Delusions Of Financial Grandeur

As the Icelandic financial system came crashing down in the fall of
2008, Icelanders woke up to realize that the much-hyped “Icelandic
economic miracle” had only been a mirage. A giant bubble that had
popped. The recession that followed in the wake meant the death of the
economic dreams of countless ordinary Icelanders, who were all of a
sudden saddled under debts that spiralled upwards as the currency
plunged downward and inflation took off.
But the crash also represented the death of a different dream – a vision
promoted by politicians, the spokesmen of the banks, the Chamber of
commerce and free market ideologues: The dream of Iceland becoming a
“global financial centre”.
More than anything, it was this dream that had set the stage for the
bubble. And it was this dream that had allowed policy makers and common
people to ignore warning signs that a huge bubble had developed in the
economy and that banks had grown “too big to save”.
The history of this dream is one of the most interesting parts of the
story of the ‘rise and fall’ of the Icelandic economic miracle.
Primarily because of how revealing it is – how well it captures the
unrealistic ideas and ideological convictions that lay at the heart of
the euphoria of the boom years.
But there is another interesting twist to the history of the dream of
Iceland as a global financial centre. Namely its origin.
“The next Switzerland”?
The dust had barely settled after the collapse of the last round of
misguided and over-leveraged investments, when the idea of turning
Iceland into a global financial centre was first hatched. At the
beginning of the ‘90s, Iceland was going through one of the worst
recessions of the post-war years. Large sections of the financial system
were virtually bankrupt and Icelanders experienced protracted
unemployment for the first time since the 1930s. The mood was gloomy. In
a poll taken in 1993, 46% said they feared the nation might actually go
bankrupt. It was in this context that the idea of Iceland as a global
financial centre first surfaced.
In the summer of 1990, a government committee – established following
the 1986 Reagan-Gorbachev summit in Reykjavik to suggest ways for
Iceland to cash in on its global image – concluded that Iceland should
1) market its pure and unspoiled nature, and 2) seek to become a global
financial centre. The government jumped on the latter idea, and KPMG
Management Consulting was hired to evaluate the proposal and figure out
how exactly this grand scheme could be realized.
The (very) small Icelandic financial community found the idea appealing.
At a conference organized by the ministry of commerce in 1991 to
discuss the idea, Gunnar Helgi Hálfdanarson, CEO of Landsbréf, the
securities subsidiary of Landsbankinn, argued that while Iceland might
not be able to become “the next Switzerland or Luxembourg,” there was no
reason not to try. The fact that global financial centres were popping
up in places like the Caribbean and the Middle East was proof that
Iceland might be able to compete. The key, according to Gunnar Helgi,
was lower taxes and less regulation.
The foreign experts were not as optimistic. Cutting taxes and red tape
was not enough; in their view Iceland simply lacked all requisite
preconditions. Among other things, they pointed out the fact that the
regulatory authorities and institutional infrastructure were weak and
underdeveloped, and were not ready to handle the complexities of
international finance. A second criticism was that Icelanders simply had
no experience within the world of global finance.
This conclusion should not have come as a surprise. Describing the state
of the Icelandic financial market in 1991 as “developing” would be a
gross understatement. Until the mid ‘80s, the few stocks that happened
to exchange hands in the country were traded at face value, and looked
upon as curiosities rather than investments. There was a more vibrant
market for antique books and stamps than for stocks, and people were far
more likely to invest their savings in philatelic rarities than
corporate securities. In fact, there hardly was a financial market in
Iceland at the beginning of the ‘90s.
Excess ambition and ideology
Still, labeling the idea of turning Iceland into a global financial
center a delusion might be too harsh. It would perhaps be more apt to
speak of excessive ambition. Or ideologically infused ambition.
The depression of 1988-1993 marked the bankruptcy of the state
controlled financial system that had characterized the country since the
great depression. In the late ‘80s, government investment funds had
poured money, based on political connections and patronage, into various
ill-conceived and mismanaged business adventures, including countless
salmon farms that wound up bankrupt. Most experts and commentators
believed that the root of the recession was in fact government meddling
in the financial markets: If government was scaled back, state owned
firms – especially the banks and investment funds – privatized, red tape
cut, and the invisible hand of the marketplace allowed to work its
magic, who could say what was, and what was not possible?
This ideological component explains why the idea kept popping up during
the 1990s despite the fact that it had been flatly rejected as
unrealistic by the aforementioned foreign experts. It also explains its
spectacular comeback in the fall of 2000. By then the results of the
free market reforms and privatization policies initiated by the
Conservative party and Davíð Oddsson, who served as Prime Minister from
1991 until 2004, were well under way. Iceland now had a modern stock
market and aggressive investment banks. The state owned investment funds
had been merged into a single investment bank, which was then sold to
the public along with stakes in the two state owned commercial banks in
1998 and 1999, sparking a intense stock mania among the public, which
helped fuel the millennium bubble.
Perhaps it was fear that the bursting of this bubble would create a
backlash against the excesses of the financial markets, or perhaps it
was the growth of the Icelandic banks, who were by then taking their
first steps in foreign markets, through acquisitions and new
subsidiaries, but in the fall of 2000 the Federation of Young
Conservatives called upon the government to take every step to make
Iceland a global financial centre. The steps to be taken were simple
enough: Corporate taxes should be lowered enough for Iceland to be
considered a global tax haven – “a tax paradise.”
By this time Hannes Hólmsteinn Gissurarson, the tireless advocate of
neoliberal economic principles, chief ideologue of the Conservative
movement and a close ally of Davíð Oddsson, had positioned himself as
the main proponent of this idea, making it a central argument in his
2001 book “How can Iceland become the richest country in the World?”
“I have a dream…”
In September 2004 the dream of turning Iceland into a global financial
centre finally became official government policy. At the annual congress
of the Chamber of Commerce in February of 2005, Davíð Oddsson’s
successor in office, Halldór Ásgrímsson, the leader of the Progressive
party, declared that “he had a dream”. The dream was – you guessed it –
that Iceland become a global financial centre. In November of that same
year, Halldór appointed a committee, chaired by then-Kaupthing director
Sigurður Einarsson. That same Sigurður is currently a fugitive from the
law, wanted by Interpol for a variety of financial crimes and forgery.
The policy recommendations of cutting taxes and red tape were warmly
embraced by both the Chamber of Commerce and The Federation of Financial
Firms, a lobbying group funded by the finance industry. In 2006 the
chamber made the idea a keystone of its policy document, “Iceland 2015,”
in which it argued Iceland should brand itself as a “Freedom country”,
and by slashing taxes and regulation become “the most competitive
economy in the world.” Using the logic of trickle down economics, this
was presented as a great boon to the general population.
But even if the foreign banks and financial firms that were supposed to
flock to the country if only their demands, as articulated by Hannes
Hólmsteinn and the Chamber of Commerce, had been met, never
materialized.
But then again, when one reads the arguments for turning Iceland into a
global financial centre a bit more carefully, one is immediately struck
by their strange hollowness. There is no shortage of people praising the
vaunted benefits of turning Iceland into a tax haven for investment
banks, some kind of North Atlantic Tortola. But it is almost impossible
to find serious discussion of the specifics.
“The plan”
It was never really explained how this would come about. It is equally
striking to find that the proponents for the idea don’t seem to have
been bothered by the fact that there was never any indication that any
foreign financial firm ever considered relocating to Iceland. One would
have expected that this would have caused some concern. But no. Equally,
there is no debate about the possible drawbacks to attracting foreign
banks in large numbers to Iceland? For example: How would their deposits
be covered?
The closest we can come to a “plan” are the constant calls for lower
taxes and lighter regulation. Conservative MP Guðlaugur Þór Þórðarson
stated in an interview with Morgunblaðið on September 18th 2005 that it
was in fact quite “easy” to turn Reykjavík into a centre of finance. All
that was needed was were tax cuts and less red tape.
Perhaps that was all there ever was to this whole idea? If one ascribes
to Hannes Hólmsteinn’s philosophy of laissez-faire economics, there was
absolutely no reason to come up with a more complicated plan: All that
needed to be done was to scale back taxation and regulation, and the
market would magically take care of the rest. If the foreign firms did
not come flocking in, it was only because we hadn’t slashed taxes enough
or cut enough red tape.
Perhaps the idea of Iceland-as-global financial centre simply served as
the justification for pursuing neoliberal economic policies.
Next issue: A nation as hedge fund.