Iceland, Again

03/19/2009

Thinking about the rise and fall of Iceland’s three banks, I’m reminded of something I was told by a big businessman and leading citizen from Wisconsin: never get heavily involved in real estate development deals where you don’t have some local political clout.

He reflected back on a deal that had worked out for him several decades earlier, when as a young up-and-comer in the Wisconsin business world, he'd been invited to participate in the financing of an enormous complex of apartment buildings on Chicago’s Near North Side. He drove down, looked around, figured that there'd be a lot of demand from proto-yuppies for apartments convenient to work and to shopping on Michigan Avenue, so he chipped in some money.

And it turned out very profitably for him. Subsequent investments in other states, however, didn’t turn out as well. Permits didn’t get approved, and other types of sand got in the gears. It was only years later that he knew enough about Chicago to work out that the other investors in that the first out-of-state group he had participated in were not just random people with some money, but a carefully assembled coalition of the Friends of Mayor Richard J. Daley and of other power players in Cook County and the state of Illinois. (Presumably, they had some long-term rationale for inviting him in involving future deals in Wisconsin.)

So, how can you beat the market consistently in lending or investing?

Inside pull. You can get your developments fast-tracked because you know the right people.
Inside information. You talk to people who talk to people.
You are backed by a huge, rich government, so you can take bigger risks than the competition because you presume that your government will bail you out if they blow up. Privatize profits, socialize risks.
A sense of what the public wants next. This is Peter Lynch’s notion of investing in, say, the little donut chain that you really like.
Economies of scale in investment. For example, you can make money at tiny arbitrage opportunities if you have enough money to play with so that you don’t experience gambler’s ruin in the short run. Or, if you are Warren Buffett, you can make a nice living as a white knight investor who buys companies threatened by hostile takeovers.

I’m sure there are other items that should be on this list. But my point is: Iceland’s money boys were at a disadvantage on everyone of these points. A quarter-million people out on an island in the middle of an ocean were spectacularly ill-suited to play the game of high finance the way it’s really played. The Icelanders figured that because they were as good as anybody at whipping up an Excel spreadsheet of the Black-Scholes option pricing model, they could compete globally.

They were naive.

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