Sigrún Davíðsdóttir's Icelog

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.

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.

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.

(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.

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.

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.

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.

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.

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.

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:

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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A short aside to those who think it’s only the economy, stupid – well, at least this is not the case in Iceland. If this is the case elsewhere, winning against parties overseeing economic growth is far from impossible: interesting now that the British Labour party is searching its feet with Jeremy Corbyn.

Early in October 2008, 90% of the Icelandic financial system collapsed, leaving the nation shocked and bewildered. The government coalition at the time – social democrats led by the Independence party (c) – took some sensible measures and i.a. called in the International Monetary Fund, IMF. Yet, the coalition could not withstand the turmoil, in society and politics, and by February 2009 it had resigned, replaced by a left coalition with the Left Green party, never before in government, led by the social democrats.

By summer 2011, less than three years after this national cataclysm, Iceland was back to 2% growth. Nothing like the growth before the collapse but still growth, enviable in a European context.

The unemployment had spiked by that time, never went above the forecasted 10%. Still, shocking in Icelandic context though again benign compared to other crisis-hit European countries.

 

At the time of the next election, in spring 2013, the economy was doing well,unemployment clearly falling, household debt falling and the two most important industries, fishing and tourism, doing well. Yet, the government that turned the economy around lost (yes, for many reasons such as vicious infighting and, what simply seemed a lack of will to live… another saga).

Now, things are going even better, finally with a plan to lift the capital controls (execution remains to be seen) and many even talk of/fear a brewing boom in Iceland.

And what do the voters say? Aren’t they happily embracing the government that has brought the economy onwards and upwards? No, actually not. Nor is there any nostalgia for the old left government, these two parties are doing badly as are the two parties in government.

Instead, the voters have cast their love, at least in polls, on the Pirate party, which has never been in government and only just made it above the 5% hurdle, needed to get elected, in the 2013 election. In an early September poll, the Pirates scored an incredible 35.9%.

In the olden days it was said that when a man traveled by a carriage the soul would lag behind as it could not keep up with the speed of the fast-moving carriage. This seems to apply to the national mood in Iceland: the economy is growing, even close to booming but the soul of the Icelanders has far from caught up – unless the Icelandic soul is simply yearning for an elusive something else not caught by the politics on offer from the other parties.

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After barely making it on to the ballot paper, Jeremy Corbyn beats even Tony Blair’s 1994 record and gathers 59.5% support for leadership. Anti-establishment parties have been sprouting in Europe but the fairly unique aspect of Corbyn’s success is his rise within an old and established party. Much is made of his (self-proclaimed) socialism. Yet, it is more likely that Corbyn gathered support not because he is a socialist but in spite of being one. Getting elected as a leader was the easy bit; leading will be the truly tricky part unless Corbyn proves to be a political virtuoso – and the European left will be watching.

For his opponents, it seems easiest to attack Jeremy Corbyn for being a socialist as the majority of voters are clearly without the slightest leaning in that direction. However, if personality matters as much as politics that tactic is bound to fail to scare voters away from him. To my mind, Corbyn was not voted for his socialism but in spite of it – in times of personality politics his ideas seem as much part of him as his beard compared to what I call patch-work politics stitched together from focus-group material and political advisers.*

Given the earlier success of Tony Blair and another charismatic politician Bill Clinton it became received wisdom that no political career could possibly be successful without their kind of flashy charisma. Also here, Corbyn disproves so far the accepted wisdom: he is serious at rallies and often grumpy in the media but what he says fits him like his beard.

Compared to recent political stars in Europe Corbyn is the only outsider in an old party to challenge the party elite and be voted as a leader. The last outsider achieving was Margret Thatcher elected as Tory leader in 1975. As Corbyn, she was not expected to last long. Famously, Thatcher and later Blair proved themselves to be eminent at capturing the nation’s mood. Briefly, Corbyn has done the same but a lasting success will only arise if he can use his popularity to create a Labour power base. The European left will be watching.

What matters is not left or right but the outsider-image

In times of slow growth and contraction, there has been no lack of new European parties of discontent and anger. The Italian Movimento Cinque Stelle, M5S rose on the fame of its leader Beppe Grillo, accountant and comedian, a year older than Corbyn. M5S has more or less imploded: Grillo was good at being angry in public but useless at organising a party machine.

The Greek Syriza, born on the old-style Greek left, shot to fame with its energetic leader Alexis Tsipras. Unable to fulfil his promises, he now fights an election and might be losing the surge that brought him to power in February. New political movements in Spain – the left Podemos, the activist “idignados” and Ciudadanos on the right – will no doubt influence the coming elections there. Again, unclear if these parties can turn popularity into power.

In the stable North long-simmering far-right anti-establishment sentiments have grown stronger in Finland, Sweden and Denmark. In Iceland, the Pirate party got 5% in the election in spring 2013, just enough to get into Parliament but has been scoring over 30% in polls since early this year.

Compared to once upon a time voters are now not only less wedded to one party but also travel back and forth between left and right. Considering the volatility of voters it seems to make more sense to see these new-comers as an expression of discontent with old parties rather than necessarily as a sign of swing to the left or right in the respective countries. It is more a question of who appeals strongest to the party-unfaithfuls and disillusioned at any given time.

This also seems to be the context for Corbyn – there is no indication that British voters are swinging to the left. After all, Ukip did well in last elections. Given the chance, voters turn against the political establishment and embrace something new.

The irony is that the new is now a 66 years old leftie backbencher, in Parliament since 1983, echoing the socialism of his youth, generally unknown to others than his Islington voters, whom he has served by mostly being in opposition to the Labour party leadership at any given time.

The lack of left response to 2008

The singular aspect of the Western crisis that surfaced in 2007 was the fact that it was created by banks and their, for the society at large, unhealthy and anti-social activities in the years up to 2007.

Strangely enough, Labour let itself be ensnared by the opposition’s narrative during the 2015 spring elections that it had mismanaged the economy during its years in power, 1997 to 2010. Fettered by this narrative Labour kept quiet about the fact that Labour and the Tories, united in its admiration for an apparently booming finance industry, shared the laissez-faire view of scaled-back regulation. During the boom, neither party worried about weak regulators and underfunded and little-loved Serious Fraud Office and Inland Revenue.

The underlying public anger surfaced in the Occupy movements and grass-root activities, largely ignored by the old and established parties both in Britain and elsewhere. In the 2010 elections Liberal democrats rose on the 2008 anger but were unable to turn that surge of popularity into lasting power.

Yet, political elites might well have found a convincing response to 2008. Politicians on the right could argue for the capitalism of creation. It is not necessarily in the capitalistic spirit to let a sector, that in theory should be serving and nurturing the economy, tie up so much capital in its own money spinning activities that went so disastrously wrong, causing calamity for the rest of society.

More surprisingly, European established left parties have mostly not responded to the crisis in any meaningful way and Labour is one of them. No leading Labour politicians seems i.a. interested in a coherent investigation of the UK banks’ activities before and after 2007. One reason why I notice the underlying anger it that hardly a week goes by without hearing someone mention the Icelandic example of investigating financial fraud related to the 2008 collapse.

This silent space has been Corbyn’s to occupy, rhetorically asking if teachers, nurses etc. caused the financial crisis and weaving into it his anti-austerity stance. Quite remarkably, seven years on from 2008 and with the economy growing again, this old anger and frustration is still a fertile ground as Corbyn has now discovered and demonstrated.

From a private election machine to a party machine

According to Corbyn, he had an army of sixteen thousand volunteers working for him. Quite something in an era of shrinking membership in established political parties. It is difficult to believe that this machine was put together in only three months – more likely, supportive trade unions provided him with all it took to build a smooth-running operation.

If Corbyn the Labour leader translates his success into convincing policies backed by the Labour party he and his party will unavoidably become a leading light on the European left as New Labour once was. However, his challenges are formidable. He must i.a. enthuse the Labour party machine as he did with his own private election machine.

Corbyn must also grapple with anchoring his messages into policies that gather support within in the party. A received wisdom in politics is that no one goes anywhere without a supportive media. Given that Corbyn uses every opportunity to kick the media, possibly perceiving it as part of the establishment and to strengthen his outsider-image, it will be interesting to see how he fares versus the media: if he will change course and court it or if he continues his adversarial angry attitude.

When new Labour rose to power in 1997 they did not only lead Britain but set the tone for the whole of the European left. New Labour is no longer new but old and stale and the top-trend post has been empty for a while. The most recent contender was Syriza. With popularity and power Tsipris shot to fame among the European left who flocked to Greece to meet Syriza’s leading lights. I.a. Italian prime minister Matteo Renzi avidly courted Tsipras but, as others, quickly seemed to realise there was little to fetch.

The European left, lately poor of success stories, will be following Corbyn closely though his anti-EU stance will make some Europeans wary. As seen in many European countries over the last few years, anger and frustration may gather popularity; but unless sustained by action and comprehensive policies it has little staying power and wanders on to the next eye-catching political promise-bidder.

*See my earlier blog on Corbyn and patch-work politicians.

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

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Jeremy Corbyn has come into the political summer like a red storm rising. No political neophyte and not charismatic in the flashy way (but well, neither are his three opponents) he sweeps up support with his slightly dour, dry reasoning embracing the word “socialism.” His message, like it or loath, has that one thing the other three lack: a coherent narrative that fits him like his beard. – His political assets stand all the more out compared to what his three contenders offer: a homeopathic blend of old New Labour and patchwork politics.

Who would have thought in early summer that electing a Labour leader would reveal a political yearning for something new by a surging support for the oldest candidate? With three wholly presentable political thoroughbreds the candidate from the “loony left” was intended as a red-hot chilli to enliven a bland concoction. But chilli is a tricky ingredient and can easily dominate a dish.

Over the last few years voters in some European countries have flocked around challengers to old party-political structures: there is the Cinque Stelle in Italy, Podemos in Spain, Syriza in Greece, the Pirate Party in Iceland and to a certain degree UKIP – new, or relatively new parties that suddenly capture the voters’ political imagination.

Contrary to these new political splashes it is interesting that Jeremy Corbyn, voted into Parliament in 1983, as were Tony Blair and Gordon Brown, is neither new in politics nor aspiring to lead a new party. Only rarely does an old hand challenging the party’s ruling elite gather the votes needed to get elected as a leader. Yes, there is the effect of Labour’s new voting rules but this does not explain the Corbyn-mania.

Two political phenomena – Tony Blair’s surge in the election 1997, which lasted until tainted by the Iraqi invasion and Nick Clegg’s unexpected popularity in 2010 – can both partly be explained by the fact that the two were political newcomers. But Corbyn is no political newcomer and neither his politics nor his rhetoric is new.

Adapted to our times his words echo the sixties and seventies when Corbyn was young and a great part of his supporters not even born. Corbyn’s newness is however something that has slowly been seeping out of politics for the last two decades: coherent conviction and a sense of mission – i.e. vision embedded in a political narrative.

Typically of the politicians of their generation Andy Burnham, Yvette Cooper and Liz Kendall are efficient, presentable and no doubt capable. But their message lacks coherence; they have no political narrative.

This lack of narrative is partly Labour’s problem but Corbyn has filled the gaping gap with his own narrative, rooted in his political story whereas his three contenders present a patchwork of headlines assembled from pollsters and focus groups with the help of political advisers. Compared to Corbyn’s red cloak, so eminently his own, the three struggle to carry their patchwork cloaks convincingly.

But why has it come to this sad state of patchwork politics?

Vision can’t be out of political fashion – politics IS vision

New Labour did not invent this adage that vision is dead, long live politics. But the Labour party reinvented and owned by Tony Blair, Peter Mandelson and Alastair Campbell certainly made this their over-arching political idea. Following scandals and the disintegration of the Tory government politics was a dirty word. The New Labour message was nothing as dirty as politics and vision but all about doing the right thing and managing well.

Ever since Labour has told voters that politics is about finding better solutions to manage the economy, the NHS, education and everything else. Oh, so wrong. Politics is not like running a company and the state is not like a company. If so, politicians like Andy Burnham, Liz Kendall and Yvette Cooper would be all the political rage. But they clearly are not.

Worshipping the managerial approach is the essence of the New Labour legacy. Since New Labour was so successful the New Labour vision-less managerial-style politics is still being remixed and reheated by the Burnham-Cooper-Kendall generation that grew up flush with its success. The three candidates are the latest blend, by now wholly diluted – a homeopathic solution of the original New Labour ideas.

But in times of Occupy and anger over rising inequality Labour voters are saying “thanks, but no thank you” to the weak blend the managerial no-vision. They want something new and potent. Against this background Corbyn rises and shines. The irony is that the new is now an elderly and battered socialist with a political soul.

Political language reeking of death and the making of patchwork politics

Under normal circumstances politicians like Burnham, Cooper and Kendall would not be compared to Corbyn but simply to other politicians more or less similar to themselves: thoroughly media-trained, only rarely at loss for an answer because every possible and impossible question has been thrown at them by media-coaches behind closed doors hours on end.

All three have Oxbridge credentials, Corbyn doesn’t. They entered professional politics as advisers soon after university and though young have lived and breathed politics and media training.

Large doses of undigested media training creates a political language reeking of death – death, because no living normal person speaks a language where the simple words “yes” and “no” have largely been banished. Where answers are long enough to make everyone forget the question that the politician doesn’t want to give a straight answer to. Where quirky words are never used but mostly only sanitised words in sentences with vacuous meaning. And no wit please, we are serious politicians (except Boris Johnson).

Corbyn certainly has a touch of media training about him but at least it hasn’t beaten the soul and spirit out of him, as it seems to have done with his contenders. Possibly because they were younger when they were subjected to the training, now seemingly permeating their grey matter.

In addition to the institutionalised media training there is the institutionalised content-building. An expert who participated in policy discussions to help a young politician (none of the three) formulate political ideas told me that whenever the participants dwelled on a topic the adviser orchestrating the whole séance stopped the discussion and told the participants to stick to the headlines. Ultimately an utterly frustrating and uninteresting experience, my source said.

This is how patchwork politics are made – no wonder politicians struggle to give it a convincing tone.

Politics in the times of personality politics

Labour’s loss in spring has i.a. been blamed on Ed Miliband’s leftism. However, in the age of personality politics maybe Labour voters sensed in Miliband the same as in the three of his generation who now offer to replace him: that he was too bland, too unconvincing because he had lost his political soul and offered only patchwork politics.

Corbyn’s supporters have not necessarily studied his thoughts on People’s Quantitative Easing and other issues but they clearly embrace him as a politician they would like to see lead the Labour party and eventually the country.

Those fearing a Corbyn leadership have tried various ways to undermine him: there are the allegedly dubious people like Hamas terrorists and Holocaust deniers he has engaged with during his many years in politics. Is it wise that Corbyn the socialist should replace a candidate thought to be too far to the left? I’ve heard it whispered he might even be posh, a cardinal sin in British politics. And so on.

None of this, however, is likely to drive his supporters away. In times of personality politics – when many voters choose leaders more for who the politician is and the combination of personality and politics matters more than single issues – any such criticism will shake the supporters no more than a splash of water on a goose.

How Corbyn the unruly whip-denier will fare as a leader is another matter. But what the Corbyn-mania shows is that yes, people are interested in politics, vision and narrative matter; patchwork politics dressed up in a dead language fail to engage with the political enthusiasm out there. – The shortcomings of patchwork politicians are all too apparent when they share the stage with a politician whose politics fits his personality like his grey beard.

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Why the Troika and the EU member states find it so difficult to trust Greece

The word “trust” has been mentioned time and again in reports on the tortuous negotiations on Greece. One reason is the persistent deceit in reporting on debt and deficit statistics, including lying about an off market swap with Goldman Sachs: not a one-off deceit but a political interference through concerted action among several public institutions for more then ten years.

As late as in the July 12 Euro Summit statement “safeguarding of the full legal independence of ELSTAT” was stated as a required measure. Worryingly, Andreas Georgiou president of ELSTAT from 2010, the man who set the statistics straight, and some of his staff, have been hounded by political forces, also Syriza. Further, a Greek parliamentary investigation aims at showing that foreigners are to blame for the odious debt, which should not be paid while there is no effort to clarify a decade of falsifying statistics.

In Iceland there were also voices blaming its collapse on foreigners but the report of the Special Investigation Committee silenced these voices. – As long as powerful parts of the Greek political class are unwilling to admit to past failures it might prove difficult to solve its results: the excessive debt and deficit.

“This is all the fault of foreigners!” In Iceland, this was a common first reaction among some politicians and political forces following the collapse of the three largest Icelandic banks in October 2008. Allegedly, foreign powers were jealous or even scared of the success of the Icelandic banks abroad or aimed at taking over Icelandic energy sources. In April 2010 the publication of a report by the Special Investigation Committee, SIC, effectively silenced these voices. It documented that the causes were domestic: failed policies, lax financial supervision, fawning faith in the fast-growing banking system and thoroughly reckless, and at times criminal, banking.

As the crisis struck, Iceland’s public debt was about 30% of GDP and budget surplus. Though reluctant to seek assistance from the International Monetary Fund, IMF, the Icelandic government did so in the weeks following the collapse. An IMF crisis loan of $2.1bn eased the adjustment from boom to bust. Already by the summer of 2011 Iceland was back to growth and by August 2011 it completed the IMF programme, executed by a left government in power from early 2009 until spring 2013. Good implementation and Iceland’s ownership of the programme explains the success. For Ireland it was the same: it entered the crisis with strong public finances and ended a harsh Troika programme late 2013; its growth in 2014 was 4.8%.

For Greece it was a different story: high budget deficit and high public debt were chronic. From 1995 to 2014 it had an average budget deficit of -7%. Already in 1996, government debt was above 100% of GDP, hovering there until the debt started climbing worryingly in the period 2008 to 2009 – far from the prescribed Maastricht euro criteria of budget deficit not exceeding 3% and public debt no higher than 60% of GDP. Both Greek figures had however one striking exception: they dived miraculously low, below their less glorious averages in time for joining the euro. Yet, only the deficit number ever went below the required Maastricht criteria, which enabled Greece to join the euro in 2001.

Greece had an extra problem not found in Iceland, Ireland or any other crisis-hit EEA countries: in addition to dismal public finances for decades there is the even more horrifying saga of deliberate hiding and falsifying economic realities by misreporting Excessive Deficit Procedure, EDP and hide debt and deficit with off market swaps.*

This is not a saga of just fiddling the figures once to get into the euro but a deceit stretching over more than ten years involving not only the Greek statistical authorities but the Greek Ministry of Finance, MoF, the Greek Accounting Office, GAO and other important institutions involved in the compilation of EDP deficit and debt statistics – in short, the whole political power base of Greece’s public economy.

Already in 2002 Eurostat discovered that the debt and deficit dip around the euro entry was no miracle but manipulation: Greek authorities simply reported wrong numbers. In 2004, Eurostat’s Report on the revision of the Greek government deficit and debt figures showed that this had been on-going between 1997 to 2003. Consequently, the Greek statistical authorities, the then National Statistical Service of Greece, NSSG (from which ELSTAT was created in mid-2010) were forced to revise its data for the years 2000 to 2003 upward, above the criteria set for Greece’s entry in the Eurozone. These issues were unique to Greece: “Revisions in statistics, and in particular in government deficit data, are not unusual… However, the recent revision of the Greek budgetary data is exceptional.”

The Eurostat 2004 report was followed by intense and unprecedented scrutiny with Eurostat using all its power to control and make sure the Greek stats were correct. Yet, NSSG did not learn its lessons, or rather, the political interference was relentless.

In autumn 2009 the ECOFIN Council requested a new report, this time from the EU Commission, EC, due to “renewed problems in the Greek fiscal statistics” after the “reliability of Greek government deficit and debt statistics (has) been the subject of continuous and unique attention for several years.”

The EC report on Greek Government Deficit and Debt Statistics, published in January 2010 showed that Greek numbers on debt and deficit were still wrong: deficit forecasts changed drastically from the March to the September reporting more than once and once the real statistics were available the numbers were still higher. Again, such a revision was rare in EU member states “but have taken place for Greece on several occasions.”

As earlier, the reason for the faulty data was methodological shortcomings, not only at the NSSG but also at the GAO and the MoF responsible for providing data to NSSG and, even more grave, political interference and “deliberate misreporting,” where the NSSG, GAO, MoF and other institutions involved in the reporting, all played their part.

The Goldman Sachs, GS, off market swap story was one chapter in the faulty data saga. In 2008, when Eurostat made enquiries in all member states on off market swaps, Greek authorities informed Eurostat promptly that the Greek state had engaged in nothing of the sort. This 2008 statement turned out to be a blatant lie when Eurostat investigated the matter, as shown in a Eurostat report in November 2010. The swap story is a parallel to the Greek data deceit in the sense that it was not a single event but a deceit running for years, involving several Greek authorities.

Needless to say, fiddling the numbers did not eradicate the debt and deficit problem. The EC report was published as Greece was losing access to markets. Negotiations on a bailout were complicated by unreliable information on Greek public finances. On May 2, 2010, as the first Greek Memorandum of Understanding was signed, with a €110bn loan – €80bn from European institutions and €30bn from the IMF – it was clear that the crucial figures of debt and deficit might still go up.

Following these major failures at the NSSG its head had resigned in 2009. At the GAO and the MoF ministers, vice ministers and general secretaries changed with the new Papandreou government but the ranks below remained unchanged, as did the mentality. With changes in the statistics law in summer 2010 ELSTAT replaced NSSG. A new board was put in place and also a new head: Andreas Georgiou, earlier at the IMF, returned home to take over at ELSTAT. This ended the battle to produce correct statistics: since August 2010, neither Eurostat nor other European authorities have questioned Greek national statistics.

It was however the beginning of an on-going horror story for Georgiou and some of his staff who have been hounded since ELSTAT began reporting correct statistics in accordance with European standards: three times, competent judiciary officials have recommended to have the criminal case launched against them put to file, i.e. to drop the case. Only recently, a council of appeals court judges have let go of charges against the three for having caused the state a loss of €171bn, which would have meant a prison sentence for life. However, charges against Georgiou for violation of duty are still being upheld; should he be found guilty he will not be able to hold a public post again.

There are now two committees, set up by the Greek parliament, investigating the past. One is the Parliamentary Truth about the Debt Committee. Set up in April 2015, with members chosen by the Syriza president of the Greek parliament Zoe Konstantopoulou, it concluded in its preliminary report, presented June 17, that Greece neither can nor should pay its debt to the Troika because that debt is “is illegal, illegitimate, and odious.” The other, a Parliamentary Investigative Committee made up of members of parliament and normally referred to as the Investigative Committee about the Memoranda, is scrutinising how Greece got into the two Memoranda of Understanding with international partners, in 2010 and 2012, in the context of adjustment programs. – Both committees have repeated the claims against Georgiou and the two ELSTAT managers.

In spite of over a decade long saga of false statistics and political interference there has been no attempt so far to set up an independent committee to tell the whole Greek debt saga, from the 1990s to the present day, manipulated statistics, deceitful swaps, political interference, warts and all.

2004: the first Greek crisis … of unreliable statistics

The first Greek crisis did not attract much attention although it was indirectly a crisis of deficit and debt – it was a crisis caused by faulty statistics, unearthed by Eurostat already in 2002. After going through the deficit and debt figures reported by Greece the 2004 Eurostat’s Report on the revision of the Greek government deficit and debt figures rejected figures put forward by the NSSG in March 2004. After revision the numbers for the previous years looked drastically different – the budget deficit, which should have been within 3%, moved shockingly:

 

	2000	2001	2002	2003
DEFICIT	% GDP	% GDP	% GDP	% of GDP
March 2004	-2.0	-1.4	-1.4	-1.7
September2004	-4.1	-3.7	-3.7	-4.6
DEBT
March 2004	106.1	106.6	104.6	102.6
September 2004
	114.0	114.7	112.5	109.9

Report on the revision of the Greek government deficit and debt figures

The institutions responsible for reporting on the debt and deficit figures were NSSG, the MoF through the GAO as well as MoF’s Single Payment Authority and Bank of Greece. Specifically, NSSG and the MoF were responsible for the deficit reporting; the MoF was fully responsible for the debt figures.

The Eurostat drew various lessons from the first Greek crisis. Legislative changes were made to eradicate the earlier problems – not an entirely successful exercise as could be seen when the same problems re-surfaced. But the most important result of the 2004 crisis was a set of statistical principles known as the European Statistics Code of Practice, adopted in February 2005, revised in September 2011, following the next Greek crisis of statistical data. Unfortunately, NSSG drew no such lessons.

2009: the second Greek crisis … of unreliable statistics

Following the 2004 report Eurostat had NSSG in what can best be described as a wholly exceptional and intensive occupational therapy: from the ten EDP notifications 2005 to 2009 Eurostat had reservations to five of them, far more than any other country received. No country but Greece got “methodological visits” from Eurostat. The Greek notifications, which passed, did so only because Eurostat had corrected them during the notification period, always increasing the deficit from the numbers reported by Greek authorities.

But in spite of Eurostat’s efforts the pupil was unwilling to learn and in 2009 there was a second crisis of statistics: things had not improved as was bluntly stated in a 30-page report on Greek Government Deficit and Debt Statistics from the EC in January 2010. In addition: what had been going on at Greek authorities had no parallel in any other EU country.

This second crisis of Greek statistics in 2009 was in the first instance not set off by a real figure but by the dramatic revisions of the deficit forecast for 2009. As in 2004, this new crisis led to major revisions of earlier forecast: the April forecast was revised twice in October. What happened between spring and October was that George Papandreou and the PASOK ousted New Democracy and prime minister Kostas Karamanlis from power; the new government was now beating drums over much worse state of affairs than earlier data and forecast showed.

After first reporting on October 2 2009 there came another set of numbers from NSSG on October 21, revising earlier reported deficit for 2008 from 5% of GDP to 7.7% – and the forecasted deficit ratio for 2009 of 3.7% was revised to 12.5% (as explained in footnote, numbers for current year are a forecast, whereas numbers for earlier years should be actual data).

And this was not all: in early 2010, Eurostat was still not convinced about the actual EDP data from the years 2005 to 2008. The earlier 2009 deficit forecast of 12.5% had risen to an actual deficit of 13.6% by April 2010 to finally land on 15.4% in late 2010.

The EC report detected common features with events in 2004 and 2009: a change of government – in March 2004, Kostas Karamanlis and New Democracy came to power, ending eleven years of PASOK rule and as mentioned above George Papandreou and PASOK won back power in October 2009.

In both cases “substantial revisions took place revealing a practice of widespread misreporting, in an environment in which checks and balances appear absent, information opaque and distorted, and institutions weak and poorly coordinated. The frequent missions conducted by Eurostat in the interval between these episodes, the high number of methodological visits, the numerous reservations to the notifications of the Greek authorities, on top of the non-compliance with Eurostat recommendations despite assurances to the contrary, provide additional evidence that the problems are only partly of a methodological nature and would largely lie beyond the statistical sphere.

In other words, the problem was not statistics but politics. As politics is well outside its remit, Eurostat could not get to the core of the problem: “Though eventually an overall level of completion was achieved, given that Eurostat is restricted to statistical matters in its work the measures foreseen in the action plan were mainly of a methodological nature, and did not address the issues of institutional settings, accountability, responsibility and political interference.”

The political interference could i.a. be seen from the fact that reservations expressed by Eurostat between 2005 and 2008 on specific budgetary issues, which had then been clarified and corrected, resurfaced in 2009, i.e. earlier corrections were reverted and were now once more wrong.

Good faith versus fraud

The EC 2010 report identified two different but in some cases linked sets of problems. The first was due to methodological weaknesses and unsatisfactory technical procedures, both at the NSSG and the authorities that provided data to the in the NSSG, in particular the GAO and the MoF.

The second set of problems stemmed “from inappropriate governance, with poor cooperation and lack of clear responsibilities between several Greek institutions and services responsible for the EDP notifications, diffuse personal responsibilities, ambiguous empowerment of officials, absence of written instruction and documentation, which leave the quality of fiscal statistics subject to political pressures and electoral cycles. “

Eurostat’s extra scrutiny and unprecedented effort had clearly not been enough: “even this activity was unable to detect the level of (hidden) interference in the Greek EDP data. In particular, after the closure of the infringement procedure at the end of 2007, Eurostat issued a reservation on the quality of the Greek data in the April 2008 notification and validated the notifications of October 2008 and April 2009 only after it intervened before and during the notification period to correct mistakes or inappropriate recording, with the result of increasing the notified deficit in both instances. As an example, Eurostat’s methodological missions in 2008 resulted in an increase of the 2007 deficit figure notified by the Greek authorities, from 2.8% to 3.5% of GDP.”

The EC 2010 report further pointed out that “on top of the serious problems observed in the functioning of other areas involved in the management of Greek public revenues and expenditures, that are not the object of this report, the current set-up does not guarantee the independence, integrity and accountability of the national statistical authorities. In particular the professional independence of the NSSG from the Ministry of Finance is not assured, which has allowed the reporting of EDP data to be influenced by factors other than the regulatory and legally binding principles for the production of high quality European statistics.”

The EC report concluded that there was nothing wrong with the quality assurance system in place at Eurostat; the shortcomings were particular for Greece: “The partners in the ESS (European Statistical System) are supposed to cooperate in good faith. Deliberate misreporting or fraud is not foreseen in the regulation.”

Again, the rarity of the magnitude of such revisions was underlined: “Revisions of this magnitude in the estimated past government deficit ratios have been extremely rare in other EU Member States, but have taken place for Greece on several occasions.”

The EC 2010 report spells out interplay between authorities, dictated by political needs. Against these concerted actions by Greek authorities, the efforts of European institutions were bound to be inadequate – “the situation can only be corrected by decisive action of the Greek government.”

The Goldman Sachs 2001 swaps – part of the Greek statistics deceit saga

In early 2010, international media was reporting that Greece had entered a certain type of swaps – off market swaps – with Goldman Sachs in 2001 in order to bring its debt to a certain level so as to be eligble for euro membership.

Already in Council Regulation (EC) No 2223/96 swaps were classified as “financial derivatives,” with a 2001 amendment making it clear that no “payment resulting from any kind of swap arrangement is to be considered as interest and recorded under property.” However at that time off market swaps were not much noted. By the mid-2000s it became evident that the use of off market swaps could have the effect of reducing the measured debt according to the existing rules. Eurostat took this into account and issued guidelines to record off market swaps differently from regular swaps. – Further, Eurostat rules specify that when in doubt national statistical authorities should ask Eurostat.

In 2008, Eurostat asked members states to declare off market swaps if any. The prompt Greek answer was: “The State does not engage in options, forwards, futures or FOREX swaps, nor in off market swaps (swaps with non-zero market value at inception).”

In its Report on the EDP Methodologial Visits to Greece in 2010, Eurostat scrutinised the 2001 “currency off-market swap agreements with Goldman Sachs, using an exchange rate different from the spot prevailing one” that the Greek Public Debt Agency, PDMA, had made with the bank. It turned out that the 2008 answer was just the opposite of what had happened: the Greek state had indeed engaged in swaps but kept it carefully hidden from the outer world, i.a. Eurostat.

After having been found out to be lying about the swaps Greek authorities were decidedly unwilling to inform Eurostat on the details. Not until after the fourth Eurostat visit, at the end of September 2010, nota bene after Georgiou took over at ELSTAT, did Eurostat feel properly informed on the Goldman Sachs swap.

The GS off market swaps were in total thirteen contracts with maturity from 2002 to 2016, later extended to 2037. As Eurostat remarked these transactions had several unusual aspects compared to normal practices. The original contracts have been revised, amended and restructured over the years, some of which have resulted in what Eurostat defines as new transactions.

The GS swaps hid a debt of $2.8bn in 2001; after later restructuring the understatement of the debt was $5.4bn. The swap transaction, never before reported as part of the public accounts, was part of the revisions in the first ELSTAT reporting after Georgiou took over. This did actually increase the deficit by a small amount for every year since 2001, as well as increasing the debt figure.

The swap story is a parallel to the Greek data deceit in the sense that it was not a single event but a deceit running for years, involving several Greek authorities. Taken together, both the swap deceit and the faulty reporting of forecasts and statistics by Greek authorities show a determined and concerted political effort to hide facts and figures, which in reality did not change when new governments came to power.

A thriller of statistical data and mysteriously acquired emails

For Greece, the economy deteriorated drastically following the financial crisis in 2008. Public debt was at 129% of GDP end of 2009. The country effectively lost market access in March 2010. With an agreement signed May 2 2010 Greece became the first Eurozone country to be bailed out. The messy statistics made the negotiations tortuous.

After the appalling failures, misrepresentations and direct manipulation of figures for political purposes, both at NSSG and other institutions involved in the collection and presentation of statistical data, things turned for the better after Andreas Georgiou took over as president of the newly established ELSTAT in August 2010. However, not everyone in the Greek political system celebrated the fact that ELSTAT was now operating strictly to ESS standards.

It is worth noting that by the time Georgiou took over most of the corrections of earlier figures had already been done under the auspice of Eurostat. There was however the last set of corrections of deficit and debt figures. As pointed out earlier, the GS off market swaps were included for the first time, changing figures for earlier years and the actual deficit figure for 2009 was yet again revised upward in the first set of data, delivered by the new President. As the EC report in January 2010 had foreseen the deficit figure was yet to rise: the April figure of 13.6% was now 15.4%.

Following the adoption of the new statistics law in March 2010, ELSTAT was now independent of the MoF although its board was politically appointed in addition to a representative from the employees’ union. This might not have been a problem if the board had understood the European Statistics Code of Practice in the same way as Georgiou.

At ELSTAT Georgiou emphasised its independence and accountability where the board should be involved only with the broader issues, not the statistical production process. Instead, the board felt, among other things, that it should vote on and approve the statistics and saw Georgiou as being manipulative, wanting to rule over the statistics. Three of the members of the new board, set up in August 2010 – ELSTAT’s vice president Nikos Logothetis, Zoe Georganda and Andreas Philippou – had applied for the position of president, which possibly did not make things easier.

The break-down of trust happened at a meeting with the presidium of the employees’ union on 21 October 2010, after Georgiou had been in office less than three months. At this meeting, the presidium showed Georgiou a document – a legal opinion from Georgiou’s lawyer with whom Georgiou had been in touch via his private email account, on issues related to the law on ELSTAT that was in the process of being changed. Georgiou realised that someone had an unauthorised access to his account. He later became aware that another member of the board, Zoe Georganda, possessed an email Georgiou had exchanged with Poul Thomsen, head of the Greek IMF mission.

Georgiou brought the case to the police who discovered that Nikos Logothetis had been entering Georgiou’s account from the first day Georgiou took up his position at ELSTAT. When the police did a house search, Logothetis was actually at his computer, logged into Georgiou’s account. After less than six months in office Logothetis resigned from the ELSTAT board in February 2011 as criminal charges, based on his hacking into Georgiou’s account, were brought against him.

Logothetis has denied accessing the account and claims instead that various leading European statisticians framed him. His case is pending in court. In spite of being charged with unauthorised access to Georgiou’s account, Logothetis has repeatedly been called in as an expert witness in parliament in the cases against Georgiou and his two colleagues. His most recent appearance was in June with the Investigative Committee about how Greece got into the adjustment programs.

When revising wrong statistics equals ignoring national interest

In September 2011, Antonis Samaras the newly elected leader of New Democracy and minister for culture, gave a much noted speech at the Thessaloniki International Expo, where he attacked George Papandreou, accusing him of manipulating the statistics when Papandreou came to power in autumn 2009. Samaras claimed that Papandreou had done this only to discredit Kostas Karamanlis, who Samaras succeeded as a party leader and who had lost the election that brought Papandreou to power. – This speech proved fateful, not for Papandreou but for ELSTAT’s president Andreas Georgiou.

A few days after Samaras’ speech, Georgiou was called to the parliament to explain why he had ignored national interests and revised the figures upwards. Georgiou referred to the ESS Code of Practice but gained little understanding. Instead he was accused of inflating the 2009 figures under instruction of Eurostat to push Greece into the Adjustment Programme. This ignored the fact that the main corrections had been done before Georgiou took over at ELSTAT.

It is important to keep in mind the context for the 2009 deficit: there was the forecasted deficit of 3.9%, put forth by the MoF and reported by NSSG in April 2009 and then the estimate of the actual 2009 deficit of 13.6%, as reported by NSSG in April 2010. All of this had happened before Georgiou took over at ELSTAT in August 2010, after which the final adjustment from 13.6% to 15.4% was made.

The accusations against Georgiou also ignored the fact that Greece had entered the Adjustment Programme three months before he took over at ELSTAT and also that the Greek statistical data had been found to be wrong already before 2000 in addition to the swaps, reporting faulty data up to 2004 and then again up to end of 2009. Political figures both on left and right of the political spectrum united against the ELSTAT president as if the only reason for the country’s debt and deficit were statistics. The Greek Association of Lawyers accused Georgiou of high treason.

Around the time of the hearing in parliament in September 2011, a prosecutor took up the case against Georgiou and two ELSTAT managers and eventually pressed criminal charges in January 2013. In accordance with due process, an investigating judge began a more thorough investigation but at its conclusion, almost two years later, in August 2013 recommended that the case be dropped as nothing was found to merit taking the case further. Following interventions by politicians the case was kept open by the judicial system.

Twice again—in 2014 and 2015—prosecutors proposed that the case be dropped, always followed by interventions from nearly all sides of the political spectrum, which insisted on charges of false statements on the 2009 deficit and debt, and breach of faith against the state/causing the state damages be sustained and that the case be taken to trial. As the punishment should be relative to the damages, calculated to amount to €171bn, this would effectively have amounted to a prison sentence for life.

The charges against Georgiou and the two ELSTAT managers for allegedly making false statements on the 2009 statistics and breach of faith have recently been dropped. However, charges against Georgiou for alleged violation of duty i.a. for not bringing the 2009 figures to vote on the former board are being upheld. Some members of that former board still insist that the actual deficit figure of 2009 turned out to be identical to the planned deficit figure for 2009 of 3.9%, put forward in April 2009.

Truth commissions and ELSTAT

One of the measures agreed on by the Eurogroup and Greece after the fateful Euro Summit July 12, “(g)iven the need to rebuild trust with Greece,” was “safeguarding of the full legal independence of ELSTAT.” – This reflects the fact that ELSTAT’s independence is still not secured and ELSTAT’s president still under attack.

The two parliamentary committees – the Truth about the Debt Committee and the Investigative Committee about the Memoranda – both seem to be in denial regarding the swaps and the faulty statistics and both uphold blaming and shaming Georgiou and the two ELSTAT mangers.

In the Truth about the Debt Commission’s preliminary findings the earlier claims against Papandreou’s government are again taken up: “George Papandreou’s government helped to present the elements of a banking crisis as a sovereign debt crisis in 2009 by emphasizing and boosting the public deficit and debt.”

Further, it concluded “that Greece not only does not have the ability to pay this debt, but also should not pay this debt first and foremost because the debt emerging from the Troika’s arrangements is a direct infringement on the fundamental human rights of the residents of Greece. Hence, we came to the conclusion that Greece should not pay this debt because it is illegal, illegitimate, and odious.”

As recently as June 18, Nikos Logothetis testified before the Committee about the Memoranda, claiming that the deficit figures for 2009 and 2010 had been deliberately and artificially inflated. He called Georgiou a “Eurostat pawn” who had used tricks to increase the deficit figure.

However and quite remarkably, the Greek parliament has never questioned anyone on the tricks and manipulations going on at ELSTAT and other public institutions involved in reporting wrong data from before 2000 until 2010.

International support for ELSTAT managers

Contrary to the sustained attacks at home, Georgiou and the two managers have enjoyed the support of Eurostat, European and international associations of statisticians, reflecting the fact that under Georgiou ELSTAT’s reporting has fully complied with Eurostat standards.

In late May, European Statistical System, ESS, published a statement expressing concern regarding the situation in Greece, “where the statistical institute, ELSTAT, as well as some of its staff members, including the current President of ELSTAT, continue to be questioned in their professional capacity. There are ongoing political debates and investigatory and judicial proceedings related to actions taken by ELSTAT and to statistics which have repeatedly passed the quality checks applied by Eurostat to ensure full compliance with Union legislation.”

On June 12 2015 The International Statistical Institute, ISI published its fourth statement regarding the situation in Greece, welcoming the proposal from the Greek Appeals prosecutor Antonis Liogas “that judicial authorities drop the investigation into claims that the current head of ELSTAT, Andreas Georgiou, inflated the country’s public deficit figure for 2009.” ISI pointed out that according to the prosecutor the probe into Georgiou and the two managers had not delivered any evidence suggesting that the three had manipulated the figures.

ISI repeated its statement from 2013 that “the charges against Mr. Georgiou and two of his Managers of exaggerating the estimates of Greek government deficit and debt for the year 2009 are fanciful and not consistent with the facts’… The ISI expresses the hope that justice will prevail in this case and that the threat of prosecution will finally be lifted from Mr Georgiou and his Managers.”

As well as the statement on ELSTAT in the Euro Summit’s July 12 statement, these recent statements on ELSTAT show that political pressure on ELSTAT is still palpable.

The lethal blend of “unhealthy politeness” and “excessive deference”

The lack of scrutiny, as demonstrated in the saga of the faulty Greek statistics, can partly be blamed on the European powers. True, both Eurostat and then the European Commission did exhume the ELSTAT failures and misreporting; but that it could happen in the first place is also due to failures at the European level.

When the European Union created a single currency the Euro countries in effect embarked on a journey all on the same ship. By now, it is evident that neither did the crew, European authorities, have the necessary safety measures to keep discipline among the passengers nor have the passengers kept an eye on each other. In the summer of 2011, Mario Monti, already tried by his experience as EU Commissary, formulated what had gone wrong:

“At the roots of the eurozone crisis lies of course the past indiscipline of specific member states, Greece in the first place. But such indiscipline could simply not have occurred without two widespread failings by governments as they sit at the table of the European Council: an unhealthy politeness towards each other, and excessive deference to large member states.”

A successful monetary union demands more than the countries being just fair-weather friends. The crisis countries, most notably Greece, can only learn from the past if they understand what happened. In Greece these failures were i.a. this basic function in a modern state of truthfully reporting statistics.

Truth or politically suitable truth

In December 2008, while Iceland was still in shock after the banking collapse, its parliament set up a Special Investigation Committee, SIC, which operated wholly independent of parliament. The three SIC members were its chairman Supreme Court Justice Páll Hreinsson, parliament’s Ombudsman Tryggvi Gunnarsson and lecturer in economics at Yale University Sigríður Benediktsdóttir who together supervised the work of ca. forty experts. Their report of 2600 pages was published April 10 2010.

The report buried the politically motivated explanations of the collapse being caused by foreigners and established instead a recount of what had happened, based both on documents and hearings (in private, not in public hearings). One benefit of the SIC report is that no political party or anyone else can now tell the collapse saga as suits their interest: the documented saga exists and this effectively ended the political blame game. Importantly, the report points out lessons to learn.

Sadly, nothing similar has been done in other crisis-hit European countries. The Irish parliament embarked on such a process in summer 2014 but so far, the efforts have not been wholly convincing. The two committees, set up by the Greek parliament, do not seem entirely credible, i.a. because the allegations of ELSTAT misconduct and manipulation under Georgiou are being recycled. Further, their scope seems myopic, i.a. as no effort is made to explain what went on at the institutions that from before 2000 until 2010 were reporting faulty statistics and forecasts and lying about the GS swaps.

All of this taken together shows a political class, also within Syriza, not only unwilling to face the past but actively fighting any attempt to clarify things in a battle where even national statistics are a dangerous weapon. The fact that leading Greek political powers are still fighting the wrong fight on statistics is unfortunately symptomatic for political undercurrents in Greece – and that partly explains the profound lack of trust among its creditors.

*A note on EU statistics: twice a year, before end of March and August, statistical authorities in the EU countries report forecasts of debt and deficit numbers for the current year, i.e. what the planned deficit and debt is and then statistical data for earlier years, i.e. the real debt and deficit, according to strict Eurostat methodology in order to produce comparable statistics. This reporting, called Excessive Deficit Procedure, EDP, is published by Eurostat in April and October every year.

Update: Andreas Georgiou’s time in office has not come to an end: he was hired for five years and is not reapplying. – It should be noted that it was George Papakonstantinou who was Minister of Finance when Georgiou was hired as president of ELSTAT. In addition, it was under Papakonstantinou that new laws to assure ELSTAT’s independence were passed in the summer of 2010.

This post was cross-posted with Fistful of Euros and The Corner. A shorter version was posted on Coppola Comment (thanks to Frances for the edititing!) and Naked Capitalism.

Follow me on Twitter for running updates.

Many controlling shareholders in China have pledged shares as collaterals for bank loans – this was a common practice in Iceland up to the October 2008 banking collapse. Now, this practice seems to be causing suspensions of trading in shares in China. If this is indeed a widespread Chinese practice the well-studied effects in Iceland provide a chilling lesson: when the steady rise of Icelandic share prices, both in banks and other companies stopped and prices fell this practice turned into a major calamity for the banks and companies involved. In hindsight, it was a sign of an incestuous and dysfunctional business environment. The Icelandic experience was well covered in the 2010 report by the Icelandic Special Investigation Committee, SIC, and provides food for thought for other countries where these practices surface.

One of the most stunning and shocking findings of the Icelandic SIC report was the widespread use of shares as collaterals for loans in all Icelandic banks, small and large but most notably the three largest ones – Kaupthing, Landsbanki and Glitnir.

It is necessary to distinguish between two types of lending against shares as practiced in Iceland: one is a bank funding purchase of its own shares, with only the shares as collaterals. The other type is taking other shares as collaterals.

These loans with shares as collaterals were mainly offered to the banks’ largest shareholders – in the big banks these were the main Icelandic business leaders – their partners and bank managers. In the smaller banks local business magnates who in many cases were partners to those Icelandic businessmen who operated abroad, as well as in Iceland. Thus, this practice defined a two tier banking system: with services like these to a small group of clients – that I have called the “favoured clients” – and then normal services for anyone else.

As a general banking model it would not make sense – the risk is far too great. But this lending mechanism and the ensuing stratospheric risks seem to have been entirely unobserved by not only the regulators in Iceland but also abroad where the Icelandic banks operated.

The SIC report, published 10 April 2010, explained in depth the effects of shares as collaterals: when share prices fell the banks could not make margin calls without aggravating the situation further. Consequently the banks lost their independent standing vis à vis their largest shareholders and clients – effectively, the banks and the business elite were tied to the same mast on the same ship and all would sink together in case the ship ran aground (as then happened).

Being familiar with the Icelandic pre-collapse situation it was with great interest that I read an article in the FT,* explaining what might be the reason behind the suspended trading in shares of almost 1500 Shanghai- and Shenzen-listed companies, mostly on the ChiNext stock exchange:

“Some analysts believe the suspensions are instead related to one of the scariest “known unknowns” surrounding the market meltdown — just how many controlling shareholders have pledged their shares as collateral for bank loans.”

If this is indeed the case the Icelandic experience indicates a truly scary outlook and dysfunctional Chinese banking. There might be further troubles ahead.

Bank lending against own shares – or – turning the loan book into equity

In Iceland, the use of shares as collaterals counted both for shares in the banks themselves, by the largest and large shareholders and their business partners and then also by managers of the banks – and shares in other companies (not banks) owned by these same investors or those of their business partners.

The use of banking shares and non-banking shares pose somewhat different problems though the fundamental problem is the same, when this is practiced on a large scale to a chosen group of “favoured clients” with complicated cross-ownership as was the case in Iceland.

The SIC report mapped all of this but before its publication there were already rumours and stories related to the practice. I started hearing these stories from Icelandic bankers and others very soon after the banking collapse in October 2008. A foreign accountant I spoke to at the time was familiar with South American examples some decades earlier of banks lending to buy own shares – not an exemplary way of banking, in his opinion. “By lending against own shares a bank is effectively converting its loan book into equity,” was his way of describing this practice.

Asking a foreign banker in London if this was a general practice that banks lent clients to buy the bank’s share with the bank’s own shares as the only collateral he said he knew of this Icelandic practice: “It’s so insane that I don’t even know if it’s legal or not. No bankers in their right mind would consider it.”

But Icelandic bankers did.

Funding own share purchase – weak(ened) equity

What the SIC report pointed out regarding banks funding their own share purchases was the following:

“The capital ratio of Glitnir, Kaupthing Bank and Landsbanki was, in their annual reports, always slightly above the statutory minimum. However, these capital ratios did not reflect the real strength of the banks and the financial system as a whole or the capacity to withstand shock. This was due to considerable risk exposure stemming from the banks’ own shares, both through primary collaterals and forward contracts on their own shares. If equity no longer provides a cushion for protecting depositors and creditors it is not equity in the economic sense. Under such circumstances it is no longer possible to take the capital ratio into account when evaluating the strength of a financial institution, as the risk of loss stemming from the institution’s own shares lies with itself.

The banks had invested their funds in their own shares. Share capital, financed by the company itself, is not the protection against loss it is intended to be. Here this is referred to as “weak equity”. Weak equity in the three banks amounted to about ISK 300 billion by mid year 2008. At the same time, the capital base of the banks was about ISK 1,186 billion in total. Weak equity, therefore, represented more than 25% of the banks’ capital base. If only the core component of the capital base is examined, i.e. shareholders’ equity, according to the annual accounts, less intangible assets, the weak equity of the three banks amounted to more than 50% of the core component in mid year 2008.

In addition to the risk that the banks carried on account of their own shares, the SIC assessed how much risk they carried from each other’s shares. Here this is referred to as “cross-financing”. Around mid year 2008, direct financing by the banks of their own shares, as well as cross-financing of the other banks’ shares, amounted to about ISK 400 billion. If only the core component of the capital base is examined this amounted to about 70% of the core component in 2008.

The SIC is of the opinion that the financing of owners’ equity in the Icelandic banking system had been based, to such a great extent, on borrowing from the system itself that its stability was threatened. The shares owned by the biggest shareholders of the banks were especially leveraged. This resulted in the banks and their biggest owners being very sensitive to losses and the lowering of share prices.

Overstatement of a bank’s equity increases its growth potential. However, the bank’s ability to deal with setbacks decreases at the same time. The risk of bankruptcy is thereby increased. Under these circumstances, the loss to depositors and other creditors becomes greater than it would otherwise have been. If the bank in question is systemically important, as was the case with all of these three banks in Iceland, the costs to society will also be significant, as has been the case.”

The spiral to hell

The Icelandic banking system was fully privatised in 2003 but anecdotal evidence indicates that these practices of banks lending against own shares or taking shares as collaterals on favourable terms had started earlier, albeit on a much smaller scale. It is interesting to keep in mind that quite intriguingly the management of the banks did not change radically with privatisation. There were the same managers in place before and after privatisation.

Apart from weakening the banks’ equity the lending against own shares turned into a major headache for the Icelandic banks already in 2007 with the drying up of credit markets. The share price of the banks started falling, forcing the banks to make margin calls.

Under normal circumstances the banks would have taken the shares, liquidated them and pocketed the money to cover the losses. But by accepting own shares as collateral the banks had created anything but normal circumstances.

These circumstances were further aggravated with cross-ownership and close connections between holding companies and the banks. Thus, the collateralised shares, banking shares or not, created a highly poisonous circumstances where the banks could not follow normal business practices: by liquidating the shares the price would have fallen further – this really was a spiral straight to hell.

2007-2008: increased lending to “favoured clients” instead of shrinking the balance sheet

But shares in Icelandic banks and companies were not only placed as collateral in the Icelandic banks. Foreign banks had to some extent taken them as collateral for loans to the major Icelandic businessmen who were making splashes abroad – all of them major shareholders of the Icelandic banks – and their companies. During the winter 2007 to 2008 the foreign banks started making margin calls, threatening liquidation, in reality threatening the existence of the Icelandic banks.

During these winter months all the Icelandic banks did the same thing: they bailed out these large businesses, i.e. the banks lent funds to repay the foreign loans in order to prevent the market to be flooded with shares in the Icelandic banks and the major holding companies, owned by the big players and their partners.

By Easter 2008 this concerted action was more or less completed and now, the Icelandic banks were the main backers of their own shareholders and the main businesses, as well as vanity objects such as chalets, jets and yachts.

Loans to the already highly leveraged businesses went up, in some cases even doubled. And this at a time when the banks should have been shrinking their balance sheet, not expanding. Indeed, practically no one, outside of the “favoured clients” was getting loans. This did of course greatly increase the losses when the game of musical chairs stopped in October 2008.

Icelandic banks and businesses really felt the effect when funding on international markets dried up in summer and autumn 2007. Much of this panic lending in the winter of 2007 to 2008 was possible only because the banks were at the time funded by foreign depositors – most notably Landsbanki with Icesave and to some extent Kaupthing with its Icesave copy-cat product, Kaupthing Edge – but also deposits from charities, universities and local councils, mostly in the UK. Kaupthing used i.a. deposits in its Isle of Man entity that it had bought earlier.

Kaupthing – a business plan based on “parking” own shares

All of this was practiced in all the Icelandic banks – large and small – but as far as I can see none practiced lending against own shares as diligently as Kaupthing. It is not an exaggeration to say that Kaupthing’s business plan was partly just this: to lend funds to buy Kaupthing shares, i.a. extra funds to large clients, who were borrowing for other things.

These loans were allegedly presented as “risk free” in the sense that there were no private guarantees attached to these loans; the client would just place the shares as collateral and nothing more could be lost than just the shares. In addition to Kaupthing share-buying loans to large clients Kaupthing managers were offered these loans.

While the going was good these “share holders” mostly pocketed the dividend instead of necessarily paying off the loans. However, the bank management seemed to place great trust in having a large chunk of its shares “off market” and i.a. not shorted.

Kaupthing managers mostly pledged a personal guarantee in addition to the shares. Just days before the bank collapsed the bank decided to absolve all the managers of their personal guarantee. This decision was later turned around in court and these loans have turned into a millstone around the neck of some of these managers.

Many of the top-level Kaupthing managers have claimed that they never sold any of their shares, thus accruing losses. However, there is evidence that at least in one case a manager sold his own shares by letting another company he himself owned purchase shares, needless to say financed by a Kaupthing loan and no guarantee or collateral but the shares. Thus he did pocket a considerable sum of money from selling Kaupthing shares though outwardly still owning them.

Why Icelandic winding up boards ended up owning big stakes in foreign companies

There is nothing inherently wrong about using non-banking shares as collaterals but prudence is a must. The shares must be valued not a par but well below if shares are to make any business sense to a bank. Also, the bank must not be dependent of the share price staying high, i.e. not falling. This rule of prudency seems not to have been followed when it came to share collaterals by “favoured clients” in the Icelandic banks.

When the holding companies of some of these big clients, such as Jón Ásgeir Jóhannesson, failed it turned out that the resolution committees (later winding-up boards) of the failed Icelandic banks ended up owning large shareholdings in companies earlier owned by Icelandic businessmen, i.e. companies such as Iceland, the supermarket chain and the toy shop Hamley’s owned by Jón Ásgeir Jóhannesson.

Shares as collaterals = sign of dysfuntion and (possibly) corruption

In hindsight, one could say that these were bad banking decisions taken when the world seemed to be made of only rising share prices and infinite funding. However, I beg to differ. As pointed out above, these offers of both funding for shares – whether shares in the same bank, the other banks or in companies always owned by a small circle of businessmen – and then taking the shares as collaterals was not a general service but only offered to a circle of “favoured clients.”

Of the European countries in crisis only the operations of the Icelandic banks have been thoroughly analysed. From hearsay and sporadic reporting my feeling is that a similar scrutiny of operations of i.e. the Spanish and the Irish banks would bring interesting stories to the surface. Spanish bankers are being charged and stories might come up in court. I keep being amazed at how remarkably relaxed Irish politicians and high-level civil servants seem to be regarding evidence of shenanigans in the Irish banks and yet these same banks brought calamity and hardship to Ireland.

As to China and Chinese banking I will for sure be interested if similarities with Icelandic banking will materialise. If that is the case, it is a bad sign.

*Thanks to Stefan Loesch for directing me to the FT article. – This post is cross-posted on Fistful of Euros.

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Now that Greece has controls on outtake from banks, capital controls, many commentators are comparing Greece to Iceland. There is little to compare regarding the nature of capital controls in these two countries. The controls are different in every respect except in the name. Iceland had, what I would call, real capital controls – Greece has control on outtake from banks. With the names changed, the difference is clear.

Iceland – capital controls

The controls in Iceland stem from the fact that with its own currency and a huge inflow of foreign funds seeking the high interest rates in Iceland in the years up to the collapse in October 2008, Iceland enjoyed – and then suffered – the consequences, as had emerging markets in Asia in the 1980s and 1990s.

Enjoyed, because these inflows kept the value of the króna, ISK, very high and the whole of the 300.000 inhabitants lived for a few years with a very high-valued króna, creating the illusion that the country was better off then it really was. After all, this was a sort of windfall, not a sustainable gain or growth in anything except these fickle inflows.

Suffered, because when uncertainty hit the flows predictably flowed out and Iceland’s foreign currency reserve suffered. As did the whole of the country, very dependent on imports, as the rate of the ISK fell rapidly.

During the boom, Icelandic regulators were unable and to some degree unwilling to rein in the insane foreign expansion of the Icelandic banks. On the whole, there was little understanding of the danger and challenge to financial stability that was gathering. It was as if the Asia crisis had never happened.

As the banks fell October 6-9 2008, these inflows amounted to ISK625bn, now $4.6bn, or 44% of GDP – these were the circumstances when the controls were put on in Iceland due to lack of foreign currency for all these foreign-owned ISK. The controls were put on November 29 2008, after Iceland had entered an IMF programme, supported by an IMF loan of $2.1bn. (Ironically, Poul Thomsen who successfully oversaw the Icelandic programme is now much maligned for overseeing the Greek IMF programme – but then, Iceland is not Greece and vice versa.)

With time, these foreign-owned ISK has dwindled, is now at 15% of GDP but another pool of foreign-owned ISK has come into being in the estates of the failed bank, amounting to ca. ISK500bn, $3.7bn, or 25% of GDP.

In early June this year, the government announced a plan to lift capital controls – it will take some years, partly depending on how well this plan will be executed (see more here, toungue-in-cheek and, more seriously, here).

Greece – bank-outtake controls

The European Central Bank, ECB, has kept Greek banks liquid over the past many months with its Emergency Liquid Assistance, ELA. With the Greek government’s decision to buy time with a referendum on the Troika programme and the ensuing uncertainty this assistance is now severely tested. The logical (and long-expected) step to stem the outflows from banks is limit funds taken out of the banks.

This means that the Greek controls are only on outtake from banks. The Greek controls, as the Cypriot, earlier, have nothing to do with the value or convertibility of the euro in Greece. The value of the Greek euro is the same as the euro in all other countries. All speculation to the contrary seems to be entirely based on either wishful thinking or misunderstanding of the controls.

However, it seems that ELA is hovering close to its limits. If correct that Greek ELA-suitable collaterals are €95bn and the ELA is already hovering around €90bn the situation, also in respect, is precarious.

How quickly to lift – depends on type of controls

The Icelandic type of capital controls is typically difficult to lift because either the country has to make an exorbitant amount of foreign currency, not likely, a write-down on the foreign-owned ISK or binding outflows over a certain time. The Icelandic plan makes use of the two latter options.

Lifting controls on outtake from banks takes less time, as shown in Cyprus, because the lifting then depends on stabilising the banks and to a certain degree the trust in the banks.

This certainly is a severe problem in Greece where the banks are only kept alive with ELA – funding coming from a source outside of Greece. This source, ECB, is clearly unwilling to play a political role; it will want to focus on its role of maintaining financial stability in the Eurozone. (I very much understand the June 26 press release from the ECB as a declaration that it will stick with the Greek banks as long as it possibly can; ECB is not only a fair-weather friend…)

Without the IMF it would have been difficult for Iceland to gather trust abroad in its crisis actions – but Greece is not only dependent on the Eurozone for trust but on the ECB for liquidity. Without ELA there are no functioning Greek banks. If the measures to stabilise the banks are to be successful the controls are only the first step.

*Together with professor Þórólfur Matthíasson I have earlier written on what Icelandic lessons could be used to deal with the Greek banks. – Cross-posted at Fistful of euros.

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Today, the Reykjavík District Court ruled in the most extensive banking case so far, a case of market manipulation and loans to Kevin Stanford and other businessmen to buy shares in Kaupthing, alleged to have part of the market manipulation by Kaupthing senior managers.

This is a complicated case, where the Office of Special Prosecutor went through, in court, months of trades to show a pattern they claimed was consistent with charges of market manipulation. – The judgement will no doubt be appealed by those who were sentenced.

Sigurður Einarsson ex-chairman of the board of Kaupthing was sentenced to a year. Hreiðar Már Sigurðsson, the banks CEO at the time, was found guilty but not sentenced to prison because he has already been sentenced in another case, the al Thani case. According to Rúv, Einarsson sentence will be added to the four years he was sentenced to in the al Thani case. Ingólfur Helgason, Kaupthing manager of Icelandic operations was sentenced to 4 1/2 year. Magnús Guðmundsson manager of Kauphing’s Luxembourg operations was acquitted as was another employee, Björk Þórarinsdóttir member of Kaupthing’s credit committee. Bjarki Diego credit officer at the time was sentenced to 2 1/2 year. Three employees, who carried out the relevant trades, got suspended sentences of 18 months to two year.

One thing, which has proved valuable in this case as in other similar cases, is phone tabs. Interestingly, they have all been done after the collapse.

A complicated case – and contrary to what some seem to think Iceland has a similar legislation regarding market manipulation and other financial fraud as other Western countries. The difference is that there is a will to prosecute these cases: they are time-consuming to investigate but it is perfectly doable and the stories are simple. The fact that big banks are too big to investigate in other countries is only because there is a lack of appetite among authorities and politicians – there really is no other reason, no other explanation.

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The waiting for Godot turned into a theatrically staged presentation at Harpa by the prime minister and minister of finance, assisted by their two main Icelandic experts. The grand plan to lift capital controls has now seen the light of day. If realised as planned the future looks bright for Iceland. But there are still political risks until the planned good deeds are indeed done.

Here are the main points of the new plan: the size of the problem is ISK1200bn, $9bn, ca. 60% of Icelandic GDP where ISK300bn, $2.2bn, is the original overhang from October 2008 (mostly carry trade funds, which flowed to Iceland in the years before the collapse) and then ISK900bn, $6.7bn, in the estates of the failed banks: ISK500bn, $3.7bn, is pure ISK assets, ISK400bn, $3bn, is debt paid in FX by Icelandic entities.

According to the new plan, there are “non-negotiable stability conditions” the estates of the three failed banks have to meet. These conditions are defined in the plan, but not spelled out in króna. On the basis of these conditions the estates have to pay a “stability contribution,” as part of the composition agreement; again, the amount of the contribution is not stated.

The composition agreement has to be in place by the end of the year. If not, the estates will be forced into bankruptcy and will then have to pay a 39% “stability tax,” a one-off tax, of ISK850bn, $6.3bn, due on 15 April 2016. However, there is a deduction to the tax, meaning it will be, according to the presentation, ISK680bn, $6.3bn.

This is all stated in the plan – but in interviews afterwards Bjarni Benediktsson minister of finance the contribution, which he aims at and not the tax, will be ISK500bn.

The rhetoric used implied that the state could, on the basis of emergency and imminent danger, overrule private property rights, i.e. of the creditors. This sounded somewhat bombastic given that Iceland is a thriving country and well capable of solving the problems related to the foreign-owned ISK. Also, there was emphasis on solving the problems for the “real economy” – all of this was interesting, clearly used to create a sense of the danger the government is averting with its plan. This is the rhetoric in the world of staged politics and the Icelandic government is no exception here (except that its spin is always rather visible, i.e. not very professional as good spin should be invisible).

According to the presentation “For seven years there were no realistic proposals from the estates” – given the fact that Glitnir and Kaupthing presented their composition draft in 2012 and 2013 and have waited for answers and clear guidelines this is again part of the rhetoric. The government’s tactic has so far been like inviting the creditors to a game of dart without telling them where the dartboard was.

The numbers

As already explained, I doubt the size of the problem as related to the estates: I estimate it being ISK500bn, not ISK900bn. The higher number is, as far as I can see, again to underline the danger and justify the means. But again, this is part of the staged performance; the numbers were flashed up again and again.

Will the stability contribution be ISK500bn? From calculations I have seen the likely contribution is in the range of ISK300bn to ISK420bn, $3.1bn, – reaching ISK500bn does not seem likely. The contribution will be paid over time, most likely two to three years. It depends on values of assets etc that change over time, therefore the uncertainty. Further insight into the numbers can be gauged from the letters received from the three estates, see here. Whatever the estates agree to 60% of creditors have to vote for it.

A tax of ISK682bn, $5bn, as stated in the press release, is also, as far as I understand too high a number; ISK620bn, $4.6bn, would be more likely.

The old overhang will be resolved by the CBI in the classic way of auctioning and offering long-term bonds, no surprise there as this plan is already on-going.

Tax (= stick) or contribution (= carrot)?

What does the government want, a tax or contribution? Interestingly, the tax was the main focus of the presentation and little time and attention given to the contribution. The same in the press release, where composition and contribution is merely mentioned en passant whereas the tax is spelled out in great detail.

This however seems to have been part of the show. I understand that the advisers are wholly on the side of composition and contribution, as are the creditors. The emphasis on the tax would then be wielding the stick to make sure the creditors go for the carrot (another matter if a stick was needed).

While emphasising tax and bankruptcy, the refrain was that the capital controls liberalisation is NOT a money-making scheme for the treasury but to lift the controls and nothing else.

The government’s chief negotiator Lee Buchheit also stressed this aim to the Icelandic media but he did put a number on the outcome. His number was ISK650bn, $4.8bn, (see here, at 9:55 min; the number comes up at 15:49) in spe for the government. As far as I can see, an unrealistically high number, closer to the tax, which no one officially wants, than the desired contribution.

Buchheit had earlier mentioned another thing: that lifting the controls would take a short time, only about six years. This may not be what most people understand as “a short time” but it is a realistic time frame: it will take some time to carry out this plan.

In spite of the emphasis on giving priority to the “real economy” easing of controls for people, businesses and pension funds will only come later. On this, the presentation gave no dates. According to my sources, new Bills in parliament coming autumn or winter will clarify this issue.

Moral hazard and political risk

In spite of the government rhetoric of big funds to come, the debate in Iceland has mostly been characterised by relief: at last a plan, which seems realistic. The opposition has embraced it, pointing out that this is very much what had always been the plan.

There have been some voices asking why Greece and Argentina are struggling with their creditors while Iceland has so effortlessly negotiated with its creditors. The answer is of course that creditors in Iceland are not creditors to the state, contrary to Greece and Argentina, where the problem is sovereign debt; not the case in Iceland.

As stated earlier it is clear that the government aims at composition and contribution, not tax and bankruptcy. There is however always a political risk and the possibility of panic politics. The Progressive party has fallen from 25% of votes in the election in 2013 to 9% in the opinion polls in spite of successfully carrying out the promised “debt correction.”

The party very much got elected on the basis of its promises to fight the “vulture funds,” mentioning ISK800bn days before the election after talking about “only” ISK300bn to ISK400bn. And this was a promise of funds right into the state coffers, not to pay down sovereign debt as is now the plan; a plan that might annually free up ISK30bn, $200m to ISK40bn, $300m, otherwise used on interest payments.

The government had been adamant about not negotiating with creditors. Since talks have been going on over the last months the government has now defined these as “conversations,” not negotiations. No matter the word used it is clear that the largest creditors agree to the plan – and what they agree to is the outlined composition. Tax is a different matter.

For some reason, the old Roman saying “Pacta sunt servanda” has never quite reached Iceland. Icelanders and Icelandic governments over decades have repeatedly understood agreement made as being only valid until they have a different idea as to what they want. This will now again be tested.

Could the composition fail if an agreement on composition is not in place by the agreed deadline at end of the year? My understanding is that this is not likely: if needed, the deadline will be extended but that would of course only happen if things are moving in a realistic way.

Having had their patience tested over the last few years, creditors and the winding-up boards are no doubt both eager and well-prepared for the coming negotiations. Unless there will be a political itch to pick a fight, serving either political interests and/or special interest groups, things could look really bright in Iceland by the end of the year, otherwise the darkest time in Iceland.

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There were negotiations and changes until last minute. So much, that the various press releases published after the presentation of the plan to lift capital controls do not have the same numbers as to the percentage of a possible tax.

The tax percentages agreed on, as far as I understand, in negotiations with representatives of creditors is the one published in the press releases referring to Kaupthing, Glitnir and LBI:

The Task Force’s preliminary analysis suggested that to achieve the goal of neutralizing a threat to the balance of payments, this Stability Tax would be set at a rate of 37% of the total assets of each estate (measured as of end-June 2015), with an automatic exemption of ISK 45bn for each estate, which would bring the effective tax rate down to about 35%. 

Tax of 37%, de facto 35% after exemption, on the assets as they are at the end of June this year – was then changed and the automatic exemption was removed. The changes were the tax as it was presented at the press conference and in a general press release following the presentation:

A new bill of legislation on a stability tax imposes a one-off 39% tax on the total assets of the failed commercial or savings banks in accordance with their assessed value as of 31 December 2015.

This indicates that the tax was in the end higher than had been negotiated with representatives of the creditors, who were not amused, or so I hear, when they saw the changes.

*I am writing this ca. 8 hours after the press releases have been published but this has not yet been corrected.

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