Landsbanki Debt Settles at 1 Cent on the Dollar

What happens to unsecured bondholders when a financial institution goes bust? A good place to start is to look at the settlement price in CDS auctions. Fannie and Freddie settled in the high 90s: yes, there was a credit event, but from a bondholder perspective there were few if any losses. WaMu settled at 57%: a much more painful outcome for fixed-income investors. Lehman, of course, settled at a gruesome 8.6%, leaving unsecured bondholders pretty much wiped out. But even that seems like a wonderful outcome compared to the result of today's Landsbanki Islands auction: the final settlement price was just 1.25%.

A few years ago I took a freelance job writing a last-minute advertorial for Landsbanki. I flew out to Keflavik, took a $140 cab ride into Reykjavik, and met with a couple of friendly, sober, and smart senior Landsbanki executives in their unimposing and even borderline-shabby headquarters. It was clear that Landsbanki was the big-and-boring bank in Iceland, compared to the acquisitive, high-paced, highly-levered, engineered-to-the-hilt Kaupthing. But it was also clear, even then, that Iceland's reliance on its own tiny currency placed it at the mercy of international capital flows to a very unhealthy degree. When the money fled Iceland all at once, there was nothing its banks or its government could do.

I'll be very interested, now, to see what happens to Ireland, which is a country quite similar to Iceland if you just look at its banking system. But as part of the euro zone, it's much safer. And I just can't imagine ever reading this kind of thing about Ireland:

Mr. Danielsson, the economist, visited the country recently and found the situation grave.
"Salaries are frozen, food prices are shooting up and they are laying off people left, right and center," he said. "Companies are going bankrupt all over the place. It's unimaginable how bad it is."
Ms. Gisladottir said Britain's decision had sent Iceland back some 30 or 40 years, to a time when it was an isolated, poor country, dependent mostly on its fishing trade.
"This is a major crisis," she said. "We haven't been in this situation for, probably, ever. We cannot solve it alone. We need solidarity from partners, from friendly countries, and we thought the U.K. was one of them."

If Ireland ever got into serious trouble -- if its CDS spreads started gapping out to distressed levels -- then I'm pretty sure the UK would be part of the solution, not part of the problem. But then again, the UK and Ireland have never had a serious fight over cod.