What really happened in this hotel? I think this tale is really interesting. And morally revealing The Financial Times has reported, in January 2008 managers from Bear Stearns and four funds (named by the FT as DA Capital Europe, King Street Capital Management, Merrill Lynch GSRG and Sandelman Partners) visited Reykjavik. According to an Icelandic banker who spoke to one of the managers, they had all decided to go SHORT on Iceland and expected a payout comparable to 'the second coming of Christ'. Iceland's equivalent of our Financial Services Authority is now investigating the visit and subsequent trading. Numerous funds around this time started to short Iceland's currency and bank stocks, at the same time as holding credit default swaps (CDS) -- tradeable instruments which provide insurance cover against the possibility of default -- relating to bonds issued by Icelandic banks. The CDS rate moves according to the market's perception of risk, and the bond issuer is obliged to pay it. Moreover, the CDS market has become speculative: CDS contracts overall are worth $45 to $60 trillion against a total underlying value of bonds that is less than a quarter of that figure. Professor Richard Portes of London Business School, a close observer of the arcane Icelandic economy, explained how this worked. 'The way a fund would play Iceland is to short both the currency and the equity markets simultaneously. This forces the monetary authorities to raise interest rates, which in turn pushes down the equity markets. In this latest Iceland episode there is a new wrinkle, the CDS market, which is highly distorted.' He went on, 'CDS rates are at ridiculous levels. For Icelandic banks at one stage they were at 1,000 basis points, so that insuring $1 million of bonds cost $100,000. This implies that all of the Icelandic banks would go under over a five-year period, which most of the market doesn't believe. The explanation is that the credit crisis means no one wants to insure debt, so the market is very susceptible to rumour and manipulation. You can push up spreads on pretty much any target this way.' And this in turn piles yet more pressure on the banks' liquidity. 'Now Icelandic CDS spreads are back down to around 800 basis points, but that's still too high: in the summer of 2007 they were at 30 basis points. So what the speculators do is short the currency and equities and talk up CDS rates. It's a triple whammy.' The point is that the triple whammy is only dubious if market manipulation can be proven. It is interesting, then, to note the actions of one fund (not one of those present on the January trip to Reykjavik) around the end of March. The Spectator has learned that a partner of the fund telephoned at least two individuals with market influence and helpfully informed them that Icelandic banks were about to TANK. He suggested that the famous Landsbanki IceSave and Kaupthing Edge internet savings accounts, currently beloved of British savers, were vulnerable to a run if Northern Rock-esque trouble were revealed -- as, he suggested, inevitably it would be. Coming at a time when bank shares and the currency were already in freefall and CDS rates were going through the roof, this was calculated to turn a reverse into a rout. A source in the British FSA confirms that it has received several reports of calls by this fund, but that the FSA has yet to launch an investigation. The ultra-litigious habits of the funds prevent naming the perpetrator at this point. But there are other instances of packs of funds attacking institutions through shorting and false rumour, which at any time would be criminal. In the present credit crunch, when the financial system is wobbling, it is tantamount to financial terrorism. The most notorious case is the collapse of Bear Stearns in March. According to a banker with direct knowledge of the matter, who insists on anonymity, 'Bear Stearns was prime broker for several hedge funds. A number of these funds started shorting Bear stock, and at the same time creating uncertainty over its liquidity. At the same time they also withdrew their business from Bear's brokerage desk. They created a run on the bank using black propaganda and abusing their client status.' Of course there was little sympathy for the vaguely thuggish Bear Stearns. Few on Wall Street had forgotten how the investment bank had walked out of talks on rescuing the stricken hedge fund Long Term Capital Management (LTCM) in 1998. There was, therefore, considerable schadenfreude, not only among the hedge funds, when Bear in turn was denied a bail-out and eaten up by JPMorgan. But the next day Lehman Brothers, a far more blue-blooded institution, came under similar speculative attack from hedge funds. A storm of rumours about the bank's health caused its stock price to dive by 50 per cent. More seriously, some Lehman clients were panicked by specific -- but false -- rumours that both Merrill Lynch and the government of Singapore had broken their relationships with Lehman because it was in trouble. Had the bank not been able to reassure its clients, this rumour could easily have proven self-fulfilling. Lehman survived by a whisker, and has now filed the details of the episode with the Securities and Exchange Commission. Whispers of illiquidity, while profitable for short sellers, are poison for a bank. The arrogance, aggression and secrecy of the hedge funds which participate in this kind of activity is off the scale. Some appear to believe that they exist in a realm removed from social, moral and legal responsibility....... Hedge funds are almost completely unregulated, and with their enormous amount of leverage, they can wreck havoc on innocent targets. Last week, Icelandic authorities accused four British hedge funds of attacking their banks and currency, and Icelandic authorities apparently were so serious that they threatened with a counter attack. This seems the stuff of Hollywood. The Prime Minister of Iceland, Geir Haarde, said at a meeting of Nordic political leaders in Sweden on Wednesday: âItâs clear that there are people out there trying to make money at our expense, and we want to get them off our backs.â The Central Bank has already asked the Icelandic Financial Services Authority to investigate whether or not investors had deliberately spread false rumours to the media in order to bring turmoil to the Icelandic financial markets. Meanwhile the Central Bank raised its key interest rate to 15.5% YIKES! on Thursday in order to protect the currency and control mounting inflation. They even go as far as to intimidate university professorsâ âDr Richard Portes, professor in economics at the London Business School and President of the Centre for Economic Policy Research, was allegedly contacted by the hedge fund which urged the professor to consider his reputation when reporting on Iceland and Icelandic banks. Dr Portes is the author of a number of influential reports on the financial situation in Iceland and has recently portrayed the Nordic country and its banks in a more positive light than many other foreign analysts and media outlets. The hedge fund in question is one of the four foreign hedge funds that Sigurdur Einarsson, Chairman of Kaupthing Bank, has accused of instigating an attack on the Icelandic financial market and Icelandic banks. âI quickly realised what was happening and decided to listen carefully and take notes,â Dr Portes said. He then contacted the FSAs in both the UK and Iceland to report the incident.â (source). The Financial Times quoted an anonymous banker from Iceland who was invited by Bear Stearns(!) to a meeting in January in the bar of Hotel 101 in Reykjavik with a couple of other hedge funds with the purpose to discuss the âbizarreâ state of the Icelandic economy. All present decided to go short, and one described that opportunity as the âsecond coming of Christâ It's nice these guys have found religion.