Five Years On: What Happened? What Did We Learn?

The 2008 collapse of the Icelandic banks has already generated some myths. One is that the Icelandic banking sector was overgrown. There is no such thing as an overgrown banking sector. It all depends on the area that the sector is serving and the institutional support it can expect to receive. Switzerland, Belgium, Luxembourg and the United Kingdom had banking sectors that were roughly as big proportionally as that of Iceland, and these sectors did not collapse.
Another myth is that the Icelandic bankers were more reckless than their colleagues elsewhere. But if they were, how did they then find customers, not only depositors, but also renowned financial institutions like Deutsche Bank? And when we read about HSBC being fined for money laundering and Barclays for libor rate-fixing, and about the excesses of the RBS management, the Icelandic bankers begin to appear, not exactly as choirboys, but rather as normal bankers.
The third myth is that the collapse of the Icelandic banks was caused by “neo-liberalism.” It is left unexplained what exactly would be the causal connection, but the crucial point surely is that the Icelandic banking sector operated under precisely the same legal and regulatory framework as banking sectors in other member-states of the European Economic Area, EEA. Therefore, this is a myth, not a plausible explanation.
What did then cause all the Icelandic banks to collapse, while most other banks survived? The Special Investigative Commission (SIC) of the Icelandic Parliament correctly identified a systemic risk in the Icelandic situation: “Of all the business blocks, which had borrowed liberally in the Icelandic banking system, the most conspicuous one was business associated with Baugur Group. In all three banks, as well as in Straumur-Burdaras, this group had become too large an exposure. The SIC considers that this has constituted a significant systemic risk, as collapse of one enterprise could affect not only one systematically important bank, but all the three systematically important banks.” The financial stability, therefore, would be significantly threatened by, for instance, Baugur Group, which had, as indicated in the report, substantial liquidation problems in the latter half of 2008.
What happened in Iceland was that in 2004, the leader of Baugur Group, businessman and adventurer Jón Ásgeir Jóhannesson, became the most powerful man in Iceland, after his critic, Davíð Oddsson, stepped down as Prime Minister. The market capitalism of 1991–2004 was transformed into the crony capitalism of 2004–2008. Not only did Jón Ásgeir and his cronies control two-thirds of the retail business, they also owned almost all the private media and one of the three banks, while having good access to the other two banks. It did not seem to make any difference to opinion-makers that Jón Ásgeir was investigated, indicted and convicted for breaking the law on business practices, being given a three months suspended prison sentence.
The other systemic risk in the Icelandic situation was that the area the banking sector served—the whole of EEA—was much larger than the area where it could depend on institutional support. This created a mismatch, or a system error. The problem was not that the banks were too big; it was that Iceland was too small. But it did not occur to anyone at the time that Iceland would, unlike all other European countries, be left totally to its own devices. The death knell of the Icelandic banking sector really sounded on September 24, 2008 when the US Federal Reserve System announced that it had made currency swap arrangements—essentially a license to print dollars—with the central banks of Sweden, Norway and Denmark. It became obvious to the financial markets that Iceland was not included, although it remained a secret for a while that Iceland’s Central Bank had indeed asked to participate, but that it had been refused.
Without these currency swap deals, these banks would probably have folded. In other words: the Icelandic banks collapsed because they did not receive the same support as banks in larger countries. They were not blameless—one of them being controlled by Jón Ásgeir, and the other two betting heavily, and inexplicably, on him—but they were not to blame for an old ally, and the mightiest state in the world, abandoning Iceland. I am not saying, either, that the banks should have been bailed out—the refusal to help Iceland was probably a blessing in disguise—but only that almost all banks in other European countries obviously needed support to survive.
The British Labour government made things worse when it closed down the two banks in England owned by Icelanders on October 8, the same day it bailed out almost all other banks in the country, including banks being investigated for rate-fixing and other questionable practices. Simultaneously, the Labour government took the drastic step of invoking the British anti-terrorism law against one of the Icelandic banks, with the almost instantaneous effect that all money transfers to and from Iceland stopped. For a while, Iceland’s Central Bank and the Treasury were also on the list of terrorist organisations, alongside Al Qaida, the Taliban and the governments of North Korea and the Sudan.
For the Icelanders, accustomed to peace and prosperity, the collapse of the banking sector was a huge shock. They did not realise until later—or even not at all—that in fact seven European countries were hurt worse than Iceland by the financial crisis. The political repercussions were serious. In came a government of petty, vengeful left-wingers. Central Bank Governor Davíð Oddsson, the former Prime Minister and the only Icelandic person of authority who had consistently warned against the financial adventures of Jón Ásgeir and his cronies, was driven from his post, and Geir Haarde, the Prime Minister at the time of the collapse, was indicted (whereas the Social Democratic ministers were not). Later, Geir was acquitted on all but one count, that he had not held enough ministerial meetings before and during the crisis.
So, what did we learn? That we should both reject the crony capitalism of 2004–2008 and the petty, vengeful socialism of 2009–2013, and try to return to the healthy market capitalism of 1991–2004 where the major objective is to create opportunities for individuals to better their condition by their own effort.

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