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How banking scams will blow up in 2012

Iceland is the model.  Once the stockmarket or property markets collapse, this will happen around the world.  Beware financial institutions bearing high interest rates.  Buy GOVT BONDS ONLY.

From Martin Wolf at FT.com:

Iceland is famous for its sagas. But the latest one is truly dramatic: the balance sheets of its privatised financial sector grew from twice to 10 times gross domestic product, in five years. In the absence of a lender of last resort, this story had to end badly. In the panic of 2008, it did.

Because Iceland was a member of the European Economic Area, its banks were allowed to set up branches freely. To raise money, Landsbanki, one of Iceland’s now collapsed banks, set up an internet bank, Icesave, which gulled depositors by offering attractive interest rates. Under the European Union directive, Iceland also had an obligation to establish a deposit insurance scheme, which it did, through a levy on those banks.

Then came the collapse. Some Icelanders blame Gordon Brown, Britain’s prime minister, for pulling the plug on their banks. That is unreasonable. Competent observers had long concluded that the financial system was a house of cards. It was sure to collapse in a panic. Less unreasonable is the complaint over the UK’s use of a section of its anti-terrorism laws to freeze assets. But some such action was justified.

Since the banks had turned Iceland into a hedge fund, with massive short-term foreign currency liabilities used to finance risky long-term assets, the economy was doomed. According to the September 2009 economic survey by the Organisation for Economic Co-operation and Development, between 2007 and 2010 the fall in real consumption will be close to a quarter and that of domestic final demand almost 30 per cent. This is a depression. The burden of debt and loss of purchasing power are worsened by the collapse of the krona, which has lost more than half its value against the euro since July 2007.

So far, so bad. But, for ordinary Icelanders, it gets even worse. The British and Dutch governments take the view that the taxpayers of Iceland have a duty to refund the amount promised by Iceland’s collapsed deposit insurance fund. The total claimed by the UK is £2.35bn and by both countries together €3.9bn. The latter is now some 50 per cent of Iceland’s shrunken GDP. In the UK context, this would be equivalent to a demand for £700bn. It is not hard to imagine how far Mr Brown would get with a suggestion that the UK should accept such a debt to refund depositors in foreign branches of bankrupt UK banks.

This, then, is the background to the decision by Olafur Ragnar Grimsson, Iceland’s president, to put the latest version of an agreement negotiated under duress to a referendum. Lord Myners, the UK’s City minister, has stated that if the Icelandic people were to reject the deal, they would “effectively be saying that Iceland does not want to be part of the international financial system”. After their recent painful experiences, Icelanders may wonder why that is so worthwhile. But without agreement to repay, a $10bn rescue plan funded by the International Monetary Fund and Nordic countries is now in doubt.

So do the ordinary Icelandic taxpayers have a legal obligation to meet the liabilities of their collapsed deposit insurance fund? The answer to that is, to say the very least, that it seems to be very far from evident. Moreover, any British or Dutch depositors who thought their money was safe because the government of Iceland guaranteed it were mad.

Do Iceland’s taxpayers have a moral obligation to pay this loan? My view is: no. The delusion that finance was the path to riches was propounded by countries that should have known far better. I cannot blame Icelanders for succumbing. I certainly do not want generations of Icelanders to bear the cost.

The final and, in truth, most important question is whether these demands are reasonable. After all, in every civilised country it has long been accepted that there is a limit to the pursuit of any debts. That is why we have introduced limited liability and abolished debtors’ prisons. Asking a people to transfer as much as 50 per cent of GDP, plus interest, via a sustained current account surplus is extraordinarily onerous.

Against this, the UK government argues that it is offering a lengthy grace period and an interest rate that is close to the cost of funding for the UK Treasury. It also argues that as much as 90 per cent of the repayment it seeks could come from liquidation of Landsbanki’s assets.

Yet the obvious answer to the latter point is this: if the assets of the bank are that valuable, why not write off the debt, in return for the claims on these assets? That would be a generous gesture. It is, more importantly, one that would do much to improve the morale of a battered and vulnerable little country. Threatening such a country with destruction, as Lord Myners has done, is simply shameful. The UK and the Netherlands should stop this self-righteous bullying at once.

Yet they – and everybody else – must learn the really big lesson here. The combination of cross-border banking with generous guarantees to creditors is unsustainable. Taxpayers cannot be expected to write open-ended insurance on the foreign activities of their banks. It is bad enough to have to do so at home.

Why innocent taxpayers should be held hostage to the reckless decisions of bankers is beyond me.  Nevertheless we are all an eye-blink away from disaster.  What to do?  What should an Icelander have done? 

They should have built up savings in gold, gotten out of debt, paid off their mortgages, gotten a safe govt job that would be protected in a recession or been a farmer without debt, secreted some assets overseas – or left the country before this blew up. 

Or they could leave right now.

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