The Collapse And Beyond

Five years after the collapse, economists all over the world carefully study Iceland’s recovery—some even call it a “miracle.” Icelanders themselves are, however, less in awe of this miracle. Although the country has moved from recession to growth and unemployment has been reduced, household debt is still a big topic and the coalition government seems painfully at a loss as to how they can fulfil promises of debt relief and unshackle the country from capital controls. The small group of businessmen and bankers, who many think caused the crash, have lost jets and yachts, but are otherwise mostly doing remarkably well. Anecdotal evidence indicates that the Icelandic lesson from the collapse and the ‘kreppa’ is that loan agreements can always be changed, and nothing is ever final.
“You Icelanders have done the right thing in letting the banks fail instead of bailing them out. And now Iceland is back to growth and unemployment is falling,” an Irish banker said recently, when discussing the status of the Icelandic economy. “The capital controls? No problem, they don’t touch ordinary people.” Right, but the capital controls do touch the economy. One economist calls the controls a “slow death.”
Iceland will not have escaped the collapse of its banks in early October 2008 until the capital controls restricting outflow of foreign currency are abolished. The new coalition government between the Progressive Party and Independence Party, led by the former, seems to be split on how to go about it. As has so often been the case in Iceland’s history, this split is partly about how to engage with the outer world. Foreign investors are being courted and yet some politicians dream of squeezing money out of the last lot of foreign investors, not only to abolish the control, but also to create the opportunity for the much criticised debt relief promise that brought the Progressive Party to power.
The very short story of the Icelandic boom and bust
Iceland is not the only country to have experienced a spectacular boom in the years leading up to 2008, followed by a no less spectacular bust, forcing it to seek outside help. Ireland, Greece, Portugal, Cyprus and Spain have, to varying degrees, been bailed out by the troika—the European Union, the European Central Bank and the International Monetary Fund. Not being a member of the EU, Iceland took the classic route to the IMF, which lent the country 2.1 billion USD in order to save it from a total collapse as its banks failed.
But Iceland is the only debt-ridden nation that has had an answer to the question: why did the banks fail? This impertinent question was answered quite thoroughly in a 2,600 page report published in April 2010 by the Special Investigative Commission (SIC) set up by Alþingi, the Icelandic Parliament.
In clear, jargon-free language, the SIC report tells the story of failed economic policy in the decade or so before the collapse in 2008. The varying governments, which always included the Independence Party (in most governments since 1944), celebrated the growth of the banking sector which, like the UK banking sector, sucked talent from other sectors by offering salaries only banks could offer. In addition, the government added fuel to the booming economy with public spending.
With low interest rates in international markets, the Icelandic banks behaved like drunkards at a free bar. The three largest banks concentrated their lending on the banks’ largest shareholders and their business partners, in many cases lending them, their employees and other clients money beyond the legal limits to buy shares in the banks, thereby artificially inflating their value.
Banking the Icelandic way
All of these practices have been seen elsewhere, such as in the Irish banks, but as far as can be ascertained, it was practiced nowhere else to the extent that it seemed to have been in Iceland. The question of why this way of banking was so prevalent is an intriguing one.
There is probably no single answer, but it is worth keeping in mind that in spite of the banks being fully privatised by 2003, the new owners did not bring with them new managers. The management, and to some extent board members, remained the same.
There is anecdotal evidence that Icelandic banks have engaged in two-tier lending for a long time: the majority of clients were made standard offers for loans that had to be repaid; a chosen minority could borrow large sums against weak or no collateral. When these practices were based only on lending Icelandic deposits, the danger was somewhat contained. When the lending was based on foreign loans, in endless supply on international lending-happy markets, the banks grew to ten times the size of the economy and created an enormous risk which proud and somewhat clueless politicians and regulators ignored.
Weak collateral is also one reason why so many of those who borrowed the most have more or less escaped the effects of the crash. Large holding companies of well-known shareholders collapsed under their burden of debt when the banks were no longer there to keep on lending, extend loans or to refrain from recovering loans. With only a couple of exceptions, the largest shareholders in the banks—the owners of these holding companies—were left unscathed.
The centrifuge of debt and assets
One of the reasons why the boom billionaires, the so-called ‘útrásarvíkingar’ (“Outvasion Vikings”), have not been bankrupted is a mechanism that could be called a centrifuge. All of these billionaires owned galaxies of off and on-shore companies, i.e. groups of companies that stretched from Iceland to other countries, such as well-known secrecy havens like the British Virgin Islands, the Isle of Man and Guernsey.
A loan goes into one company and assets are bought. Over time, assets and debt are split, for instance by paying dividends and/or via sales and acquisitions between companies within the group, or to related parties. When bad things happen, the company that holds the debt goes bankrupt and little of value is found there for the creditors.
This is no Icelandic invention. Highly specialised and well-paid lawyers and accountants in London and elsewhere construct these galaxies each and every day. The Icelandic boom billionaires have practised this with great skill and great help from the banks, meaning that almost none of them have gone bankrupt.
In fact, some famous Icelandic billionaires still own companies in Iceland, such as Björgólfur Thor Björgólfsson of Landsbanki fame, Jón Ásgeir Jóhannesson of Baugur Group and Glitnir bank fame, and Ólafur Ólafsson, the second largest shareholder of Kaupþing bank.
Prosecuting the past
Shortly after the Icelandic collapse, the Office of the Special Prosecutor (OSP)—now a permanent serious fraud prosecutor—was founded in Iceland. None of the big cases have yet been resolved in the Icelandic Supreme Court, but recent rulings on white-collar crime cases indicate that the Supreme Court is far from lenient on punishment.
Top-level managers in all the banks as well as a few major shareholders have been charged. Two of those charged are Jón Ásgeir Jóhannesson and Ólafur Ólafsson, but their cases have not been ruled on yet. By next year, the OSP plans to have filed charges on all collapse-related cases.
Compared to Ireland, where there is great anger over the fact the management of the collapsed banks have not been investigated for alleged fraud, it seems safe to conclude that prosecuting the bankers and shareholders, seen to be partly responsible for the crash, changes the public mood. Nonetheless, many Icelanders complain that investigations are taking too long. Compared to complicated fraud cases in other countries, the Icelandic cases follow a familiar pattern and the extensive galaxies of companies partly explain the time it takes to get to the bottom of what went on and how things were done.
In addition, the administrators of the collapsed banks are suing managers, board members and accountants of the banks, in order to recover assets. The outcomes of these cases, especially against the accountants, are interesting in an international context since it is widely believed that the role of accountants in failed banks has not been scrutinised enough.
Legacies and lessons
The SIC report was written partly to explain what had happened and partly to provide lessons. Many public institutions spent some time studying and discussing it, but it is difficult to say if the report helped provide the necessary lessons.
Compared to other debt-ridden European countries, another unique phenomenon in Iceland following the collapse was debt relief. People whose mortgage repayments spiked, either because of the fall of the króna or because loans were indexed, have been offered various measures to make their debt sustainable.
The fact that the Progressive Party was voted into power by making promises of further debt relief shows that some voters believed that not enough had been done. The expectations are still high, although research shows that households in arrears are now fewer than before. In addition, the debt problem seems to be much more contained than certain politicians and popular opinion indicate.
The fact that some currency basket loans have been ruled as illegal has also changed the financial status of many households. Normally, a loan agreement is utterly unchangeable. Now, with many loan agreements either being torn up or changed, there is anecdotal evidence that Icelanders might be learning that legal agreements need not be adhered to, and some fear this might not be a good lesson for the future in a country that has had chronically high household debt.
Did the crash change anything more fundamental in Iceland than many people (mainly women) taking up knitting? Time will tell, but there are doubts. Some bankers whisper that they still dream of 2007 happening again and salaries in the banking sector are rising. The return of 2007 might be good for a few bankers and some chosen clients but, as tried and tested, it would be decidedly bad for the Icelandic economy.
The battle for the soul of Icelanders
Iceland is certainly not the only country that finds it easier to blame foreigners for its misfortunes than their own countrymen. In Greece, Cyprus and Ireland there is wide-felt anger towards the troika, as if it had caused the deadly debt in these countries rather than their own countries’ actions or inactions.
The same is felt in Iceland. Until the SIC report clearly spelled out what had happened, many Icelanders felt that the British had caused the collapse of the banks. Now it is the foreign creditors of Glitnir and Kaupþing who get to bear the blame for the capital controls. And EU membership, seen as a salvation in an uncertain world just after the collapse, no longer has the majority support of Icelanders. Yet, a majority of voters would like to see the negotiations for membership concluded and the agreement sent to a referendum.
Compared to the other debt-ridden European countries, the Icelandic economy bounced back quickly and well. But Iceland does not “graduate” from the “kreppa” until the capital controls are abolished.
Five years ago, when resolving the big issues around the collapse, the attitude was “fuck the foreigners,” meaning that Iceland would, understandably, first and foremost pay attention to its own interests. At the time, the action taken enjoyed a certain understanding abroad since Iceland clearly was in dire straits in October 2008.
Again, Iceland needs to resolve a problem, the capital controls, where foreigners are one part of the equation. There now seems to be a tension within the coalition government as to how the foreign creditors should be treated. Some think it is still legitimate to say, “fuck the foreigners” while others fear the possible consequences. These diverging attitudes seem to hinder the first steps towards abolishing the capital controls, which will no doubt be done in steps over the course of several years.
The story of Argentina since its default in 2001 is the story of a country that seeks to write its own rules, ignoring the international community. Iceland did not default in 2008 and the collapsed banks are now private companies. But after changing Iceland’s currency laws this past spring, the minister of finance has to agree to measures regarding the estates of the banks, meaning the government is involved. This also exposes the government to the risk of being sued by foreign creditors.
Most countries have their Faust stories but the Icelandic Faust, Sæmundur the wise, is the only one to have defeated the devil. Maybe that partly explains the daredevil attitude Icelanders often take when resolving their national problems.