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Iceland’s recovery: myths and reality (or sound basics, decent policies, luck and no miracle)

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Icelandic authorities ignored warnings before October 2008 on the expanded banking system threatening financial stability but the shock of 90% of the financial system collapsing focused minds. Disciplined by an International Monetary Fund program, Iceland applied classic crisis measures such as write-down of debt and capital controls. But in times of shock economic measures are not enough: Special Prosecutor and a Special Investigative Committee helped to counteract widespread distrust. Perhaps most importantly, Iceland enjoys sound public institutions and entered the crisis with stellar public finances. Pure luck, i.e. low oil prices and a flow of spending-happy tourists, helped. Iceland is a small economy and all in all lessons for bigger countries may be limited except that even in a small economy recovery does not depend on a one-trick wonder.

“The medium-term prospects for the Icelandic economy remain enviable,” the International Monetary Fund, IMF, wrote in its 2007 Article IV Consultation
Concluding Statement, though pointing out there were however things to worry about: the banking system with its foreign operations looked ominous, having grown from one gross domestic product, GDP, in 2003 to ten fold the GDP by 2008. In early October 2008 the enviable medium-term prospect were clouded by an unenviable banking collapse.

All through 2008, as thunderclouds gathered on the horizon, the Central Bank of Iceland, CBI, and the coalition government of social democrats led by the Independence party (conservative) staunchly and with arrogance ignored foreign advice and warnings. Yet, when finally forced to act on October 6 2008, Icelandic authorities did so sensibly by passing an Emergency Act (Act no. 125/2008; see here an overview of legislation related to the restructuring of the banks and here more broadly on economic measures).

Iceland entered an IMF program in November 2008, aimed at restoring confidence and stabilising the economy, in addition to a loan of $2.1bn. In total, assistance from the IMF and several countries amounted to ca. $10bn, roughly the GDP of Iceland that year.

In spite of mostly sensible measures political turmoil and demonstrations forced the “collapse government” from power: it was replaced on February 1 2009 by a left coalition of the Left Green party, led by the social democrats, which won the elections in spring that year. In spite of relentless criticism at the time, both governments progressed in dragging Iceland out of the banking mess.

After the GDP contracted by 4% in the first three years the Icelandic economy was already back to growth summer 2011 and is now in its fifth year of economic growth. In 2015, Iceland became the first European country, hit by crisis in 2008-2010, to surpass its pre-crisis peak of economic output.

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Iceland is now doing well in economic terms and yet the soul is lagging behind. Trust in the established political parties has collapsed: instead, the Pirate party, which has never been in government, enjoys over 30% following in opinion polls.

Compared to Ireland and Greece, Iceland’s recovery has been speedy, giving rise to questions as to why so quick and could this apparent Icelandic success story be applied elsewhere. Interestingly, much of the focus of that debate is very narrow and in reality not aimed at clarifying the Icelandic recovery but at proving or disproving aspects of austerity, the euro or both.

Unfortunately, much of this debate is misleading because it is based on three persistent myths of the Icelandic recovery: that Iceland avoided austerity, did not save its banks and that the country defaulted. All three statements are wrong: Iceland has not avoided austerity, it did save some banks though not the three largest ones and did not default.

Indeed, the high cost of the Icelandic collapse is often ignored, amounting to 20-25% of GDP. Yet, not as high as feared to begin with: the IMF estimated it could be as much as 40%. The net fiscal cost of supporting and restructuring the banks is, according to the IMF 19.2% of GDP.

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Costliest banking crisis since 1970; Luc Laeven and Fabián Valencia.

As to lessons to avoid the kind of shock Iceland suffered nothing can be learnt without a thorough investigation as to what happened, which is why I believe the report, a lesson in itself, by the Special Investigative Commission, SIC, in 2010 was fundamental. Tackling eventual crime, as by setting up the Office of the Special Prosecutor, is important to restore trust. Recovering from a collapse of this magnitude is not only about economic measures and there certainly is no one-trick fix.

On specific issues of the economy it is doubtful that Iceland, a micro economy, can be a lesson to other countries but in general, the lessons are simple: sound public finances and sound public institutions are always essential but especially so in times of crisis.

In general: small economies fall and bounce fast(er than big ones)

The path of the Icelandic economy over the past fifty years has been a path up mountains and down deep valleys. Admittedly, the banking collapse was a major shock, entirely man-made in a country used to swings according to whims of fishing stocks, the last one being in the last years of the 1990s.

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(Statistics, Iceland)

 

Sound public finances, sound institutions

What matters most in a crisis country? Cleary a myriad of things but in hindsight, if a country is heading for a major crisis make sure the public finances are in a sound state and public authorities and institutions staffed with competent people, working for the general good of society and not special interests – admittedly not a trivial thing.

Since 1980 Icelandic sovereign debt to GDP was on average 48.67%, topped at almost 60% around the crisis in late 1990s and had been going down after that. Compare with Greece.

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Trading Economics

Same with the public budget: there was a surplus of 5-6% in the years up to 2008, against an average of -1.15% of GDP from 1998 to 2014. With a shocking deficit of 13.5% in 2009 it has since steadily improved, pointing to a balanced budget this year and a tiny surplus forecasted for next year. Again, compare with Greece.

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Trading Economics

As to institutions, the CBI has been crucial in prodding the necessary recovery policies; much more so after change of board of governors in early 2009. Sound institutions and low corruption is the opposite of Greece, where national statistics were faulty for more than a decade (see my Elstat saga here).

Events in 2008

In early 2007, with sound state finances and fiscal strength the situation in Iceland seemed good. The banks felt invincible after narrowly surviving the mini crisis on 2006 following scrutiny from banks and rating agencies (the most famous paper at the time was by Danske Bank’s Lars Christensen).

Icelanders were keen on convincing the world that everything was fine. The Icelandic Chamber of Commerce hired Frederic Mishkin, then professor at Columbia, and Icelandic economist Tryggvi Þór Herbertsson to write a report, Financial Stability in Iceland, published in May 2006. Although not oblivious to certain risks, such as a weak financial regulator, they were beating the drum for the soundness of the Icelandic economy.

But like in fairy tales there was one major weakness in the economy: a banking system with assets, which by 2008 amounted to ten times the country’s GDP. Among economists it is common knowledge that rapidly growing financial sector leads to deterioration in lending. In Iceland, this was blissfully ignored (and in hindsight, not only in Iceland: Royal Bank of Scotland is an example).

Instead, the banking system was perceived to be the glory of Icelandic policies in a country that had only ever known wealth from the sea. Finance was the new oceans in which to cast nets and there seemed to be plenty to catch.

In early 2008 things had however taken a worrying turn: the value of the króna was declining rapidly, posing problems for highly indebted households – 15% of their loans were in foreign currency, i.a. practically all car loans. The country as a whole is dependent on imports and with prices going up, inflation rose, which hit borrowers; consumer-price indexed, CPI, loans (due to chronic inflation for decades) are the most common loans.

Iceland had been flush with foreign currency, mainly from three sources: the Icelandic banks sought funding on international markets; they offered high interest rates accounts abroad – most of these funds came to Iceland or flowed through the banks there (often en route to Luxembourg) – and then there was a hefty carry trade as high interest rates in Iceland attracted short- and long-term investors.

“How safe are your savings?” Channel 4 (very informative to watch) asked when its economic editor Faisal Islam visited Iceland in early March 2008. CBI governor Davíð Oddsson informed him the banks were sound and the state debtless. Helping the banks would not be “too much for the state to swallow (and here Oddsson hesitated) if it wanted to swallow it.” – Yet, timidly the UK Financial Services Authority, FSA, warned savers to pay attention not only to the interest rates but where the deposits were insured the point being that Landsbanki’s Icesave accounts, a UK branch of the Icelandic bank, were insured under the Icelandic insurance scheme.

The 2010 SIC report recounts in detail how Icelandic authorities ignored or refused advise all through 2008, refused to admit the threat of a teetering banking system, blamed it all on hedge funds and soldiered on with no plan.

The first crisis measure: Emergency Act Oct. 6 2008

Facing a collapsing banking system did focus the minds of politicians and key public servants who over the weekend of October 4 to 5 finally realised that the banks were beyond salvation. The Emergency Act, passed on October 6 2008 laid the foundation for splitting up the banks. Not into classic good and bad bank but into domestic and foreign operations, well adapted to alleviating the risk for Iceland due to the foreign operations of the over-extended banks.

The three old banks – Kaupthing, Glitnir and Landsbanki – kept their old names as estates whereas the new banks eventually got new names, first with the adjective “Nýi,” “new,” later respectively called Arion bank, Íslandsbanki and Landsbankinn. Following the split, creditors of the three banks own 87% of Arion and 95% of Íslandsbanki, with the state owning the remaining share. Due to Icesave Landsbanki was a different case, where the state first owned 81.33%, now 97.9%.

In addition to laying the foundation for the new banks, one paragraph of the Emergency Act showed a fundamental foresight:

In dividing the estate of a bankrupt financial undertaking, claims for deposits, pursuant to the Act on on (sic) Deposit Guarantees and an Investor Compensation Scheme, shall have priority as provided for in Article 112, Paragraph 1 of the Act on Bankruptcy etc.

By making deposits a priority claim in the collapsed banks interests of depositors were better secured than had been previously (and normally is elsewhere).

When 90% of a financial system is swept away keeping payment systems functioning is a major challenge. As one participant in these operations later told me the systems were down for no more than ca. five or ten minutes during these fateful days. All main institutions, except of course the three banks, withstood the severe test of unprecedented turmoil, no mean feat.

The coming months and years saw the continuation of these first crisis measures.

It is frequently stated that Iceland, the sovereign, was bankrupted by the collapse or defaulted on its debt. That is not correct though sovereign debt jumped from ca. 30% of GDP in 2008 until it peaked at 101% in 2012.

IMF and international assistance of $10bn

That fateful first weekend of October 2008 it so happened that there were people from the IMF visiting Iceland and they followed the course of events. Already then seeking IMF assistance was discussed but strong political forces, mainly around CBI governor Davíð Oddsson, former prime minister and leader of the Independence party, were vehemently against.

One of the more surreal events of these days was when governor Oddsson announced early morning on October 7 that Russia would lend Iceland €4bn, with maturity of three to four years, the terms 30 to 50 basis points over Libor. According to the CBI statement “Prime Minister Putin has confirmed this decision.” – It has never been clarified who offered the loan or if Oddsson had turned to the Russians but as the Cypriot and Greek government were to find out later this loan was never granted. If Oddsson had hoped that a Russian loan would help Iceland avoid an IMF program that wish did not come true.

On November 17, 2008 the Prime Minister’s Office published an outline of an Icelandic IMF program: Iceland was “facing a banking crisis of extraordinary proportions. The economy is heading for a deep recession, a sharp rise in the fiscal deficit, and a dramatic surge in public sector debt – by about 80%.”

The program’s three main objectives were: 1) restoring confidence in the króna, i.a. by using capital controls; 2) “putting public finances on a sustainable path”; 3) “rebuilding the banking system… and implementing private debt restructuring, while limiting the absorption of banking crisis costs by the public sector.”

An alarming government deficit of 13.5% was now forecasted for 2009 with public debt projected to rise from 29% to 109% of GDP. “The intention is to reduce the structural primary deficit by 2–3 percent annually over the medium-term, with the aim of achieving a small structural primary surplus by 2011 and a structural primary surplus of 3½-4 percent of GDP by 2012.” – This was never going to be austerity-free.

By November 20 2008 IMF funds had been secured, in total $2.1bn with $827m immediately available and the remaining sum paid in instalments of $155m, subject to reviews. The program was scheduled for two years and the loan would be repaid 2012 to 2015.

Earlier in November Iceland had secured loans of $3bn from the other Nordic countries together with Russia and Poland (acknowledging the large Polish community in Iceland). Even the tiny Faroe Islands chipped in with $50m. In addition, governments in the UK, the Netherlands and Germany reimbursed depositors in Icelandic banks, in all ca. $5bn. Thus, Iceland got financial assistance of around $10bn, at the time equivalent of one GDP, to see it through the worst.

In spite of a lingering suspicion against the IMF, both on the political left and right, there was never the defiance à la greque. Both the “collapse coalition” and then the left government swallowed the bitter pill of an IMF program and tried to make the best of it. Many officials have mentioned to me that the discipline of being in a program helped to prioritise and structure the necessary measures.

Recently, an Icelandic civil servant who worked closely with the IMF staff, told me that this relationship had been beneficial on many levels, i.a. had the approach of the IMF staff to problem solving been an inspiration. Here was a country willing to learn.

Part of the answer to why Iceland did so well is that the two governments more or less followed the course set out in he IMF program. This turned into a success saga for Iceland and the IMF. One major reason for success was Iceland’s ownership of the program: politicians and leading civil servants made great effort to reach the goals set in the program. – An aside to the IMF: if you want a successful program find a country like Iceland to carry it out.

Capital controls: a classic but much maligned measure

For those at work on crisis measures at the CBI and the various ministries there was little breathing space these autumn weeks in 2008. No sooner was the Emergency Act in place and the job of establishing the new banks over (in reality it took over a year to finalise) when a new challenge appeared: the rapidly increasing outflow of foreign funds threatened to sink the króna below sea level and empty the foreign currency reserves of the CBI.

On November 28 the CBI announced that following the approval of the IMF, capital flows were now restricted but would be lifted “as soon as circumstances allow.” De facto, Iceland was now exempt from the principle of freedom of capital movement as this applies in the European Economic Area, EEA. The controls were on capital only, not on goods and services, affected businesses but not households.

At the time they were set, the capital controls kept in place foreign-owned ISK650bn, or 44% of Icelandic GDP, mostly harvest from carry trades. Following auctions and other measures these funds had dwindled down to ISK291bn by the end of February 2015, just short of 15% of GDP. However, other funds have grown, i.e. foreign-owned ISK assets in the estates of the failed banks, now ca. ISK500bn or 25% of GDP.

In addition, there is no doubt certain pressure from Icelandic entities, i.e. pension funds, to invest abroad. The Icelandic Pension Funds Association estimates the funds need to invest annually ISK10bn abroad. Greater financial and political stability in Iceland will help to ease the pressure. (Further to the numbers behind the capital controls and plan to ease them, see my blog here).

With capital controls to alleviate pressure politicians in general have the tendency to postpone solving the problems kept at bay by the controls; this has also been the case in Iceland. The left government made various changes to the Foreign Exchange Act but in the end lacked the political stamina to take the first steps towards lifting them. With up-coming elections in spring 2013 it was clear by late 2012 that the government did not have the mandate to embark on such a politically sensitive plan so close to elections.

In spring 2015, after much toing and froing, the coalition of Independence party led by the Progressive party presented a plan to lift the controls. The most drastic steps will be taken this winter, first to bind what remains from the carry trades and second to deal with the estates, where ca. 80% of their foreign-owned ISK assets will be paid as a “stability contribution” to the state. (I have written extensively on the capital controls, see here). The IMF estimates it might take up to eight years to fully lift the controls.

It is notoriously difficult to measure the effects of capital controls. It is however a well-known fact that with time capital controls have a detrimental effect on the economy, as the CBI has incessantly pointed out in its Financial Stability reports.

In its 2012 overview over the Icelandic program the IMF summed up the benefits of controls:

“… as capital controls restricted investment opportunity abroad, both foreign and local holders of offshore króna found it profitable to invest in government bonds, which facilitated the financing of budget deficit and helped avoid a sovereign financing crisis.” – Considering the direct influence of inflation, due to CPI-indexation of household debt, the benefits also count for households.

Again, measuring is difficult but the stability brought by the controls seems to have helped though the plan to lift them came none too soon. Some economists claim the controls were unnecessary and have only done harm. None of their arguments convince me.

Measures for household and companies

Icelandic households have for decades happily lived beyond their means, i.e. household debt has been high in Iceland. The debt peaked in 2009 but has been going down rapidly since then.

CBIhouseholdDebt

CBI

Already in early 2008, the króna started to depreciate versus other currencies. From October 2007 to October 2008 the changes were dramatic: €1 stood at ISK85 at the beginning of this period but at ISK150 in the end; by October 2009 the €1 stood at ISK185.

Even before the collapse it was clear that households would be badly hit in various ways by the depreciating króna, i.a. due to the CPI-indexation of loans as mentioned above. In addition, banks loaded with foreign currency from the carry trades had for some years been offering foreign currency loans, in reality loans indexed against foreign currencies. With the króna diving instalments shot up for those borrowing in foreign currency; as pointed out earlier, 15% of household debt was in foreign currency.

The left government’s main stated mission was to shield poorer households and defend the welfare system during unavoidable times of austerity following the collapse. In addition, there was also the point that in a contracting economy private spending needed to be strengthened.

The first measure aimed directly at households was in November 2008 when the government announced that people could use private pension funds to pay down debt.

Soon after the banking collapse borrowers with loans in foreign currency turned to the courts to test the validity of these loans. As the courts supported their claims the government stepped in to push the banks to recalculate these loans.

In total, at the end of January 2012 write-downs for households amounted to ISK202bn. For non-financial companies the write-downs totalled ISK1108bn by the end of 2011 (based on numbers from Icelandic Financial Services Association). In general, Icelandic households have been deleveraging rapidly since the crisis.

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CBI

Governments in other crisis countries have been reluctant to burden banks with the cost of write-downs and non-performing loans. In Iceland, there was a much greater political willingness to orchestrate write-downs. The fact that foreign creditors owned two of the three banks may also have made it less painful to Icelandic politicians to subject the banks to the unavoidable losses stemming from these measures.

Changes in bankruptcy law

In 2010 the Icelandic Bankruptcy Act was changed. Most importantly, the time of bankruptcy was shortened to two years. The period to take legal action was shortened to six months.

There are exemptions from this in case of big companies and bankruptcy procedures for financial companies are different. However, the changes profited individuals and small companies. In crisis countries such as Greece, Ireland and Spain bankruptcy laws has been a big hurdle in restructuring household finances, only belatedly attended to.

… and then, 21 months later, Iceland was back to growth

It was indicative of the political climate in Iceland that when the minister of finance, trade and economy Steingrímur Sigfússon, leader of the Left Green party, announced in summer 2011 that the economy was now growing again his tone was that of an undertaker. After all, the growth was “only” forecasted to be around 2%, much less than what Iceland had enjoyed earlier. Yet, this was a growth figure most of his European colleagues would have shouted from the rooftops.

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Abroad, Sigfússon was applauded for turning the economy around but he enjoyed no such appreciation in Iceland.

As inequality diminished during the first years of the crisis the government could to a certain degree have claimed success (see on austerity below). However, the left government did poorly in managing expectations. Torn by infighting, its political opponents, both in opposition and within the coalition parties never tired of emphasising that no measures were ever enough. That was also the popular mood.

The króna: help or hindrance?

Much of what has been written on the Icelandic recovery has understandably been focused on the króna – if beneficial and/or essential to the recovery or curse – often linked to arguments for or against the EU and the euro.

A Delphic verdict on the króna came from Benedikt Gíslason, member of the capital controls taskforce and adviser to minister of finance Bjarni Benediktsson. In an interview to the Icelandic Viðskiptablaðið in June 2015 Gíslason claimed the króna had had a positive effect on the situation Iceland found itself in. “Even though it (the króna) was the root of the problem it is also a big part of the solution.”

Those who believe in the benefits of own independent currency often claim that Iceland did devalue, as if that had been part of a premeditated strategy. That however was not the case: the króna has been kept floating, depreciating sharply when funds flowed out in 2008. The capital controls slammed the break on, stabilising and slowly strengthening the króna.

Lately, with foreign currency inflows, i.a. from tourism, the króna has further appreciated but not as much as the inflows might indicate: the CBI buys up foreign currency, both to bolster its reserve and to hinder too strong a króna. Thus, it is appropriate to say that the króna float is steered but devaluation, as a practiced in Iceland earlier (up to the 1990s) and elsewhere, has not been a proper crisis tool.

Had Iceland joined the EU in 1995 together with Finland and Sweden, would it have taken up the euro like Finland or stayed outside as Sweden did? There is no answer to this question but had Iceland been in the euro capital controls would have been unnecessary (my take on Icelandic v Greek controls, see here). Would the euro group and the European Central Bank, ECB, have forced Iceland, as Ireland, to save its banks if Iceland had been in the euro zone? Again, another question impossible to answer. After all, tiny Cyprus did a bail-in (see my Cyprus saga here).

On average, fisheries have contributed around 10% to the Icelandic GDP, 11% in 2013 and the industry provided 15-20% of jobs. Fish is a limited resource with many restrictions, meaning that no matter markets or currency fishing more is not an option.

Tourism has now surpassed the fishing industry as a share of GDP. Again, depreciating króna could in theory help here but Iceland is not catering to cheap mass tourism but to a more exclusive kind of tourism where price matters less. Attracting over a million tourists a year is a big chunk for a population of 330.000 but my hunch is that the value of the króna only has a marginal effect, much like on the fishing industry: the country’s capacity to receive tourists is limited.

Currency is a barometer of financial soundness. One of the problems with the króna is simply the underlying economy and the soundness of the governments’ economic policies or lack of it, at any given time. Sound policies have often been lacking in Iceland, the soundness normally not lasting but swinging. Older Icelanders remember full well when the interests of the fishing industry in reality steered the króna, much like the soya bean industry in Argentina.

The króna is no better or worse than the underlying fundamentals of the economy. In addition, in an interconnected world, the ability of a government to steer its currency is greatly limited, interestingly even for a major currency like the British pound. What counts for a micro economy like Iceland is not necessarily applicable for a reserve currency.

Needless to say, the króna did of course have an effect on how Iceland fared after the collapse but judging exactly what that effect has been is not easy and much of what has been written is plainly wrong. (I have earlier written about the right to be wrong about Iceland; more recent example here). In addition, much of what has been written on Iceland and the króna is part of polemics on the EU and the euro and does little to throw light on what happened in Iceland.

Iceland: no bailouts, no austerity?

There have been two remarkably persisting stories told about the Icelandic crisis: 1) it didn’t save its banks and consequently no funds were used on the banks 2) Iceland did not undergo any austerity. – Both these stories are only myths, which have figured widely in the international debate on austerity-or-not, i.a. by Paul Krugman (see also the above examples on the right to be wrong about Iceland) who has widely touted the Icelandic success as an example to follow. Others, like Tyler Cowen, have been more sceptical.

True, Iceland did not save its three largest banks. Not for lack of trying though but simply because that task was too gigantic: the CBI could not possibly be the lender of last resort for a banking system ten times the GDP, spread over many countries.

When Glitnir, the first bank to admit it had run out of funds, turned to the CBI for help on September 29 2008, the CBI offered to take over 75% of the bank and refinance it. It only took a few days to prove that this was an insane plan. The CBI lent €500m to Kaupthing on the day the Alþingi passed the Emergency Act, October 6 2008, half of which was later lost due to inappropriate collaterals. This loan is the only major unexplained collapse story.

The left government later tried to save two smaller banks – a futile exercise, which only caused losses to the state – and did save some building societies. The worrying aspect of these endeavours was the lack of clear policy; it smacked of political manoeuvring and clientilismo and only added to the high cost of the collapse, in international context.

As to austerity, every Icelander has stories to tell about various spending cuts following the shock in October 2008. Public institutions cut salaries by 15-20%, there were cuts in spending on health and education. (Further on cuts see IMF overview 2012).

With the left government focused on the poorer households it wowed to defend benefit spending and interest rebates on mortgages. These contributions are means-tested at a relatively low income-level but helped no doubt fending off widening inequality. Indeed, the Gini coefficients have been falling in Iceland, from 43 in 2007 to 24 in 2012, then against EU average of 30.5. (See here for an overview of the social aspects of the collapse from October 2011, by Stefán Ólafsson).

In addition, it is however worth observing that although inequality in general has not increased, there are indications that inter-generational inequality has increased, as pointed out in the CBI Financial Stability Report nr. 1, 2015: at end of 2013 real estate accounted for 82% of total assets for the 30 to 40 years age group, compared to 65% among the 65 to 70 years old. The younger ones, being more indebted than the older ones are much more vulnerable to external shocks, such as changes in property prices and interest rates. Renters and low-income families with children, again more likely to be young than older people, are still vulnerable groups.

In the years following the crisis the unemployment jumped from 2.4% in 2008 to peak of 7.6% in 2011, now at 4.4%. Even 7.6% is an enviable number in European perspective – the EU-28 unemployment was 9.5% in July 2015 and 10.9.% for the euro zone – but alarming for Iceland that has enjoyed more or less full employment and high labour market participation.

Many Icelanders felt pushed to seek work abroad, mostly in Norway, either only one spouse or the whole family. Poles, who had sought work in Iceland, moved back home. Both these trends helped mitigate cost of unemployment benefits.

Austerity was not the only crisis tool in Iceland but the country did not escape it. And as elsewhere, some have lamented that the crisis was not used better to implement structural changes, i.a. to increase competition.

The pure luck: low oil prices, tourism and mackerel

Iceland is entirely dependent on oil for transport and the fishing fleet is a large consumer of oil. Iceland is also dependent on imports, much of which reflect the price of oil, as does the cost of transport to and from the country. It is pure luck that oil prices have been low the years following the collapse, manna from heaven for Iceland.

The increase in tourism has been crucial after the crisis. Tourism certainly is a blessing but the jobs created are notoriously low-paying jobs. As anyone who has travelled around in Iceland can attest to, much of these jobs are filled not by Icelanders but by foreigners.

Until 2008, mackerel had never been caught in any substantial amount in Icelandic fishing waters: the catch was 4.200 ton in 2006, 152.000 ton in 2012. Iceland risked a new fishing war by unilaterally setting its mackerel quota. Fishing stocks are notoriously difficult to predict and the fact that the mackerel migrated north during these difficult years certainly was a stroke of luck.

The non-measureables: Special Prosecutor and the SIC report

As Icelanders caught their breath after the events around October 6 2008 the country was rife with speculations as to what had indeed happened and who was to blame. There were those who blamed it all squarely on foreigners, especially the British. But the collapse also changed the perception of Icelanders of corruption and this perception has lingered in spite of action taken against individuals. This seems to be changing, yet slowly.

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When Vilhjálmur Bjarnason, then lecturer at the University of Iceland, now MP for the Independence party, said following the collape that around thirty men (yes, all males) had caused the collapse, many nodded.

Everyone roughly knew who they were: senior bankers, the main shareholders of the banks and the largest holding companies, all prominent during the boom years until the bitter end in October 2008. Many of these thirty have now been charged, some are already in prison and other fighting their case in courtrooms.

Alþingi responded swiftly to these speculations, by passing two Acts in December: setting up an Office of a Special Prosecutor, OSP and a Special Investigative Committee, SIC to clarify the collapse of the financial sector. These two Acts proved important steps for clearing the air and setting the records straight.

After a bumpy start – no one applied for the position of a Special Prosecutor – Ólafur Hauksson a sheriff from Reykjavík’s neighbouring town Akranes was appointed in January 2009. Out of 147 cases in the process of being investigated at the beginning of 2015, 43 are related to the collapse (the OSP now deals with all serious cases of financial fraud).

The Supreme Court has ruled in seven cases related to the collapse and sentenced in all but one case; Kaupthing’s second largest shareholder and three of the bank’s senior managers are now in prison after a ruling in the so-called al Thani case. – Gallup Iceland regularly measures trust in institutions. Since the OSP was included, in 2010, it has regularly come out on top as the institution enjoying the highest trust.

As to the SIC its report, published on 12 April 2010, counts a 2600 page print version, which sold out the day it was published, with additional material online; an exemplary work in its thoroughness and clarity.

The trio who oversaw the work – its chairman then Supreme Court judge Páll Hreinsson (now judge at the EFTA Court), Alþingi’s Ombudsman Tryggvi Gunnarsson and Sigríður Benediktsdóttir then lecturer in economics at Yale (now head of Financial Stability at the CBI) – presented a convincing saga: politicians had not understood the implication of the fast growing banking sector and its expansion abroad, regulators were too weak and incompetent, the CBI not alert enough and the banks egged on by over-ambitious managers and large shareholders who in some cases committed criminality.

How have these two undertakings – the OSP and the SIC – contributed to the Icelandic recovery? I fully accept that the effect, as I interpret it, is subjective but as said earlier: recovery after such a major shock is not only about direct economic measures.

Setting up the OSP has strengthened the sense that the law is blind to position and circumstances; no alleged crime is too complicated to investigate, be it a bank-robbery with a crowbar or excel documents from within a bank. The OSP calmed the minds of a nation highly suspicious of bankers, banks and their owners.

The benefit of the SIC report is i.a. that neither politicians nor special interests can hi-jack the collapse saga and shape it according to their interests. The report most importantly eradicated the myth that foreigners were only to blame – that Iceland had been under siege or attack from abroad – but squarely placed the reasons for the collapse inside the country.

The SIC had a wide access to documents, also from the banks. The report lists loans to the largest shareholders and other major borrowers. This clarified who and how these people profited from the banks, listed companies they owned together with thousands of Icelandic shareholders.

The SIC’s thorough and well-documented saga may have focused the political energy on sensible action rather than wasting it on the blame game. Interestingly, this effect is no less relevant as time goes by. To my mind, the atmosphere both in Ireland and Greece, two countries with no documented overview of what happened and why, testifies to this.

In addition, the report diligently focuses on specific lessons to be learnt by the various institutions affected. Time will show how well the lessons were learnt but at least heads of some of these institutions took the time and effort, with their staff, to study the outcome.

A country rife with distrust and suspicion is not a good place to be and not a good place for business. Both these undertakings cleared the air in Iceland – immensely important for a recovery after such a shock, which though in its essence an economic shock is in reality a profound social shock as well.

I mentioned sound institutions above. Their effect is not easily measureable but certainly well functioning key institutions such as ministries, National Statistics and the CBI have all been important for the recovery.

Lessons?

In its April 2012 Ex Post Evaluation of Exceptional Access Under the 2008 Stand-by Arrangement the IMF came up with four key lessons from Iceland’s recovery:

(i) strong ownership of the program … (ii) the social impact can be eased in the face of fiscal consolidation following a severe crisis by cutting expenditures without compromising welfare benefits, while introducing a more progressive tax system and improving efficiency; (iii) bank restructuring approach allowing creditors to take upside gains but also bear part of the initial costs helped limit the absorption of private sector losses by public sector; and (iv) after all other policy options are exhausted, capital controls could be used on a temporary basis in crisis cases such as Iceland, where capital controls have helped prevent disorderly deleveraging and stabilize the economy.

The above understandably refers to the economic recovery but recovering from a shock like the Icelandic one – or as in Ireland, Greece and Cyprus – is not only about finding the best economic measures, though obviously important. It is also about understanding and coming to terms with what happened.

As mentioned above, I firmly believe that apart from classic measures regarding insolvent banks and debt, both sovereign and private, the need to clarify what happened, as was done by the SIC and to investigate alleged criminality, as done by the OSP, is of crucial importance – something that Ireland (with a late and rambling parliamentary investigation), Greece, Cyprus and Spain could ponder on. All of this in addition to sound institutions and sound public finances before a crisis.

The soul lagging behind

In the olden days it was said that by traveling as fast as one did in a horse-drawn carriage the soul, unable to travel as fast, lagged behind (and became prone to melancholia). Same with a nation’s mood following an economic depression: the soul lags behind. After growth returns and employment increases it takes time until the national mood moves into the good times shown by statistics.

Iceland is a case in point. Although the country returned to growth, with falling unemployment, in 2011 the debate was much focused on various measures to ease the pain of households and nothing seemed ever enough.

The Gallup Expectations monitor turned upwards in late 2009, after a steep fall from its peak in late 2007, and has been rising slowly since. Yet it is now only at the 2004 level; the Icelandic inclination to spending has been sig-sawing upwards. – Here two graphs, which indicate the mood:

Screenshot 2015-09-23 14.31.48

Screenshot 2015-09-23 14.34.23

With plan in place to lift capital controls, the last obvious sign of the 2008 collapse will be out of the way. Implementation will take some years; a steady and secure execution this coming winter will hopefully lift spirits in the business community.

Living intimately with forces of nature, volcanoes and migrating fish stocks, and now tourists, as fickle as the fish in the ocean, Icelanders have a certain sangue-froid in times of uncertainty. Actions by the three governments since the collapse have at times been rambling but on the whole they have sustained recovery.

A sign of the lagging soul is that growth has not brought back trust in politics. Politicians score low: the most popular party now enjoying ca. 35% in opinion polls, almost seven years after the collapse and four years since turning to growth, is the Pirate party, which has never been in government.

Recovery (probably) secured – but not the future

As pointed out in a recent OECD report on Iceland the prospect is good and progress made on many fronts, the latest being the plan to lift capital controls: “inflation has come down, external imbalances have narrowed, public debt is falling, full employment has been restored and fewer families are facing financial distress. “

However, the worrying aspect is that in addition to fisheries partly based on cheap foreign labour the new big sector, tourism, is the same. Notoriously low productivity – a chronic Icelandic ill – will not be improved by low-paid foreign labour. Well-educated and skilled Icelanders are moving abroad whereas foreigners moving to the country have fewer skills. Worryingly, there is little political focus on this.

As the OECD points out “unemployment amongst university graduates is rising, suggesting mismatch. As such, and despite the economic recovery, Iceland remains in transition away from a largely resource-dependent development model, but a new growth model that also draws on the strong human capital stock in Iceland has yet to emerge.”

Iceland does not have time to rest on its recovery laurels. Moving out of the shadow of the crisis the country is now faced with the old but familiar problems of navigating a tiny economy in the rough Atlantic Ocean.

This post is cross-posted with A Fistful of Euros.

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Written by Sigrún Davídsdóttir

September 23rd, 2015 at 3:17 pm

Posted in Uncategorised

Myth-busting

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It was good to see the FT (paywall) taking up some of the myths of Icelandic recovery. Funnily enough, Icelanders have not been the proponents of the idea that Iceland is some sort of a model. From early on, after the collapse in October 2008, foreign economists have looked to Iceland in search for arguments for their various ideas, often with quite misunderstood facts and/or context.

More on this later – I’ve often mentioned these myths and will do more of it – but I was intrigued to see my Economonitor article, co-written with professor Thorolfur Matthiasson, University of Iceland, quoted by the FT  as the work of “two Icelandic experts.” The article shows that the cost to Iceland of the collapse of the banks has indeed been substantial, 20-25% of GDP. There are now 355 tweets and 205 Facebook shares of the Economonitor article so it is far to say it has had a lively distribution.

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Written by Sigrún Davídsdóttir

March 4th, 2013 at 11:54 pm

Posted in Iceland

Iceland: successful recovery and the non-bail-out banking myth

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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.

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Written by Sigrún Davídsdóttir

November 22nd, 2011 at 6:04 pm

Posted in Iceland

How is this possible, Greece?

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The Greek ELSTAT saga has taken yet another turn, which should be a cause for grave concern in any European country: a unanimous acquittal by three judges of the Greek Appeals Court in the case of former head of ELSTAT Andreas Georgiou has been annulled. This was announced Sunday December 18 – the case  was up in court December 6 – but no documents have been published so far, another worrying aspect.

The acquittal was the fourth attempt to acquit Gergiou – and this is now the fourth attempt to  thwart the course of Greek justice and revive the unfounded charges against him. The intriguing thing to note here is that the acquittal was annulled by a prosecutor at the First Instance Court, who in September brought a whole new case regarding the debt and deficit statistics from 2010 and ELSTAT staff role here, this time not only accusing ELSTAT staff of wrongdoing but also staff from Eurostat and the IMF; a case still versing in the Greek justice system.

All of this rotates around the fact that ELSTAT, and now Eurostat and IMF staff, is being prosecuted for producing correct statistics after more than a decade of fraudulent  reporting by Greek authorities.

It beggars belief that the justice system in Greece seems to be wholly under the power of political forces who try as best they can to avoid owning up to earlier misdeeds. In spite of acquittals, those who corrected the fraudulent statistics are being prosecuted relentlessly while nothing is done to explain what  went on during the time of the fraudulent reporting. It should also be noted that in order to stop the ELSTAT prosecutions completely, four other cases related to this one, need to be stopped.

The ELSTAT staff is here reliving the horrors of the Lernaen Hydra in Greek mythology. Georgiou and his colleagues have had international support but that doesn’t deter Greek authorities from something that certainly looks like a total abuse of justice. How is it possible to time and again take up a case where those charged have already been acquitted?

Icelog has followed the ELSTAT saga, see here for earlier blogs, explaining the facts of this sad saga.

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Written by Sigrún Davídsdóttir

December 19th, 2016 at 5:20 pm

Posted in Uncategorised

Iceland: back to its old conservative roots?

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“Epic success! There are a lot of coalition possibilities” tweeted elated newly elected Pirate MP Smári McCarthy the morning after polling day. Quite true, the Pirates did well, though less well than opinion polls had indicated. Two of the four old parties, the Left Greens and the Independence Party could also claim success. The other two oldies, the Progressives and the Social Democrats, suffered losses. Quite true, with Bright Future and the new-comer Viðreisn, Revival, in total seven instead of earlier six parties, there are plenty of theoretical coalition possibilities. But so far, the party leaders have been eliminating them one by one leaving decidedly few tangible ones. Unless the new forces manage to gain seats in a coalition government Iceland might be heading towards a conservative future in line with its political history.

In spite of the unruly Pirates and other new parties the elections October 29 went against the myth of Iceland abroad as a country rebelling against old powers – the myth of a country that lost most of its financial system in a few days in October 2008 instead of a bailout, then set about to crowd-write a new constitution, investigate its banks and bankers and jailing some of them and is now, somehow as a result of all of this, doing extremely well.

True, Iceland is doing well – mostly due to pure luck: low oil prices, high fish prices on international markets and being the darling of discerning well-heeled tourists. No new constitution so far and at a closer scrutiny the elections results show a strong conservative trend, in line with the strong conservative historical trend in Icelandic history: during the 72 years since the founding of the Icelandic republic in 1944 the Independence Party has been in government for 57 years, most often leading a coalition and never more than two to three years in opposition except when the recent left government kept the party out in the cold for four years, 2009 to 2013.

The results: historic shift to new parties screenshot-2016-11-03-15-04-55

(From Iceland Monitor)

With 63 MPs the minimum majority is 32 MPs.

Of the seven parties now in Alþingi four are seen as the old parties – Independence Party, Left Green, Progressives and the social democrats – in Iceland often called the “Four-party.” Their share of the votes was 62%, the lowest ever and down from 75% in the 2013 elections, meaning that the new parties grabbed 38%. A historic shift since the old parties have for decades captured 80-90% of the votes. The Four-party now has 42 seats, the new-comers 21 seats.

The left government 2009 to 2013: an exception rather than a new direction

As strongly as the Nordic countries have been social democratic Iceland has been conservative. And still is. Iceland is not living up to its radical image and the left government of 2009 to 2013 was more the exception than a change of direction. The present outcome shows no left swing but the swing to the new parties may prove to be a game changer in Icelandic politics.

The left parties, Left Green and the social democrats, now have thirteen seats, compared to sixteen in 2013, the centre/neither-left-nor-right Bright Future, the Pirates and the Progressives have 22 seats, 28 in 2013 but the right/conservative parties, the Independence Party and Revival, are the largest faction with 28 seats, up from nineteen in 2013. – As I heard it put recently in Iceland there are Progressive-like conservatives in all parties and the Progressives tend to strengthen the worst sides of the Independence Party, such as illiberal cronyism.

With seven parties in Alþingi, the Icelandic Parliament, up from six during recent parliamentary term, the party game of guessing the possible coalition, both in terms of number of MPs and political synergies, is now on in Iceland.

A right centre outcome seems more likely than a left one

It’s the role of the president to decide which leader gets the mandate to form a government, normally the leader of the largest party but other leaders are however free to try. The task facing the newly elected president Guðni Th. Jóhannesson, a historian with the Icelandic presidency as his field of expertise, seems a tad complicated.

The president followed the traditional approach and gave the mandate to Bjarni Benediktsson leader of the largest party, the Independence Party who first met with the Progressive’s Sigurður Ingi Jóhannsson who lead the Progressive-Independence coalition that has just resigned. The two parties now only have 29 seats between them. – Given the right-leaning/conservative weight in Alþingi a right-centre government might seem more likely than a left government.

The leader of Bright Future Óttar Proppé, seen as a possible coalition partner for the conservatives, seemed surprisingly unenthusiastic: to him a coalition with the Independence Party and Revival “doesn’t seem like an exciting option,” adding that there is a large distance policy-wise between his party and the largest one.

Proppé had earlier suggested to the president that Revival’s leader Benedikt Jóhannesson be given the mandate; Jóhannesson has already suggested he’s better poised to form a government than Benediktsson since Revival can appeal both to left and right.

Katrín Jakobsdóttir leader of the Left Green has stated that her party would be willing to attempt forming a five party centre-left coalition, i.e. all parties except the Independence Party and the Progressives, a rather messy option. The Pirates leader Birgitta Jónsdóttir has said her party could defend a minority left government.

Four winners

Since the founding of the Republic of Iceland in 1944 the Independence Party has always been the country’s largest party and the one most often in government. Its worst ever result was in the 2009 elections, when it got only 16 seats. Getting 19 in 2013 and 21 seats now may seem good but it’s well below the now unreachable well over 30% in earlier decades. Yet, gaining two seats now makes the party a winner.

Its leader Bjarni Benediktsson sees himself as the obvious choice to form a coalition, given the support of his party but it will strongly test his negotiation skills. In the media he comes across as rather wooden but he’s popular among colleagues, which might make his task easier though he can’t erase policy issues unpopular with the other parties such as the parties anti-EU stance and being the watchdog of the fishing industry.

The Left Green Movement was formed in 1999 when left social democrats split from the old party and joined forces with environmentalists. The Left Green has always been the small left party but is now the largest left party next to the crippled social democrats. The elf-like petite Katrín Jakobsdóttir has imbued the party with fresh energy. Her popularity, far greater than the results of the party, no doubt helped secure a last minute swing against predictions. She has been the obvious candidate to lead a left-leaning government, now an elusive opportunity.

Viðreisn, Revival, is a new centre right party, running for the first time but founded in disgust and anger by liberal conservatives from the business community. In general they felt the Independence Party was turning too illiberal, too close to the fishing industry so as to lose sight of other businesses.

But most of all the Revivalists were angered by the broken promises of the Independence Party in 2013 regarding EU membership. During the 2013 campaign the party tried to ease out of taking a stance on EU by promising to hold a referendum asking if EU membership negotiations should be continued. Once in government the Independence Party broke this promise causing weeks of protests and widespread anger some of which Revival captured.

Revival’s founder Benedikt Jóhannesson was seen as an unlikely leader and admitted as much to begin with but has proved an adept leader, also by attracting some strong and well-known candidates from the Icelandic business community. Getting seven MPs in its first run spells good for the party but history has shown that getting elected is the easy part compared to keeping a new party functioning in harmony. However, the Revival’s energetic start has for the first time in decades given the Independence Party a credible competition on the right wing.

The outcome has made Jóhannesson flush with success and he was quick to put his name forward as the right person to form and lead a centre right government. Revival did no doubt capture some Independence party voters but many of them had already defected to the social democrats now leaving that party for Revival.

The Pirate Party is the winner who lost the great support shown earlier in opinion polls, probably never a likely outcome; growing from three MPs to ten is the success McCarthy tweeted about. The party rose out of protests and demonstrations after the 2008 calamities and ran for the first time in 2013, winning three seats.

Their feisty leader Birgitta Jónsdóttir, with 32.000 Twitter followers and foreign fame for her involvement with Wikileaks and Iceland as a data protection haven, is unlikely to be the first Pirate prime minister in the world. Given that the party has had some in-house friction to deal with – they had to call in an occupational psychologist to restore working relations – the unity of the parliamentary group might be in question, making the party less appealing for others as a coalition partner.

Two losers and one survivor

The Social Democrats suffered a crushing defeat, even worse than the opinion polls had predicted and worse than the dismal outcome in 2013. As parties consumed with infighting – the UK Labour Party springs to mind – the energy of the Social Democrats has been wasted on infighting at the cost of a constructive election campaign. Common to other sister parties in Europe the Icelandic Social Democrats have not been able to come up with a convincing policy and its standing with young people is low.

Party leader Oddný Harðardóttir struggled with her speech on election night when all she seemed to be able to think of was that the party once had a good cause; the long list of helping hands she named sounded like each and every of the few voters left. Harðardóttir has now inevitably resigned, giving space for more destructive infighting. Some wonder if the party will survive, others speculate its remains will unite with the Left Green and restore unity and strength on the left wing. Historically seen, the Icelandic left has always split when it grew, adding strength to the right wing and the indomitable Independence Party.

The Progressive Party has lost its incredible upswing of nineteen MPs in 2013 to a much more plausible eight MPs. Plausible, because its upswing to 24% in 2013 was built on cheap promises made by its leader Sigmundur Davíð Gunnlaugsson that brought him all the way into the Prime Minster’s office. But the votes had hardly been counted in 2013 when voters started to lose faith in the party: it has been on a downward slide towards a more natural, in a historical perspective, just over 10% shares of votes.

This old agrarian centre party, sister party of other old Nordic centre parties of similar origin, has traditionally been related to the Icelandic now mostly defunct cooperative movement and still close to certain special interests in agriculture and fishing. Its strength was to appeal to both the left and the right but under Gunnlaugsson it turned more nationalistic/right-leaning, trying to appeal equally to urbanistas and racists and not only old farmers. His successor, representing more traditional Progressive policies might revert to the old party roots, yet needing to find a modern twist for an old party slowly losing ground.

The Panama Papers exposed Gunnlaugsson as a cheat – he had kept quiet about the infamous Wintris, the offshore company he owned with his wife, meaning the couple had huge assets abroad as Icelanders were locked inside capital controls – and a liar as he tried to ease out of the story. He lost his office and then lost his leadership of the party only shortly before the elections. After the elections he claimed to have had a campaign plan, which would have taken the party to 19%. “A bad loser” commented one Progressive ex-MP. Gunnlaugsson’s successor Sigurður Ingi Jóhansson dryly said Gunnlaugsson had not shared this plan with the party leadership.

Bright Future is one of several parties that rose out of protests following the 2008 banking collapse, partially an offspring of the group close to Jón Gnarr the comedian-turned-mayor of Reykjavík 2010 to 2014. It was the new political darling in 2013, securing six MPs. Seen as a centre left liberal party its leader Óttar Proppé is a soft-spoken intelligent politician. The party has recently been hovering around the 5% limit needed to secure a seat in Alþingi but did in the end better than forecasted, losing only two of six seats. Consequently, the party still has a future in Icelandic politics and possibly even a bright one as it might be essential whatever part of the political spectre a coalition will cover.

Scrabbling with numbers – the eliminated options

Juggling parties and numbers of MPs – the minimum majority is 32 MPs – there are in total seventeen possible combinations for a coalition. Although the Progressives have traditionally been a true centre party appealing to left and right, the first elimination seems to be the Progressive Party, unless a path is found around one specific hindrance: the former party leader.

Were the Progressives offered to be in a coalition and given that Gunnlaugsson is an MP it’s almost unthinkable to form a government without him as a minister; but it seems equally unthinkable that the other parties would want to be in government with him. His career as a prime minster has given all but his ardent admirers the feeling that he is shifty and untrustworthy. His admirers will say that opponents fear his toughness.

In spite of losses the Progressive leadership is eager to get into government but Progressive leader Jóhannsson has so far evaded answering if the party could join a coalition without Gunnlaugsson as a minister. There are speculations that the parliamentary group is split: some support Gunnlaugsson, others his successor but some are now speculating that the party would indeed willingly sacrifice Gunnlaugsson in order to get into government again.

Both Left Green Katrín Jakobsdóttir and the Pirates’ Birgitta Jónsdóttir have excluded joining a government with or lead by the Independence Party. When Jónsdóttir went to meet Benediktsson, holding court to hear views of all the parties, she said she doubted that his party was interested in fighting corruption, a key Pirate issue.

Revival’s Benedikt Jóhannesson excluded reviving the present government of Progressives and the Independence Party by joining them. – Thus, the realistic possibilities seem quite fewer than the theoretical ones.

Scrabbling with numbers – the realistic options

Out of the flurry of the first days and considering parties and policies the most realistic combination seemed to be a government with the Independence Party, Bright Future and Revival. That poses an existential dilemma for Revival: though ideologically close to the Independence Party there is this one marked exception – the EU stance.

In the same vein as the British conservatives, to whom the Independence Party is much more similar than to its Nordic sister parties, the anti-EU sentiments have over the years gradually grown stronger. Bjarni Benediksson was on the pro-EU line around ten years ago but not any longer. The lack of EU option on the right was indeed the single most important reason why Revival was founded as mentioned above.

Jóhannesson is a former fairly influential member of the Independence Party – and a close relative of Benediktsson in a country where blood is always much thicker than water and family-relations matter. One of the party’s MPs, Þorgerður Katrín Gunnarsdóttir, was a minister for the Independence Party in 2003 to 2009 but left politics after the banking collapse, tainted by her husband’s high position with Kaupthing, at the time the largest bank in Iceland.

The question most often put to Revival candidates during the election campaign was if the party wasn’t just the Independence Party under another name. Going into government simply to help the Independence Party stay in power would be unwise as Revival would risk to be seen as exactly that what it’s claimed to be: the Independence Party under another name.

Fishing quota – and EU: a lukewarm topic but possibly a political dividing line

Revival will have to take up the EU matter, i.e. in a coalition with the Independence Party it would have to get that party to fulfil its 2013 promise to hold a referendum on the EU negotiations started under the Left government in summer of 2009. At the time EU membership was driven by the social democrats in spite of the Left Green anti-EU stance: the social democrats had for years campaigned for EU membership, also in the 2009 spring election, and once in government felt they had the mandate to open membership negotiations. The plan was to put a finalised membership agreement to a referendum on membership. Ever since the negotiations started anti-EU forces have claimed it was without a mandate.

The attempts of the Progressive-Independence coalition after it came to power in 2013 to end the negotiation turned into a farce: the two parties didn’t want to bring it up in Alþingi where it risked being voted down and the EU didn’t want to accept a termination unless supported by a parliamentary vote.

Forcing a referendum on the membership negotiation would fulfil Revival’s EU promises and it could most likely count on the support of Bright Future. For the Independence Party it would be a very bitter pill to swallow. Opinion polls have always shown a majority for negotiating though there rarely has been a majority for joining the EU. Event though EU membership isn’t an issue in Icelandic politics it could well draw certain insuperable lines in the coalition talks.

If Revival’s Jóhannesson should be given the mandate to form a government as Bright Future’s Proppé has suggested it would certainly strengthen Jóhannesson’s agenda.

Apart from EU policy Revival has fought for a new agriculture policy, away from the old Progressive emphasis on state aid and most of all for a new way to allocate fishing quota, a hugely contentious issue in Icelandic policies. The two old former coalition partners are dead against any changes whereas all the other parties have presented more or less radical policies to change the present fishery system.

Left government in a conservative country

Ever since the 2013 elections, which ended the left government in power since 2009, the opposition parties have aired the idea of joining political forces against the Progressive-Independence coalition.

Few days before the elections the Pirate leader Birgitta Jónsdóttir called the opposition to a meeting to prepare some sort of a pre-elections alliance or as she stated to clarify the options for a coalition. Revival didn’t accept the invitation and Bright Future wasn’t keen. The Independence Party claimed this was a first step towards a left government and by stoking left fears this Pirate initiative might indeed have driven voters to the conservatives.

Jónsdóttir is now peddling a more simple solution: a minority government of Revival, Bright Future and Left Greens that the Pirates, together with the remains of the Social Democrats, would support. Five parties in a government sounds chaotic – coalitions of three parties have never sat a full term in Iceland. And given the alleged tension in the Pirate Party the other parties might be wary of fastening their colours to the Pirate mast, inside or outside a government.

Minority governments have been rare in Iceland contrary to the other Nordic countries and suggesting this solution as politicians are only starting to explore coalition options will hardly tempt anyone until possibilities of a majority government have been exhausted.

Supporting a government but not being in it would be a plum position for the Pirates. The party has pledged to finish the new constitution, in making since 2008. A new constitution needs to be ratified by a new parliament and the Pirates had called for the coming parliament to sit only for s short period, pass a new constitution and then call elections again. No other party is keen on this and there has been only a limp political drive to finalise a radical rewrite of the constitution.

There are those who dream of a government spanning the Independence Party and the Left Green; this government would however need the third party to have majority. For anti-EU forces this is the ideal government since it would most likely prevent any EU move. But as stated: Left Green Jakobsdóttir has so far claimed the distance between the parties is too great, leaving no basis for such a coalition.

Discontent in a boom without xenophobia and racism

In a certain sense all the new parties are protest parties but not with the sheen of demagogy seen in many other recent European protest parties. The response to the banking crisis and the ensuing massive fall in living standards was certainly a protest against the four old parties giving rise to various new parties of which Bright Future and the Pirates are the only ones now in Alþingi.

The only real touch of demagogy with a tone of xenophobia didn’t come from any of these parties but from the Progressive Party under the leadership of Gunnlaugsson in the 2013 elections and the 2014 local council elections. However, there has so far never been any real appetite in Iceland for this agenda. The Icelandic Popular Front, lingering on the fringe of Icelandic politics for years and the only party offering a pure xenophobic racist agenda, this time got the grand sum of 303 votes or 0.16%.

Compared to the political environment in Europe the real political sensation in Iceland, so far, is that there is no sign of the xenophobia and outright racism in the main parties. Yes, people lost jobs following the 2008 collapse but there wasn’t the sense that foreigners were taking jobs or that foreigners were to blame. As so clear from the debate on foreigners, inter alia in Britain, sentiments normally override facts and figures. These sentiments can be heard rumbling in Iceland but have so far not flourished.

Although the economy has been growing since 2011 following the sharp downturn the previous years and is now booming the discontent is still palpable. Very much directed towards politicians based on a sense of cronyism and the sense that politicians, especially from the old parties, are there to guard and aid special interests such as the fishing industry and wealthy individuals with political ties.

Gunnlaugsson with his Panama connections was ousted. But both Bjarni Benediktsson and Ólöf Nordal his deputy chairman, named in the Panama Papers, have brushed it off easily. Nordal was linked to Panama through her husband, working for Alcoa, but claimed the company was just an old story. Benediktsson owned an offshore company related to failed investments in Dubai and also claimed it was an old story, causing remarkably little curiosity and coverage in Iceland.

The left government, in power 2009 to 2013, did in many ways tackle the ever-present cronyism in Iceland by using stringent criteria and gender balance for hiring people on boards, leading jobs in the public sector etc. Yet, it earned little gratitude for this. One of the most noticeable changes when the Progressive-Independence coalition came to power in 2013 was its reverting back to the bad habits of former times. Over the last few years sales of certain state assets have also raised some questions. Sales of the two now state-owned banks and other state assets on the agenda these will again test the Icelandic hang to cronyism and corruption.

The underlying discontent in booming Iceland possibly shows that it’s not only the economy that matters. But it also shows that after a severe shock it takes time for the political powers to gain trust. The coming four years will be a further test. As one voter said: “I would have liked to see all parties acknowledge the events in 2008 and come forth with a plan as to how to how to avoid the kind of political behaviour that led to the 2008 demise – but there was no such comprehensive plan.”

– – –

The new Alþingi: The new gathering of MPs has a greater number of women than ever before: 30 MPs of 63 are women. The tree youngest MPs are born in 1990, the oldest, and newly elected, is born in 1948. Katrín Jakobsdóttir, born in 1976, is one of seven MPs voted into Alþingi before 2008. Following the three last elections a large number of MPs have left and new ones coming in. As prime minister Sigurður Ingi Jóhannsson said it’s good to get new energy into the austere halls of Alþingi but it’s equally worrying to lose competence, knowledge and experience: 22 have never sat in Parliament before, ten are new but with some parliamentary experience, in total 32 out of 63 MPs.

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Written by Sigrún Davídsdóttir

November 3rd, 2016 at 3:08 pm

Posted in Uncategorised

The ELSTAT case takes a new turn – IMF and Eurostat staff implicated

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Anyone who has followed the Greek crisis will be familiar with stories of insane corruption and absurd clientilismo. As the criminal prosecution of the former head of ELSTAT, Andreas Georgiou, shows the Tsipras government prefers scapegoats rather than facing painful truths about the past. Now, also foreigners working for the IMF and Eurostat are being implicated in a new criminal case against Georgiou and his colleagues.

Before the January 2015 elections, which brought Alex Tsipras and his Syriza party to power, Tsipras had been adamant on the need to tackle corruption. Once in power this discourse ebbed out. Now Tsipras and his government is watching a so-called independent judiciary persecuting the former head of ELSTAT, the Greek statistical bureau, Andreas Georgiou, who demonstrably turned ELSTAT and statistics around after a decade of falsified statistics.

The latest and most remarkable turn in the ELSTAT saga is a new criminal investigation, not only focusing on Georgiou and two of his colleagues, whose cases have all been dismissed more than once (see my detailed ELSTAT saga, written after I visited Athens in June 2015) but also on the IMF and Eurostat staff.

As I have earlier pointed out the ELSTAT prosecutions are a test of the new Greece trying to be born after the crisis: as long as ELSTAT staff and now foreigners striving to bring clarity to statistics, one of the absolute pillars of any modern country, are being prosecuted Greece is failing to free itself of political corruption. The fact that the Greek state is yet again trying to prosecute civil servants who did their jobs admirably is a sign of something seriously wrong in this country.

To Icelog Georgiou says: “The prosecutions within the borders of the European Union of official statisticians, whose work has been thoroughly checked and fully validated by the competent European Union institutions for six years in a row, should be a cause of great concern given their important precedential significance at a European Union level and an international level as well.”

A new criminal investigation of ELSTAT directors – as well as IMF and Eurostat staff

The latest move was brought on by the chief prosecutor of the Greek Supreme Court, Xeni Demetriou. As a deputy prosecutor of the Supreme Court until June 2016, Demetriou had been responsible for proposing in September 2015 to annul the last acquittal decision regarding Andreas Georgiou and his two colleagues. In the event, the Supreme Court published a decision in August 2016 accepting that annulment proposal and referring the case back to the lower court so that the latter reconsider its decision.

Amazingly, in this latest move, Demetriou as chief prosecutor, initiates an additional, brand new criminal investigation. The case was brought following a publication of two articles in the Greek newspaper Dimokratia at the end of August; the articles were introduced with photos of Andreas Georgiou, as well as of Eurostat and IMF officials.

Apparently based on emails and other sources, Dimokratia focuses on the 2009 deficit calculation. The newspaper’s coverage doesn’t seem to add anything but clamours statements such as “The Mafia of the Deficit,” to what was earlier investigated and then dismissed in previous attempts to bring Georgiou and his colleagues to court. The magazine reported inter alia of burglaries to allegedly make the case against the ELSTAT directors go away, postulating that they incriminate Georgiou and his colleagues.

This new prosecution does not only involve ELSTAT directors but goes further, involving IMF and Eurostat staff. Dimokratia claims that Eurostat’s Director General Walter Radermacher forced Greece to use statistical methods not used in any other country, directly causing the high deficit. The grand scheme was to force Greece to pay foreign banks, or as stated by the magazine: “the dirty plan of the destruction of Greece was planned and executed with distorted data so that the foreign banks can be repaid completely.”

One of the Dimokratia sources is Nikos Stroblos, a former director of the national accounts division of Greece’s statistics office during the years of fraudulent reporting. As so often pointed out on Icelog: quite extraordinarily, Georgiou and ELSTAT directors who brought the reporting of statistics to international standards, are being hounded in Greece but nothing has been done to investigate what went on during the years of false reporting.

International support for Georgiou and his ELSTAT colleagues

Eurostat and the European commission have earlier voiced concern over the turn of events in Greece. On August 24 Commissioner for Employment, Social Affairs, Skills and Labour Mobility, as well as European statistics, Marianne Thyssen was adamant that the independence of ELSTAT and the quality of its statistics were essential, adding that from the point of view of the Commission and Eurostat “it is absolutely clear that data on Greek Government debt during 2010-2015 have been fully reliable and accurately reported to Eurostat.” The Commission called “upon the Greek authorities to actively and publicly challenge the false impression that data were manipulated during 2010-2015 and to protect ELSTAT and its staff from such unfounded claims.”

The International Statistical Institute, ISI, has earlier voiced great concern for the course of events in Greece and has recently, yet again, called upon “the Greek authorities to actively and publicly challenge the false impression that data were manipulated during 2010-2015 and to protect ELSTAT and its staff from such unfounded claims.”

Further, ISI, “is extremely concerned about the persecution/prosecutions of Mr. Andreas Georgiou, Ms. Athanasia Xenaki and Mr. Kostas Melfetas for doing their work with the highest professionalism, integrity and adherence to international standards and the UN Principles, regardless of political pressure. It is inconceivable that such work, independently verified and approved in line with international standards, could lead to prosecution, and even successful prosecution of those responsible. Instead, such work should be praised!”

Persecution due to correct statistics shows the Tsipras government’s ties to the past

So far, none of this has had the slightest effect on the Tsipras government.

As pointed out recently on Icelog, the case against Georgiou and his colleagues, and now also involving IMF and Eurostat staff, is a test of the Greek government’s commitment to change and to acknowledge fraudulent behaviour in the past.

As pointed out by Tony Barber in the Financial Times on September 12, Tsipras is “yet again testing his EU partners’ patience. He is not only dragging his heels on economic reform, but is letting a criminal prosecution go ahead in a blatantly politicised case against Andreas Georgiou, a former head of the national statistics agency.”

In his review of “Game Over,” ex minister of finance George Papaconstantinou’s book on his six years in politics, Peter Spiegel notes the significance of the ELSTAT case and the Greek tendency to find scapegoats: “… it is Greece’s abiding myth that somehow the day of reckoning was avoidable. Papaconstantinou’s highly readable book makes that falsehood clear. No doubt Mr Georgiou’s trial will do the same.”

As long as Alexis Tsipras and his government continue to persecute the ELSTAT directors it is clear that the old bad ways and corrupt powers are untouched and still ruling.

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Written by Sigrún Davídsdóttir

September 16th, 2016 at 11:04 pm

Posted in Uncategorised

Iceland, capital controls and foreign pundits

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One of the problems with the debate in Iceland on capital controls is that so few seem to grasp the essentials. Consequently, politicians and special-interest agents on a mission can get away with saying almost whatever they fancy without being challenged. Once in a while, foreigners dive in, equally ill-informed, thwarting the debate further for Icelanders who, as so many small nations, tend to swallow everything coming from abroad. A case in point is a recent FT article by Gillian Tett with a somewhat misleading description of the Icelandic situation only some weeks after the IMF published a most informative report on Iceland. IMF gives some intriguing hints on two key issues: the Central Bank of Iceland and the legal routes out of the capital controls’ impasse.

Practically all nations forced to save themselves by slamming on capital controls struggle to get rid of them. It is by now an all too familiar problem that the shelter, provided by the controls for solving the original problem calling for controls, tends to turn into a hammock for in-action. Iceland is no exception.

The situation in Iceland however offers further complexities: getting rid of the controls will not prove easy at the best of times – but the overwhelming sense among control-watchers is that there might be wheels within the capital control wheels: first of all, steering the two new banks, Arion and Íslandsbanki, now owned by the failed estates of respectively Kaupthing and Glitnir, into hand-picked, politically-palatable ownership in what could be called “the asset sale of the century” (Icelog on this topic). Secondly, the government is seeking to preferably score a “victory” (à la Argentina) over the foreign creditors by securing funds from them for the state.

Iceland’s attraction for pundits in search of a good case to prove their point

Over the past few years, Iceland has been seductively attractive to economists and pundits looking for a story to prove their points/theories. Writing in July 2010 à propos an article by Paul Krugman on Iceland I pointed out that “when it comes to small countries (or exotic topics) it seems permissible to express opinions without knowing very much – or even anything at all.” – Those in the know and understanding are few and far between.

One myth has been that by letting its banks fail, Iceland’s cost of the collapse was almost negligible (more on this here). The cost partly rose from misguided attempts to save two private banks, possibly because of some domestic interests at stake. In addition, there was the cost of propping up the Icelandic “Sparkassen-system.” Thus, the cost of the collapse and resurrecting the country’s economy is more likely to be one of the highest for every country over the last few decades, ca. 20-25% of GDP.

In a recent article in the FT Gillian Tett joins the company of Krugman and many others on the well-trodden path of misunderstandings regarding the Icelandic collapse, subsequent events and the state of affairs right now. Apart from it being slightly shocking that such an esteemed paper as the FT does not take more care with what it prints the article provides a good opportunity to sum up the essentials on post-collapse Iceland and the capital controls. However, Tett’s general point certainly is valid: there is an essential topic for debate on emergency measures that are used as delaying tactics instead of a necessary shelter to work on solutions.

What happened when the banks collapsed?

Tett writes:

When the three banks collapsed, the government decided to save the domestic parts of the system (and its own taxpayers) by piling pain on to foreign creditors and depositors. So bank bonds held by foreigners were tossed into default and turned into implicit equity claims on the collapsed lenders – and bank deposits that foreign investors held in Icelandic krona were trapped in the country by capital controls.

True, the idea was to save the domestic part. The dilemma was how to dismantle a banking system ca. eight times the GDP of Iceland without drowning the whole economy at the same time. (The Icesave saga is about depositors in Landsbanki’s accounts in the UK and the Netherlands and EU’s passport rules for the financial sector; remarkable there was a mini-rerun of the passport conundrum in the UK following the Cyprus crisis; some aspects of Iceland vs Cyprus here).

Consequently, the operations of the three largest banks were divided into domestic and foreign operations. There were, and still are, persistent rumours that during the hectic days in early October 2008, when the emergency Act was being finalised, the policy really was called “f**k the foreigners.” Hardly shocking: a country staring into the abyss will go to great lengths to save itself, thinking less about others.

As explained in the Financial Services Authority, FME’s, annual report 2009 (there was no annual report in 2008) following the emergency Act (Act 125/2008) passed on October 6 2008 the three largest banks – Kaupthing, Landsbanki and Glitnir – were taken over by the FME and divided into “old” banks (destined to be wound up or liquidated at some point) and “new” banks. Like any estate of a failed private entity these failed banks are controlled on behalf of creditors, now by Winding-up Boards, one for each bank.

The three so-called new banks were turned into fully operating domestic banks. Following a crash settlement in the days after the October 2008 collapse the FME oversaw the finalising of financial instruments, based on valuation of assets transferred, between the old and the new banks. The new banks for Kaupthing, Landsbanki and Glitnir are respectively Arion, Landsbankinn and Íslandsbanki.

Thus there was a clear dividing line – not that “bank bonds held by foreigners were tossed into default.” And as in any failed company the creditors hold claims in the three failed/old banks.

According to the FME assets and liabilities of the new banks the “principal asset classes were loans to customers, on the one hand, which were further subdivided into loans to large corporations, small and medium sized enterprises and retail loans and, on the other hand, other assets. Liabilities consisted almost solely of deposits, which were valued at principal value. Gross loans to customers (that is the outstanding loan balances before any provisions or adjustments) represented over 80% of gross assets in each of the three new banks. Large corporate group loans (with liabilities in excess of ISK 2.5 billion) represented ca. 40%-70% of total gross loans to customers and ca. 55%-85% of corporate loans to customers across the three new banks at the respective carve-out dates.”

The problem that called for capital controls

The original problem, calling for capital controls, was foreign-owned ISK, or “nonresident holdings of liquid krona” as the IMF calls it. At the time these funds were over ISK600bn, but following CBI auctions these funds now amount to ISK322bn (at the end of February 2014) or 18% of GDP; 67% of gross reserves. These funds mostly originated from so called “glacier bonds” – bonds issued in Icelandic króna, ISK, often sold to wealthy individuals, popular in Germany and the Netherlands. At the time, both the government and the CBI chose to ignore the potentially destabilising effect of these, in spite of the effect of similar flows on some Asian countries in the 1980s and the 1990s.

These funds are no longer the greatest threat to Icelandic financial stability. In addition, it seems that at least some part of these funds willingly stays in Iceland because of the (still) high interests there.

But what is now the problem if it is no longer these liquid foreign-owned ISK? Tett talks about the bank bonds held by foreigners being “tossed into default and turned into implicit equity claims on the collapsed lenders – and bank deposits that foreign investors held in Icelandic krona were trapped in the country by capital controls.

The main obstacles towards lifting the controls are the ISK assets of Glitnir and Kaupthing, in total ISK450bn (end of 2013; further here) and the two Landsbanki bonds of which ISK226bn is still unpaid (more here; more on the numbers and how they are found in CBI’s latest stability report).

The bondholders now hold a claim on the estates, as happens in any other failed company. They were inevitably mostly foreigners since the banks’ fast growth was fuelled by international lenders and not by domestic deposits and domestic bond sales.

It is also worth noting that in total, 5.7% of the claims are owned by Icelanders, or just over ISK100bn, mostly held by the Eignasafn Seðlabanka Íslands, ESÍ (the CBI holding company). These funds could possibly be part of the solution, i.e. used in swaps with foreign creditors. (See here for numbers and facts, in my digest of the latest IMF report and here for my latest overview of numbers and possible solutions).

Why is it important to lift the controls?

In the past few weeks the government has indicated that it wants to start removing these controls to attract more investment to the energy sector and to create a more “normalised” financial system,” writes Tett.

The story is a lot longer than just a few weeks. The left government, in power from spring 2009 until the elections last spring, did got very far with plans to remove the capital controls – also because it was too weak to tackle the issue towards the end – but some progress was made. The CBI presented a plan in 2011, still the basis as no new plan is in place (here is an Arion bank analysis from December 2011 of that plan; the time frame has since been lifted, meaning that the plan is no longer anchored in time but to certain benchmarks).

During the election campaign the Progressive party, which until early last year seemed destined to be close to a wipe-out in the spring elections, attracted an unexpected following by promising voters debt relief funded by creditors, i.e. funds that would “inevitably” flow to the state as the controls on the two bank estates would be lifted. The numbers mentioned escalated from ISK300bn to as much as ISK800bn mentioned just before the election. However, when the debt relief was presented last November it was not funded by these “inevitable” sources of money but from a bank levy, also on the estates and from people’s own pension savings, a step IMF warns against in its last Iceland report.

It is misleading to say that the scope for lifting the controls is only to attract FDI for the energy sector. And it certainly is not just to normalise the financial sector, but to normalise the whole economy. As the CBI now points out at every opportunity the capital controls do in themselves induce a long-term risk, i.a. here:

Capital controls limit possibilities for cost-efficiency in business and distort the premises for investment decisions. The longer the control regime remains in force, the greater is the risk that investment options will be determined to a growing extent by possibilities of returns within the controls, while at the same time emphasis grows on seeking ways to circumvent the controls. The structure of business and industry could therefore in time develop differently within the control regime than without it. Options decline in number, and output growth and living standards deteriorate.

This spring, numerous individuals and organisations in the business community univocally called for government action towards lifting the capital controls. But no matter the policy it will realistically take some years until the controls are lifted. In addition, Iceland will also have to come up with a credible vision for the króna and the future. There are also those who believe some controls will be needed for years and possibly decades to come.

Correct proportions, correct numbers

According to Tett, Iceland’s “sovereign debt is “just” 84 per cent of gross domestic product, according to the International Monetary Fund. But if you add the remaining liabilities of the banks – which are implicitly owned by the government – the total debt ratio is 221 per cent, and there is little chance of the island repaying it in full.” (Emphasis mine).

According to the IMF’s latest report Iceland’s sovereign debt was 89.9% last year and projected to be 86.4% this year. The three new banks are not “implicitly owned by the government”: the state owns 13% of shares in Arion and 5% in Íslandsbanki with the estates of Kaupthing and Glitnir respectively owning the rest. The government owns 97.9% of Landsbanki with the employees owning the tiny rest.

Further, Tett writes that “any relaxation will force a new debate about that debt mountain, since the $7.4bn of krona held by foreigners in Iceland’s banks will almost certainly flee if controls are removed without any clarity on how creditors who hold Icelandic bank debt will be treated. And a flight of capital could spark a fresh crisis.”

“That debt mountain” seems to refer to the 221%. What the $7.4bn of foreign-owned krona assets refers to is not entirely clear: the foreign-owned ISK in Glitnir and Kaupthing are in total ISK450bn, $3.9bnbn – and the original overhang is ISK322bn, $2.8bn.

Thinking that the controls will be lifted “without any clarity on how creditors who hold Icelandic bank debt will be treated” seems to indicate a fundamental lack of understanding of the problem: this is exactly the main problem now being worked on and no lifting can or will happen until it is solved. As the CBI and the IMF have repeatedly pointed out any steps towards lifting the controls will have to include a plan as to how to deal with foreign-owned ISK in Glitnir and Kaupthing. And not until then can the estates start paying out to the creditors (see here).

The good news,” according to Tett, “is that the government announced this week that it has appointed external advisers for talks with creditors. But the bad news is that finding any resolution could prove very hard. A group that represents about 70 per cent of bond holders wants its claims to be settled by selling the successors to the collapsed Icelandic banks to new foreign owners.”

True, it is good news that there are foreign advisers (given that their expertise will be used wisely). The bad thing is not, as Tett points out, that it could prove hard to find a solution. The bad thing is, as I have pointed out earlier, if the government does not have any plan to get their advise on – or is not ready to accept their proposals (perhaps because it is focused only on a solution that will move the ownership of Arion and Íslandsbanki to Icelandic owners with the right political pedigree).

Finding a solution is indeed not necessarily very hard (see here). Again, it will not be easy if the government is hell-bent on not just lifting the controls but also securing some special interests at the same time. According to the Act on Financial Undertakings  no. 161/2002 (the “Act on Financial Undertakings”) votes of parties controlling at least 2/3 of share capital or guarantee capital need to accept all major decisions of the estates.

Iceland is not Argentina – or at least not just yet/does not need to be

Tett is not the first to mention Iceland and Argentina in the same sentence as if the two countries shared the same problems: “So there is every likelihood the country will either end up in a protracted court fight, like the one between Argentina and its “holdout” creditors; or that the government keeps playing for time by extending those supposedly “temporary” controls indefinitely.

Argentina defaulted and has for a long time (in)famously been involved in legal warfare with some of its creditors (my favourite Argentinian commentaries are those by Joseph Cotterill on the FT Alphaville). Iceland has not defaulted and its problems are, so far, contained in the estates of the three failed private banks.

However, if the Icelandic government strides into the field and incurs liabilities by legal measures, which might make the creditors sue the government, i.a. because of breech of property rights, the situation could turn Argentinian. With foreign advisers, no doubt aware of all of this, as well as being concerned about reputational risks, as is indeed both the IMF and the CBI, it seems unlikely (though by no means unthinkable) that the Icelandic government will by accident or recklessness (or both) unwittingly find itself exposed to legal wrangling with the creditors.

I have argued earlier that the government is incidentally already exposed to such a risk. After a change in the capital controls Act last year, the minister of finance has to agree to certain steps regarding the fate of the estates. It is easy to think up several such scenarios resulting from this. I.a. the creditors could take legal action if they at some point feel that by inaction the minister is indeed a hindrance to payouts.

As many other pundits Tett is recounting the Icelandic financial disaster saga to prove general points. “The first is that “emergency” policy measures that distort the financial world tend to become addictive. Second, this addiction is very hard to break when there is an unpleasant debt overhang, be that of the public or semi-public sort.

With gross debt rising in the world these are indeed important and never too oft repeated lessons to be learnt from the Icelandic collapse saga. The Icelandic reality is not quite what Tett makes out of it but does never the less support the lessons she wants to draw from the Icelandic fall and recovery.

*All the essential information on Iceland, its economy and capital controls are here: the IMF pages on Iceland – and the CBI financial stability reports.

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Written by Sigrún Davídsdóttir

July 28th, 2014 at 3:35 pm

Posted in Iceland

New Government – what is known so far (updated)

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At 11.15 Icelandic time, the two parties, the Progressive Party and the Independence Party will hold a press conference to announce new ministers and their coalition agreement. What is known so far is that the Independence Party will get five ministries: finance, home office, trade and industry, education and health. The Progressive Party will lead the Government, i.e. Sigmundur Davíð Gunnlaugsson will be Prime Minister. In addition, his party will get social affairs, agriculture and fisheries, environment and foreign affairs.

The ministries are fewer than the ministerial posts because there will be more than one minister in some of the ministries. The Left Government had merged ministries. In the Welfare Ministry there is health and social affairs. In the Ministry of Industries and Innovation there is trade and industry.

And what about the membership negotiations with the European Union? According to Morgunblaðið, whose editorial stance is against Icelandic membership of the EU, the negotiations will be called off immediately. This is an indirect quote (in Icelandic) from leader of the Independence Party, Bjarni Benediktsson.

New Government, new style: the two leaders will sign the coalition agreement at some sort of a ceremony, apparently in the presence of the media, ca 100 km from Reykjavík, at Laugarvatn, a small village on the lake, Laugarvatn, which has grown around a few schools there.

In addition:

There are two things that I will be paying most attention to: EU membership and negotiations with creditors of the estates of Glitnir and Kaupthing that respectively own the two new banks, Íslandsbanki and Arion. As I have blogged on earlier, the development of these negotiations determine if and how the capital controls will be abolished.

In his recent piece on Vox EU, the Icelandic economist Jón Daníelsson writes about the Icelandic recovery, “myth or a miracle?” – Just briefly, I rather believe it is neither of these two. Further, he states: “The main reason why the Icelanders voted out their government was its deference towards foreign creditors. Iceland came under significant pressure from the IMF to accommodate foreign creditors, and the government gave in.” – I also disagree on this. The unanimous understanding in Iceland is that the Progressive Party did well because it made the simple promise of returning money to voters. As irresistible to Icelandic voters as a similar promise by Silvio Berlusconi to Italian voters recently.

Daníelsson seems to ignore that Iceland cannot both fleece foreign creditors and expect foreigners to be willing to invest in Iceland. In a global world isolationism and nationalism have its limits if a country wants to be connected to foreign trade and investments. And, by the way, attracting foreign investments has always been a problem in Iceland, incidentally as it has been in Italy.

Daníelsson seems to indicate that the drop in inflation is just a temporary one and the króna, having been stronger recently, will fall again. It remains to be seen but so far, the indication is that inflation is falling, partly due to a stronger króna, that might be fairly steady in the coming months. The Central Bank has indicated it will aim for the present króna level. More on the here, in analysis from Íslandsbanki.

According to polls, major part of Icelanders is against membership – but the majority wants to end the negotiations, get an agreement and vote on it.

PS I will be following the press conference, tweeting from it – and will blog on it later today.

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Written by Sigrún Davídsdóttir

May 22nd, 2013 at 9:12 am

Posted in Iceland

The cost of the Icelandic financial meltdown: 20-25% of GDP

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I’ve earlier pointed out that Iceland can’t quite be taken as an example of a country that didn’t bail out its banks. True, the three largest banks failed – but the cost of financial assistance to other banks and of setting up the new banks is substantial. Together with Thorolfur Matthiasson professor of economics at the University of Iceland I’ve written an article on the cost, published today on EconoMonitor.

Our concluding remarks are:

We are aware that the final cost, accrued from supporting the Icelandic financial system, to the Icelandic State will not be clear for some time to come. But there is a cost – and as we have shown above it is possible to plausibly calculate the potential cost. Since Iceland has become a popular comparison for economists studying crisis-stricken European countries we feel it merits this attempt. Our calculation shows that Iceland cannot be taken as an example of a country, which did not bail out its banks.

Compared to the UK, Icelandic taxpayers will pay 5 to 7 times more for government interventions in the financial market than is the case in the UK. Hence, the widely held belief that Icelandic citizens did force bondholders, bankers and shareholders of financial firms to shoulder the burden of the collapse of the Icelandic financial sector is wrong. Icelandic taxpayers used what amounts to almost a year’s worth of taxes to recapitalise the domestic part of the financial sector. Whether these bailouts were necessary or not can be debated but the cost of 20-25% of GDP is, according to our calculations, a reality.

However, a major difference, in terms of costs to UK and Icelandic taxpayers is that foreign creditors carry the bulk of the cost of the Icelandic collapse – as the three big banks failed in October 2008 these creditors lost what amounts to 5 to 6 times the Icelandic GDP.  But that is a wholly different saga.

Here are four blogs I’ve written earlier about this myth that Iceland didn’t bail out its banks, also comparing Iceland to Greece and Ireland.

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Written by Sigrún Davídsdóttir

December 5th, 2012 at 7:11 pm

Posted in Iceland

Ireland and Iceland – better to let fail or to bail out?

with 11 comments

When it comes to bailing out banks Ireland and Iceland chose different paths. Interestingly, there are those who see the two countries as a test of whether it is better to let the bank system fail – or bail it out. That is at least how Jim Leaviss, head of retail fixed interest at M&G Investments is quoted as saying in an article on Ireland in the FT (subscription needed). “Iceland and Ireland were a test of whether it was better to let your bank system collapse or bail it out. So far it is not clear which was best. Irish bond yields have fallen a lot but that was skewed by the ECB’s actions.”

On the basic indicators, growth and unemployment Iceland, is doing much better.

Unemployment: Iceland: 4.5% – Ireland: 15.1%

Growth 2011/2012 (forecast): Iceland: 2.6% / 2.5% – Ireland 0.7% /  0.9%

The Irish ray of light these last days is the notch up by Fitch: from negative to stable (for those who still take any notice of the big rating firms), at BBB+.

As I’ve pointed out earlier it is however a myth that Iceland didn’t bail out its banks. It did bail out some smaller financial institutions to quite a cost but it didn’t bail out its three big banks – Kaupthing, Glitnir and Landsbanki – in October 2008. From early 2008, the Government (a coalition of the Independence Party, conservative and the social democrats, who now lead the Government) and the Central Bank did try to get loans from all and sundry to prepare for this eventuality – it did get a credit swap from the Scandinavian central banks of €1.5bn – but not enough to save the banks. The reality was that the banks couldn’t be saved.

The Icelandic Government has posted what amounts to 20-25% of GDP in bailing out – or trying to bail out – various other financial institutions and one insurance company. Some of this might be recovered later on but some of it is already lost. It is therefor not correct to say there were no bailouts in Iceland and therefore Iceland is not a crystal clear case of no bailouts vs bailouts.

As I have also pointed out earlier, the recovery in Iceland can partly be attributed to wide-reaching write-downs, both for companies and individuals and for changes in the bankruptcy law. All of this helps but it is over-simplification to say that there is any one policy that has made all the difference.

Ireland and Iceland have been very much in my mind for the last two days. I’ve been immersed in all things Irish, attending a conference at Goldsmiths University on the Future State of Ireland, brilliantly organized by Derval Tubridy senior lecturer in English Literature and Visual Culture at Goldsmiths. With illuminating lecturers like columnist and adviser to the EU on corruption Elaine Byrne, Roy Foster professor of Irish History at Oxford, Luke Gibbons professor of Irish Literary and Cultural Studies at National University of Ireland and journalist and writer Fintan O’Toole, this was bound to be an interesting event.

When I first saw the programme for the conference (which Elaine drew my attention to; thanks Elaine) and saw there were some artists involved my first thought was that this was most likely going to be a pretty fluffy event. It turned out to be the contrary – a very dense event with a fascinating insight into Irish History, culture and the Irish psyche.

The artist duo (Gareth) Kennedy (Sarah) Browne showed a video of ‘How Capital Moves’ – taking inspiration from an American company moving from Ireland to Poland. The story of this move is told from several aspects by creating several characters, all lovingly portrayed by one Polish actor. It’s funny and witty but also sadly true, based on words from people working for this company.

The photographer Anthony Haughey has been photographing the Irish and their surroundings for over 20 years, immigrants in this country of emigrants, as well as looking at parallel stories in other nations. His light is the living light caught by long exposures during the night. This profound realism – real as it gets – turns into strangely surreal scenes. The almost disturbingly beautiful photos reveal tension and troubled lives – portraying at the same time striking, still images and strong stories.

Foster’s stories of Irish radicals in the early 20th century seemed to indicate that something is lost in modern Ireland. Where is the radicalism now? Yet, listening to O’Toole and Byrne there doesn’t seem to be any lack of radical thought among journalists and columnists – and interestingly, Jim Clarke at Trinity College pointed out that the tabloids, though conservative in many ways, have been better at portraying people’s anger and disgust, than others.

There is one thing that Ireland has and not Iceland: a strong diaspora. That enriches the debate since it is easier being an outsider looking inside. Ireland is a small country where people speak carefully because everything and everybody is connected. A journalist who in the 1970s spoke of politicians taking bribes, proven right 40 years later, was at the time ostracized and forced to emigrate.

“Shame” and “blame” were two words that ran through the debate. For foreigners it’s easy to forget the other great power in Ireland, next to the state – the Catholic Church. The Irish have not only been thrown into economic turmoil, seeing the political class fail – but also seen grotesque moral failure and criminal child-abuse exposed in the church. Interesting times for the Irish – as was so strongly born out at the conference.

What the Irish still lack is a comprehensive overview of the collapse of their banks. To my mind, the Irish still have only a sporadic evidence of how they have been governed this last fateful decade before their main banks collapsed. The feeling in Ireland is that they do know it all. Before the SIC report was published in April 2010, Icelanders thought the same. The report showed that things had been much worse than even the most pessimistic thought: a complete failure of politicians, regulators, the Central Bank, the business “elite” – and of course the private banks, where bank managers are now being charged by the Special Prosecutor and sued by the three banks’ Winding-up boards. – In terms of legal action against bankers there is peculiarly little happening in Ireland.

It’s difficult to say which of the two countries will fare better. I still believe it’s been wrong for European governments to save failed banks. In Iceland, it was a relatively easy decision to take – there was no alternative regarding to the three big banks. The fact that the creditors were foreign financial institutions – mainly German banks – made it easier, both politically and financially.

Interestingly, it was the same with the Irish banks. Also there, the creditors were mainly foreign and yes, mainly German. But the sums in Ireland were much bigger – and the European Central Bank and the Germans weren’t happy to see banks fail in the euro zone: the ECB because of principles and euro pride; the Germans because German banks were at risk. The Germans are rather sanctimonious about their banks – after all, they are still standing. But the story is that German banks were prudent at home but wrecked havoc abroad – the German banks have been like teenagers who are model kids at home but cut up the furniture and paintings on the walls when they go partying out of their parents’ sight.

As has later become evident, the troika treatment of Ireland in November 2010 set the example of private bank debt migrating to the state, turning the state into an unsustainable borrower – as has now happened in Greece, Portugal and Cyprus, with Spain fiercely resisting to pick up that lethal same burden.

For every imprudent borrower there is a risk-blind lender. With the one-notch up on the Irish rating scale some will hope that the example made of Ireland will turn out to be the good example. There are voices in Ireland saying it is just not fair for the state – and the taxpayers – to be paying the privately accrued debt. It is painful to see the Irish struggling with the debt, which was so recklessly showered over them.

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Written by Sigrún Davídsdóttir

November 19th, 2012 at 12:48 am

Posted in Iceland