Now that so many European countries are struggling, how is Iceland doing? Iceland is doing rather well, thank you. A growth of around 2% is forecasted for this year and the unemployment, though at a horrible high, from the Icelandic point of view, 8% isn’t too bad compared to the neighbouring countries. When reading about Iceland’s good standing, compared to many other countries, the usual refrain is that Iceland didn’t bail out its banks. As shown below, that’s only partially true. Iceland’s economy is indeed weighed down by the cost of its banking crisis.
Iceland’s recovery was the topic of an IMF conference in Reykjavik October 27, most appropriately at Harpa, the new concert house (and since I happened to be in Iceland I was there). Harpa was half-built when the crisis struck but instead of letting it stand as a sad reminder of the insane optimism, it’s now finished, much to the delight of the culturally gluttonous Icelanders.
Martin Wolf from the FT was there and has just published an excellent overview of some of the topics. In addition, he uses the opportunity to show-case Iceland as a good example of a country profiting from not being in the euro. One of the reasons why so many economists seem to be interested in Iceland is that they find there facts and figures to underpin their ideas. Hence, Iceland is quickly becoming all things to many economists.
At Harpa, leading luminaries from the dismal science, such as Willem Buiter and Paul Krugman, pondered on the state of Iceland. But from my point of view, it was most interesting to hear Gylfi Arnbjornsson president of the Confederation of Trade Unions and professor of economy Gylfi Zoega speak, as well as Stefán Olafsson, professor of sociology, both from the University of Iceland. In addition, professor Fridrik Mar Baldursson, Reykjavik University, gave an excellent overview of the Icelandic economy. All this is accessible here.
Arnbjornsson was adamant that with the krona Iceland couldn’t prosper. Export had deteriorated, in spite of sharp depreciation. Such a small open economy wasn’t sustainable with its own currency.
Stefan Olafsson underlined that in spite of cuts, the worst off in society had not lost out the most as seems to be happening elsewhere. The gap between the worst off and those at the top has not widened. This is perhaps the success saga, less that Iceland didn’t save its banks. More on that below.
Gylfi Zoega underlined that it was a fairy tale that Icelanders are different. He characterised Icelandic banking rather well: “others talk about related party lending; we call it banking.”
Jon Danielsson, LSE, argued vehemently against the currency control and has just published an article on the matter, together with Ragnar Arnason, University of Iceland.
But let’s look at this popular belief, running through the IMF conference and most things written on Iceland, that Iceland didn’t bail out its banks. Correct, Iceland didn’t bail out its three large banks that all collapsed in October 2008. The Government tried to safe Glitnir end of September but failed miserably. This attempt made it abundantly clear, that it was, of course, beyond the Central Bank of Iceland to be a lender of last resort for these three, compared to the Icelandic economy, gargantuan institutions. The Government was unable to do anything but watch in horror.
Because these banks failed and weren’t saved, Iceland has become the heroic example of a country that, contrary to ia Ireland, didn’t bail out its banks. So much drivel has been written about this as Grapevine, an Icelandic magazine published in English, pointed out earlier. In this heroic story that’s going around in the world, Iceland didn’t let the debt of private banks migrate from the private to the public sector. I wish this was true but it isn’t. Not quite. Quite some myth-making here.
In the Emergency Act, passed on Oct 6, 2008, there was a provision for helping the Icelandic building societies (similar to the German ‘Sparkassen’). This was later done. Also, the Government helped two banks, VBS and Saga Capital.
With documents from Landsbanki, I have already shown that many years before the crash, Landsbanki kept VBS afloat. Just before Landsbanki collapsed there was the last helping. This kept VBS alive until the following spring when the Government propped it up with ISK26bn (€16.2m), which prolonged its life until early 2010. Together with support to Saga Capital, the Icelandic Government helped these two banks with almost 3% of GDP 2009.
The building-societies system has collapsed, partly because it was taken over – as everything else with a cash flow – by the main banking protagonists, the banks and its main shareholders and clients. The core functions in this system, such as lending, was very unprofitable during the years before the collapse but this fact was masked by prop trading and financial engineering.
In the Icelandic IMF programme, ISK25bn (€15.5m) was set aside to fix the building societies. Out of ten remaining societies, five have been saved by the state. If the cost of saving these banks and a few others are all added it, the amount is over ISK70bn (€43.6m). By adding the cost of saving Sjova, an insurance company, and ILS, the state mortgage company, this bail-out sum rises to ISK118bn (€73.6m) – and that amounts to 7,7% of GDP, not a trivial sum.
But this isn’t the whole story of ‘not bailing out the banks.’ The two main problems from this system of small financial institutions are indeed not small. Byr, horribly abused by Glitnir Bank and its main shareholder Baugur and FL Group, was bought by Islandsbanki (the resurrected Glitnir, now owned by its creditors). Sparisjodur Keflavikur, a building society from Keflavik (yes, where the international airport is) has a huge gaping hole, a string of truly shabby loan stories and was taken over by Landsbanki, owned by the state (the Icesave bank that no creditors want to touch).
These two sales/mergers happened last year but the sales aren’t yet finalised, probably because the state then has to cough up a lot to make these institutions palatable to the new owners. Consequently, these two banks are now a walking danger, zombie banks. The rumour is that just for the Keflavik society, ISK30bn (€18.7) will be needed.
The worst thing is that there doesn’t seem to be any policy in all this bail-out activity. Saving VBS was clear and pure madness and amounted to throwing ISK26bn into the North Atlantic. There might very well be some good reasons to save some of the building societies but there just doesn’t seem to be any clear policy. The Government hasn’t made it clear if all the remaining 10 societies, out of which the state now is a stakeholder in 5, should be run as now, should be merged into one or into a few larger ones.
All in all, Iceland has some ISK200bn (€124.7m)at risk in the banking system, ca 14% of GDP. So here is the correct version of bank bail-outs in Iceland: the Icelandic Government at the time couldn’t save the three largest banks – but a lot of the undergrowth in the financial system has been saved. And it’s not clear why or what the policy is.Follow me on Twitter for running updates.