Published October 2, 2012
In the autumn of 2008, international media and famous economists descended on Iceland to watch the first European country plunge into crisis and become a financial basket case. Now, they are flocking to Iceland to study how a country could rise up so fast after its deep plunge. Some even talk about a “miracle.” The only people who don’t seem to be in awe of the “miracle” are the Icelanders themselves.
“The ‘Kreppa’ is over,” Gylfi Zoega professor of economics at the University of Iceland stated this summer. After severe contraction of the Icelandic economy following the October 2008 collapse of the country’s three main Icelandic banks—Kaupthing, Landsbanki and Glitnir—years of misery, with rising unemployment and stagnated or diminishing salaries, seemed unavoidable. But the “Kreppa” seems to have ended and the economy is, all things considered, doing remarkably well.
So well that those who descended on Iceland in 2008 to witness the doom and gloom are now returning to study the Icelandic “Kreppa” remedies. Famous economists like Nobel-prize winners Paul Krugman and Joseph Stiglitz debate the Icelandic case and use it to further their theories.
The short answer is that not saving the banks and issuing massive write-downs of loans, both to companies and individuals, has unshackled the economy. Additionally, the devalued króna makes Icelandic goods and services attractive to foreigners. Even nature has come to aid: the tried and tested means of Icelandic survival, fishing, has been good the last few years.
For the national psyche the most important indicator is the unemployment figure. In Iceland, it peaked at 9% in the second quarter of 2009. At the time, Iceland seemed to resemble Ireland with its mass emigration, but that trend has now changed. This year, unemployment might land just under 7%. In the newly presented budget for 2013, the estimated unemployment figure is 5.3%. Last year saw a 2.6% increase in GDP after a contraction of 6.6% in 2009 and 4.4% the following year.
(Almost) no Icelandic banks saved
How did Iceland’s “Kreppa”-beating measures compare to those employed in other European countries in recession? Unlike other badly “Kreppa”-hit countries like Ireland, Greece and now Spain, the Icelandic state didn’t refinance the three failed banks. In other words, Iceland didn’t save its failed banks.
The credo of the European Central Bank and the European Commission has been that no bank must fail in the Eurozone and no bondholders must suffer losses, so as not to undermine the faith in the euro. Consequently, the debt accumulated by private banks has migrated from the private sector to the public sector in countries that refinanced failed banks. Instead of the losses being born by private institutions, which incurred them by reckless lending, they are being born by taxpayers.
Iceland wasn’t burdened with any such lofty ideals. Or mostly not—the Icelandic government did indeed hope to rescue the banks, but faced with the enormity of a triple bank failure in autumn 2008 it was forced to drop the idea. Thus was born the heroic—but not entirely true—saga of the little country that refused to save its banks. The three big banks were well beyond salvation—but the state did recapitalise a swath of smaller banks, at quite a substantial cost to Icelandic taxpayers. However, this doesn’t alter the fact that foreign creditors bore the brunt of the collapse of the banks and the Icelandic economy was not dragged down by the three failed banks.
Write-downs: a force of good—and bad
Another concerted action that set Iceland apart from other European countries in recession is the widespread and extensive write-down of loans, both for companies and individuals. When debt is too high to be repaid, writing it down or off is a classic tool. An economy weighed down by unsustainable debt turns into a zombie state of the living dead. Japan in the ‘90s is still the scariest example of this situation: debt wasn’t written down as necessary, partially because no one wanted to admit the problem.
In Iceland, it was quickly understood that a massive write-down would benefit the economy. The “currency basket” loans—foreign-currency loans in or pegged to more than one currency—had gone from being an escape from high Icelandic interest rates to the road to hell for the borrowers as the króna collapsed with the banks and the terms of the foreign-currency loans shot up. The plight of these borrowers became the most visible and discussed effect of the collapse of the banks—and finding a solution for them became the dominant political issue.
The legality of the foreign-currency loans was tested in courts with the Icelandic High Court ruling that it was legal to lend in króna, but illegal to peg loans to foreign rates. It was a simple verdict, but anything but simple in practice as the loans varied greatly. Consequently, the loans have turned into a nightmare for the new banks, and are so far only partially resolved.
For private individuals, the “110% way” has become the standard solution: mortgages above the value of the property are written down to 110% of its value. This has more or less solved the problem of private debt overhang and though there will still be people suffering payment difficulties the “110% way” seems to have benefitted the economy as a whole. Similarly, the banks have developed standard debt guidelines for companies.
Other economic lubricators are changes to bankruptcy laws, shortening the period of bankruptcy to two years. Compare this to Spain where the debt period lasts the rest of your life. A recent article in the German magazine Der Spiegel recounted how an owner of several trucks went bankrupt, the bank took all his trucks and now he and those who worked for him are out of work and the truck-owner will remain in this situation for the rest of his life. In Iceland, the bank would most likely have written part of the debt off and the truck-owner keeps one or two trucks, enabling him to keep some staff. If the plan had worked out, he would have repaid the remaining debt and everyone lived happily ever after.
The tricky thing for the Icelandic banks is to convince Icelanders that write-downs aren’t being used to help those who were the banks’ favoured clients before the collapse and who had access to far too favourable lending. Write-downs awake suspicion in Iceland although economists view these means as an important step out of the economic zombie state.
Is all of this as good as it seems?
The greatest challenge to prosperity in Iceland is recession and low growth in the European Union, Iceland’s biggest market. Icesave—this interminable dispute with the Dutch and the British over the Landsbanki internet accounts, called Icesave—is still unsettled.
Lack of foreign direct investment is a great weakness of the Icelandic economy. ‘No wonder, in a country with capital controls,’ someone might say. But this weakness is much older than the capital controls put in place in November 2008. Foreign investors find Iceland difficult to penetrate if you don’t happen to be born and bred in Iceland. It’s not necessarily the lack of money per se that poses problems—after all, the Icelandic pension funds can only invest in Iceland for the time being and the country increasingly shows signs of too many krónur chasing too few investment opportunities. Lacking are foreign contacts, inspiration and know-how that good investors bring along.
In any country coming out of a “Kreppa” it takes some time before the national psyche senses the positive change and feels uplifted. Icelanders aren’t necessarily convinced, though foreign pundits are right to talk about a “miracle.” The “Kreppa” mentality evaporates only when people sense that family and friends don’t need to go abroad for jobs, that companies are hiring and that they and those they know can again travel abroad once in a while. Anecdotal evidence indicates that this might now be happening in Iceland.
So far, the Conservatives in government with the Social Democrats in October 2008 have profited by the perceived lack of coherent government policy. If the voters, however, sense that the “Kreppa” has left Iceland it might strengthen the two parties presently in government, the Social Democrats and the Left Green, in the election next year.
But in the global economy, no country is an island, not even an island in the middle of the Atlantic. Iceland isn’t entirely dependent only on the fish in Icelandic waters but also on how much fish and other goods foreigners can afford to buy. The dark clouds hanging over the European continent are now the greatest threat to the remarkably sturdy economy of Iceland.