of 75 and 85? This does not make sense. It is a joke and at the same time it is criminal. Don’t tell me that the third biggest town in Iceland that has huge debts is more reliable creditor than the Icelandic government that has no debts at all. And do people overlook the fact that the Nordic central banks have agreement to step in if one has problem with cash. The Norwegian CB would solve any crisis rising in Iceland with less than 10% of their currency on hand. I think that prominent and respected scholar like you self, Mr. Krugman, should take a closer look at the situation and write about your findings. Sure you will find things that are no in order and we have our dirty laundry, but you will also see that we mainly have a healthy economy and strong banks that do not warrant the CDSs or the press we are getting.

Andres April 1, 2008 · 9:26 pm

What about illuminats, freemasons etc? What about war in Iraq and nurture wars all around. Who is paying all these things?
It looks like a payment will come from both, stable and non stable countries. If country is not stable enough that somebody should make it stable. But some day he will ask to get back his shares. Just because there is war and it cost a lot.

One from Iceland. Third one I believe.