Cablegate: Iceland: Govt Buys 75 Percent Share in Third-Largest Bank

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TAGS: ECON EFIN IC
SUBJECT: ICELAND: GOVT BUYS 75 PERCENT SHARE IN THIRD-LARGEST BANK

1. (U) Summary: The Government of Iceland announced on 29
September that it is taking a majority share in Glitnir Bank, the
country's third largest bank. The move follows a frantic round of
secret weekend consultations between Prime Minister Haarde, the
Central Bank, the heads of all major political parties, and
Iceland's leading banks. Under the agreement, the Government will
purchase 75 percent of Glitnir at roughly $878 million. This is the
first significant government intervention in the Icelandic economy
during the recent crisis and comes after a week of harsh criticism
for perceived inaction -- in particular, for not managing to include
Iceland in the 24 September exchange agreement between the U.S.
Federal Reserve and the central banks of the other Nordic countries
and Australia. The immediate result of the bailout was the
pre-filing for bankruptcy of a holding company which is
interconnected to a large portion of businesses. It appears that
Glitnir will be saved, but the domino effect of weakened share
prices could still damage the overall economy. End Summary.

2. (U) The Government of Iceland announced on September 29 that it
would buy a 75 percent share in the country's third-largest bank,
capping a tumultuous week in the economy here. On September 24, the
US Federal Reserve announced it was making $30 billion available to
the central banks in Australia, Denmark, Sweden and Norway to ease
money markets through an exchange agreement to improve global
liquidity. The Central Bank of Iceland came under immediate fire
from Icelandic financial experts and the media for not getting
itself included in the agreement. After refusing comment for nearly
24 hours, the Central Bank of Iceland issued a statement saying that
it had been engaged in talks with the Federal Reserve in the past
weeks. According to the statement, the U.S. Fed did not see a
reason to make such an agreement with the Central Bank of Iceland at
this point, but the possibility of a future agreement has not been
ruled out.

3. (U) For most of September, several well-respected economists and
leading editorialists have publicly criticized the Central Bank's
monetary policy and the GOI's handling of the ever worsening
economic situation. Some even called for the resignation of the
entire board of governors of the Central Bank. The rapid fall of
the Icelandic krona (40 percent since the beginning of 2008) and the
news of the exclusion of Iceland from the other Nordic's agreement
with the U.S. Federal Reserve only exacerbated the public outcry.
This criticism has fueled a growing sentiment that Iceland should
explore joining the EU and adopt the euro, with recent opinion polls
showing for the first time majority support for exploring the
possibility.

4. (U) On September 27, PM Geir Haarde called a meeting with the
board of governors at the Central Bank and his economic advisors.
When asked, Haarde said he was only familiarizing himself with any
developments that had taken place while he had been attending the
UNGA in New York. After the meeting he said that such a meeting was
normal and that no big news was about to break. On September 28,
Haarde and the Central Bank of Iceland's board of governors held a
late-night meeting with executives from Iceland's three main
commercial banks, Kaupthing, Landsbanki, and Glitnir and
representatives from the Social Democratic Alliance -- the junior
party in the coalition government -- and the opposition parties.

5. (U) On Monday, September 29 the media announced that the GOI was
taking control of Glitnir, the third largest Icelandic bank, buying
a 75 percent stake for 600 million euros (approximately $878
million), more than 6 percent of Iceland's 2007 GDP. This move was a
surprise to the general public. All parties involved quickly
announced the problem was related to international financial markets
and not the management or assets of the bank itself. The Central
Bank said Glitnir's asset portfolio and capital position were solid
and its loans were good quality; it said it did not intend to keep
its stake in Glitnir for an extended period. The Prime Minister
held a press conference to echo the Central Bank's sentiments and
added that the government must safeguard financial stability.
Glitnir said its core operations were robust and CEO Larus Welding
had been asked to stay. Glitnir said it had been successful in
raising funds this year despite very challenging market conditions,
"nonetheless, the events unfolding in international financial
markets in the past two weeks have had unforeseen consequences
drastically changing the conditions of Glitnir's short-term
funding," the bank said in a statement.

6. (SBU) Post's contacts at Glitnir confirmed that even bank
employees had no idea this was coming. Glitnir's management has
told employees that because the bank was very well run and
management was not the problem, everyone will probably keep their
jobs. The larger concern is for stockholders; because the number of
Glitnir's stock had to be increased to provide the state with 75

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percent equity, Glitnir's stock lost even more value than
market-induced declines and had dropped 88 percent of its value by
the end of the day. The biggest shareholder of Glitnir is Stodir
(formerly FL Group and connected with Baugur Group) which just filed
for pre-bankruptcy. The ripple effect of one of financial titan
Baugur Group's major assets going bankrupt could set off other
disruptions in the economy.

7. (SBU) Comment: Although the main problem of Glitnir was the
inaccessibility to short term-credit caused by the global shortage
of liquidity, resolving this has not cured all ills. The news on
Glitnir's bailout sent the Icelandic krona to a fresh record low
against the euro and caused the value of Glitnir's stock to plunge.
Given that in recent years Iceland's economic success has been
largely based on leveraged buyouts, the plummeting value of stocks
could have drastic consequences throughout the economy.

VAN VOORST

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