Tuesday, 17 July 2012

The Zombie Pension System

The term "zombie bank" is sometimes used for banks that are effectively in negative equity - technically bankrupt - but with assistance, sometimes from the State, or accounting gymnastics they manage to stay "alive".

Zombie banks are more often than not troublesome creatures for multiple reasons. One thing they try to do is to gamble for their own resurrections. That they do by investing in very profitable but risky projects that could possibly heave them out of the most severe equity problems. This gamble is considered "OK" from their point of view since the most dreadful thing that could possibly happen is that they would have to cheat a bit more on the accounting rules - maybe post a different LIBOR rate than the true one is? - or ask for more assistance from the State.

Zombie banks also suck capital from profitable investments. The capital that is used to keep them alive could be used for anything else, such as housing for the poor or lower taxes. This is effectively what Austrians call "malinvestments".

Finally, zombie banks are sometimes kept alive by the public administration if they are "too big to fail." The banks, zombies or not, are so systemically important that their bankruptcies would wreck havoc to the economy. This havoc could be for the shorter or the longer term, nobody knows. And exactly because nobody knows, no one is willing to stare the devil in his eyes and allow the capital sucking gamblers for resurrection to go bust. Least of all politicians who are more concerned about getting re-elected than anything else.

It is a lot better for the longer term to get rid of zombie financial institutions rather than allowing them to wander around in the economy, spreading economic disease. But "I'll be gone, you'll be gone" is a real problem in this case as in any other case when somebody has to take initiative in tough short term problems with huge long term benefits. There are normally plenty of ostriches around.

The zombie pension system of Iceland
A new annual report by the Financial Supervisory Authority of Iceland shows it in black ink on white paper how severely bankrupt the Icelandic pension system is. At year end 2011, its actuarial position was negative by 668 billion ISK. That amount is equal to 135% of the government's gross income in the same year and 40% of GDP. This deficit compares to a deficit equal to roughly 13% of GDP in case of the United Kingdom. And the Brits are worried about their own system.

The hole in the actuarial position has grown from last year's 651 billion ISK. The main reason why the gap isn't bigger than it actually is is that the funds wrote off at least 130 billion of pension rights in 2010 and 2011. Well done guys, you are fine representatives of the ever lasting Icelandic pension system!

The Icelandic pension system is a zombie pension system. It is actuarially bankrupt by 40% of GDP and its organisation is a major barrier for economic reconstruction of the country. This applies both to the defined benefits and defined contribution systems but the State backs up the former part.

Nevertheless and so very well according to the ostrich's behaviour, the leaders of the pension system and the politicians have postponed it for many years to rebuild the system. Instead, they have gotten themselves into the ultimate lie where they sincerely believe their own nonsense about the system being one of the pillars in the economy of Iceland. But that pillar is instead a rotten one!

But some of them probably don't care. The politicians and the current leaders of the pension funds will all be gone when the pillar finally collapses and the economy with it. Politicians' pension rights are backed up by the State and are furthermore fatter than the rights that are given to the everyday working man. The leaders of the pension funds can in the meanwhile play around with the money they are entrusted with. A gentleman called Helgi Magnusson is one of them. He is the Chairman of Pension Fund of Commerce but eloquently enough, he is also a personal holder of roughly one billion ISK worth of stock in Marel Ltd. The company produces e.g. food processing units. The Pension Fund of Commerce is a major stockholder too, owns roughly 8.8 billion ISK and has repeatedly strengthened its holdings in the company after the collapse in 2008. Very convenient for Magnusson the stock owner.

But it is not the criss-crossing of personal wealth of directors of the pension funds that I am going to investigate further. The pension system in Iceland is a zombie system that cannot go on. It is a quintessential case of a Ponzi scheme. The worst thing is that the Ponzi structure was not and is not the actual plan of the directors and politicians, it simply just happened to be the case even though the initiative behind the system is to secure the income of thousands of pensioners. But exactly because people never planned to con the system, they feel so burned when somebody points out its flaws.

The newest report by the FSA in Iceland is material for multiple pages of analysis on the Icelandic pension system. They will be posted in small packages in the coming days and weeks.

An Icelandic version of this post first appeared on my Icelandic blog.

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