Sigrún Davíðsdóttir's Icelog

Following the course of events in Ireland – a struggling government, the national sentiment refighting an old war of independence, the international media descending on Ireland – is a déjà vu for an Icelandic observer. Iceland went through it all two years ago. The events then and events and development since provide some interesting points of comparison.

Through 2008, the Icelandic government tried to raise money abroad but to no avail. The Bank of England offered assistance to disentangle the crisis that, according to the bank, was far too large to be solved with the couple of billions of dollars that Iceland was seeking. At the US Fed Tim Geithner told Icelandic officials that a loan of a couple of billions would indeed only make things worse since it would demonstrate to the markets that Iceland didn’t realise the extent of its problems. Nothing less than ten billions would do and the US Fed wasn’t a willing lender.

Towards the end of September 2008, Glitnir, the smallest of the three Icelandic banks, turned to the Icelandic government for help. Glitnir couldn’t meet its repayment. The government’s first step was to attempt saving the bank by taking over 75% of its shares. It didn’t take more than a few days to make it crystal clear that even the smallest Icelandic bank was too big for Iceland to save. And anyway, it wasn’t enough: the two other banks collapsed as well. Later, some smaller banks and building societies have gone the same way.

Because of the enormous size of the Icelandic banking sector, compared to the Lilliputian country, the government couldn’t save the banks. That it would have liked to is clear but Iceland really didn’t have the choice: bankruptcy was the only viable option. It took a heroic effort to make the transition from the old banks to the new ones as smooth as it was. The payment system didn’t go down and deposit holders had access to their money all along.

The three Icelandic banks were split up: the foreign debt was stacked into the bankrupt banks, under the auspices of resolution committees, the domestic debt went into the new banks founded on the ruins of the old ones.

In this way, deposit holders were safe and saved, bond holders felt the pain and the loss. And why not? Bond holders, those who lent money to the Icelandic banks, are mostly other banks and financial institutions. They should have known better than to heap loans on banks in a tiny country. But they probably didn’t even need to worry too much about their losses. In most cases their loans will have been insured. There must be some smarting insurance companies out there.

‘What’s the difference between Ireland and Iceland? One letter and six months.’ This joke circulated when Iceland collapsed two years ago and has now been widely quoted. ‘One letter’ is correct, the time wasn’t exact (Ireland had actually declared some weeks earlier that it would save the banks, gave them all a guarantee in January 2009 but it never was enough) but the major difference is that Ireland saved its banks, Iceland didn’t.

As a consequence, the cost of the Icelandic bank collapse is mostly born by foreign banks that were ignorant or reckless enough to lend far too much to the Icelandic banks (and the insurance companies that insured the loans). The cost of the Irish bank salvation is born by the Irish taxpayer. And what a burden it will be!

The most serious cost for the Icelanders is that as the banks collapsed their krona collapsed though its decline had already started much earlier in 2008. Part of the ingenuity of the Icelandic banks had been to convince ordinary people, with all their income in the local currency, to take out mortgages and loans in foreign currencies. Consequently, many Icelanders are struggling to meet repayments of forex loans that have shot up (and this problem has taken up most of the attention in Iceland).

The krona has been gaining strength but this, as well as rising unemployment (now just under 5%, staggering on an Icelandic scale, enviable for most other countries), have been the gravest cost to Icelanders. With a domestic currency that was to some extent squeezed at home by foreign currencies Icelanders were hit by a currency crisis.

What Icelanders didn’t know in October 2008 was the extent of bad loans and dubious corporate governance in the banks – the loans to the major shareholders and to bankers, often without any guarantee and on terms very favourable to the borrower but unsustainable for the banks. My feeling is that the Irish don’t quite know the extent of bad loans in their banks. The Irish state stepped in and bailed out banks without the cost being at all clear.

I’ve earlier pointed out that the same unsavoury tricks used by the Icelandic banks to help their largest shareholders and bankers have been used by at least one Irish bank. I find it profoundly improbable that this would be just a singular incidence. The Irish bankers drove the reckless lending into the property market as if houses peopled and sold themselves. The Irish bankers who didn’t see that they were playing with the financial safety of their fellow countrymen are, to a large extent running the banks. In Iceland, there have been major changes at the level of top management but many Icelanders will still feel that the changes haven’t been wide-reaching enough.

A major difference between Iceland and Ireland – and for that matter the rest of the world – is that Icelanders now have a hugely clear insight into i.a. the Icelandic banking system, the economic policy and the events that led to the demise in October 2008. There is the Althingi Special Investigative Commission’s report (unfortunately not yet translated into English except for a few chapters). No other country has, so far, probed and investigated these matters like Iceland has. Two reports have been done in Ireland but as I’ve already demonstrated these reports leave plenty to be desired and are nowhere near as thorough as the Icelandic report. It will be interesting to see that the coming Peter Nyberg report will be like.

In the wake of the Icelandic collapse some Irish politicians mentioned with horror that certainly they wouldn’t let Ireland go down the same route as Iceland. In reality, it wasn’t such a bad route and Iceland will most likely wind itself out of its bend more quickly and less painful than Ireland. Icelandic tax payers won’t have to work their socks off for foreign bondholders.

Being an Icelander, I can shrug my shoulders and say that at least Icelandic and foreign banks and bankers were taught a lesson in October 2008. It surely wasn’t a lesson that the Icelandic government wanted to teach them. It would have liked to save the banks but couldn’t – that opportunity had passed sometime in 2005. If I were Irish I would be furious that the recklessness of the Irish and the international banking world has now been rewarded by a bail-out that Irish tax payers have to fund.

But being a citizen of the world I am furious that there isn’t an outcry for splitting banks apart to make it a harmless event if a bank can’t close its books. Everything has been tried – the banks have been pleaded with, asked and begged to save the rest of the world from their dangerous activities. Instead, they raise their bonuses and keep on as if nothing had happened. And it hasn’t. The bail-outs take the risk out of the system, the recklessness can go on – and taxpayers can rest assured that they will keep on toiling away a certain amount of hours every week to keep bankers happily at what they have shown themselves to be brilliant at: playing with fire and setting the world ablaze.

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