Iceland: The broken economy that got
out of jail
The small nation went bust spectacularly. But its recovery has been remarkable, too
– and holds lessons for other countries. Ben Chu reports
Ben Chu
Tuesday, 6 September 2011
Iceland was a pioneer in recklessness during the credit boom. And now the small nation in
the north Atlantic is a pioneer in political accountability during the credit bust. Geir Haarde,
the Icelandic prime minister between 2006 and 2009, appeared in a special constitutional
court in Reykjavik yesterday on charges of "failures of ministerial responsibility" during the
2008 financial meltdown. But there is an irony here. For the economy that Mr Haarde helped
to wreck has fared surprisingly well since the bust.
Iceland experienced one of the most severe recessions in the world when the markets
crashed in 2008. Economic output fell by about 12 per cent over two years. But the latest
report on Iceland by the International Monetary Fund shows that growth is resuming. GDP is
expected to increase by a relatively healthy 2.5 per cent in 2011. The Icelandic public
finances are on a sustainable path too with government debt projected to fall to 80 per cent
of GDP in 2016.
The turnaround should not be exaggerated. Iceland is still more than 10 per cent below precrisis output levels. Unemployment remains at about 6.7 per cent, considerably higher than
before 2007. The standard of living of most Icelanders is well down. Access to foreign
currency is tightly controlled. And risks to recovery remain. Central bank interest rates are
going up in order to curb inflation. This could stifle growth. Yet the fact remains that the
outlook for the Icelandic economy is looking rather healthier than other distressed
economies in Europe such as Greece, Portugal and Ireland.
So how did Iceland manage it? There were four pillars to Icelandic policy in the aftermath of
the bust: external assistance, debt repudiation, currency depreciation and capital controls.
The assistance was considerable. Reykjavik called in the IMF in November 2008. So far
Iceland has received €1.56 billion (£1.38bn) in assistance from the fund (in the context of a
GDP of €8.4bn). It has had help from friendly governments, too. Iceland received $3bn
(£2bn) from Nordic nations to bolster the foreign exchange reserves of its central bank.
Iceland's debt repudiation was considerable too. The three largest banks – Landsbanki,
Kaupthing and Glitnir – collapsed in autumn 2008. Rather than nationalising them, the
government allowed the banks to go into administration. Foreign bondholders lost some of
their money and saw the rest of their loans converted to equity. A hard line was also taken
with other creditors. Icesave, an online subsidiary of Landsbanki, took deposits from some
400,000 people in the UK and the Netherlands. When it went bust, these depositors were
rescued by the Dutch government as well as our own. Iceland refused to guarantee
reimbursement. That saga might, however, have a relatively happy ending. Last week the
administrators of Landsbanki said that the estate of the banks should yield more than
enough to pay the UK and Dutch governments what they are owed.
Depreciation has helped too. The value of the krona fell by 50 per cent against the euro
from peak to trough. This has delivered a boost to Iceland's two main exports, aluminium
and fish. Finally, capital controls were imposed to prevent investors withdrawing funds from
the country in a panic. The overseas owners of high-yielding "glacier bonds" were prevented
from selling them. This helped to prevent a total collapse of the currency. All this has helped
Iceland to absorb the pain of a fiscal consolidation, under IMF supervision, of 10 per cent of
GDP over the past two years.
Reykjavik was warned that it would never borrow again if it failed to honour the debts of its
financial sector. But the country already seems to have been forgiven by the markets. The
Icelandic government issued $1bn in sovereign debt in June at an interest rate of around 6
per cent. This was twice oversubscribed by investors. The contrast with Ireland, which
assumed responsibility for all the liabilities of its bust banking sector, is stark. Thanks to
Dublin's blanket bailout, total government debt is now more than 100 per cent of GDP, four
times pre-crisis levels. And Ireland's reward from the markets has been a rise in the cost of
insuring its sovereign bonds. Iceland's currency depreciation also looks good by
international comparisons. Latvia doggedly kept its peg with euro after the 2008 crash and
has experienced a catastrophic 25 per cent decline in GDP and seen unemployment reach
22 per cent.
The economic policy orthodoxy through this crisis – pushed by ratings agencies and
European politicians alike – has demanded that national governments honour the debts of
their banking sectors, protect their exchange rates, eschew capital movement restrictions,
and impose massive austerity to earn back the confidence of bond markets. Much of that
wisdom was ignored by Reykjavik. And the early signs are that Iceland is doing quite well as
a result.
Haarde on their heels
Geir Haarde heads a cast of hundreds who could face prosecution for their part in Iceland's
financial implosion.
Iceland's special prosecutor, Olaf Hauksson, has named more than 200 suspects in his
criminal investigation into the country's financial crisis.
So far, those convicted in connection with the country's big banks – Landsbanki, Kaupthing
and Glitnir – include former Kaupthing brokers who got six months in jail for manipulating
bond deals and Baldur Gudlaugsson, a former permanent secretary at the finance ministry,
who received two years for insider trading of Landsbanki shares. Haukur Thor Haraldsson, a
former managing director with Landsbanki, was sentenced to two years in July for
embezzlement.
With the full criminal investigation set to run until 2014, there may well be bigger fish to
fry. Hreidar Mar Sigurdsson, the former boss of Kaupthing, and Landsbanki's ex-chief
executive, Sigurjon Arnason, were both arrested in the last two years.
Mr Hauksson has also linked up with Britain's Serious Fraud Office. In March they swooped
on properties in London and Reykjavik, in connection with the collapse of Kaupthing. The
British tycoons Robert and Vincent Tchenguiz were arrested but were released the same
day; they have not been charged and have denied wrongdoing.
Later in March the SFO, Luxembourg authorities and Mr Hauksson's team raided premises
including Banque Havilland, owned by David Rowland, the former Conservative Party
treasurer. Mr Rowland's son Jonathan said the investigation covered events before Mr
Rowland bought the bank.
The former chief executive of Kaupthing Luxembourg, Magnus Gudmundsson, was also cochief of Banque Havilland until he was arrested as part of the investigation in May last year.
Sean Farrell