In Flailing Iceland, Disbelief and Regret
By ERIC PFANNER
REYKJAVIK, Iceland — People go bankrupt all the time.
Companies do, too. But countries?
The global financial crisis has laid waste to some major banks and other financial institutions in the United States and
Europe, but Iceland may be the first country to face the prospect of going bust along with them.
After a decade-long binge in which Iceland’s banks, and some of its citizens, expanded beyond their means, the bill has come due. While the full effects of the potential crash have not hit yet, some Icelanders like Bubbi Morthens are already feeling the pain.
“There is a lot of fear in society and there are people who are losing everything,” Mr. Morthens said Wednesday after
singing at an impromptu midday concert in central Reykjavik intended to lift people’s spirits.
Mr. Morthens is a former fish industry worker turned rock singer who is now known as the Elvis of Iceland. Like many of his compatriots, he did well when Iceland was riding high, accumulating considerable wealth.
Then, the financial crisis gripping his country intensified last month. The government seized control of Iceland’s third-
largest bank. Mr. Morthens said he lost his life savings, which he had invested mostly in the bank’s stock.
“What is important at a time like this is not picking out whom to blame,” he said. “We have a government that is trying to do their best, but we will have to see what they come up with. Maybe it is a new dawn for Iceland.”
The government’s attempts to get ahead of the problems cascading through its financial system have not restored confidence. In just 24 hours, for instance, it abandoned an effort to peg its currency to a basket of others.
In a country raked by icy North Atlantic winds and dotted with volcanoes and geysers, where people live with the threat of earthquakes and maritime disasters, few seem to be losing their cool over the financial crisis — yet.
Still, with the country facing the imminent threat of “national bankruptcy,” as Prime Minister Geir H. Haarde put it earlier this week, many people are talking about an epochal change.
The only problem is that nobody knows what that might mean.
Nations have gone bankrupt before, of course, but countries like Argentina — not a country that thinks of itself as closer to Europe than the developing world.
What it means for Iceland so far, people here say, is that the days when the economy seemed capable of gravity-defying feats are gone. So are the days when Icelandic investors went on an international buying spree, adding some of the biggest names of the British and American retail industries to their portfolios.
So too, they conclude, are the days when ordinary citizens effortlessly joined in the fun, taking out second mortgages to finance their own trips abroad or at least to the Laugavegur, the main shopping strip in Reykjavik.
“It’s difficult; the landscape is very difficult,” said Franch Michelsen, a watch dealer in downtown Reykjavik, as he took a break from cleaning his shop window on Wednesday.
People are still buying watches costing up to 100,000
Icelandic kronur, or about $900, he said. Above that price, there is a flight to quality similar to the one that has
galvanized the financial markets. Buyers are apparently
interested only in the biggest name, the most liquid investment, Mr. Michelsen said — in this case, Rolexes.
“People want something they can take anywhere in the world and sell it,” he said.
This capital city of 120,000 still displays the fruits of the decade-long economic boom that followed the deregulation of Iceland’s financial sector in the 1990s — hip cafes, lobster restaurants and stylish shops selling outdoor gear.
After the government nationalized Mr. Morthens’s bank, Glitnir, in September, some people rushed to grocery stores, worried about possible shortages on a remote island where fish is one of the few foods that does not need to be imported.
But the shelves are still stocked, and any such hoarding this time around seems to have eased.
Instead, the financial situation is playing out in a parallel universe inside the offices of Glitnir and the other two big banks, Landsbanki and Kaupthing.
The government had originally planned to take a 75 percent stake in Glitnir, but said Wednesday that the bank was in even worse shape than it had thought and would be handed over to financial regulators. Landsbanki, the nation’s second- largest bank, was nationalized on Tuesday.
But not just bankers are getting hurt. Some Icelanders with recently acquired mortgages face a double threat. Home prices have been falling, and analysts expect them to decline further. But many of these mortgages were taken out in
foreign currencies — marketed by the banks as a way to benefit from lower interest rates abroad, as rates in Iceland rose into the double digits over the last year.
Now, with the Icelandic krona plunging, homeowners have to pay back suddenly far more expensive euro- or dollar-value of their mortgages — a kind of negative equity, squared.
The Rev. Karl Sigurbjornsson, the bishop of Iceland, who leads the state-sponsored Lutheran church, says he worries about how the prospect of financial suffering will affect a society that “was led to believe that it was unlimited growth forever.”
“What will happen when the dust settles?” he asked during an interview in his office. “A lot of people will be very angry.
It will be a challenge for our society,” which in the past placed a premium on cohesion rather than the pursuit of wealth.
What will happen next? Analysts say events in the financial sector are moving too fast to make useful economic forecasts.
Some in this country of 300,000 think the economy will prove to be resilient, regardless of what happens to the banks or even the country’s finances. They point to Iceland’s recent prowess in heavier industries like aluminum production — Alcan and Alcoa both have plants here — and alternative energy.
For instance, Eyjolfur Rafnsson, chief executive of Mannvit Engineering, which designs geothermal and hydroelectric power plants, said he had seen no negative effects on his business from the financial crisis. The company plans to open an office in Budapest next week, adding to international sites in Germany and Britain.
He said he even saw some possible benefits for his company, if not for Iceland as a whole. Because of the fall in the value of the krona, he said, “today we can compete anywhere in the world, except maybe India.”
To Bishop Sigurbjornsson, the silver lining in the financial crisis is the prospect that it will bring Icelanders, steeped in the sagas of the Vikings, back in touch with traditional
values.
In his office, he points to a picture from 1908, showing an isolated country church. Villagers gather for a Sunday
service at the wooden church, whose roof is covered with turf
— a cheap form of insulation.
“Other countries build houses with brick and stone,” he said.
“These good times, these times of wealth, are a fairly short part of our history.”
Meanwhile the prime minister, Mr. Haarde, was drawing some practical conclusions, as Fitch Ratings downgraded the country’s debt and Iceland awaited a possible loan from
Russia.
“What we have learned from this whole exercise is that it is not wise for a small country to try to take a leading role in international banking,” he said at a news conference.
Terror law used for Iceland deposits
By FT reporters
Published: October 8 2008 17:11 | Last updated: October 8 2008 22:54
Anti-terrorism powers were used on Wednesday to recoup money owed to UK depositors in a failed Icelandic bank in a move that risked sending Britain’s relations with Reykjavik to their lowest since the 1970s “cod wars”.
UK taxpayers are likely to pay out at least £2.4bn as part of a £4.6bn scheme to compensate hundreds of thousands of account holders at Landsbanki, the Icelandic lender, according to Whitehall sources.
Alistair Darling, chancellor, offered a blanket guarantee to UK retail depositors with money placed in Icesave, a failed internet bank owned by Landsbanki. But wholesale depositors in failed Icelandic banks – including dozens of local authorities and some universities – were offered no immediate support.
Some councils have lost sums of up to £40m, prompting the Local Government Association, which represents about 400 councils, to urge Mr Darling to extend protection to town halls.
The Conservatives said the black hole was a threat to services and could increase council tax bills.
“Government needs to stop dithering and clear up this uncertainty,” said Eric Pickles, shadow local government secretary.
Gordon Brown unveiled “legal action against the Icelandic authorities” to recover depositors’ money, as the tone deteriorated to its lowest level since fishing and coastguard vessels clashed over cod stocks in the north Atlantic in 1976.
The chill came as Geir Haarde, Iceland’s prime minister, expressed disappointment at the refusal of western allies to help prop up the krona and said he had to find “new friends” in the form of Russia, which is considering a €4bn (£3bn) loan.
However, officials from both the UK and Iceland later said that relations were not as bad as the political rhetoric implied.
The Treasury expected Iceland’s depositor compensation scheme to cover about £2.2bn of the £4.6bn owed to about 300,000 Landsbanki depositors, with £1.4bn coming from the UK industry financial services compensation scheme and the remainder from the government.
Public cash would be needed to cover the industry share, the Treasury added, as the compensation scheme lacked sufficient money. It would try to recoup the taxpayers’ contribution later from the proceeds of the sale of Landsbanki’s estimated £7bn UK assets.
Treasury officials wanted to ensure wholesale creditors were treated “fairly”. But Mr Darling told MPs that local authorities – unlike individual depositors – were “informed investors”.
Lawyers said the Treasury’s unprecedented use of anti-terror powers to freeze Landsbanki’s estimated
£4bn UK financial assets could create knock-on problems for other institutions with which the failed lender was doing business.
The freezing order was issued under the 2001 Anti-Terrorism, Crime and Security Act that was passed after the September 11 attacks the same year.
Reporting by Tom Braithwaite in Reykjavik and Alex Barker, Michael Peel and Jimmy Burns in London
Time for Iceland’s authorities to pull the plug on their banks William Buiter for FT
A government should only nationalise a bank (let alone most of its banking sector) if it has the fiscal strength to support the bank (or its banking sector). If it does not have the fiscal resources, now and in the future, to restore the banks to solvency, a private sector insolvency problem is transformed into a government insolvency problem. On the whole, the consequences of state default are more serious for the residents of a country than the consequences of a private bank default.
If the banks in question have a large amount of foreign currency debt, maintaining government solvency when the government tries to make all the banks’ creditors whole, requires two distinct resource transfers: an internal fiscal transfer, through spending cuts or tax increases from the domestic private sector to the government, and an external transfer through a larger primary surplus in the balance of payments accounts. Such an external transfer generally requires a depreciation of the real exchange rate and a worsening of the country’s external terms of trade.
Iceland is a rich country, but it has just 300,000 inhabitants (like Coventry in the UK). It does not have the fiscal resource base to support a credible nationalisation of its banking sector, unless it is willing and able to securitise the future revenues from its hydro- and geo-thermal power resources (something Anne Sibert and I recommended last April).
Apparently, the government is not willing to do that.
The acquisition by the government of a 75 percent stake in Glitnir and the recent nationalisation of Landsbanki were therefore a mistake. Rather than hammering its tax payers and the beneficiaries of its public spending programmes, rather than squeezing the living standards of its households through a sustained masstive real exchange rate depreciation and terms of trade deterioration, and rather than creating a massive
domestic recession/depression to try and keep its banks afloat, it should now let Glitnir, Landsbanki and Kaupthing float or swim on their own. The interests of domestic tax
payers and workers should weigh more heavily than the interests of the creditors of these banks.
It is likely that, without further official support, these banks will fail, and that the banks’
creditors will not recoup the full value of their investments in the banks. Domestic retail deposit holders of kroner deposits will presumably be protected, but all other creditors will have to wait and see. The failure of Iceland’s three main internationally active banks would be most unfortunate, indeed a tragedy; it will be very costly to the country.
But not as costly as would be an attempt to keep these banks afloat by putting all of the country’s foreign exchange resources and all its fiscal resources at risk in support of the survival of the banks. I assume the government can let a nationalised bank fail without this counting as a sovereign default. If this is not the case, the nationalised banks should again be privatized (pro forma) and then left to fend for themselves.
Iceland should now conserve its remaining foreign exchange reserves and other foreign assets to prepare for the post-default disruptions of its international trade and its
international financial relations.
I am surprised that Iceland’s Scandinavian partners (Norway, Sweden, Denmark) could not be convinced to do more than create the rather miserly €500mn swap lines with the Central Bank of Iceland that they agreed to last summer. The EU, the Eurosystem and the governments of the larger European countries (the UK, Germany, France, Italy, Spain) also don’t come out of this covered with glory. Neither does the government of the USA. And where was the IMF in all this?
Apart from unhelpful, the aforementioned parties were also not smart. According to estimates by Anne Sibert and myself made during the spring of this year, it would not have taken much more than $10 bn to see the Icelandic banks into 2009. Now the authorities of the US, the UK, Germany, France, Italy, Spain and the rest of the EU will be able to test the strength of the contagion effects that follow from some more high- profile bank failures. Faced with the choice of hanging together or hanging separately, they chose the second alternative. They will probably regret it before long.
Indignant Iceland faces a problem of perception
By Gillian Tett
Published: March 26 2008 19:37 | Last updated: March 26 2008 19:37
In recent weeks Geir Haarde, Iceland’s prime minister, has been engaged in an unusual sales mission. As his tiny country has been battered by the markets, Mr Haarde has flown to places such as New York, intent on convincing investors that Icelandic assets remain a good bet – notwithstanding recent falls in the krona or a sharp rise in the cost of insuring its banks’
bonds against default.
The movements in credit markets “are totally out of line and not justified”, Mr Haarde recently told the Financial Times, adding that the cost of protecting Iceland’s sovereign debt is also
“totally unjustified”.
EDITOR’S CHOICE
Icelandic CDS costs surge again - Jul-22
Comment: Iceland pays price for financial excess - Jul-01 In depth: Icelandic economy - May-16
Iceland bank action demanded on krona - Jun-24 Iceland seeks loan as inflation rises - May-27 Iceland wealth fund is proposed - Apr-25
A cynic might suggest that such comments have a familiar ring. Over the past year, numerous hedge funds caught up in the global financial turmoil have also complained about “irrational” or
“unfair” investor behaviour. Similar sentiments have been voiced by many Wall Street banks in recent weeks as they faced mounting liquidity pressures.
But at least some outside economists fear that the market judgment on Iceland has become too extreme. Richard Portes, a London Business School professor who recently co-authored a report on the country, says “slander” is now a driving force. “The data just don’t fit the rumours,”
says Prof Portes, who believes both investors and credit rating agencies are acting irrationally.
But slander or not, the sense of déjà vu points to a much bigger trend in global markets. To a casual observer, the country of Iceland might seem to have little in common with a Wall Street bank or a Mayfair hedge fund. But in reality, its predicament reflects a problem besetting many financial groups. At the core of Mr Haarde’s public relations battle is the issue of leverage – and, above all, the changing attitude of investors to debt.
During the first seven years of this decade Iceland enjoyed a boom partly driven by the fact that its banks and companies have been able to borrow cheaply to engage in an overseas
expansion drive. One expert on the Icelandic economy recently remarked that the nation had turned into “the world’s first country run like a hedge fund”.
Until recently, this strategy seemed to have delivered wonderful benefits – in much the same way that high levels of leverage were previously producing fat returns for hedge funds. Iceland’s 300,000 citizens are now ranked as some of the richest in the western world. Moreover, global investors who bought Icelandic assets this decade have enjoyed strong returns, many earned via a so-called “carry trade” strategy – borrowing in low-yielding assets (such as the euro) to invest in the krona and other high-yielding currencies.
But the spreading credit crisis has turned “leverage” into a dirty word – and that is hurting Iceland in several ways.
On the one hand, international investors who borrowed to purchase Icelandic assets earlier this decade are seeing their own funding costs soar, forcing them to abandon the carry trade. At the same time, the leverage that fuelled Iceland’s recent overseas expansion is also provoking growing alarm – and concern that the pattern is unsustainable.
Having enjoyed the benefits of acting like a hedge fund when markets were benign, in other words, Iceland is now reaping the costs of high gearing as the credit cycle turns – in ways that seem as unfair to Mr Haarde as to many western banks.
The data illuminate the perception problem. The classic way that economists measure the debt burden of a country is to look at the ratio of debt to gross domestic product. On this metric, Iceland’s position does not necessarily look alarming: gross debt is currently just 24 per cent of GDP, better than most other western nations, and the country has a fiscal surplus.
However, Iceland – together with many eastern European countries – is bedevilled by a large current account deficit, running at 16 per cent of GDP in 2007 according to official statistics.
More striking still, this decade the country’s banking assets have grown at a speed rarely seen in the modern world.
In 2000, the combined assets of Icelandic banks – mostly centred on Glitnir, Kaupthing and Landsbanki – were just below a year’s GDP. By 2006 they had risen to eight times GDP and the ratio is now thought to be near 10 times.
The Icelandic banks vehemently deny that this explosion in activity has created any risk and say they have made strenuous efforts to put their operations on a solid footing. Most notably, the level of funding they receive from retail deposits – as opposed to money markets – has risen sharply. They have also boosted their capital base to high levels by international standards.
But such measures have not allayed investor concerns: last week Moody’s, the rating agency, placed the Icelandic banking sector on negative watch and the banks’ credit default swaps, which measure the cost of insuring against default, have soared.
Notwithstanding the growth of retail deposits, Iceland’s banks still need to raise a hefty chunk of debt in the global markets. While this finance used to be freely available, fundraising costs have soared this year, since CDS spreads are typically used to set the price of bonds.
Most pernicious of all, the speed at which Iceland’s banking assets have grown relative to GDP has left investors worrying whether the government would have sufficient firepower to bail out the banking system if it did tip into full crisis. Or, as Prof Portes has observed: “The question arises whether the banks are not just too big to fail but also too big to rescue.”
Prof Portes, for his part, insists that the answer to this question is actually very reassuring: if Iceland’s banking system faced a crisis, the government could either use its existing resources to rescue the banks or borrow more funds from the markets. Indeed, the government has already agreed steps to bolster the system: in addition to a 1.25 percentage point interest rate rise this week, the Treasury will conduct a special bond auction to enhance short-term market liquidity.
Yet Icelandic officials know only too well that in times of stress, market rumours have a nasty habit of becoming self-fulfilling. Mr Haarde, however, has a perception challenge on his hands that many investment bankers might recognise. Or as Thor Herbertsson, an economist who is an expert on Iceland, notes carefully: “Let’s say that Iceland is not in more danger than Wall Street banks.”
With additional reporting by David Ibison
