Monday, January 18, 2010

Forza Iceland!

On 7 October 2008 the global financial crisis spread to Iceland, when the Icelandic government put Landsbanki, the second largest bank by value, into receivership. On 8 October the government took control of Glitnir, the third largest bank, buying a 75 per cent stake for €600m; on 9 October it took control of Kaupthing, its biggest bank. These events triggered off a row between Iceland and the United Kingdom over the losses of UK depositors with the collapsed banks, especially in high interest accounts held with Icesave, an online arm of Landsbanki; Dutch depositors also lost out to a lesser degree. Icelandic funds for deposit guarantee were grossly insufficient to provide cover. The Brown-Labour UK regime actually used anti-terror legislation against a fellow NATO-member to freeze Landsbanki and other Icelandic assets held in the United Kingdom. The UK, and Dutch governments, reimbursed most of their depositors for their Icelandic losses, and claimed the money back from Iceland – UK depositors had lost something of the order of over €2.4 billion, the Dutch over €1.3 bn. This represented a per-capita burden of the order of €12,000 for each of the 317,000 Icelanders, or about €40,000 per household, or roughly 50% of Iceland’s GDP. On this, debt interest would be charged at 5.5% per year – a superb rate of return these days. According to the FT, “A year’s interest equals the running cost of the Icelandic healthcare system for six months.”

The deal was approved by the Icelandic Parliament on a narrow 33-30 vote, but over 60,000 people (some quarter of Iceland’s voting population) raised a petition against it, so that President Olafur Ragnar Grimsson refused to sign legislation and blocked the settlement – an implicit vote of no confidence in the Centre-Left Premier Johanna Sigurdardottir. A referendum will take place before 6 March. “The involvement of the whole nation in the final decision – said the President – is … the prerequisite for a successful solution, reconciliation and recovery.”

Two out of the three opinion polls taken since the president’s decision indicate that the legislation will be rejected in the referendum. Considerable pressure is being placed on Icelandic voters, under threat to lose a $10 billion loan package by the IMF, the EU and Nordic countries, and to see the rejection of Iceland's application to join the European Union, which was submitted last July.

The roots of the Icelandic crisis are in the unrestrained neo-liberal policies followed over the last ten years: the privatisation of the banks in question, their de-regulation, the policies pursued by a former Prime Minister of Iceland both in government and then as governor of the Central Bank, not to mention the responsibilities of British and Dutch regulators faced with inordinately fast growth in the foreign operations of the Icelandic banks. “Since the banks had turned Iceland into a hedge fund, with massive short-term foreign currency liabilities used to finance risky long-term assets, the economy was doomed.” (Martin Wolf, FT, 14 January 2010).

Deposit guarantees at the time of the Icelandic banks' collapse differed across Europe, with different national ceilings (only €22,000 in Iceland); what counts is the nationality of deposit-taking banks, not that of depositors. EU regulations require only that a deposit-guarantee system must be in place with “sufficient resources” to cover deposits, but leaves the central bank’s top up (up to 100% in the Netherlands) to bilateral treaties that neither the UK or the Netherlands have with Iceland. Moreover the Dutch Finance Minister Wouter Bos admitted that deposit guarantees are not designed to cover the case of systemic crises (see Sveder van Wijnbergen, NRC Handelsblad, 12 January 2010). And of course such guarantees are not a claim that can be instantly executed at the request of the depositor or his government, but a credit that can be challenged and tested in courts. It is not by chance that Alistair Darling still has not compensated foreign investors in Northern Rock.

The UK and the Dutch are at liberty to cover their nationals’ deposits with Icelandic banks but – until an agreement with Iceland not only has been signed but has also cleared all the protective hurdles put in place by the Icelandic constitution – they cannot unilaterally and automatically execute their resulting credits towards Iceland. The use of anti-terrorist legislation by Gordon Brown to seize Icelandic assets in Britain undoubtedly damaged Iceland’s credit rating and credibility; it was an outrageous, illegitimate insofar as it had nothing to do with terrorism, crass and aggressive move that backfired, notably the referendum initiative was taken by an Association that called themselves “Icelanders are not terrorists”. If Iceland needed a pretext to have second thoughts about the deal, which it does not, redoubtable Gordon Brown’s use of anachronistic gunboat diplomacy is more than enough.

Iceland is already over-indebted. Its stock exchange fell by 90% in the crisis, the krona has lost more than half its value against the euro since July 2007, and even the IMF reckons that “further depreciation of the currency would not be feasible, as it would raise the debt-to-GDP ratio to 240%. The Icesave deal would have done the same. The country’s ability to pay foreign debts – out of net exports – is limited” (Michael Hudson, FT 13 January 2010). According to an OECD economic survey (September 2009) between 2007 and 2010 Iceland's real consumption will have fallen by almost a quarter and domestic final demand by almost 30 per cent. Iceland can invoke customary provisions for "onerous debt". A renegotiation of the original settlement with the UK and the Netherlands would be in the interest of creditors as well: claiming the impossible is bound to result in obtaining less than if a more modest but feasible claim was put forward.

The same bullying tactics – not to say blackmail – that pushed Ireland into ratifying the Lisbon Treaty in last year’s referendum under threat of losing all kind of EU subsidies, are now being used to bully Iceland. Wouter Bos threatened an EU boycott and International Monetary Fund blockade, and a Dutch director of the IMF, Age Bakker, announced that all aid already committed to Iceland would be delayed – a decision that is not his to take but for the IMF Board of Directors, within which he would have to abstain on this issue because of his evident conflict of interest. This is a further disgrace, for neither the interests of Ireland nor those of the EU, or the interests of global financial stability, are changed by a jot with the settlement of a relatively small claim (by EU and IMF standards) with or without a dispute – a settlement which will have to be negotiated, or ruled upon in the European Court of Justice, but either way will be resolved in due course. There is no legal or moral case, and – more to the point – it is not in anybody’s economic interest, to imprison Icelanders in their own country for debt.

'Lord' Myners, the UK Financial Services Secretary, has said that if the deal with the UK and the Netherlands is rejected in the referendum, voters would “effectively be saying that Iceland does not want to be part of the international financial system” (Martin Wolf, cited). It is true that after the President’s decision Fitch has already downgraded Iceland debt to junk status (though not other rating agencies, who have refused to aid the pressure), but it is up to the Icelanders to decide at what price they want Europe and access to international finance. Not unnaturally Icelandic support for joining Europe has decreased significantly since the dispute: by last September a Gallup poll showed that 48.5 per cent now were opposed and only 34.7 per cent in favour. Support cannot have improved since then. The threat of not joining the EU might be treated by Icelanders as a welcome promise.

There are only two redeeming features of this particular Icelandic saga. One is Iceland’s small size. Small is not only beautiful, it is also economically manageable and digestible. €3.8 billion is chump change these days. Which offers the main, probably only ground left for hope in Latvia.

The other piece of good news is that, at the end of last October, McDonalds announced the closure of its three outlets in Iceland and said that it had no plans to return. This was due to the “very challenging economic climate” and the “unique complexity” of its operations (i.e. importing most ingredients from Germany at rising costs, with the Economist’s Big Mac Index still making the krona very much over-valued). Such a privilege for Iceland is shared with only Albania, Armenia and Bosnia and Herzegovina in Europe. A high price to pay for exclusivity, but a privilege nevertheless.


Jim said...

I think you are too soft on the Icelandic authorities here.

Granted, there is plenty of blame to go round: regulators in the UK and Netherlands were far too relaxed about foreign banks (not all of them from Iceland) scooping up deposits; savers in both countries, egged on by irresponsible media (at least in the UK) were far too willing to earn higher returns without worrying about the risks, then quick to demand compensation to which they were not truly entitled when it all went wrong; and the UK was too quick to provide compensation, though in the fraught context of the time that was perhaps understandable.

However, would you not agree that the authorities in both the UK and the Netherlands had a reasonable right to assume that their counterparts in Reyjavik were doing their job properly? It was the failure of the Icelandic central bank to realise that the country was being turned into a hedge fund (as you put it, though I think it was more of a gigantic money laundry) that ultimately caused the crisis.

The people of Iceland didn't question any of this while the economy was booming on the back of dodgy offshore banking activities. They can't legitimately escape their share of the reckoning.

D. Mario Nuti said...

Thanks, Jim. I did list, among the roots of the Icelandic crisis, "the policies pursued by a former Prime Minister of Iceland both in government and then as governor of the Central Bank". But I do not feel that all Icelanders should pay the cost of those policies. After all, foreign depositors - including speculators and many UK local authorities - in Icelandic banks earned a handsome interest rate differential and took a corresponding additional risk by choice. Cuius commodum ejus incommodum...

Whether or not Icelanders can or cannot "legitimately escape their share of the reckoning" - if the deal with the UK and the Netherlands is rejected by voters -will be decided by the courts, as it should be.

Jim said...

Seems to me that most of the commodum accrued to Icelanders -- Reykyavik experienced an amazing boom over the past decade, and a lot of Icelandic companies went on wild, debt-fuelled spending sprees -- but now they want to weasel out of the incommodum!

Like you I would have been happy for those who invested with the Icelandic banks in ignorance of the risks to have taken a loss, and in fact a lot of them have still not seen any of their money returned to them. But in the fraught circumstances of the time I can see why the UK government chose to ensure that many of them were quickly reimbursed.

I'm sure you know that economic relations between the UK and Iceland have often been tense in the past -- cod wars and all that! Once again we are learning that Iceland is not afraid of playing hardball in defence of its interests.

D. Mario Nuti said...

Yes, I am aware of at least three Cod Wars, and the net-cutting and boat-ramming that those involved.

The real issue is not the morality but the legality of the possible Icelandic refusal to reimburse the UK and Holland for their support to depositors in Icelandic banks.

It is very hard to deny that there is a prima facie case for the Icelandic giant liability - whose rejection is still only theoretical though likely - to be tested in court.

A. Viirlaid said...

The tragedy in Iceland shows us the types of problems that will INEVITABLY arise when Moral Hazard is introduced to, and even woven elementally into (and then nurtured within) Financial Systems and Economies by the implicit or explicit guarantees by central banks and their governments to cover all losses from Financial Failure.

In America, as just one example of this, only a short time after being bailed out by The People's Money, the big banks are once again playing at the high-risk poker tables of international finance. Some of them are even involved with Greece's current problems and others are back in the derivatives game that landed them in such trouble only a few short years ago. Have the big banks learned NOTHING? The answer is YES, they have learned NOTHING.

Well, maybe they have learned one thing. They once again know FOR SURE (through the affirmation from the 'Bailouts' they received) that their activities are ALWAYS going to be 'guaranteed' by the State and by the private resources of average Americans.

The saddest part of the current fiasco in Iceland is that common Icelanders are being threatened if they do not INDIVIDUALLY agree to pay for mistakes that most of them had nothing to do with. And an even worse insult is those people who are asking them to do this do not acknowledge that it is a Faulty System that allowed for this tragedy to unfold.

These other people know that they are running a Rigged Game that 'little people' like common Icelanders will have to pay up for. They are very smart. And it is even more a rigged game then we might think. When central banks manipulate the Money System, they encourage activities that create a Bubble Mentality. This has happened countless times in history. The best example in modern times was the paper money system created and manipulated by Scotsman John Law "the first modern central banker" in France in 1720.

This tragedy alone should have taught all of us for all time never to abuse the Money System. But we never leaned. Countless tragedies have occurred as money systems have been manipulated and destroyed.

Whether it has been the hyperinflation of the Weimar Republic leading directly to the tragedy of Hitler, or more recently the Greenspan Federal Reserve leading to the Mother of all Housing Bubbles and its collapse with all the attendant misery of that fiasco, we simply do not know how to safely operate fiat money systems.

And the central banks around the western world tend to all behave the same way. This leads to all of us, concurrently, taking on the Bubble Mentality, not just in Iceland.

For example, Greenspan's central bank ("The FED") was keeping interest rates below the rate of price inflation for an unusually long time (because he could not see any Consumer Price Inflation he thought he could get away with it, but he forgot about the dangers of asset price inflation).

A. Viirlaid said...

In China (and in many other countries), in order to ensure that their local currency did not rise relative to American currency, the CCB (Chinese Central Bank) printed local money like crazy, in order to buy up American currency with which to buy U.S. Treasury Bonds. This the CCB did by using their newly-printed local currency to buy American money from their own exporters who had a surplus and besides needed local currency with which to pay off their own labourers and suppliers. This created net-new money, and prevented the local currency from rising relative to American currency, and also created a boom in China. Other places like India and the rest of Asia similarly experienced Bubble states. And so did Iceland.

The Asian nations all had to print net-new (additional) money because none of them wanted to be left at a competitive disadvantage relative to China, and its manipulated ("dirty-float") currency.

Even today there are Bubbles everywhere you look. This will all end very badly. People like us tend to think these Bubbles come from the air. That some times are "Bubbles" and other times are "Busts". But these are all manmade. They are all artificial.

Yes, our psychology gets the better of us. We see house prices go up. So what is more natural then to want to invest in a piece of that ever-appreciating asset class? Nothing. We are not to blame. The authorities and money manipulators and central banks are. Sure, they create their easy-money conditions with good intentions. But the Road to Hell is strewn and covered several meters thick with 'Good Intentions'.

Let's wake up to reality and look at the basic cause of our misfortune. Let's fix what is essentially just a Broken Money System. A System which allows for abuse by any politician who just wants to 'speed up' the Economy for just a short time, in order to be reelected. Let's not pretend this is not seriously damaging.

Even China for its internal political reasons is willing to live on and in a Bubble. When it bursts, watch out, because revolution will be in the air. And to forestall revolution, what better logic to follow than to create some 'external enemies' to fight with and through which to 'rally the nation'?

This Faulty System (that I refer to as a Broken Money System) does not exist only in Iceland. All western countries have banking and central banking systems that contribute to this Broken Money System, that periodically creates such similar tragedies and thereafter demands grievous sacrifices from common people, very few of whom understand or contribute in any way to the continuance of this 'Broken Money System'.

The types of Failure that happened in Iceland, in America, in the U.K. (and soon will happen in Greece and Spain) MUST be allowed to occur. They must play out. The chips must fall where they will.

The inept and stupidly-managed banks must fail and the investors must lose. There are no guarantees in life. The stronger, better banks will survive and pick up the pieces of the incompetent ones. That is how good management techniques and sound risk management strategies propagate throughout the system, and how bad ones are buried in the dustbins of history. Anything else, like rewarding ineptness, would only encourage the bad techniques to propagate and continue to live, like zombies drinking the blood of the young and the living.

A. Viirlaid said...

If Britain or Netherlands insist on covering the losses of their own citizens (those who were depositors in the Icelandic banks) then let them do so. But for them to then lay claim to the resources and assets of common Icelanders to 'cover' those payouts -- that is immoral in my opinion.

Yes, the legal system and courts will make the final decisions. But I support the Icelandic people in their quest to resist the threats being made against them by Europe, most especially by the government of the U.K.

What those threats consist of is nothing less than bondage, and serfdom, and want and starvation -- exactly what the original Icelander-settlers were fleeing from when they arrived in their fair country in the first place. No wonder Icelanders are not too enamoured by what some of their own politicians have come up with.

Without at least the POSSIBILITY of failure, the Money System can never expunge the rot from within it. The exact opposite is the case. If you never allow for the possibility of failure, you actually guarantee that Failure will occur.

The reverse is similarly true. If your system allows for failure to occur, systems will be built to make failure less likely.

Yes, I know, the intent of the original founders of Deposit Insurance schemes was exactly this -- that is, put deposit insurance in place that gives depositors 'confidence' that they will never lose their deposits and THEREBY ensure that bank runs etc. are prevented. But while some warned against this, many did not see that they were creating the conditions for exactly what they were trying to prevent. And that of course is Moral Hazard.

In fact, if we all individually knew ahead of time that in reality we COULD lose our 'deposits' (which are really just loans to our bank) then we would be far more careful as to which institutions we entrusted our money to -- as would they be with the use of those funds. Institutions would compete less on the basis of interest 'return' and more on 'safety' and capital preservation.

It is nice but foolish to think that it is a good thing to have possible future losses covered by societal 'insurance'. But what if the price of this insurance is too high -- that is, what if it allows Moral Hazard itself to weave into the System more and more future failures?

How can we afford the payout from such an insurance policy when the system makes the claim against that policy, that is, upon us, to cough up?

The only thing that Moral Hazard can 'guarantee' is more and more, and bigger and bigger FUTURE FAILURE. The end result will be a long-lasting Mother of all Depressions.

No bank that fails should ever be rescued or backstopped by the government, that is to say, by The People and by the wider society.

If a bank wants to buy insurance, then let it do so. Such a bank may even garner more business as a result.

But to say that a whole society must pay for mistakes made by a few, even if those few are heads of central banks, or governments, or commercial banks, is, in my humble opinion, ludicrous.

This is the state that our Broken Money System has brought us to.

Prime Minister Brown treats Iceland as a criminal and a terrorist. Will he do the same with Greece and Spain when they too cannot pay their bills? In my opinion he will. Greece and Spain after all incurred their debt as Sovereign Nations. Iceland did no such thing.

Just because this happened in the small country of Iceland does not in any way mean it cannot happen elsewhere.

How can we possibly BAIL OUT EVERYONE?

I salute Icelanders and the Icelandic Nation. I wish all Icelanders the best of luck in their referendum and in their struggle to resolve this mess.

A. Viirlaid said...

And lastly, a big Thank-You to D. Mario Nuti for a wonderful article -- I am sure Icelanders are grateful to you!

I felt privileged to read your writing, as in just some examples here:

"It is not by chance that Alistair Darling still has not compensated foreign investors in Northern Rock."

"The threat of not joining the EU might be treated by Icelanders as a welcome promise."

"A high price to pay for exclusivity, but a privilege nevertheless."


A. Viirlaid said...

One article that could be linked to this one is from the Canadian newspaper, The Globe and Mail.

The link is

and the article linked to is "Iceland stares into Icesave abyss" published on Friday, Febrauary 26, 2010.

Several people have posted their opinions there as well.

A. Viirlaid said...

Icelanders stared into the abyss and did what?

Voted 93% to tell Gordon Brown to jump into the nearest Hot Spring!

D. Mario Nuti said...

Please add any comment on Iceland to the latest post on the subject, "Iceland: Three Cheers For Democracy" on 9 March,