Whom To Blame?

Icelanders are upset. That may be an understatement, and it’s also unfortunate. The real unfortunate part is that they’re a little unsure what they’re upset about.
Domestic bankers made some bad loans. Icelandic consumers took on more leverage than might otherwise be sensible. Politicians (corrupt or otherwise) made some promises that they couldn’t keep. In a common story, bankers and politicians became unusually friendly during the boom years. In an unusual twist, central bankers and politicians made for strange bedfellows.
Whom should we blame? There are the usual suspects—the ones that made out so well during the boom that no one could object to penalising them today. And while some of this group—those bankers that made money by both hook and crook—seem to be all-too-easy targets, others were just trying to make an honest króna.
It’s the same thing on the political side of the fence. Although we can easily point to some less than level-headed representatives during the boom, there were also plenty of honest politicians. After all, after the elections of 2009 only 26 Alþingi seats had a new bottom to fill them—far less than half.
CBI’S LOOSE-MONEY POLICY
I would like to draw attention to another usual suspect, but with a twist. The Davíð Oddsson led Central Bank of Iceland (CBI)—that venerable, if recent creation of Alþingi—controls two important facets of banking: regulation and monetary policy. The CBI’s loose-money policy throughout the 2000s ushered in low interest rates (at least when adjusted for inflation), and enticed investors and consumers to take on more debt than was prudent. Few would argue today that Icelanders have not become aware of the risks of burgeoning debt levels.
More latent, if salient, are the types of guarantees that the CBI had committed itself to through its regulatory role. Contained in the new Central Bank Act of 2001 (passed, incidentally, while Davíð Oddsson served as Prime Minister), was a promise by the CBI to insure all bank accounts held with any Icelandic bank. This pledge extended regardless of the currency the account was denominated in (whether krónur, euro, dollar, yen, or even, presumably, Congolese francs), and regardless of the geographic location where the deposit was held (whether in Reykjavík, Amsterdam, New York, Tokyo or, again presumably, the Congolese capital of Kinshasa).  The new Act on the Central Bank of Iceland is brief—700 words exactly, including the title—but the ramifications were drastic.
By explicitly committing itself to act as a “lender of last resort”, the CBI effectively gave investors a carte blanche to not worry about their banks’ activities. No longer would a depositor be concerned with whether her bank prudently managed her hard-earned wages, or whether the bank’s management was being transparent and sensible. Bankers didn’t have to worry much about these things either. The CBI, backstopped by Alþingi, was there to provide the necessary funds when profits turned to losses. Heck, even the IMF gave the green light to Icelanders to continue their reckless spending during the boom and to not fret over and potential problems that could develop. And problems did develop. So many problems that no one was able to deliver on their promises when the time came.
WHERE WERE ICELAND’S FRIENDS?
It’s nice to have people say that they will support you in your time of need. The unfortunate part about this “support” is the behavioural change that comes with it. Caution gets thrown to the wind. A whole nation got swept up in a euphoric sense of success, guaranteed by multiple layers of guarantees. If you think that these guarantees are being used as a scapegoat to absolve some individuals from acting sensibly, read what none other than Kaupthing’s ex-CEO Ármann Þorvaldsson had to say about his own decisions: “I always believed that if Iceland ran into trouble it would be easy to get assistance from friendly nations.” These types of quotes only beg the wrong type of questions: Where were Iceland’s friends? Why didn’t they come through? We can speculate on why the guarantees and promises never materialised, but it’s mostly bygones by now.
Lest I be misunderstood, I am not absolving Þorvaldsson (or any other banker, lender or borrower) of responsibility. Nor do I pick him out for any other reason than the fact that his concise quote encapsulates the whole point I wish to make. He was and is only human; so were all the other Icelandic bankers. If one wants to start finger pointing, one needs to find the reasons why that finger is directed at someone. Lots of bankers (and individuals, businesses, and even politicians) acted completely rationally given the incentive structures they faced—however perverse they were.
If you make someone an offer he can’t refuse, he won’t. If you offer someone an investment that she can’t lose money on, she’ll invest. If you make the deal sweet enough, she won’t even ask questions about it. Depositors, lenders and borrowers were given just such a sweet deal in 2001 via the CBI’s guarantee to insure their deposits—regardless of the money’s physical location or denomination.
THE RISK OF A FUTURE NOT UNLIKE THE PAST
I don’t write this as anyone who had to live through the last three years of Icelandic recession (or, unfortunately, the boom). There are, in all honesty, at least a milljónir ranghala that I don’t understand about the beautiful country and its people. I write as a person that knows a crisis when he sees one. Finger wagging at some guilty suspects might provide some closure, but it doesn’t do anything to improve an already bad situation. The losses have been earned, and the profits have been lost—finding the guilty parties isn’t going to reverse history. Identifying the true root causes of the turmoil will enable Icelanders to make sure that the same mistakes don’t repeat.
Looking at how laws, particularly banking laws, affect the incentives we face will go far in reducing (or even eliminating) the risk of these unfortunate events from happening again. Guaranteeing people’s deposits is just one such way that the Central Bank of Iceland created an atmosphere of risk-taking from an otherwise reasonable country. And as my co-author Philipp Bagus and I outline in our new book ‘Deep Freeze: Iceland’s Economic Collapse’, these guarantees came from all layers of government, and covered all sorts of investments. The guarantees on Icelandic bank accounts that I have discussed herein still remain on the CBI’s statutes. Until they are changed, the country faces the risk of a future not unlike its recent past.