William K. Black - The Best Way to Rob an Icelandic Bank Was to Own One

William K. Black has specialized in fraud for most of his professional life and is the author of the book The Best Way to Rob a Bank is to Own One.  Black held a lecture almost exactly a year ago in Iceland during a period when the immense growth and corruption of banking in the past years was dawning upon the Icelandic public.  Main points of that lecture can be seen here (in Icelandic) - http://mixa.blog.is/admin/blog/?entry_id=875606.

Today Black held a lecture titled Never "Fuzzy" & no "Boundaries": The Best Way to Rob an Icelandic Bank Was to Own One, an obvious reference to the title of his book.  This summarization is written in English, since the lecture is in that language and the subject matter is of international interest.

Intro: Black appeared on Silfur Egils the previous Sunday in which Egill Helgason interview focused on his views on fraud, not least the public's perception regarding the possibilities of such matters.  Black's opinion is that fraud and looting was rampant on a wide scale within the Icelandic financial system where CEOs made sure that they and their cronies would become rich while their firms would eventually become bankrupt. The Icelandic Financial Report is discussed; Black considers it being well done but lacking a definite conclusion that fraud occurred.  Black says that the report demonstrates that a text book case in accounting control fraud occurred, listing the 4 elements (weapon of choice within financial firms) needed in a recipe to create the possibility of fraudulent behavior.  Those elements are:

  1. Growing like crazy
  2. Bad loans - high yields (here, the emphasis is probably high yields providing temporary profits, regardless though of inherent risks)
  3. Extraordinary leverage
  4. No meaningful loss reserves

This is mathematically guaranteed to produce incredible gains for a short period of time as long as all the above elements are followed.  With a bonus system intact, such a system will generate huge bonuses but also ensure that the company will eventually become bankrupt.  Black thus maintains that the highest ranking banking officials should be prosecuted as criminals. 

Black added that all the above where elements in the Savings & Loans debacle in the 80s and early 90s in the US.  Icelanders added to the recipe, however, self-funding in buying stocks and thus creating a market illusion of the worth of the banking stocks (it may be added here that the stability of the stock prices was remarkable compared to their counterparts in Europe in 2008, until of course the crash).  The Report labels this as weak funding, Black labels it as fictional funding stating that this was simple market manipulation of equity (and keeping stock prices up).

Enablers - Egill asks whether politicians and regulators helped in enabling such practices to exist.  Black agrees saying they were cheerleaders who made fun of those who questioned the soundness of the extraordinary growth of banks.  He turns the attention to auditors and credit agencies and the role of those agencies since their 'opinions' where often used as a basis in justifying the expansion.  Finally, Black criticizes the Report, stating that its conclusion that banks where trying to salvage themselves in the last months, stating that banks where first and foremost trying to salvage the directors and main owners.

The lecture:

As last year, the room is packed, clearly the venue is way too small.  Black reckons that the attendance shows that many people do want accountability - people who destroyed the Icelandic banking system.  He pondered what could have happened had the growth been allowed to continue, Icelanders would have been unable financing the losses with the main export being Icelanders themselves.  "Dick Fuld at Lehman's saved you".

Historical retrospective:

Fraud is a sure thing.  Black points at the 4 control fraud elements stated above.  The recipe to bake this cake is to grow like crazy, make high yield loans, extreme leverage and trivial loan loss reserves. This fakes record profits and real catastrophic losses.  Hence, same thing that produces profits also produces losses.  This causes executives to produce high (fake) earnings that leads to high bonuses.  Needed is auditors and credit agencies to bless such practices.  An example is loan officers gaining bonuses from volume of lending, not the quality (this was similar in Scandinavia during the real estate boom in the late 80s).

Fraud - leads to deceit that eventually erodes trust. Confidence in institutions vanishes, they fail.

Akerlof & Romer (1993) - Looting: Bankruptcy for Profit. A carefully chosen title, failure of firm is not a failure of fraud scheme.  People creating the crater walk away with far more profits than the losses of stock options, which were all the while worthless.  "Iceland was never a wealthy country, this was a fraud".  Empirical support of this exist since the early 80s, "time to learn from those lessons".

Examples of other frauds - Chinese infant formula, asbestos, building inspectors, toxic waste, fake certificates.  "There are people in the world who are willing to kill your children for money".

Fraud in the S&L debacle - The typical large failure grew rapidly with owners often the main culprits in gaining personal gains.   Enron era - accounting fraud.  Current crisis - Hindsight should be 20/20 but Black is surprised how little is learned from past frauds and are quickly to forget.  Who were on the front pages, talk shows etc.? CEOs is the answer.  This happened despite the FBI in 2004 predicting a major crisis due to fraud in front of congress.  Yet, no referrals of criminal activity were reported from the regulatory authorities (Black was unclear on this matter).

Black listed a few institutions were massive fraud was committed.  Names include Washington Mutual, Citigroup, Lehman, Goldman, Rating agencies and Fannie & Freddie.  Liar loans, i.e. unverified loans, were an unbelievable percentage of loans made during the last years, 60-70%.  


Irony how good the report is because the facts are correct but findings are short on fraud.  All 4 elements of recipe mentioned above are in place, grossly.  The finding that this was Bad Luck, a perfect storm, is something Black strongly disagrees with.  Black points to a gambling metaphor, principle owners bought large amounts of shares using money lent to them with the shares as capital (this is of course well established in Iceland).  Why did banks inflate their share price?  Banks were loaning on the basis of share prices, the survival of the firm depended on it while the 'owners' were looting. Black is sure that the owners knew long ago that that would be the end result.

Decisions were not made by banks, but CEOs and their cronies.  They were not making bets, using funds to buy shares while an illiquidity crisis was in full force.  They were not betting on life but death, they didn't care and kept the bank going using a Ponzi scheme. Black says: "They had spectacularly good luck" keeping this going for as long as it did.


Eirikur Tomasson points out that The Report may have been more of a fact finding mission since authorities were concerned that it may damage investigations into criminal activities.

Yours truly asked whether Accounting Fraud similarities are to be found today as before during historical financial crises.  Black pointed out that the crises in Thailand was of a similar sort, but then the authorities lied about their reserves, creating an illusion of stability.  Similar things happened in Indonesia where the ruling family basically drew lots of resources from the economy and yet keeping appearances of, again, stability.  The dot.com era produced also fraud, e.g. showing earnings on deals done the day before report periods, which were later cancelled. Ergo, nothing new occured in Iceland.

Black shows that bad loans need not be stated in a way that they are bad.  Simply say, "you receive bonuses on the amount of loans you generate, quality does not matter".  Giving loan officers a green light in lending regardless of quality is an indirect way of fraudulent lending, everything looks fine on the surface but it won't last.

How do we regulate the regulators? Hire people with a record of integrity.  Black further stated that Fraud begin immediately after privatization.

Auditors, were they to blame because they knew no better or ....? Weak capital was really fictional, as with other practices, the art is not defeating controls but to subordinate them.  Hence, auditors were according to Black subordinated.

Are Iceland's political parties criminals?  Having survived Keating, Black is ready to commit 'suicide' by answering that loan sizes are astonishingly large.  Highest return on assets (ROA) is political contributions.

In the US, 3 dollars are spent to save every $.  The rule against fraud is not important, more attitudes.  The attitude is changing a great deal in the US, the F word being more common.

It is suggested that foreign bankers took part of this 'game' and should hence not receive a krona back.  Black's view is that private market discipline became an oxymoron.  That, in the US, may lead to added responsibilities to lenders, example is Enron where banks' claims were denied since they aided in the fraud.  

Glass Steagall re-enacted (the question I would have asked if possible) - YES, every nation should have one, Chinese Walls never work in practice. (For Icelandic readers, see Ađskilnadur fjarmalathjonustu articles on the left side of this page).  

How can new banks have social responsibilities operate?  Basically, banks that make money the old fashioned way.  Concentrate first on fixing the banks.  Black maintains that Iceland would have possibly cease as a nation had things gone further out of hand.

Conclusion of Eirikur Tomasson - Icelandic judicial system will in the next 4-6 tackle the issues regarding financial fraud, and is more optimistic than most in the system's effort in bringing justice to fraudulent activity.  More resources are, however, needed, plus added independence.  He hopes that the political attitude changes in the coming years, providing necessary resources. "People who committed a crime must be judged and punished".

Additional notes:

My regular readers are probably fed up with this but, sorry, this has all happened before.  Iceland during the 2002-2008 period showed remarkable similarities to the Roaring 1920s in the US, see here - http://www.slideshare.net/marmixa/once-in-khaki-suits-lokautgafa

Silfur Egils TV interview regarding the subject is here (last interview on the show): http://www.rokkland.ruv.is/upptokur/silfrid-1nov and radio interview (Spegillinn) is here: http://dagskra.ruv.is/spegillinn/thattafaerslur/spegillinn453/

For Icelanders, related books of interest of this subject are for example:

Den of Thieves - http://www.slideshare.net/marmixa/20020829-den-of-thieves - During the take over frenzy of 2007 I began to wonder whether such a storm was brewing again, with the atmosphere uncomfortably similar to the one described in the book.  Sadly, it was.

Enron: The Smartest Guys in the Room - http://www.slideshare.net/marmixa/20041202-the-smartest-guys-in-the-room-enron - I had a talk with a senior business editor regarding this book when I turned in the book report.  The editor was shocked seeing similarities to the descriptions in the review and how the Icelandic banks were growing (this was late 2004).  We both agreed that the growth was too much at that point but time proved that it was only the beginning. 

Other material worth while reading regarding makings of financial bubbles is - http://www.slideshare.net/marmixa/20040506-tulipomania-extraordinary-popular-delusions - http://www.slideshare.net/marmixa/20040122-bubbles-human-judgement-and-expert-opinion - http://www.slideshare.net/marmixa/20011108-manias-panics-and-crashes - and last but not least - http://www.slideshare.net/marmixa/20020718-only-yesterday



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