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Iceland - back from the financial abyss

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Bara Kristinsdottir for The New York Times


Updated: July 9, 2012

Iceland is a small but rugged country far from anywhere that suffered from financial wreckage as severely as any in the developed world after its overstretched banks failed in 2008. In a matter of weeks after the banks’ collapse, the unemployment rate jumped to 10 percent, house prices fell, the currency plunged and inflation surged.

During the boom years, Iceland became a nation obsessed with banking. The success of the nation’s banks, however, was deceptive. The economy was fueled almost entirely by foreign money. Then, as the global financial infrastructure teetered on the verge of collapse, the bonds came due, and Iceland’s banks couldn’t repay them.

Depositors in other countries raced to pull their money out of Icelandic banks. The government didn’t have the resources for a bailout; the banks failed. The government did guarantee that Icelanders would not lose the money in their savings accounts, but other financial assets — including the many investment funds that the banks offered — plummeted in value, and many ordinary Icelanders lost large sums that they believed were safely invested.

Iceland has been on the road to recovery since the 2008 crisis, helped by its traditional tourism and fishing industries. Some economists have argued that the collapse of its banks forced the country to deal with its problems faster.


Turning It All Around

By July 2012, Iceland seemed to be doing surprisingly well for a country that just four years earlier had plunged into a financial abyss. It repaid, early, many of the international loans that kept it afloat. Unemployment was hovering around 6 percent, and falling. And while much of Europe was struggling to pull itself out of the recessionary swamp, Iceland’s economy was expected to grow by 2.8 percent in 2012.

Analysts attribute the surprising turn of events to a combination of fortuitous decisions and good luck, and caution that the lessons of Iceland’s turnaround are not readily applicable to the larger and more complex economies of Europe.

During the crisis, Iceland did many things differently from its European counterparts. It let its three largest banks fail, instead of bailing them out. It ensured that domestic depositors got their money back and gave debt relief to struggling homeowners and to businesses facing bankruptcy.

Iceland also had some advantages when it entered the crisis: relatively few government debts, a strong social safety net and a fluctuating currency whose rapid devaluation in 2008 caused pain for consumers but helped buoy the all-important export market. Government officials, who at the height of the crisis were reduced to begging for help from places like the Faroe Islands, are now cautiously bullish.

But not all is perfect. Inflation, which reached nearly 20 percent during the crisis, is still running at 5.4 percent, and even with the government’s relief programs, most of the country’s homeowners remain awash in debt, weighed down by inflation-indexed mortgages in which the principal, disastrously, rises with the inflation rate. Taxes are high. And with the country’s currency, the krona, worth between about 40 and 75 percent of its pre-2008 value, imports are punishingly expensive.

Strict currency controls, imposed during the crisis, mean that Icelandic companies are forbidden to invest abroad. At the same time, foreigners are forbidden to take their money out of the country — a situation that had tied up foreign investments worth, according to various estimates, between $3.4 billion and $8 billion.


Former Leader Prosecuted Over Financial Crisis

In March 2012, Iceland opened a criminal trial against its former prime minister, Geir H. Haarde, becoming the first country to prosecute one of its leaders over the financial crisis of 2008.

Mr. Haarde was charged, in effect, with doing too little to protect the country against the depredations of its bankers as they pursued wildly expansionary lending that resulted in financial disaster for the country. He was indicted in 2010 by a sharply divided Parliament, charged with violating the laws of ministerial responsibility.

On April 23, Mr. Haarde was found guilty of failing to keep his cabinet informed of major developments during the 2008 financial crisis, but was cleared of three more serious charges of negligence.

Mr. Haarde was acquitted of three charges that were linked to his management during Iceland’s economic collapse in 2008, which could have resulted in a jail sentence. A Reykjavik court ruled that Mr. Haarde would not receive any punishment on the one guilty count, and that his legal expenses would be covered.

Public opinion had been largely split over the case against the former prime minister, with some people saying they hoped it would help society learn from the traumatic missteps of government leaders, while others told pollsters it amounted to scapegoating by criminalizing incompetence. Mr. Haarde had pleaded not guilty on all charges and said the case was a “political vendetta.” He also insisted that nobody in the government at the time had realized that the banks, which had grown too much and too fast, posed a threat to the economy.

Several witnesses had supported Mr. Haarde during the trial, saying that no one person should be held accountable for the demise of Iceland’s banking system and its economy.

Prosecutors also indicted the former heads of Kaupthing, one of the three failed Icelandic banks, on charges of fraud and market manipulation. Hreidar Mar Sigurdsson, Kaupthing’s former chief executive, and Sigurdur Einarsson, the former chairman, pleaded not guilty and are due in court later in 2012.

Mr. Haarde served as prime minister from June 2006 until February 2009, when his center-right Independence Party was ousted in general elections by a coalition of the Social Democrats and the Left-Green Movement under Johanna Sigurdardottir.



In 2011, the British and Dutch governments took steps to sue Iceland to claw back the billions of euros they paid to depositors in their countries after Icelandic banks collapsed.

With assets eight times the country’s gross domestic product, the banks could not depend on the government to bail them out as some European countries, like Ireland and Britain, had done for their banks.

As a result, the 400,000 depositors in Britain and the Netherlands, who had been lured by the high interest rates of Icelandic banks, were reimbursed by their governments. Those countries are seeking to recover that payout, which approached 4 billion euros ($5.8 billion).

The prospect of legal action, likely to take more than a year to resolve in an international court, arose in April 2011 after Iceland’s voters rejected a deal for the country to repay Britain and the Netherlands over 30 years starting in 2016.

The government of Prime Minister Johanna Sigurdardottir had pushed hard for approval, arguing that Iceland, amid a financial rescue program backed by the International Monetary Fund, needed to put the issue behind it if it hoped to re-enter international financial markets and join the European Union.

But after a devastating recession and with animosity toward bankers still running high, Iceland’s electorate was not swayed.

The case will be taken up by the European Free Trade Association Surveillance Authority, an international court based in Brussels.

Iceland, unlike many other nations that went mad for credit, still has many things going for it: a low average age of 37, highly educated workers, a nearly positive birthrate, over-financed pension funds and abundant natural resources.

That said, statistics paint the remarkable fiscal challenge Iceland faces. The central bank estimates four out of 10 households took out loans denominated in foreign currencies to buy cars. And 80 percent of Icelandic homes have mortgages with payments either directly linked to inflation or denominated in foreign currencies.

When the krona was soaring, this might have seemed rational. The strong currency, buoyed by artificially high official interest rates, allowed hot money to flow over Iceland. Everyone from American hedge fund managers to Austrian dentists could borrow cheaply at home, or in low-rate currencies like the Japanese yen, and buy higher-yielding Icelandic paper.

When this vast “carry trade” ended, though, the currency crashed and the cost of servicing all those liabilities spiked. So did the prices of imports, which led to inflation. Because many Icelandic mortgages carried payments linked to consumer prices, one in six households faced  mortgage payments equal to 60 percent or more of their take-home pay.

Iceland’s banks also got into this game, rolling in easy money they then lent to entrepreneurs known locally as “business Vikings.” Soaring stock prices also encouraged them to expand their businesses abroad. At its peak, the Reykjavik market’s capitalization rose to more than 250 percent of gross domestic product — making it the most highly valued in the world.

The bust led to the ousting of the conservative government that oversaw the boom. It was replaced by a leftist coalition led by Ms. Sigurdardottir, the first woman to lead Iceland’s government and the first openly declared lesbian to lead a government in the modern world. Her fragile government has struggled to balance a recognition of the public’s deep bitterness against the need to resolve obligations left from the collapse to move economic recovery along.




COMMENT: If Iceland can do this with it's natural resources and innate assets, why can't Australia do much the same, without the crash and crisis phase?

Ancient Icelandic and Viking heritage runs through so much of the Australian population, with a courage as yet untapped.

Australians do have what it takes to resolve our own situation.

We must not allow our relationships with other countries to stand in our way.

We do not have to go downhill with them a second time - wasn't once enough?

Australia has so much going for it, so much more it can draw on to self-resource compared to Iceland.

We can take their model and adapt it for our purposes.

Learn from the winners, observe the losers and make our own decisions.

It's common sense.

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  • doyla66
    doyla66 Wednesday, 07 November 2012

    This is what Australia needs now. A CRIMINAL TRIAL against our Prime Minister, to be charged, with doing too little to protect the country against the predations of its bankers as they pursue wildly predatory lending that will result in financial disaster for our country.
    Politicians here are also sticking their heads in the sand. They must heed the warnings that: Nobody in the government at the time had realized that the banks, which had grown too much and too fast, posed a threat to the economy. Our Banks are now a serious threat to the economy!

  • doyla66
    doyla66 Wednesday, 07 November 2012

    most of the country’s homeowners remain awash in debt, weighed down by inflation-indexed mortgages in which the principal, disastrously, rises with the inflation rate. suicide that type of mortgage be....renting would make 100% sense

  • doyla66
    doyla66 Wednesday, 07 November 2012

    Bizarre - principal rising with inflation. Why would they do that?

  • doyla66
    doyla66 Wednesday, 07 November 2012

    One of the challenges in assessing what's really happening on the ground in other countries is the tendency of the MSM to skew the reporting. The same happens in Australia, of course. If we didn't know the real situation and put it out there for others to read then people could get (and have) a very unusual view of the Australian economy, distorted for political purposes.

  • doyla66
    doyla66 Wednesday, 07 November 2012

    There is much we can learn, but what we need are brave and true regulators and responsible i.e. able to respond, government.

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