We are 8 years after the fall of Lehman Brothers. The all West is in crisis … All? No! A small island of irreducible Icelanders still resists to the finance. And life is not easy for banks and other bankers.
I think that we all eared about Iceland letting its banks fail and putting bankers in prison. Every time you read an article about Iceland recovery after the 2007 crisis it is polarized. The reason is that Iceland dealt with this crisis in an unconventional way which, depending on the arguments you keep, is in favour or against the EU policies, that is to say austerity. Some people will tell you that Iceland is the paradise on Earth, the land of justice when other will explain that the success of the country is all about luck, austerity and help from other countries. As you can imagine the reality is just between these two points of view. That is why we will divide what permitted Iceland to become one of the countries recovering the fastest and the better after the crisis in two parts: the external factors and the internal factors. And this in order to determine what is due to the action of the government and what is not.
The crisis was a wave coming from the United-States but the sensibility of each country to this wave was linked to its own financial system. In Iceland the financial sector was deregulated in the 90’s with low-tax policy, the goal was to attract foreign investments and companies. The banks of the country – especially the tree biggest Landsbanki, Glitnir, and Kaupthing – began raising their interest rates on the loans encouraging people to borrow and making the island an international financial centre. Traders and individuals from all over the world borrowed in foreign currencies to the banks, especially in the United-Kingdom and Netherlands. In 2007 banks’ debts were worth 900% of Iceland GDP. “Iceland, in the decade and a half leading up to the crisis, was an example of collective madness”, said Willem Buiter, chief economist at Citigroup. When the crisis hit the island the consequences were disastrous. “Over 80 percent of the financial system buckled and almost all businesses on the island were bankrupted. The stock market fell by around 95 percent and interest payments on loans soared to over 300 percent. Over 60 percent of bank assets were written off within a few months after the banks collapsed and interest rates were hiked up to 18 percent in order to curb inflation rates”, according to World Finance. But Iceland managed to recover from the crisis.
Firstly the two external factors we will speak about are linked to the geographical position of the island. The Eyjafjöll volcano that paralyzed the air traffic in 2010 contributed to attract tourism by leading people to know about this particular country located on an oceanic breach. In 2010 the country welcomed 486,000 tourists for only 320,000 inhabitants. Tourism represents now almost one third of the exportations. Another external factor is an increase of mackerel in the Icelandic seas. This is linked to global warming, the Atlantic Ocean is becoming hotter and the mackerel migrated to the North. “Fishing is more important for Iceland than the car industry for Germany or the oil industry for Norway,” according to Sigurgeir Thorgeirsson, Iceland’s chief fisheries negotiator. It represents 23% of the exportations.
The other external factors are the drop of the krona and the loans from the IMF and the neighbouring countries. The IMF accorded a $2.1bn loan to Iceland in November 2008 – which is 50 times less than the one to Greece in 2010 – and the neighbouring countries $2.5. These loans helped the country to protect domestic deposits and reduce the devaluation of the krona in value. But at the same time this devaluation was helpful for the country because it regained competitiveness. Inside the country there was no difference for the people, they kept the same purchasing power but at an international level their work and production was worth less.
Now that we have seen the external factors on which Iceland did not have the control we will focus on the internal factors, e.g. the decision making of the government. One of the first and most original action was to decide not to save the banks. Because the banks were “to big to save” Iceland decided to let the banks fail. In fact the banks were not “to big to save” in a sense that you can save the banks even if they were worth 10 times your GDP, but then you have a gigantic debt, like Ireland. The Icelandic government just chose not to impose this burden to future generations. And it is understandable. Why does a State would have to pay for the bad behaviour of private banks? So Iceland let its banks fail but at the same time guaranteed the deposits of its citizens, the ones that lost money were the foreign creditors (in majority in the United-Kingdom and the Netherland). These two countries in response asked Iceland to give back the money, the IMF and the European Commission sided with them. In the end the European Free-Trade Association decided that Iceland did not have to pay for the actions of its banks. “The ruling made it clear that the country where a banking company has its headquarters is not responsible for guaranteeing that company’s foreign liabilities” says Eva Joly, who advised Iceland Special Prosecutor in the criminal investigation after the crisis.
Then the bank CEOs, finance managers, banks’ lawyers, major shareholders and high-ranking civil servants responsible were condemned or at least put under investigation. The central bank of Iceland took the control of the banks to reform the financial sector. “After the crash, the government cleaned house in all the three banks, establishing new boards and management. Banks in Iceland are well capitalised with high equity levels and financial supervision has been strengthened immensely”, said Gudrun Johnsen, Assistant Professor of Finance at the University of Iceland, told World Finance.
However Iceland also applied austerity and budget cutting, and it is a key of its recovery. But austerity alone increases inequalities, the reason why Iceland was able to show good economical and social results at the same time is because it kept a strong welfare state. The role of these spending in social protection is to be an automatic stabiliser, as Joseph Stiglitz calls it, which permitted to sustain household demand. Benefits were redirected to lower income groups, according to Stefán Ólafsson from the University of Iceland.
As you can see on the following charts created from Eurostat’s database Iceland is performing very well. The country has the lowest unemployment and inequality rate compared to Germany, Greece, France, Italy, Sweden and the United-Kingdom.
The question raised is: do another country applying the same methods than Iceland would have been able to reach the same results? And the answer is obviously: no. For several reasons the case of Iceland is unique: it is a country with a small population living for the most part in a city, tourism due to the volcano and the rise of fishing is specific to the island and the country is not in the European Union. However the political courage of refusing to bail out the banks, searching for the culprits, judging them and regulating the banks must be an example for other countries.
– Théo Quint
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