Iceland Shows Ireland Did 'Wrong Things' Saving Banks
Hoskuldur Olafsson, chief executive officer of Arion Banki hf, poses looking out of a conference room suspended by steel cables at the bank's headquarters in Reykjavik, Iceland. Photographer: Tom Wagner/Bloomberg Markets via Bloomberg
Feb. 1 (Bloomberg) -- New York University Professor Nouriel Roubini, billionaire investor George Soros and Bain Capital Partners LP Managing Director Stephen Pagliuca talk about deficit risks in the global economy. This report also includes comment from Organization for Economic Cooperation and Development Secretary General Angel Gurria, Bank of Israel Governor Stanley Fischer, Bank for International Settlements General Manager Jaime Caruana and WPP Plc Chief Executive Officer Martin Sorrell. They spoke at last week's World Economic Forum meeting in Davos, Switzerland. (Source: Bloomberg)
On his second day as head of Iceland's third-largest bank, Arni Tomasson faced a crisis: The firm he had been asked by regulators to run was out of cash.
It was Oct. 8, 2008, at the height of the global financial meltdown, and Iceland's bank assets in the U.K. had been frozen, Bloomberg Markets magazine reports in its March issue. Customers flocked to branches of Tomasson's Glitnir Banki hf to withdraw money, even though the government had guaranteed their deposits. By the end of the day, the vaults were empty, says Tomasson, recalling the drama two years later.
The only way Glitnir and other lenders could avoid a panic the next morning was to get more cash, which they were having trouble doing. A container of crisp kronur sat on the tarmac at Reykjavik's airport awaiting payment, Tomasson says. The British company that printed the bills, De La Rue Plc, was demanding sterling, and the central bank couldn't access its U.K. account.
"Everybody was panicked -- depositors, creditors, banks around the world," Tomasson says. "The effort by all of us at the time was to make sure life could go on as normal."
Tomasson, 55, got the cash he needed that night after the central bank managed to open an emergency line of credit with a European lender. Now, he's sitting in an office in Reykjavik, handling about $24 billion of claims by creditors as life in Iceland's capital returns to normal.
Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country's banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.
Krona Devaluation
The crisis almost sank the country. The krona lost 58 percent of its value by the end of November 2008, inflation spiked to 19 percent in January 2009 and GDP contracted by 7 percent that year. Prime Minister Geir H. Haarde resigned after nationwide protests. With the economy projected to grow 3 percent this year, Iceland's decision to let the banks fail is looking smart -- and may prove to be a model for others.
"Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks," says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. "Ireland's done all the wrong things, on the other hand. That's probably the worst model."
Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital -- 46 billion euros ($64 billion) so far -- to prop them up. That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.
New Banks
Ireland's banks had more than 10 times the assets of Iceland's lenders, making their collapse more dangerous for the European financial system. Ireland also couldn't devalue its currency because it is part of the euro zone. Still, countries with larger banking systems can follow Iceland's example, says Adriaan van der Knaap, a managing director at UBS AG.
"It wouldn't upset the financial system," says Van der Knaap, who has advised Iceland's bank resolution committees. "Even Irish banks aren't too big to fail."
Under an emergency act of Iceland's parliament on Oct. 6, 2008, the assets and liabilities of the three biggest banks -- Kaupthing Bank hf, Landsbanki Islands hf and Glitnir -- were divided based on whether they were originated at home or abroad. The act created three new banks that were given the deposits and loans made to Icelandic companies and consumers. Resolution committees were set up to manage and liquidate what the old banks were left with: the overseas borrowing and lending that fueled a sevenfold increase in assets from 2000 to 2008.
Saving the Future
Arni Pall Arnason, 44, Iceland's minister of economic affairs, says the decision to make debt holders share the pain saved the country's future.
"If we'd guaranteed all the banks' liabilities, we'd be in the same situation as Ireland," says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.
By guaranteeing bank liabilities, Ireland faces a potential public debt burden that could swell to twice its GDP, up from 94 percent now. Iceland's debt ratio is about 85 percent.
"Our future isn't as bleak because our public debt isn't as high," says Hoskuldur Olafsson, chief executive officer of Arion Banki hf, the new bank formed to take over Kaupthing's domestic assets.
'Disappeared Overnight'
Today, Iceland is recovering. The three new banks had combined profit of $309 million in the first nine months of 2010. GDP grew for the first time in two years in the third quarter, by 1.2 percent, inflation is down to 1.8 percent and the cost of insuring government debt has tumbled 80 percent. Stores in Reykjavik were filled with Christmas shoppers in early December, and bank branches were crowded with customers.
Half a mile from where Tomasson runs Glitnir's resolution committee, the bank's former headquarters glitters against Reykjavik's dark winter skies. The building, one of the largest in Iceland, is lit in red neon with the logo of the company that emerged from its wreckage: Islandsbanki hf.
"We had built trust over 100 years, but it disappeared overnight," says CEO Birna Einarsdottir, 49, who was executive vice president of commercial banking when Glitnir collapsed. Einarsdottir, who spent five years working for Edinburgh-based Royal Bank of Scotland Group Plc, says, "It will take more than two years to regain that trust."
Banking Boom
Iceland's banking boom began in 2001, after the U.S. Federal Reserve began cutting interest rates, pumping cheap money into the global economy. The next year, Iceland sold its majority stakes in Landsbanki and a predecessor of Kaupthing. The new owners, along with those of Glitnir, which was already in private hands, expanded lending at home and overseas.
Kaupthing's income surged 100-fold from 2000 to 2006, reaching 100 billion kronur ($850 million). Banking's share of national output almost doubled to 9 percent, while that of fishing, the traditional backbone of Iceland's economy, halved to 4 percent. More homes were built from 2004 to 2008 than in the entire previous decade, fueled by a government decision in 2003 to lower down payments on mortgages to 10 percent from 30 percent. The 367 Range Rovers sold in Iceland in 2007 exceeded the number in Denmark and Sweden, which combined have almost 50 times Iceland's population of 318,000.
Tchenguiz Loans
The banks were particularly aggressive in the U.K., where loans were made to developers of the NoHo Square complex in the Fitzrovia section of London and to All Saints, a retail chain. Many of the borrowers had insufficient or low-quality collateral, according to investigations launched by the Icelandic government since the crisis.
"Our banks found their own subprime borrowers," says Magnus Arni Skulason, founder of Reykjavik Economics ehf, a financial consulting firm.
Loans were also made to companies in which bank executives and owners had stakes or which were controlled by their friends, according to dozens of lawsuits initiated by regulators and resolution committees. Kaupthing lent 1.5 trillion kronur to such related parties, often without collateral, Prime Minister Johanna Sigurdardottir said in 2009. In 2008, lending to U.K. entrepreneur Robert Tchenguiz, chairman of R20 Ltd., and related parties accounted for more than 25 percent of Kaupthing's equity, according to a 2010 report by a parliament-appointed special investigative commission.
Tchenguiz, 50, Kaupthing's biggest retail borrower, was also a board member in Exista hf, one of the bank's owners. His spokesman said Tchenguiz wasn't available to comment.
Red Flags
"It's hard to see where the lines between bad decisions and violating the law were crossed," says Gunnar Andersen, director general of Iceland's Financial Supervisory Authority.
Andersen says that before his arrival in April 2009, the agency was understaffed and failed to see the red flags being raised as the banks grew through risky lending. So did auditors and credit-rating firms, he says. Moody's Investors Service gave the Icelandic banks its fourth-highest rating of Aa3 in 2007, even though the central bank had long since lost its ability to be lender of last resort if those firms ran short of cash, Andersen says. Abbas Qasim, a spokesman for Moody's in New York, declined to comment.
David Oddsson, who became chairman of the central bank in 2005 after a 14-year stint as prime minister, says he relayed his concerns about surging growth of the industry to government leaders.
'Party Was On'
The three banks had become the largest companies in Iceland, creating thousands of well-paid positions and controlling the top trade associations, says Oddsson, who oversaw the privatization of Iceland's state-owned lenders as prime minister. Their headquarters were the largest buildings in Reykjavik, dwarfing the parliament.
"Nobody wanted to listen when the party was on," says Oddsson, 63, now editor of Morgunbladid, one of the largest dailies in the country, with a circulation of about 50,000.
It was Oddsson's decision not to build up the central bank's foreign currency reserves from 2005 to 2008 that made a bailout impossible.
"They were collecting debt in such a fast pace, it would be stupid for us to build a mountain they could lean on if they failed," Oddsson says. "The creditors that were lending to the banks recklessly had to face the losses."
After the three lenders were seized by regulators, the government negotiated with the creditors, almost all of them outside the country, including mutual funds and hedge funds in the U.S. and the U.K. and European banks and pension funds.
Glitnir Creditors
Kaupthing's creditors agreed to take an 87 percent stake in Arion, and Glitnir's creditors now own 95 percent of Islandsbanki. Glitnir's biggest creditor as of June was Dublin- based Burlington Loan Management Ltd., followed by Royal Bank of Scotland and DekaBank Deutsche Girozentrale, the fund manager for Germany's state-owned savings banks.
Glitnir's 8,500 creditors and Kaupthing's 28,000 expect to get about 30 cents on the dollar for their claims, based on secondary-market prices of the banks' debt and asset valuations by the resolution committees. About half of Kaupthing's creditors are German depositors who had Internet accounts, have gotten their principal back and are seeking interest payments.
Landsbanki's creditors opted for a promissory note from successor NBI hf instead of a stake in the new bank. Landsbanki had collected about $5 billion of overseas deposits through branches in the U.K. and the Netherlands. Iceland didn't guarantee those deposits at the time it seized the bank, as it did for domestic customers, leading to a dispute with the British and Dutch governments.
Icesave Depositors
In December, Iceland agreed to compensate the U.K. and the Netherlands in full for their payments to Icesave depositors, as the Landsbanki accounts were known. Payment, including interest of about 3 percent, will be made over 35 years.
The U.K. and Dutch governments are claiming priority over other creditors so they can recoup funds from Landsbanki to cover the payments, based on a hierarchy created by the 2008 emergency act. If they succeed, other creditors would get nothing from the sale of Landsbanki's assets. The priority of depositors is being challenged by creditors in court.
"The German banks and pension funds that loaned to Landsbanki in the early 2000s argue that their investments were made well before the law was changed," says Heidar Asberg Atlason, a partner at Logos Legal Services in Reykjavik, which represents about 100 creditors of the 3 lenders.
Suspended by Cables
Claims against the three banks add up to $107 billion, and it may take years to resolve them in court, even after the resolution committees finish their work.
At Kaupthing's offices, housed on the seventh floor of a building with floor-to-ceiling windows overlooking the Atlantic Ocean, a half dozen asset managers huddle over computer monitors watching market prices for stocks and bonds the bank owns. They and their counterparts at Landsbanki and Glitnir are in no hurry to sell.
"Some things, like our subsidiary in Norway, we sold really fast because we had good offers," says Tomasson, the Glitnir resolution committee chairman. "Others we resisted selling immediately because we wouldn't get a good price. Creditors are telling us not to hurry, not to do fire sales."
At Arion headquarters, visible from Kaupthing's resolution office, CEO Olafsson sits in a meeting room that's suspended by steel cables and surrounded by see-through glass floors, talking about the challenges facing the new bank. Those include restructuring thousands of consumer loans, mortgages and debts of small Icelandic companies.
'Just Can't Pay'
While the bank got the loans from Kaupthing at steep discounts -- in some cases for nothing, if no recovery was expected -- it has to work with borrowers to make sure they can pay back, Olafsson says.
"Asset values and income in Iceland have gone down a lot, so people just can't pay," he says.
Iceland's government, now led by the Social Democratic Alliance, has pushed laws through parliament that would require the new banks to write off $1.4 billion in consumer debt.
"There have been lots of interventions, which creates uncertainty," Islandsbanki's Einarsdottir says. "But hopefully those are all behind us, and we can complete all the restructuring by the end of 2011."
Creditors have an interest in seeing Einarsdottir and Olafsson succeed. They stand to recover more if the new banks can be sold for a good price to strategic investors or in a public offering. Glitnir aims to do so in three years; Kaupthing is shooting for five.
Rebuilding Confidence
While the shattered trust of the public may take years to rebuild, there aren't any alternatives for Icelanders, who have kept their deposits at the new banks.
"I lost all the confidence in the banks, but where else can we go?" says Jon Birgir Valsson, a customer at an Islandsbanki branch in downtown Reykjavik who was paying some bills for the government agency that employs him. "Life continues. We need to bank, and these are the banks we have."
Rebuilding the confidence of international investors may take longer. Iceland's banks won't be able to access international markets until political and financial uncertainties are removed, say creditors and their representatives, who asked not to be identified.
Those include the agreement reached with the U.K. and the Netherlands, which has to be approved by President Olafur R. Grimsson. The politically independent head of state has said he'll decide by February whether to put the issue to a referendum again. Voters rejected a previous arrangement last year that forced a higher interest rate on Iceland.
'Grow Cautiously'
Einarsdottir agrees that settlement of these issues and completion of debt restructuring is required before the government and the banks can access international capital markets again.
"In the beginning, banks and other financial institutions in Europe were telling us, 'Never again will we lend to you,'" Einarsdottir says. "Then it was 10 years, then 5. Now they say they might soon be ready to lend again."
This time her bank won't use foreign funds to go on a lending binge, she says.
"We will only focus on areas where we can bring on the nation's expertise, such as fishing and geothermal energy," says Einarsdottir. "We will grow cautiously."
Fishing, Banking
Economy Minister Arnason wants more for Iceland than fishing and geothermal energy. He acknowledges that the nation got into banking without the right infrastructure or the know- how to do it well. Still, he doesn't think Icelanders have to go back to fishing now that they've proven themselves inept at finance.
His government needs to find work for the 2,000 highly educated finance-sector employees who lost their jobs, he says. Otherwise, they'll migrate, and a shrinking population is the biggest scourge for this small, isolated island nation.
"The choice isn't between fishing and banking," Arnason says. "The choice is building a healthy, diversified economy."
Arnason will have a better chance of keeping his countrymen home if Iceland can resume growth as predicted. It would also help prove his predecessors were right to let the country's banks fail: Ireland, which rescued its financial institutions, is on the way to shrinking for a fourth consecutive year.
Letter from Kabul
The Afghan Bank Heist
A secret investigation may implicate dozens of high-ranking government officials.
by Dexter Filkins February 14, 2011
A guard at Kabul Bank. "If this were America, fifty people would have been arrested by now," one American official said.
In the spring of 2009, as the reëlection campaign of President Hamid Karzai was gathering momentum, a group of prominent Afghan businessmen met with the candidate for breakfast at the Presidential palace. Among them was Khalil Ferozi, the chief executive officer of Kabul Bank, a freewheeling financial institution owned by some of the most colorful and politically well-connected Afghans in the country, including one of President Karzai's brothers.
Ferozi, a banking novice, had a history that seemed lifted from a Saturday-afternoon adventure movie. In the late nineteen-nineties, working for the legendary anti-Taliban commander Ahmed Shah Massoud, he sold emeralds mined in the crags of the Panjshir Valley and used the proceeds to pay an obscure Russian company to print truckloads of Afghan currency. In this way, he helped underwrite Massoud's movement. But, according to a Massoud associate, the commander became enraged when he discovered that Ferozi was helping to print currency for the Taliban as well. Before Ferozi could be hauled in—"Tie his hands, tie his legs, and bring him to me," Massoud reportedly said—Massoud was killed, on September 9, 2001, by Al Qaeda assassins. Ferozi denied the story and went on to become Kabul's most improbable C.E.O. With a body like an oil drum, and a retinue of gunmen around him, he prowls the streets of Kabul looking less like a banker than like a footballer lost in a war zone.
"We'd like to contribute to the campaign," Ferozi told President Karzai at the breakfast in 2009. "What can we do?" The President pointed Ferozi in the direction of his finance minister and campaign treasurer, Omar Zakhilwal.
Two days later, Zakhilwal told me recently, two men identifying themselves as Kabul Bank employees appeared bearing a briefcase containing two hundred thousand dollars in cash. "Two guys, one case," he said. Zakhilwal said that he took the briefcase and passed it directly to his colleagues at Karzai's campaign headquarters. Zakhilwal didn't keep a record of the contribution, and no record of it was made available by the Independent Election Commission, either. "You will never ever find a record of a gift from them of any value, not even a dollar," Zakhilwal said, denying any wrongdoing.
Now American officials say that Zakhilwal was one of many Afghan leaders and businessmen who, collectively, accepted tens of millions of dollars in gifts and bribes—some sources say as much as a hundred million dollars—from executives at Kabul Bank. The scandal is perhaps the most far-reaching in the nine years since Karzai took power.
Poring over stacks of documents, investigators at the American Embassy in Kabul have pinpointed dozens of instances in which Kabul Bank executives may have bribed Afghan officials, including a successful bid to process the salaries that the government pays its employees each month—at least seventy-five million dollars. Access to the salaries would give bank officials an opportunity to earn millions of dollars in interest in the course of a single year.
American officials say that Kabul Bank's largesse extended to members of parliament and almost anyone whose silence would allow bank executives to embark on a spree of buying, lending, and looting. In addition, some current and former Afghan officials say, Kabul Bank became an unofficial arm of the Karzai government, bribing parliamentarians in order to secure votes for its legislative agenda.
The investigation into Kabul Bank was run by a remarkable but little-known group of Americans working at the Embassy called the Afghan Threat Finance Cell. Their findings are considered so sensitive that almost no one—generals, diplomats, the investigators themselves—is willing to talk about them publicly. The unit, made up of agents from the F.B.I., the Drug Enforcement Administration, the Treasury Department, and the Pentagon, has compiled extensive evidence of bribery. "If this were America, fifty people would have been arrested by now," an American official told me.
Secretary of State Hillary Clinton was briefed on the investigation in January, but some people fear that the Obama Administration won't do anything about what has been discovered. After months of sparring with Karzai, the Administration appears to be paralyzed. "We have to work with these people,'' a senior NATO officer told me.
The Threat Finance Cell also has almost single-handedly demonstrated the degree to which the American-led war in Afghanistan is compromised by connections among the Taliban, drug traffickers, and Afghan officials. The group was set up, in 2008, to sever the links between Taliban insurgents and their financing, much of which was believed to come from the drug trade. Instead, the investigators found that the lines connecting the Taliban and the drug smugglers often ran through the Afghan government. They also uncovered one of the darker truths of the war: the vast armies of private gunmen paid to protect American supply convoys frequently use American money to bribe Taliban fighters to stand back. These bribes are believed by officials in Kabul and in Washington to be one of the main sources of the Taliban's income. The Americans, it turns out, are funding both sides of the war.
By last summer, the Threat Finance Cell and its Afghan counterpart—a group called the Sensitive Investigative Unit—had begun looking into Kabul Bank, previously one of the most successful institutions in post-2001 Afghanistan. The American and Afghan investigators quickly realized that the bank was hugely overextended and headed for disaster. The bank, under the guidance of its top executives, Ferozi and Sherkhan Farnood, a world-class poker player, had begun to founder, in part owing to the collapse of the property market in Dubai. Farnood had spent tens of millions of dollars in depositors' money to buy more than a dozen luxury villas on or near Palm Jumeirah, an exclusive man-made island. At the urging of Americans, the Central Bank of Afghanistan, which is charged with insuring that Afghan banks adhere to financial regulations, stepped in and replaced Ferozi and Farnood.
The evidence, according to American officials close to the inquiry, appears to implicate Afghan officials and businessmen at the highest levels. Many of them, like Zakhilwal, are among Karzai's most trusted advisers, with regulatory responsibilities for the Afghan financial system. Others are regarded by American officials as being some of the most capable in Karzai's government: Farook Wardak, the Minister of Education; Yonous Qanuni, a former speaker of the Afghan parliament; and Haneef Atmar, a former Minister of the Interior. It's not clear exactly how much each official got, or what they are believed to have done to get it.
Atmar, Wardak, and Qanuni told me that they had never received any gifts from the bank. Qanuni said that he had accepted money from executives at Kabul Bank in the form of donations for his parliamentary campaign but could not recall how much. In an e-mail, Atmar laid the blame for the allegations on a dispute within the bank. "I have NOT borrowed or received any type of funds from the Kabul Bank under any name for any purpose," he wrote.
Former Afghan officials say that the bribery and influence-peddling was at times florid and spectacular, with some of it unfolding in Dubai, the Vegas-like sheikhdom where many high Afghan officials maintain second homes. Mahmoud Karzai, the President's brother, was allowed to live in one of Farnood's villas, as was Ahmed Zia Massoud, a former Vice-President. When I visited Massoud's house in Dubai last summer, a blue Rolls-Royce was parked out front, but nobody was home. "Girls, money, cars," one Afghan official with knowledge of the investigation said. "Whatever the human weakness."
At least some of Kabul Bank's payments to high-ranking local officials appear to have been intended to prevent anyone from examining the bank's practices too closely. An Afghan political leader, who was once a senior member of Karzai's government, told me that Ferozi had bragged to him that much of Karzai's government was on Kabul Bank's payroll: "Ferozi said to me, 'None of the ministers have the guts to speak against us. They are ours.' " The senior NATO official called the payments "just straight bribes."
Investigators say that they are now trying to determine the extent of illegality committed under Afghan law, which requires candidates to report their campaign contributions, and which prohibits bribery. But there is no way to know how much any individual gave, because election officials have not released the records. Given that Karzai has not indicted a single senior official of his own government, U.S. officials are skeptical that he will act without overt American pressure. Some of those suspected of wrongdoing might be liable under Western law, if they have dual citizenship.
The money that has apparently been doled out by Kabul Bank to Afghan officials is part of an estimated nine hundred million dollars that is lost or missing from the bank. That amount far exceeds the three hundred million dollars in losses that emerged after the Central Bank's takeover. Investigators said that the nine hundred million dollars includes failed loans and loans to apparently fictitious corporations. The chairman of the Central Bank said that it has recovered some of the loans, but a Western official told me that much of the money is gone: "They can't find it."
The troubles at Kabul Bank stand as a parable for the sometimes malign effect that the influx of billions of dollars has had on this impoverished country since the current war began, in 2001. Although Western money has done a great deal to create a modern economy, much of it has been captured by a tiny minority of well-connected Afghan businessmen and politicians, often illegitimately. The loss of nine hundred million dollars or more at the bank represents a significant percentage of Afghanistan's gross domestic product, which is only about twelve billion dollars.
Politics and business in Kabul are increasingly dominated by criminal networks and their patrons in the Afghan government. The vast majority of the loans appear to have gone to Kabul Bank's sixteen shareholders. One of them is the President's brother Mahmoud Karzai. He spent most of his adult life in the United States, eventually owning a number of restaurants, until returning to Kabul after the Taliban were driven out of the city, in 2001. He has an American passport and is currently under investigation by federal prosecutors in the United States for failing to report income. Another shareholder is Haseen Fahim, the brother of Mohammed Fahim, who is one of Karzai's two Vice-Presidents. For the Obama Administration, such official connections make something like the Kabul Bank scandal difficult to confront but impossible to ignore. "I'm really hoping that something positive comes out of this," the senior NATO officer said. Then, after a pause, he added, "Maybe it's too big to turn away from."
Graft infests nearly every interaction between the Afghan state and its citizens, from the police officers who demand Afghani notes to let cars pass through checkpoints to the members of Karzai's government who were given land in Kabul's once empty quarter of Sherpur, now a neighborhood of huge rococo-style buildings, where homes sell for hundreds of thousands of dollars.
Bribes feed bribes: if an Afghan aspires to be a district police officer, he must often pay a significant amount, around fifty thousand dollars, to his boss, who is usually the provincial police chief. The policeman earns back the money by shaking down ordinary Afghans. In this way, the Afghan government does not so much serve the people as prey on them. Last year, Transparency International ranked Afghanistan as the world's hundred-and-seventy-sixth most corrupt country out of a hundred and seventy-eight, surpassed only by Somalia and Myanmar. "It's a vertically integrated criminal enterprise," one American official told me.
The war in Afghanistan is not a simple conflict, with the U.S. and the Afghan government on one side and the Taliban insurgents on the other. When it comes to money—particularly American money—allies and enemies often seem interchangeable. One example, offered by an American investigator: the director of an Islamic charity in Pakistan, which American investigators believed was giving money to insurgents, had close ties to Afghan leaders.
At Kabul Bank, according to a Western official familiar with the investigation, records show that Ruhullah, a field officer for a private security company and an ally of Ahmed Wali Karzai, the President's half brother, transferred money into accounts believed to be controlled by the Taliban. Ruhullah claims that he has never made any payments to Taliban commanders, and he says he left the private security business in August. Ahmed Wali Karzai, who heads the provincial council in Kandahar, has long been suspected of siphoning profits from the drug trade. He has steadfastly denied such links. "People think it's the Taliban versus the Afghan government," an American investigator told me last year. "But, I'm telling you, the Afghans just don't see it that way. The Afghans look at this war very differently from the way we do."
Despite months of public hectoring by the Obama Administration, the corruption appears to have worsened. One of the reasons is the war itself. President Obama's deadline for beginning his withdrawal of American forces, later this year, confirmed for many Afghans that time is running out. "Right now, this country is all about raping and pillaging as much as you can, because there is no faith in the future," an Afghan businessman told me.
The businessman, who spoke on the condition of anonymity, described a recent dinner with a number of Afghan officials: "I said to them, 'Look at the Taliban. They believe in their cause, and that sustains them. You people have no cause. You don't believe in anything.' And these guys just sat there in their chairs. They agreed with me."
One Western diplomat told me that bribes paid to Taliban commanders by private security contractors, along with the other ways that the Taliban extort Western money, from aid projects to military bases, are themselves enough to finance a robust insurgency. "It costs NATO a hundred and forty thousand dollars to keep a soldier in the field for a year, and a Taliban fighter a fraction of that," he said. "If just ten per cent of that money gets to the Taliban—through bribes or extortion or whatever—that's enough to keep five Taliban fighters in the field." The U.S. military, acting on evidence compiled by reporters and congressional investigators, recently banned a private security company and several of its affiliates from doing business with the United States, at least in some cases because of suspicions of links to insurgents.
U.S. commanders say with near unanimity that corruption drives Afghans into the arms of the Taliban. For months, officials in the Obama Administration pressed Karzai to indict, or at least get rid of, some of the corrupt people around him. But now the Americans seem to have given up hope that Karzai will take action against any of his officials. "We have had long conversations about this with President Karzai," Richard Holbrooke, Obama's special envoy, told me in Kabul not long before he died, in December. "They're completely useless."
What's more, American investigators have been ordered not to speak to reporters. Almost without exception, top American diplomats will not discuss Kabul Bank, the investigation into Mahmoud Karzai, or any other investigation of senior Afghan officials. "I'm handcuffed," an Embassy official told me recently. He held his arms out and pushed his wrists together. "I'd love to help you, but I can't." Not surprisingly, Afghans repelled by the pervasive illegality have learned to keep quiet, too. When they agree to talk, it's almost always in secret.
Today, what little the Americans say publicly about corruption usually concerns relatively minor matters. They focus on the graft that unfolds in local precincts, where, the theory goes, ordinary Afghans feel the impact most. Typically, such corruption does not involve the officials around Karzai.
The former senior official in Karzai's government recalled a recent conversation with Karl Eikenberry, the U.S. Ambassador. Eikenberry has a reputation as one of the most clear-eyed critics of Karzai's dysfunctional government. The former senior official was thus startled when even Eikenberry seemed to have given up on fighting corruption. "He was asking me, 'Do the Afghans really mind about corruption, do they really?' " the former senior official said. "When I heard this question, just by the Ambassador asking, it was disgusting."
These days, Fazel Ahmed Faqiryar sits in his house in Kabul and doesn't open the door. Until August, Faqiryar, a stout, energetic man of seventy-two, was the deputy attorney general. He was fired, he said, for insisting on pursuing investigations of officials around Karzai. "The law in this country is only for the poor," he told me just after his dismissal. Afghan officials maintain that he was due to retire.
Faqiryar's former boss, Attorney General Mohammed Ishaq Aloko, has opened a criminal investigation into Faqiryar, which apparently involves allegations that he libelled Karzai's ministers by accusing them of corrupt activities. Faqiryar's former colleagues say the investigation is meant to insure that he keeps his mouth shut.
Faqiryar lives in a three-story town house in western Kabul. When I visited him recently, Faqiryar, normally a hospitable man, refused to answer his door. On another occasion, after three knocks, he finally spoke, but the door stayed shut.
"I have a lot of things to say, but I am not allowed to say them," Faqiryar said through the door. "This government is so corrupt, and it is run by a small number of individuals who are very powerful. They don't like intruders, and don't want people putting their noses in their business. These people are very evil."
The last time I saw Faqiryar, he had invited me inside and offered me tea and cookies. Now he refused to come out.
"What's the use of talking?" he said. "The moment I decided to fight corruption, I knew I would run into problems. Not only me, but every single patriotic Afghan who has tried to fight corruption has been pressured and, in the worst cases, has been fired and accused of something. You can't find a single honest person fighting corruption who is still in his job.
"I'm really sorry for not opening the door," he said, and then shuffled away.
Faqiryar's dismissal came after he pushed for the prosecution of Mohammed Zia Salehi, a Presidential aide who had been caught on a wiretap demanding a bribe—a Toyota, for his son. The bribe was in exchange for scuttling an investigation into New Ansari, a bank known as a hawala, which enables people to move money into and out of the country without any electronic record.
Early last year, American officials had encouraged their Afghan counterparts to find a test case for Karzai: a powerful senior official whose indictment would signal that the President was finally serious about cleaning up his government. Faqiryar took the Americans at their word. When Afghan investigators raided New Ansari's offices, in January, 2010, they found financial statements that told much of the story of modern Afghanistan. New Ansari was moving money for government officials, Taliban leaders, and drug dealers. Its couriers were carrying millions of dollars in cash out of Kabul International Airport to Dubai, part of the flow of American money out of Afghanistan which investigators say totalled as much as $2.5 billion in 2009. What's more, New Ansari appeared to be intimately connected to a supposedly legitimate financial institution, Afghan United Bank, whose vice-chairman is a man named Hajji Rafi Azimi. An American investigator looking at New Ansari's books told me, "It's a gold mine." New Ansari denied any wrongdoing.
Afghan and American investigators had compiled six CDs of secretly recorded conversations. In the decisive discussion, Azimi beseeched Salehi to stop the investigation into New Ansari, and Salehi asked for the Toyota. In an interview last year, Azimi denied that he was connected to New Ansari or that he had made the call to Salehi.
Salehi, like so many of those who occupy high positions in Karzai's government, appears to harbor no ideology other than his own survival. During Afghanistan's civil war, he served as a Russian translator for Abdul Rashid Dostum, the thuggish Uzbek warlord. In Karzai's Administration, he sometimes carries money to other Afghans being paid for political favors, and he has been one of those involved in the President's efforts to negotiate with the Taliban. An American official said that Salehi has also been a paid informant of the Central Intelligence Agency. Salehi did not respond to requests for comment.
After American officials played some of the wiretaps for one of Karzai's advisers, Karzai approved Salehi's arrest. In late July, Aloko, the Attorney General, allowed Afghan agents to move in. But Karzai's resolve quickly crumbled. According to a Western official with knowledge of the investigation, Salehi telephoned Karzai from his jail cell. "He told Karzai, 'If I spend one night in jail, I'll bring the whole thing down,' " the Western official recalled.
Salehi was released later that day, after Karzai sent a car from the palace to pick him up. Karzai publicly complained about what he described as the heavy-handed tactics of the American-backed investigators, and the case against Salehi was dropped, on the ground that Afghan law prohibits wiretap evidence in corruption cases. Afghan lawyers say that wiretap evidence is regularly used in such cases.
When the case against Salehi was dropped, no one in the U.S. Embassy, or in Washington, said a thing publicly. When Faqiryar was fired, the American Embassy in Kabul was silent.
In January, Aloko announced that his office would investigate allegations of improprieties at Kabul Bank. But since Salehi's arrest much of the anti-corruption machinery inside the Afghan government has been dismantled. First, Karzai and Aloko banned a team of American and British attorneys from mentoring Afghan prosecutors, demanding that they renegotiate what they are allowed to do. The two top prosecutors who were overseeing the Salehi case were demoted.
Most dramatically, at least for the prosecutors involved, representatives of the Karzai Administration told British officials that they could no longer pay the prosecutors so-called "top-up salaries"—pay incentives, funded by the British government, that often boosted typical salaries from about sixty dollars a month to about six hundred. "I'm so disappointed," one of the prosecutors told me, about the lack of support. "I didn't expect this after all our hard work. We tried so hard to follow the law. I'm disgusted with the international community. Look at the condition you have left us in."
The crusade against the crusaders continues. According to the Western official, Aloko has prohibited anti-corruption prosecutors from working with the Major Crimes Task Force, another group of Afghan investigators who have unearthed evidence of corruption in Karzai's government. According to a former Afghan official and an American official, the chief of the Major Crimes Task Force, Nazar Mohammed Nikzad, has sought permission to leave Afghanistan for the United States. Aloko also added several layers of authorization that prosecutors must secure in order to carry out searches, open investigations, and prepare indictments.
Not a single senior member of Karzai's government has been arrested, and most of the investigations have stalled. The anti-corruption prosecutor who met with me detailed a half-dozen instances where Aloko, who is understood to be acting on Karzai's orders, had thwarted investigations into suspected wrongdoing. Among the investigations that have been blocked are those into Azimi, the bank executive who allegedly bought the car for Salehi, and Ghulam Ghaws Abubaker, a former governor of Kapisa Province, for allegedly colluding with the Taliban and extorting money from contractors. Both men have denied the allegations.
"Aloko said, 'Don't work on this,' " the anti-corruption prosecutor recalled of one of the investigations. "This man is very well liked by Karzai."
The senior NATO officer confirmed the prosecutor's account of the changes that took place inside the Attorney General's office, and cited another case that is going nowhere: that of Ali Shah Paktiawal, the police chief of Nangarhar Province. Paktiawal is suspected of having run a kidnapping ring when he was in an earlier post. He has not responded to requests for comment.
The man who kept the secrets of Kabul Bank is its flamboyant former chairman, Sherkhan Farnood. Working out of Russia in the nineteen-nineties, when Afghanistan was mired in civil war, Farnood started a hawala called Shaheen Exchange, then moved it to Dubai, before founding Kabul Bank, in 2004, and hiring Khalil Ferozi as C.E.O. Nowadays, Farnood isn't saying much publicly. His passport has been revoked—as has Ferozi's—and he is living in a guesthouse adjacent to Kabul Bank's headquarters, in downtown Kabul. "If I say one thing, the President will send me straight to Pul-e-Charkhi!" Farnood told me recently. "Do you know what Pul-e-Charkhi is? It's a jail."
Mahmoud Karzai, though, was willing to talk. He lives in a two-story house in Karte Char, in western Kabul, one of the city's most expensive neighborhoods. Yet even here the absence of government services was evident. When I visited not long ago, the streets were lined with open sewers and strewn with garbage.
Inside the house, the furniture was vinyl and veneer. The walls were mostly bare. Mahmoud was seated on a couch, bantering with a dozen other Afghans. This is the way that powerful men in this country spend their days: fielding requests for money (for funerals, for weddings) and adjudicating disputes. Mahmoud was speaking Pashto, then Dari, then Pashto again.
Like other élite Afghans with connections to the state, Mahmoud shuttles constantly between Kabul and Dubai. He has left Farnood's villa, and moved into his own, multimillion-dollar house on Palm Jumeirah. "That's the key to understanding the Afghan leaders," a Western official told me. "If you are willing to put up with squalor and danger in Kabul, you can live like a king in Dubai."
Mahmoud's manner is open and unassuming; his English is fluent. For an hour, over black tea and almonds, he chatted amiably about his entanglement with Kabul Bank. As the talk turned to financial irregularities and criminal investigations, he did not ask his visitors to leave; the Afghans stared blankly, seemingly unable to understand the conversation taking place in English. "I'm not worried, I'm not worried at all," he said of the U.S. investigation into his finances. "The only thing I'm worried about is how much money it's going to cost me—how much money I'm going to pay the lawyers. But me? I know myself. I'm clean."
The story, he said, goes like this: In 2007, he was offered shares worth about seven and a half per cent of the bank and the amount—six million dollars—he would need to buy them. Farnood lent him the cash. Mahmoud said he figured that Kabul Bank's people needed his business acumen. "It's nothing to do with politics—that hurt the bank," Mahmoud said. "I felt I could make a contribution. If they had consulted me, we could have made a fortune."
A few days later, the senior NATO officer in Kabul suggested to me that Kabul Bank's officials had offered positions to Afghans like Mahmoud and Haseen Fahim, a shareholder who is the brother of the Vice-President, in order to get closer to power. "Why does Kabul Bank want Mahmoud Karzai as a shareholder?" the officer said. "So it can develop political protection for its illicit practices."
Mahmoud argued that Sherkhan Farnood was a dictator, and that none of the bank's shareholders had any say in how the bank loaned or invested its money. "The management is at fault because it did illegal things single-handedly while avoiding everybody else," Mahmoud said. "It never had a shareholders' meeting. It always refused when we asked." He added, "We never knew Kabul Bank was in trouble, O.K.?"
Mahmoud told me that his relationship with the bank was hardly worth it, considering the problems it has caused him. With three million dollars of additional loans from the bank, he founded Afghan Cement, in 2007. He said that he's already paid back the principal on the loans. "I'm done," he said.
This tale may be self-serving, but it's nearly identical to that of Haseen Fahim and Ferozi, the former C.E.O. All three men now place the blame for the bank's failure squarely on Farnood. "We never had any idea what was going on," Ferozi told me.
Still, Mahmoud's story was full of contradictions. Though he had enjoyed living in the villa in Dubai, he said, he warned Farnood against buying luxury properties there, because the market was heading for a crash. "I told him to sell," he said, adding, "This was as friends, you know, playing tennis."
Even as he insisted that he had not known what Farnood was doing at Kabul Bank, Mahmoud told me that he had tried to warn the Americans and the Central Bank that the bank's executives were acting improperly. "I told them something fishy was going on in the bank," Mahmoud said of American investigators at the Embassy. "Things didn't look right. They"—the bank executives—"were taking money. They were not doing the right businesses."
Another problem is this: American officials say that Kabul Bank appears to have made a number of loans to Afghans close to Mahmoud, possibly even to bodyguards or laborers. The officials suspect that the money actually went straight to Mahmoud. In our interview, Mahmoud denied this.
The more pressing political question, of course, is not what Mahmoud knew but what President Hamid Karzai knew—and what he did or didn't do, and how he might have benefitted. To answer this question, I went to the Serena, the fanciest hotel in Kabul, to meet Ferozi, the former C.E.O. of Kabul Bank. Ferozi told me that the bank gave the Karzai campaign four million dollars, meaning that the two hundred thousand dollars in the briefcase described by Zakhilwal was just the beginning.
As with so many things in Afghanistan, the official record is nearly worthless. Records filed by the Karzai campaign indicate that it raised and spent roughly two million dollars. A prominent member of the Afghan government at the time of the election puts the figure at between twenty-five and thirty million dollars.
According to several current and former Afghan officials, Kabul Bank and Karzai's 2009 reëlection became nearly interchangeable. Afghans who served in Karzai's government say that the more likely contribution from the bank was between seven and fourteen million dollars. Karzai eventually won the election, even though monitors found that about a million ballots had been fraudulently cast.
Even after the election, Kabul Bank kept doling out money. In January, 2010, lawmakers in the Afghan parliament rejected seventeen of twenty-four ministers whom Karzai had nominated for his Cabinet. Parliamentarians complained that the nominees included too many hacks. "I think, unfortunately, that the criteria were either ethnicity or bribery or money," Fawzia Kufi, a parliamentarian, told the Associated Press at the time. Two weeks later, Karzai submitted a new slate of seventeen nominees—some of them the same as before. This time, the parliament approved seven and rejected ten. Karzai didn't try again after that; he merely designated some of the rejected nominees as "acting ministers." The current and former Afghan officials said that parliamentarians suspected of opposing Karzai's nominees were paid by people at Kabul Bank to change their votes and support them. "They were bringing the parliamentarians to that guesthouse," the former senior official said of where Farnood now lives. "They were paying people."
"With Mahmoud at the bank," the former official went on, "it was seen as an extension of the Karzai family." Fahim, Ferozi, and Mahmoud Karzai all say that they didn't know about any payments to Afghan members of parliament or to any other Afghan officials.
Other Afghans say that President Karzai was warned of the bank's problems long before they became acute—and chose to do nothing. In the months before the bank's troubles became public, a Kabul Bank shareholder told me, President Karzai called Mahmoud repeatedly to implore him to "tell Farnood to bring the money back to Afghanistan." In his interview with me, Mahmoud acknowledged that Hamid Karzai had complained to him that January about the bank's troubles, but claimed that the President never asked him to do anything. "He was upset about it because he didn't know who was doing it," Mahmoud said of the President. President Karzai's office did not respond to requests for comment regarding Kabul Bank and the wider issue of corruption.
In March of last year, just before Kabul Bank's problems surfaced, Karzai got a sharp warning. Amrullah Saleh, then the head of the national intelligence service, told Karzai that the bank was on the brink of collapse. Karzai summoned Abdul Qadir Fitrat, the governor of the Central Bank, to the palace. Fitrat assured the President that the bank's finances were sound; in fact, they had been certified by an independent auditor, A. F. Ferguson, an affiliate of PricewaterhouseCoopers, only a few months before.
Saleh was told, "Go back to chasing car bombers."
As for Mahmoud, he is waiting for word on the American investigation into his finances and on the inquiry into Kabul Bank. Speaking of Farnood, he said, "I hope he goes to jail for the rest of his stupid life. He ruined everyone."
In February, 2008, Joseph Biden, then a senator, arrived with two colleagues at the Presidential palace for a dinner with Karzai. Biden got right to the point, urging Karzai to address the corruption in his government. In a fashion later described as bordering on the surreal, Karzai denied that graft was a serious issue in Afghanistan and changed the subject. Biden persisted. Karzai offered Biden plates of lamb and rice; Biden pressed his host about corruption. Finally, Biden threw his napkin on the table and stood up. "This dinner is over," he said, and walked out.
Last month, Vice-President Biden returned to Kabul, and, according to Afghans with knowledge of the visit, this time the two leaders got along splendidly. They had talked on the phone before Biden's arrival, to smooth the way. Biden thanked Karzai for his efforts. Their meeting, originally scheduled to be brief, went on for more than an hour, officials at the American Embassy said.
Afterward, Biden and Karzai stood before a group of American and Afghan reporters. They took no questions. Instead, Biden read a prepared statement making clear what America intended to do in Afghanistan and, more important, not to do. He turned and faced President Karzai.
"Let me say it plainly, Mr. President: It is not our intention to govern or to nation-build," Biden said.
"Wonderful," Karzai said.
And the two men walked out of the room. ♦
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