Iceland’s meltdown

The collapse of the banking system has already rocked the small country and now economists are using Iceland as a textbook case of how to ruin a nation's economy. FST’s Matt Buttell investigates how Iceland can save itself from truly sinking.

“At the end of the second quarter of 2008, Iceland's external debt was at €50 billion, with more than 80 percent of that being held by the banking sector”
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Iceland’s economy has always been small and subject to high volatility. It has also always been a mixed economy, with both high levels of free trade and government intervention; however, until last year, government consumption had always been less than in other Nordic countries.

Back in the 1990s, for example, Iceland began extensive free market reforms, which initially produced strong economic growth, and, at the time, Iceland was rated as a having some of world’s highest levels of economic freedom. Then, in 2007, Iceland obtained the highest score on the Human Development Index and was considered as having one of the most egalitarian economies in the world.

However, over the last two years the economy has faced massive problems of growing inflation and current account deficits and in response to, and as a result of, the earlier reforms the financial system both expanded rapidly and then entirely collapsed. Iceland was forced to obtain emergency funding from both the International Monetary Fund (IMF) and a range of other European countries to try and stabilize the economy.

But now, having included the failings of all three of the Iceland’s major banks, the Icelandic financial crisis is the largest suffered by any country in economic history – at least relative to the size of its economy. So how did it happen and how will the repercussions of the crisis shape the future of Iceland’s economy?

The problems began on September 29 last year when Icelandic government stated that it intended to nationalise the Glitnir bank by acquiring a 75 percent share for €600 million. While the government had stated it did not intend to keep the ownership of the bank for a long period of time, the nationalisation never actually went ahead as the bank was taken over by the Icelandic Financial Supervisory Authority (FME) before the initial stake could be approved. On the same day Landsbanki was also taken over by the FME, and, soon afterward, the same organisation placed Iceland’s largest bank, Kaupthing, into receivership as well. Then Prime Minister Gein Haarde remarked of the emergency measures, “There was a very real danger that the Icelandic economy could be sucked up with the banks into a whirlpool, and the result could be national bankruptcy.” In addition, he also noted how the actions that had been taken by the government would prevent such a catastrophe from ever happening.

Yet, at the end of the second quarter of 2008, Iceland’s external debt was at €50 billion, with more than 80 percent of that being held by the banking sector, and in January 2009 Haarde announced he would step down as chairman of the Independence Party at the next party congress, citing health problems as a reason for this decision. On the same day he announced that an early general election would be held on May 9, in which he would not stand as a candidate.

Then, three days later, after weeks of widespread protests because of the banks’ collapse, he announced that he and the Social Democrats would not continue in the coalition government and Jóhanna Sigurõardóttir from the Social Democratic Alliance replaced Haarde as Prime Minister on February 1st.

“We need a strong government that works with its people,” Sigurõardóttir explained after her installation as the head of the interim centre-left coalition in February, and while doubts still remain as to whether she can retain power after May’s elections, it has tpo be noted that Sigurõardóttir’s approval rating sat at 73 percent in back in November – marking her as the only Icelandic minister to see her popularity improve on the previous year’s score.

“It’s a question of trust,” explains analyst and political scientist Olafur Henderson, “Icelanders believe that she actually cares about people.”

Undoubtedly though her main task will be stewarding the economy, which, following the collapse of all of Iceland’s major banks and the countries negotiation of €7.5 billion in bailout loans, is in turmoil.

Even with the loans currently being held as foreign currency reserves and those banks that were last year nationalised now once again open and trading, Iceland still owes millions of pounds to foreign depositors.

Help needed
When the IMF agreed to lend Iceland the funds to both support its falling currency and permit international money transfers, it was done on the agreement that Iceland would adopt the IMF’s recovery programme and repay the loans between 2012 and 2015.

Now, according to the IMF itself, the work to restructure the country’s economy has already been successful. In a statement made by the IMF back in March, “The crisis has led to a sharp drop in economic activity, but a late-year turnaround remains within reach.” The statement went on to detail how the króna has now stabilized, and inflation appears to have peaked – indicating that the programme is delivering the necessary results.

What’s more, reports from the G20 conference, held in London at the beginning of April, indicates that US President Barack Obama even told the Icelandic foreign minister that he [Obama] wished to come to Iceland in the near future, stating that, “although Iceland was the first country to go down, it will be one of the first countries to go up again.”

Nonetheless, the news that IMF’s recovery programme is working has raised questions among Icelanders as to why, if it is this easy, other struggling countries have not signed on to the IMF. Some are running scared, wondering why those countries that have accepted IMF assistance in the past – such as South Korea and Argentina – remain so bitter about the experience?

Some believe that the IMF’s entry into the country is merely a subterfuge for gaining control over the nation’s resources and John Perkins, author of The Confessions of an Economic Hit Man, bluntly announced on Icelandic television that, “the IMF is here to serve the corporatocracy and is not here to serve the Icelandic people.” He added, “In every case where countries have gone along with IMF policies, it has caused tremendous disruption.”

Perkins also noted that the same people who imposed the IMF austerity programs on debtor countries are the same people that are now advising Obama to expand the money supply, to engage in new spending programs, and to increase the social safety net.

Alongside Michael Hudson, author of Super Imperialism, Perkins’ television appearance earlier this month set the Icelandic blogosphere in overdrive. Both Hudosn and Perkins shared the belief that Iceland’s best course would be to default on its foreign loans (much like Argentina has done) and strongly assert control over its resources before they are taken away all together.

In response to the comments made by both Hudson and Perkins some of Iceland’s most prolific commentators have expressed shock, dismay and anger: The country’s largest paper, Fréttablaõiõ, quoted Iceland’s minister of finance, Steingrímur J. Sigfússon, as saying that revoking the IMF was “out of the question” – though he did acknowledge being released from it as soon as possible was advisable.

With such disparity, it is hard to believe that just a few years ago Iceland had much to be proud of. The good times were rolling in fast: business was booming, society overfed and the capital was the destination for travellers, culture lovers and rich revellers alike. When Iceland topped the UN's Human Development Index for its high standard of living, literacy and life expectancy, the tiny community of 300,000 felt they had proved their educated, hard-working and resilient character on an international scale.

With the growth that came, few stopped to consider whether their swift financial ascent would end in an equally swift plunge into troubled waters. In many ways, Icelanders were too busy flying off on vacation, investing in art, buying cars and enjoying the growth too much to care – indeed Iceland soon gained a heady reputation as one of the top car-owning countries in the world.

Then, almost overnight, the nation’s three main banks were nationalised and declared bankrupt, and any Icelander who had bought such status symbols or invested in luxury properties with foreign loans found the value plummeting as repayments soared. Then the króna fell to one quarter of its value before trading in it was suspended, and thousands of hard-working retirees that had placed their life savings in stocks with these banks saw every penny disappear.

“The feeling is that we are unable to look after our own affairs,” explained leading Icelandic novelist Hallgrimur Helgason after the collapse. “We were on our own for years and we went too far, too fast, in too little time. We behaved like children and the first thing we did when the stock market opened 10 years ago was go to London and buy toy stores and candy stores. Now we are bankrupt and there will be no money for years to come and we have more debts than we can ever repay.”

Helgason paints a bleak picture. Today, as work to try and stabilize the economy continues, the blame for the collapse seems to be falling on greed, corrupt politicians and a lack of financial regulation. There are even predictions that things will get much worse, as Iceland – which has in the past survived nationwide famine, volcanic eruptions and a smallpox epidemic – not only has to tackle the world’s worst man-made disaster, but also has face the fact that they are to blame for it too.