Sigrún Davíðsdóttir's Icelog

Iceland’s way – the right way or no way?

with 21 comments

In times of towering sovereign debt, there is a constant murmur in the media that countries should do like Iceland: refuse to bail out the banks and the bankers. This shows some lack of understanding of what Iceland did and why. In short, the Icelandic way is no way and the notion that it is rests on ignorance and misunderstanding. Or wishful thinking. On a broader scale the question is why private enterprises are being bailed out on both sides of the Atlantic, why private debt is allowed to migrate into tax payers’ pockets. In short: why have developed countries and institutions, like the ECB, been so willing to help banks to privatise the gains and nationalise the losses? In this, Iceland hasn’t entirely been a shining example leading the say.

In an interview yesterday with Irish PM Enda Kenny Evan Davis on the BBC radio 4 Today programme asked Kenny twice why Ireland wasn’t just doing like Iceland, refusing to pay. Or rather, Davis taunted him on this since Iceland was doing much better than Ireland. Kenny was clearly not deeply versed in the Icelandic way and ignored the taunts rather than pointing out the misunderstanding. There are indeed some interesting similarities between Iceland and Ireland, as I have pointed out earlier (on crisis and corruption and then broader similarities and differences) but the Icelandic way as a way of writing off debt caused by the banks isn’t really a sustainable example.

Yesterday, there was an editorial in the NY Times along these lines, on ‘Iceland’s Way.’ Though more nuanced and more accurate than just saying that Iceland is refusing to bail out the banks it wasn’t entirely correct.

The government of Iceland failed to rein in bankers’ excesses. But its refusal to take on bank debts, forcing creditors to take losses and share in the pain, looks increasingly smart as Iceland’s economy begins to recover.

The European Union and the International Monetary Fund — their bailouts of Greece and Ireland were designed to make creditors whole — should learn from Iceland’s example. As they negotiate a rescue for Portugal, they should realize that taxpayers cannot bear the entire cost of the banks’ misdeeds.

The government of Iceland wasn’t intentionally daring or smarter than others. It couldn’t afford to bail out its banks, so it let them fail. It transferred domestic deposits and loans, at a discount, into new banks, with some $2 billion in money from taxpayers. And it left the banks’ foreign assets and foreign debts behind. Some foreign creditors could get as little as 27 cents on the euro.

There is a contradiction here: the editorial both mentions the fact that Iceland couldn’t afford to bail out the banks and is refusing to do so. The former refers to the fact that the Icelandic state couldn’t save the banks in 2008 and the latter seems to refer to the fact that the last, the third, Icesave agreement was rejected in a recent referendum. But the referendum wasn’t about bailing out bankers. At its core is paying a debt to the British and the Dutch Government, rising from deposits guarantees on Icesave, Landsbanki’s internet bank.

As to the Icelandic way, the three banks failed in October 2008 because they were well beyond sovereign salvation. A fumbling attempt end of September 2008 to save Glitnir, the smallest one, proved the impossibility of that wish. But billions of ISK, ca 60bn, ca €370m, have since been posted into saving banks and an insurance company (interestingly, Icesave III might have incurred a sovereign cost of ca IKS35bn; Icesave has taken the Icelandic mind hostage for more than two years, deflecting attention from other issues but that’s another story). Both the present and the previous Governments have repeatedly said that the Icesave debt to the UK and the Dutch will be paid.

The general truth is that the European endgame needs to involve a different approach from the one the ECB is trying to force through, as eloquently demonstrated recently by Lee Buccheit (the Icesave III chief negotiator) and Mitu Gulati. A more relevant lesson than the Icelandic one is that, as Buchheit has been pointing out in recent lectures (i.a. in Iceland; see the end of this interview) in previous sovereign debt crisis during the latter part of the last century the banks have been rebuffed and forced to take the hit. This time, private debt, i.a. in Ireland, migrates to the public sector, i.a. with the help of the ECB. Yes, governments, i.a. in Greece, have overstretched themselves but the banks over-lent. By far. The Icelandic banks are a case in point.

The question is: why are governments taking on private debt now when it wasn’t accepted earlier? How come, that now it’s taken as a law of nature that private debt migrates to the public sector, all the way to the tax payers?



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Written by Sigrún Davídsdóttir

April 19th, 2011 at 10:47 am

Posted in Iceland

21 Responses to 'Iceland’s way – the right way or no way?'

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  1. Your last question is indeed THE question.

    Cold facts aside, I really think the Icelandic people, rightly or wrongly, wanted to use the recent referendum to express indirectly their disgust at the idea that it should be acceptable to let private debt migrate to the public sector.
    This is a factor in the referendum which really should not be ignored.

    We need to dig into why this idea is being propagated, and it is quite clear that it was already happening several years ago in the U.S.A. – before our banking collapse – when Hank Paulson and Ben Bernanke appeared to find it a perfectly normal thing to introduce this preposterous idea to the world.
    I can still remember how stressed they looked at the time… They undoubtedly knew just how preposterous their idea was.


    19 Apr 11 at 1:36 pm

  2. One of the most important aspects of a free market is failure. The same banks will scream at regulation and how much a free market is better until this happens.

    There is one other point. Why aren’t any of these bankers, at least on the other side, either on trial for fraud, terrorism, or in prison for having the financial equivalent of a nuclear bomb with a twitchy fuse? Worse, why are the taxpayers paying lavish bonuses to these miscreants?

    If they are making a case that it is a crisis (not unlike the Earthquake/Tsunami and Fukushima in Japan), then the first thing would have been to take the top 25 and entire boards of any bailed out institution and revoke every license, disgorge every bonus, and otherwise place them where they lose all benefit and cannot repeat it.

    If the banks are now something like the departments of motor vehicles, those running them should be paid what the people running them do. And be as heavily regulated and monitored.

    The price of taxpayer bailouts should be nationalization.


    19 Apr 11 at 1:46 pm

  3. I agree. The senior debt holders should share the pain. There is no risk free investment.

    For the EEC, the fear is that the weakened German regional banks and the French banks cannot take the hit from a haircut within the PIGS.


    19 Apr 11 at 2:40 pm

  4. Here in the USA there was a section of the political Right that wanted to let the banks fail and were furious that Bush bailed them out. In this stand, they were being internally consistent in their free market ideology.

    The remarkable thing is how it all played out later – as Sigrún mentions, effectively the gains were allowed to be private and the losses were nationalized. I recall Krugman suggesting at the time that at least some of the banks ought to be nationalized temporarily, but Obama was scared *hitless to go anywhere near that for fear of reinforcing the “socialist” tag that the Right had stuck on him.

    Rajan P. Parrikar

    19 Apr 11 at 4:26 pm

  5. You are absolutely correct. I think most Icelanders understand the basics of this (way overblown) issue, but there is a logical side to this and an emotional one, which I think the govmt has discounted. Icelanders see themselves having to bail out obnoxious bankers who – and this I believe is the main reason for the “no” vote – haven’t had to face up to one iota of negative consequences for what they did. If there was evidence that they shared in the sacrifices that Icelanders have had and will have to make, then a yes vote would not have been unlikely.

  6. “…privatise the gains and nationalise the losses…”
    Nail-on-the-head, Madame.

    In the US, I would suggest that at least part of the reason is the seamless way that our financial ‘masters’ move between the White House, Wall St., and K Street — where the lobbyists lurk. Josh Bolten, Robert Rubin, Rahm Emanuel, Gary Gensler, Henry Paulson, Phil Gramm, Peter Orszag, Stephen Friedman… Like a list of Goldman alums. It’s human nature that they will favor “their own”.


    20 Apr 11 at 12:16 am

  7. “why are governments taking on private debt now”

    Actually, its not that the governments are taking the debt on now, its that the PUBLIC has realised that they liable for the debt. This liability has existed since banks were invented and banks have taken advantage of it many times before.


    20 Apr 11 at 9:34 am

  8. I disagree, Peter.
    I think the “No” vote represented the thinking public’s awareness that they were NOT liable for the debt. Although of course some voted “No” for rather dubious reasons.

    Clearly, neither the banks nor the government like the public’s conclusion, but, as Nick says, they always favour their own.


    20 Apr 11 at 12:19 pm

  9. What is always forgotten in the debate on Icesave, are the beneficiaries of the Dutch and UK payments. It was not banks but deposit holders, regular families who entrusted their hardearned savings to the Islandic banks. Even if some argue, that the depositholders should have had a better knowledge of the stability of Icelandic banks than the Icelandic Central Bank and FME, there is still an European Economic Area rule garantueeing private deposits up to 20.000 euros. Icelanders, who had their own deposits garantueed at 100% by their government, have now for the second time said “bad luck” to Dutch and British families. They should not expect sympathy for that stance.


    20 Apr 11 at 1:47 pm

  10. Harry, you are right: Icesave is about depositors, not bankers. I’ve time and again underlined that Icesave isn’t about bailing out bankers. But with the public mood in Iceland as it is, many saw the referendum as a way to express anger over bankers and the Government. That’s what invariably happens in a referendum: the voters answer not what they are asked about but what they want to say with their vote.

  11. “I disagree, Peter.
    I think the “No” vote represented the thinking public’s awareness that they were NOT liable for the debt. Although of course some voted “No” for rather dubious reasons.”

    They only voted to be not liable for non-icelandic deposits. By accepting liability for one set of debtors but not others, the vote was about acceptance of the EU principle for equal treatment. Well, Iceland is in the EEA and thats a core principle that cannot be disputed.
    There is also the fact that the vote is an issue for Iceland’s government and its voters, the government has acceptable liability and the liability rests on the sovereign nation. Iceland should sue its government ministers for the cost and damages if they have broken Icelandic law. The debt is still there, however, its external to Iceland’s constitution issues.


    21 Apr 11 at 8:56 am

  12. My only point was that your literal interpretation of the referendum result, while quite correct in itself, disguises the fact that many voters also wished to use the opportunity to express their contempt for the behaviour of some of their alleged representatives.

    They made their point, and they won’t go away until they feel decently represented by people who did NOT cause this mess.


    21 Apr 11 at 4:52 pm

  13. It isn’t really about the depositors, either. It’s about the Dutch and British governments; they’re trying to foist their moral hazard on the people of Iceland. So long as Iceland’s banks looked like happy little gravy trains, the Dutch and British governments were fine with having them stop in, and they weren’t terribly interested in checking on the likelihood of those trains dumping their toilet tanks at the station. Then the trains jumped the tracks and spilled their loads all over the station platform, and the governments said, “Oops, we just got caught with our due diligence down. Time to pass the buck.”

    Sorry, but if you’re a sovereign government, it’s YOUR job to enforce the regulations intended to protect your people, not somebody else’s job. The mere fact that you were drinking Austro-Chicago Kool-Aid on the job is no excuse.

    Knute Rife

    21 Apr 11 at 10:50 pm

  14. Of course, that argument also applies to Iceland, especially as it was responsible for the actual regulation of Landsbanki.

    Both UK & NL believed that they were required to let Landsbanki operate in their countries and, in fairness to the FSA & the NL equivalent, can you imagine the stink that Landsbanki and Iceland would have caused if Icesave had been blocked? Also, I doubt that either the UK or the NL were actually happy that deposits were being made with a foreign bank rather than a local one.

    You’re wrong when you say that the UK/NL did nothing. The NL certainly tried to limit Icesave’s expansion, but with little success as their understandings and agreements on limiting that expansion were ignored by Landsbanki. That in itself is an indication of the expectations of Landsbanki with respect to the ability of the UK/NL to actively prevent them attracting deposits.

    Both countries are paying the price for not being tougher, as they’ve had to pay out to their deposit guarantee limits and have both elected to cover an amount on top of that.


    22 Apr 11 at 12:07 am

  15. “They made their point, and they won’t go away until they feel decently represented by people who did NOT cause this mess.”

    That is done with an election to change the government, not a referendum of repaying bank depositors.

    Besides, Iceland has already removed the government that caused the Kreppa.


    22 Apr 11 at 8:02 am

  16. “Besides, Iceland has already removed the government that caused the Kreppa”

    …While the same people sit in the parliament and prepare to cause another one…?

    Of course you are right about the due process of government change through election, but the government that caused the kreppa was essentially removed through popular revolt, which is not exactly synonymous with “due process”.

    A large number of Icelanders did not much care about the finer points of agreement III, as opposed to II or I, although of course they knew that this was the reason for the referendum.
    My point still stands that, for many, the referendum was ALSO an opportunity to express frustration and outrage at the continuing lack of transparency and accountability in parliamentary, governmental, judicial AND banking affairs, which are perceived as being far too strongly interlinked.
    The “No” vote would undoubtedly not have been so strong without that element.

    If a large percentage of the people of any country feel that they have no effective representation within an existing system, they will insist upon it being changed.
    The anger underneath Iceland’s beautiful surface is very real, and I encounter it every day.


    23 Apr 11 at 2:34 am

  17. >The anger underneath Iceland’s beautiful surface is very real, and I encounter it every day.

    Fair enough. Is that a sensible way to run a country’s foreign policy though? If 40% of people in Iceland today would vote for the same muppets that landed them in the crap, that’s the best advert I’ve seen for limiting public participation.


    24 Apr 11 at 1:03 am

  18. ´Fair enough. Is that a sensible way to run a country’s foreign policy though? If 40% of people in Iceland today would vote for the same muppets that landed them in the crap, that’s the best advert I’ve seen for limiting public participation.´

    In Iceland you dont vote for the person. You vote for the party. The representatives are the ones that the party put forward. The people of Iceland have a whopping 4 real parties to choose from. 3 of which are linked with the banking crisis.
    Unless 100% of the country voted for the Left Greens or equally unthinkably, the leaders of the 3 other parties would have to nominate totally new people who they had no control over to be the candidates.
    Icelanders are in a bit of a Catch 22. Its pretty easy to play they people are responsible for the government they choose argument unless you have actually tried to vote Independent in Iceland.


    25 Apr 11 at 6:35 pm

  19. I was responding to the point that that disassociation/anger was manifested in the referenda results.

    That said, you have a good point. It shows just how bad the situation is that a (intentionally) total farcical party could win in mayoral elections. More importantly for Icelandic politics, at least from my limited outsider perspective, the failure of the Citizens’ Movement party to actually stick to what the people who voted for it wanted rather than what their representatives wanted ended a brief flirtation with another way.

    Birgitta et al. may (or may not – I’m not immersed in it) have thought that they were doing the right thing, but destroying the faith of Icelanders in a third way (or perhaps fifth way in Icelandic politics) was detrimental. IMO anyway.

    Not that we can talk over in the UK. We have a massive disconnect with politicians. What’s our answer to it? We (I say “we”, but who decided AV was a good idea?) pick the wrong Antipodean voting system to vote on. Madness that, in its own way, is just as bad as the vote on Icesave II when Icesave II.5 was on the table.


    26 Apr 11 at 12:21 am

  20. “Harry, you are right: Icesave is about depositors, not bankers. I’ve time and again underlined that Icesave isn’t about bailing out bankers.” Þú meinar þó ekki að almenningur þurfi að axla ábyrgð sem eigendur einkarekinna banka ættu að axla? Hvar stendur í lögum að gjaldþrota innistæðutryggingasjóður sé á ábyrgð almennings?


    8 May 12 at 12:40 am

  21. Geri ráð fyrir að þessu verði ekki svarað …?


    12 May 12 at 2:26 am

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