The Skeleton Economy

The Icelandic economy has crashed. The government has nationalized all three of the major banks in Iceland and most Icelandic financial institutions overseas are bankrupt. The global credit crisis that has left banks in Europe and the US bankrupt has hit Iceland like a natural disaster. During a two-week period our economy was wiped out and left in ruins

Sunday September 21, the CEO of Glitnir Bank, Lárus Welding was a guest on the political talk show Silfur Egils, where he was asked to elaborate on the international financial crisis that was hitting financial institutions hard on both sides of the Atlantic, and how it would affect the Icelandic banking industry, his own bank included. “We can see now that the flexibility in our structure and the way we have prepared ourselves has landed us a very secure position,” he boasted. Today, it seems obvious that he was lying, or at best being delusional, but at least he looked good while doing it.

A week later, on Monday, September 29, the Icelandic government announced its decision to nationalise Glitnir in the face of the bank’s imminent bankruptcy. Sto›ir, the largest shareholder of Glitnir and one of Iceland’s biggest investment companies, declared insolvency, and the exchange rate of the Icelandic Króna continued to plummet.

People were concerned when markets closed on Friday October 3. News that trickled out during the weekend suggested that the crisis was getting worse, although Prime Minister, Geir H. Haarde stated that he believed there was no cause for further intervention from the Icelandic government at the time. It was difficult to decipher the situation when markets opened on Monday morning. Despite Prime Minister Haarde’s optimism, shares of all major Icelandic banks were not being traded in the Iceland Stock Exchange.

That afternoon, Prime Minister Geir H. Haarde, addressed the nation and cryptically stated that the Icelandic banks were all on the verge of bankruptcy and emergency legislation would be pushed through the parliament, allowing the government to take full control of their operations. The following days gave us news of a total governmental seizure of Landsbanki and Glitnir Bank and that Kaupthing was granted a loan of 500 million Euros to continue its operations, and at the time of print, it looks like it may fall into the hands of the government, too. In a matter of two weeks, the Icelandic financial system went from A-OK to total ruins.

What the Hell Happened?
Only a week passed from the seizure of Glitnir Bank until an emergency legislation was passed in Parliament, allowing the state to overtake all the. This was perhaps the most dramatic week in the history of Icelandic economy. But this eventful period had a long prologue and it will certainly leave us with a bitter aftermath. Although the meltdown was caused by a complex interplay of various economic factors, both at home and abroad, the deciding factors can be traced to a relatively simple cause.

It may have started with the privatization of the state-owned Icelandic banks and the deregulation of the banking industry that began around 2000 and the simultaneous financial influx from foreign investment in the energy and aluminum sectors. Competing with the state-run Housing Financing Fund, the newly privatized banks offered real estate mortgages to individuals at lower interest rates and financed a higher percentage the real estate prices than the Housing Financing Fund offered. This created real estate boom, and caused a rapid increase in the value of the banks. The 40-year real estate mortgages provided by the banks were financed mostly with short-term loans from international banks and financial institutions, leaving the banks dependent on frequent re-financing to keep the ball rolling. During the economic boom of the last few years, this was an easy cycle to maintain.

Encouraged by their rapid growth of the banks, Icelandic investment bankers and companies soon started to expand to other countries, acquiring banks, retail companies, airlines, fashion stores, and professional football teams – more or less (mostly more) financed by short-term loans. New acquisition were used as collateral for further loans to bankroll further acquisition. Before the crisis, the Icelandic banks had accumulated foreign assets worth about 10 times the Icelandic gross domestic product (GDP), 80% of which was financed by foreign loans. When the credit crunch hit, following the sub-prime mortgage collapse in the US, and the cash flow to Icelandic banks dried up, investment companies found it increasingly more difficult to re-finance. Due to the disproportionate size of the banking industry, their collapse would have spelled bankruptcy for the whole country as the government was no longer able to guarantee their operation. Faced with that prospect, Icelandic authorities had little choice but to force the banks into receivership.

Who’s to Blame?
The collapse of the Icelandic economy is a highly complicated issue that involves many technical economical terms, only a part of which are even intelligible to John Q. Public. The collapse will have far-reaching effects for the foreseeable future. Although everyone involved, from bankers to government officials, have tirelessly repeated the mantra that now is not the time to assign blame, and there will be plenty of time to review the situation and find culprits sometime in the future, someone must be held responsible.

Economists in Iceland have gainfully pointed to technical errors made by the Icelandic Central Bank in dealing with inflation and the currency exchange rate of the Icelandic Króna, which may have encouraged Icelandic bankers to seek short term loans in foreign currency to re-loan in Iceland where the interest rates have been much higher than in most of the civilized world, and for failing to maintain the foreign currency reserve at a point that would suggest that the Central Bank could step in to assist the banks in a time of need.

The government should receive it’s share for deregulating the financial sector to the point that they had little or no say in any matters regarding the financial market, and for failing to keep taps on inflation, expansion and maintaining a proper supervision authority on the economy. It has also been a political decision to stash away old and defunct politicians as Governors of the Central Bank, a highly suspectible decision, given thte Central Bank’s role in Icelandic economic policy.

The Icelandic people obviously deserve a share of the blame. Their blatant consumerism was fueled by the easy access to cold, hard cash and the misconception that the party would last forever. Well, it was fun while it lasted, but now we will need to clean up and get our house in order.

And last, but not least, there are the adventurous investment bankers who were even more delusional than the general public when they joined the party. Greed seems to have been their guiding principle and eventually, they bit off more than they could chew.

What will Happen Next?
Despite watching our economy collapse in two weeks, the worst may be yet to come. A wave of bankruptcies is on the horizon, likely followed by unemployment, recession and general hardship.

It is a damn shame, really. We all thought we could work in big money-making factories and throw stress-balls around and make silly jokes about David Duchovny’s sex addiction, but now it seems that the Icelandic voyage, as President Ólafur Ragnar Grímsson, called the foreign acquisitions adventure, has stranded.