Jonsson's story on page 63: The weak position of the Kaupthing bank relative to other banks was noticed first in 2005 by a trader named Herleif Havik at the Petroleum Fund of Norway. He began doing what he perceived to be a kind of low- or no-risk pair of trades, by selling Credit Default Swap (CDS) protection on Barclays bank while buying the same protection on Kaupthing. The reason was apparently that Barclays and Kauthing debt traded at the same premium. Havik figured that Iceland could not, in the event of a crisis, offer the same back-up to Kauthing as Britain could to Barclays. To do the buying and selling of CDS, it was not necessary to actually hold any of the debt and in fact, Jonsson says the PFN did not own any Kaupthing bonds. Havik's trades attracted attention and drove up CDS premiums on Kaupthing. Other financial players began to focus on Iceland. The weakness of the business model of the Icelandic banks had been noticed.
It was by detecting the mis-priced bonds of Kaupthing (aka market inefficiency) and exploiting it that the market forced an eventual and brutal return towards efficiency.
The incident leaves questions to ponder:
- Was PFN, a state-controlled fund no less, and Havik somehow morally to blame for doing so, since the dénoument has left Icelanders suffering?
- Is naked CDS trading bad or merely the equivalent of buying a put or a call? e.g. Bad - SEC chairman Maison Fleury; OK - Derivatives Dribble)
- Was the pendulum swing the other way, all the way to bankruptcy of all the Icelandic banks, the only way back to efficiency, or was it too far?