The Crisis In Greece Seen Through Icelandic Eyes

In October 2008, Iceland was hit by a ton of bricks in the form of three collapsing banks. The International Monetary Fund (IMF) agreed to help Iceland out with a loan of $2.1bn, then approximately 20% of the country’s GDP. Greece, too, was hurting at that time, though it was not until March 2010 that it had to seek assistance and the IMF—in addition to European institutions and EU member states—came to its rescue with a loan of €110bn. But this did not solve the debt problem and it received another loan package in March 2012, this one worth €164.5bn. Now, as Greece’s public debt reaches 180% of its GDP, a third rescue package worth approximately €90bn is being negotiated.

It just so happens that the same man, a Dane named Poul Thompsen, was the International Monetary Fund’s head of mission in both Iceland and Greece. His task was to coach the two countries through a country-specific financial assistance programme, to ensure that their loan would be used to restore the economy. However, the outcome of the assistance in the two countries could hardly have been more different.

The Icelandic programme, which ended in summer 2011, has been deemed a total success, much to Thomsen’s credit. Meanwhile, Greece has staggered from crisis to crisis and Thomsen has been much maligned for the unsuccessful attempts to revive the nation’s economy. The differing outcomes clearly have a lot less to do with the stoic Dane than they do with the circumstances in Iceland and Greece. Unlike in Iceland, the political class in Greece is unwilling to acknowledge past failures. Instead, there is stubborn refusal to embrace changes to the nation’s “clientelismo” economy, wherein public funds have for decades been used to buy political favours and support special interests.

To stabilise the Greek economy, creditors will either need to accept a writedown of a substantial part of the nation’s debt or agree to a debt holiday for up to 40 years, during which time Greece would not pay off its debt. Yet, doing so is tricky, as it absolves clientelismo politicians of all their mistakes.

The fallacy of “happy times are here to stay”

Iceland was literally flush with success in the years following the privatisation of its banks in 2003. For a period of five years, Icelanders seemed able to both walk on water and fly. This boom was fundamentally different from past booms: It did not stem from something as fickle as fish stocks, but from a financial sector where all curves pointed firmly skywards. The nation’s politicians blissfully neglected lessons from the world’s economic history, where bust follows boom as night follows day.

Icelanders’ savings were clearly not enough to fund a financial system growing from one GDP in 2002 to nine times the GDP by 2008. International credit was cheap and easy to acquire, and everything was going swimmingly. With international investors seeking to profit from Iceland’s high-interest environment, the króna became particularly strong. This eventually became a millstone on the Icelandic economy, as the króna depreciated through 2008, culminating in a banking collapse in October.

Despite an unfortunate expansionary policy of lower tax and public investments during the boom years, there was a budget surplus and public debt was only around 30% of GDP when the crisis hit.

Greece, too, was doing well in the years after joining the Eurozone in 2001. As in Iceland, the expansion was driven by a strong domestic demand in an environment of unprecedentedly low interest rates. However, in Greece, the government used the boom years to instigate more deficit and debt, which stemmed from an unsustainable pension system.

In fact, Greece had been suffering from a chronically high level of debt and deficit since the mid 1990s. Miraculously, these numbers dived down to the Maastricht criteria (public debt below 60% and budget deficit of no more than 3%) in time for adopting the Euro. Upon closer scrutiny, this upheaval was no miracle, but simply a case of falsified statistics.

Foreseeable, not just in hindsight

Differences aside, the Greek crisis is still worth considering from an Icelandic perspective. In Iceland, an over-extended banking system caused the collapse, even though public finances had been sound. In Greece, however, unsound public finances eventually crippled the nation’s banking system.

The IMF did not foresee the Icelandic collapse. Yet, an IMF statement on Iceland in June 2007 brought both praise—“the medium-term prospects for the
Icelandic economy remain enviable”—and stark warnings: fast-growing banks might undermine stability. Consequently, the government should prepare for imminent risks stemming from maintaining such a large financial sector.

Greece got a much stronger warning in an IMF report in December of 2007. After the sweet reminder that the Greek economy had grown fast for several years there came serious warnings, that had by then been repeated for a few years: competitiveness was steadily eroding and the labour market rigid; public debt was high and rising because of an unsustainable pension system. As in earlier years, the government recognised the weaknesses and claimed to be working on improvement, according to the IMF report, and yet little had been done so far.

Interestingly, the 2007 IMF message to Greece was: do not be complacent during the good times, instead use them to accomplish necessary reforms and avoid later pain. As the IMF foresaw already in 2007, the consequences of inaction have been severe.

Ignored warnings

Iceland’s government did not pay particular attention to the words of warning in 2007. All through 2008, the Icelandic Central Bank (CBI) was trying to convince other central banks to make currency swaps with Iceland, which was growing dangerously short on foreign currency. Time and again, central bankers in the other Nordic countries, in Great Britain and the United States, warned the CBI in no uncertain terms that its gigantic banking sector could be problematic. The CBI resolutely ignored the warnings.

Meanwhile, the same situation was unfolding in Greece. The IMF and others kept warning the Greek government, which—like Iceland’s—resolutely ignored their advice. Iceland effectively lost market access in the summer of 2008 as no one wanted to lend money to Iceland. Not until late October, some weeks after the banking collapse, did the Icelandic government turn to the IMF for a loan.

Greece lost market access in March of 2010. On May 2, 2010, the Greek government signed a Memorandum of Understanding (MoU), receiving a bailout packet from the IMF, the European Central Bank (ECB) and the Eurozone countries, worth €110bn, to be paid out over three years. In return, Greece agreed to follow the IMF’s adjustment programme. In 2012, the programme was adjusted along with a new loan package of €164.5bn.

Iceland: from crisis to a steady recovery

During the first weeks and months of disbelief and shock following the banking collapse of October 2008, Iceland’s parliament, Alþingi, took action in several matters that have later proved to be steps in the right direction. Alþingi established an independent Special Investigation Committee (SIC) to look into the causes of the banking collapse, which published its report in April 2010.

Also, the Office of a Special Prosecutor was established to investigate and eventually prosecute alleged crimes connected to the overgrown banks’ operations. Strictly speaking these were not measures to improve the economy but it can be argued that this aided the economy by freeing political energy from the blame game; instead it could concentrate on more constructive work to rebuild the economy.

Later on, the Social Democrat-led coalition with the Left Green party, in power from early 2009 until spring 2013, instigated measures to write down mortgages. This helped alleviate nonperforming loans in the banks and set things in motion again. Another helpful measure was a change in bankruptcy law, which shortened the time limitation of bankruptcy to two years from the earlier four, ten or twenty years, depending on the kind of claim.

By mid summer 2011, Iceland had entered a steady growth phase. Yet, the mood in Iceland changed slowly, and it took the country some years to get out of crisis mode. Icelandic households have always been good at spending on credit, but since 2009 households have actually been paying down their debt.

Greece: from ignored warnings to ignored measures

Greece has followed a more unfortunate path. Changes that the IMF had been advising for years before Greece lost market access in March of 2010 were part of the prescriptions in the bailout programme. However, the Greek authorities did not embrace the changes suggested by their lenders, nor did the Greek governments find other means to reach the goals of a sounder economy.

Greek politicians behaved much like Icelandic politicians did in 2008: they made empty promises in order to secure much-needed assistance. Understandably, lenders today worry that Greek politicians will behave as they have in the past: promising all they could and then delivering on only a fraction of the promises.

Greece also has a history of cheating on statistics and giving erroneous information on certain financial transactions—swaps—made with the US investment bank Goldman Sachs in 2001, in order to hide loans and make it look as if the state finances fit the Eurozone. These deceptions surfaced in early 2010, just before the bailout.

Since a new president, Andreas Georgiou, took over at the Hellenic Statistical Authority, ELSTAT, in August of 2010, the statistics have been in accordance with international standards. However, Greek politicians have continuously threatened Georgiou and two ELSTAT managers with charges of treason—for correcting upwards the deficit number for earlier years. Being sentenced for treason could have resulted in a prison sentence for life. These charges have been dropped but Georgiou still faces minor charges. Yet, those guilty of wilfully reporting false statistics have never been touched.

Embracing change, or resisting it

After some initial resistance to seeking help from the IMF, politicians in Iceland have came to value the expertise that the IMF had to offer in dealing with the crisis. Iceland’s governments, first on the right and then on the left, cooperated with the IMF. As planned, the programme ended in summer 2011.

Meanwhile, politicians in Greece have fought and resisted changes, accepting IMF prescribed programmes to access funds but failing to fulfil them. Two committees set up by the Greek parliament are less occupied with investigating the causes of the Greek collapse than proving that the crisis was caused by foreigners and their Greek emissaries, and that Greece’s public debt should therefore not be repaid.

All of this, in addition to the falsified statistics, has caused huge irritation and eventually a breakdown of trust among lenders to Greece. It was no coincidence that there was great emphasis on the need for renewed “trust” in the July 12 Euro Summit statement, which formed the basis for a new programme.

Write-down and securing change for good

Much of the debate about Greece will seem familiar to any Icelander. There are foreign pundits who feel tremendously sorry for the Greeks, and want their debt written down for humanitarian reasons. This, however, seems based on the assumption that things were done to Greece—that the nation’s governments were somehow blameless—which is a misconception. As mentioned earlier, there was no lack of warning signs, which Greek governments chose to ignore for more than a decade.

Mistakes have certainly been made by creditors, from Greece’s first bailout in 2010 and onwards. As the IMF has already admitted, demands for cuts in public spending were too great, causing a needlessly harsh contraction in the economy. A write-down of approximately 50% of Greek debt in 2012 helped, but only briefly, partly because the Greek government again did not do what was advised, nor did it come up with solutions of its own.

Still, it’s evident that Greece needs some form of a write-down of its public debt or an extension of its loans. The German government, as well as the Finns and many other stakeholders, oppose this, but there are some indications that it will eventually happen.

Until some compromise is reached, Greece is stuck. But then again, not much will happen if Greek politicians continue to dig in their heels to protect the status quo, which caters to special interests. Greece is yet to come up with sustainable solutions, and the lenders have failed to come up with the right incentives to push the nation into the right direction.

However, absolving Greece of all its debt, as if nothing had happened, will only bolster the political forces that caused this mess in the first place—and in the long run, this will not help Greece. This is not about crime and punishment, but about a country that needs to learn good governance and sensible lessons from a crisis long in the making.