Reports now document that Iceland is out of its banker-induced economic crisis.

Because it defauled.

Iceland’s decision to let its banks fail in the financial crisis increasingly looks like the right call as its institutions and the economy make a strong recovery, writes Yalman Onaran.

ON his second day as the head of Iceland’s third-largest bank, Arni Tomasson faced a crisis. The firm he had been asked by regulators to run was out of cash.

It was October 8, 2008, at the height of the global financial meltdown, and Iceland’s bank assets in Britain had been frozen. Customers flocked to branches of Tomasson’s Glitnir Banki to withdraw money, even though the government had guaranteed their deposits. By the end of the day, the vaults were empty, Tomasson says, recalling the drama two years later.

The only way Glitnir and other lenders could avoid a panic the next morning was to get more cash, which they were having trouble doing.

A container of crisp kronur sat on the tarmac at Reykjavik Airport awaiting payment, Tomasson says. The British company that printed the bills, De La Rue, was demanding sterling, and the central bank couldn’t access its British account.

”Everybody was panicked – depositors, creditors, banks around the world,” Tomasson says. ”The effort by all of us at the time was to make sure life could go on as normal.”

Tomasson, 55, got the cash he needed that night after the central bank managed to open an emergency line of credit with a European lender. Now, he’s sitting in an office in Reykjavik, handling about $US24 billion of claims by creditors as life in Iceland’s capital returns to normal.

Unlike other nations, including the US and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country’s banks, whose assets had ballooned to $US209 billion, 11 times its gross domestic product.

The crisis almost sank the country. The krona lost 58 per cent of its value by the end of November 2008, inflation rose to 19 per cent in January 2009 and GDP contracted by 7 per cent that year. The prime minister, Geir Haarde, resigned after nationwide protests.

With the economy projected to grow 3 per cent this year, Iceland’s decision to let the banks fail is looking smart – and may prove to be a model for others.

”Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks,” says the Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York.

”Ireland’s done all the wrong things, on the other hand. That’s probably the worst model.”

Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital – €37 billion ($US50 billion) so far – to prop them up.

That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.

Ireland’s banks had more than 10 times the assets of Iceland’s lenders, making their collapse more dangerous for the European financial system. Ireland also couldn’t devalue its currency because it is part of the euro zone. Still, countries with larger banking systems can follow Iceland’s example, Adriaan van der Knaap, a managing director at UBS, says.

”It wouldn’t upset the financial system,” Van der Knaap, who has advised Iceland’s bank resolution committees, says. ”Even Irish banks aren’t too big to fail.”

Under an emergency act of Iceland’s Parliament on October 6, 2008, the assets and liabilities of the three biggest banks – Kaupthing Bank, Landsbanki Islands and Glitnir – were divided based on whether they originated at home or abroad.

The act created three new banks that were given the deposits and loans made to Icelandic companies and consumers. Resolution committees were set up to manage and liquidate what the old banks were left with: the overseas borrowing and lending that fuelled a sevenfold increase in assets from 2000 to 2008.

Arni Pall Arnason, 44, Iceland’s minister of economic affairs, says the decision to make debt holders share the pain saved the country’s future. ”If we’d guaranteed all the banks’ liabilities, we’d be in the same situation as Ireland,” says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.

By guaranteeing bank liabilities, Ireland faces a public debt burden as high as 12 times the country’s GDP. Iceland’s is about 85 per cent.

”Our future isn’t as bleak because our public debt isn’t as high,” says Hoskuldur Olafsson, the chief executive of Arion Banki hf, the new bank formed to take over Kaupthing’s domestic assets.

Today, Iceland is recovering. The three new banks had a combined profit of $US309 million in the first nine months of this year. GDP grew for the first time in two years in the third quarter, by 1.2 per cent. Inflation is down to 1.8 per cent and the cost of insuring government debt has fallen to 80 per cent. Stores in Reykjavik were filled with Christmas shoppers in early December, and bank branches were crowded with customers.

Categories: Miscellaneous Musings
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