Iceland, Part II

A report in Bloomberg (click here) suggests that Iceland's reaction to its fiscal calamity was the opposite of Ireland's.

"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."

Within a week of the collapse of Lehman Brothers and its own financial institutions, Iceland briefly took over its three main banks. Although it never nationalized them, it divided each into two new banks. One of each of these pairs was devoted to local (Icelandic) creditors, and the other to overseas creditors. The Icelandic creditors were protected, but the parts of the three banks devoted to foreign creditors (the much larger part in each case) were placed into receivership -- similar to chapter 11 bankruptcy in the U.S. Except for actual depositors, creditors in these parts could expect to receive back only a small  percentage (less than half) of their investments.

Since I don't have access to the Icelandic press of 2008 or actual accounts of the debates in Reykjavik about these decisions, it is hard to tell exactly why the government decided to do this. Their stated purpose was to protect Icelanders from the ruin of having to pay back all the debt incurred in the international disaster. Because of the overvaluing of the Kroner and other factors mentioned in my previous blog, there was a lot of speculative money put into the Icelandic financial system, and certainly Icelanders, and probably their government, must have felt that the very nature of speculation is risk, so that their first duty was to preserve their own country. Here's how Arni Tomasson,  the president of Glitnir, Iceland's third largest bank, put it:

“Everybody was panicked -- depositors, creditors, banks around the world. The effort by all of us at the time was to make sure life could go on as normal.” 

To be perfectly fair, there really wasn't much choice. Iceland gross foreign debt was around 7 times its Gross Domestic Product -- though the total assets of the three banks taken down was more than the debt (but this included deposits either guaranteed or potentially guaranteed). The Central Bank of Iceland (CBI) had nowhere the resources to assume responsibility for this debt; in fact, the Icelandic banking industry had become much larger than the entire rest of the Icelandic economy. Thus, Iceland could either cut loose the foreign creditors, or try to borrow -- at very bad terms -- enough Euros (or dollars) to save the banks (Ireland's path); it chose the former.

To protect its own citizens, the UK, which had been bad-mouthing the Icelandic economy, seized the assets of Landsbanki (Iceland's second-largest bank) in Britain. The fact that it did this under a provision of its Anti-Terrorism and Security Act partcularly rankled Icelanders and their government, and very harsh words were exchanged publicly; one of the governors of the CBI said "we do not intend to pay the debts of the banks that have been a little heedless." The UK decided to guarantee its depositors -- later, CBI  agreed to help as well; nevertheless, hard feelings persisted (probably still do).

There were also criminal investigations (still continuing) into favoritism in loans by the big Icelandic banks. I don't get the feeling that this was anything particularly unusual in the financial community, but it became magnified because of the huge surge in the financial sector of Iceland during the boom years, and the resulting crash which outraged Icelanders. The small size of the country made their unhappiness with their banks quite evident. Large demonstrations in Reykjavik, attended by thousands -- a good chunk of the total population of about 300,000!
-- was reported faithfully by the press, and had a direct effect on the democratic government. Several measures involving repayment to lenders and creditors were defeated by the pressures of these public displays. Iceland has a very strong tradition of popular democracy.

Eventually, Iceland sought help from Russia, the IMF, and other Scandinavian countries (and Finland). The IMF, as usual, forced certain austerity measures on the Icelandic economy which created more unemployment (more than 10% which is very very high for the country); nevertheless, the money was needed to repair Iceland's credit.

The Kroner, after a period of free fall and drastic fluctuation, stabilized at about half its previous value against the Euro, while inflation also soared.

Then the situation began to improve. More favorable loans were obtained from other Scandinavian countries; the "Icesave" bill repaid  the UK and the Netherlands a large amount of money lost to depositors; and the GDP stabilized and even saw some modest growth. The prime minister during the boom and bust, Geir Haarde (shouldn't he be Geir Tomasson?), was forced to resign (the reason given was his health.); he was replaced by the Social Democrat Johanna Sigurtharddottir in 2009. She has been a strong advocate for full membership in the EU -- a policy which has helped Iceland economically and politically in Europe. Other European countries which had vowed never to lend or invest in Iceland have come around -- replacing "never" with "maybe in a decade," then "maybe in five years." In fact, in 2011, Iceland was able to raise $1 billion in an international bond issue.

The people of Iceland have very little faith in their now much scaled-down banks, but they realize that it's what they have, and they need them to regrow their economy. Unemployment, while still high, has not increased; there are some signs that it will soon come down. Most of Iceland's social programs, while undergoing cuts, remain in place, thanks to the refusal of the government to sell out everything to rescue its banks.

After only a week in the country we could not make any serious personal observations of the effects of the 2008 crisis. Prices are very high on almost everything (hamburgers are $12 in most places; paperbacks are $20; we couldn't afford the famous Icelandic wool sweaters). People seemed cheerful and we didn't see any of the noisy demonstrations common several years ago. At least one restaurant we ate at devoted a full page of its menu to a denunciation of the financial community. Although everyone we met spoke English, we couldn't decipher the newspapers we saw, which were in Icelandic. In any case, we went to do sightseeing, not make a political report.

Iceland is a unique and wonderful country, with very laid-back and hard-working people. Their disastrous experience with international finance has left them somewhat sadder, somewhat wiser, and a whole lot poorer. But things are getting better, and they didn't sell their future to bail out  international speculators: good for them.