Sigrún Davíðsdóttir's Icelog

How to a break up a relationship? Do you say you need a break, yet making it clear it’s finite – or do you make a clean cut and say it as it is, that you really don’t want to stay in this relationship? The Icelandic government is having a major difficulty in breaking up with the European Union although the relationship was only that of negotiating a further relationship. Saying “no, it’s over” seems difficult – and that is exactly what foreigners often say about Icelanders: they find it difficult to commit themselves to final decisions. 

At meetings in Brussels earlier this summer minister of foreign affairs Einar Bragi Sveinsson made it clear that the Icelandic coalition government (led by Sveinsson’s party the Progressive Party, together with the Independence Party) does not intend to continue its accession talks with the European Union. Sveinsson was categoric, there did not seem any way back. In Brussels those involved with the talks took this to be the end, I understand, though nothing final has been said.

Formally, there was to be a report in the Icelandic Parliament, on the state of the EU and on the state of the negotiations, already now in autumn. After discussing this report decisions would be taken. Well, no decisions have yet been taken who is going to write this report – will it be a committee or some organisation? No decisions on that so far. Consequently, it is completely unclear when the Althing will be able to have a say.

In Iceland, Sveinsson has stated quite clearly that the accession talks are over and this government will not continue. Sveinsson has also said that in spite of both parties, during the election campaign, favoured a referendum on continued negotiations he now sees no need for that. Officially, the government still talks officially about a break.

There are some Independence Party MPs, as well as some influential people connected to the party, who are in favour of Icelandic membership and who feel decidedly unhappy that this matter is being dealt with by only one minister without any further debate. This creates disgruntled mood between the parties.

The situation is now as if the government is trying to find a way of saying “no” to further talks without breaking off the relationship completely – it seems afraid of taking this decision knowing that the majority of Icelanders, according to polls, want to finish the talks and vote on an agreement. Sveinsson has been pointing out that in fact the EU has rejected Iceland by discontinuing the IPA grants Iceland has enjoyed the last few years thereby trying to tell the story as if the rejection is coming from the EU side.

Leader of the social democrats Árni Páll Árnason asked Sveinsson some questions recently regarding the talks but little was clarified (here are the questions and answers, in Icelandic). What is clear is that the government does not intend to continue the talks nor does it want a referendum, which it might very well lose.

The government may well be trying to keep this uncertainty going until the EU loses it patience and calls the negotiations off. But as it is now, the way the government is handling the issue portrays a government with an unclear idea of how to break without completely locking the door. A government that wants to say “no” but does not quite know how to do it and does not quite dare to do it. Since the government has only been in power for a few months this does not bode well for the major decisions that will have to be taken in the coming months, i.a. re capital controls.

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The foreign creditors of Glitnir and Kaupthing understand full well that they will not get the foreign assets of these two estates until a way has been found to deal with their ISK assets. There is not – and will not be for the many coming years – enough foreign currency in Iceland to convert their ISK assets. All of this is explained in an earlier Icelog.

Tonight, I reported on Rúv (in Icelandic) of an idea to put some of this ISK problem aside, so to speak. The idea is that considerable funds, perhaps ISK50bn from each estate, ISK100bn, €3.1bn, will be put in a fund, which will become the property of the Icelandic nation. The fund could be used for public good such as initiatives in education and health.

The government has said it wants to “extract” – how, is still unclear – considerable funds out of the liquidation process in order to fund an extensive debt relief fund, called “correction fund” for those who are too well off to have profited from earlier debt relief. It will be interesting to see what its reaction will be to this new idea – no comments forthcoming when Rúv sought comments tonight.

Meanwhile, the capital controls continue to hurt Iceland. Icelandic investors with money abroad shy away from bringing funds to Iceland. Salary is low in Iceland compared to the neighbouring countries. The government might think it is safest to wait and see – but that is actually a very expensive option for Iceland.

The Glitnir estate has hired the economist Lord Eatwell president of Queen’s College Cambridge as its special adviser in the winding-up process of the estate.

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According to Rúv, prime minister Sigmundur Davíð Gunnlaugsson (Progr.) will next week appoint someone to a new post to oversee work towards the abolition of the capital controls and be in charge of contacts with the creditors of the failed banks. The idea is to simplify the work regarding the capital controls and failed banks since this work concerns many ministries and institutions. This person will lead a group of experts who all will work towards abolition of the capital controls.

The really interesting thing is of course who this person is. Will this be a person who is undisputedly qualify to lead this work in a convincing and professional way and likely to succeed? Will it be a politician but professionally unconvincing? Someone with close ties to the Progressive Party and the prime minister? Or someone who has little pondus and is unlikely to achieve much?

We will have to wait until next week, unless the name leaks out, in which case I will update this post.

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Ever since the financial crisis erupted in Iceland in October 2008, foreign media has been obsessed with events in Iceland though it often seems to struggle to understand the financial issues at stake. However, that is of little real importance since the intensive media focus has drawn attention to Iceland as a tourist destination and life is too short to search for erroribus. But sometimes the errors and misunderstanding are  just so comical that it merits some attention.

“Another Icelandic meltdown may be coming. That would reignite investor fear, leading to yet another panic on the continent,” writes Cyrus Sanati for Fortune Magazine. – As happens in every country, Icelanders sometimes feel that they are the epicenter of the universe but Sanati seems to outdo most Icelanders. I can’t remember ever having run into anyone with any insight into finance or economics who thinks that events in Iceland have led to or are likely to lead to a “panic on the continent.”

Sanati seems partly to base his article on the latest IMF report on Iceland, though not quoting it, but seems to have read it rather hastily and to draw rather more alarming and far-reaching conclusions than the IMF economists.

According to Sanati “(s)ince 2008, the small island nation has been able to avoid an all-out economic meltdown thanks largely to government-imposed capital controls that have kept its currency from imploding. At the same time, the nation’s zombie banks have managed to avoid total collapse thanks to delay tactics that have allowed them to avoid settling with their creditors.”

The capital controls were introduced end of November 2008 at the advice of the IMF but in full agreement with the government. The new Icelandic banks were formed swiftly in early October 2008 by splitting the old banks into foreign operations, kept in the old failed banks and the domestic operations, in the new banks, the now operating banks.

The new banks are much less zombie-like than many other European banks, partly because bad loans were left with the estates of the three failed banks, partly because assets were moved into the banks at reduced value. The new banks have nothing to settle with the creditors of the failed banks. The two new banks, Íslandsbanki and Arion are owned respectively by the estates of Glitnir and Kaupthing, which in turn are owned by creditors who mostly are foreign financial institutions.

It’s quite right that the main problem in Iceland is the capital controls but the effect isn’t quite as Sanati depicts it:

Capital controls imposed by the government in 2008 are still in effect, forcing its citizens, and, more importantly, the nation’s massive pension fund, to invest mainly in Iceland. At the same time, Icelandic consumers still find it hard to buy foreign goods, forcing them to buy less-desirable local equivalents, giving an artificial boost to the domestic economy. Meanwhile, high interest rates have made borrowing expensive.

Yes, the nation’s massive pension funds are forced to invest in Iceland, which might in the longer run lead to too many kronas, ISK, chasing too few investment opportunities. Asset prices have been rising and are closely monitored by the Central Bank of Iceland and financial analysts in Iceland. So far, the rising prices are deemed to be sustainable but the bubble risk is certainly there, a well-known risk in countries with capital controls.

Consumers are however not much touched by the capital controls since importers can still import, just as exporters can export. There is no lack of foreign goods in Iceland and even if Icelanders were buying more of home-produced goods that is hardly artificial growth – the competition with foreign goods is still in place. The high interest rates in Iceland reflect inflation, which is high as has so often been the case in Iceland.

Re growth Sanati writes that “… real output in Iceland remains 10% below the pre-crisis peak. And while GDP did grow at around 2.9% in 2011, it slowed to around 1.6% last year and is expected to fall even further this year. This is the ugly side of capital controls. In short, by restricting what people can buy and invest in, i.e. only Icelandic goods and opportunities, individuals eventually stop spending.”

The IMF report states that “legacy vulnerabilities weigh on growth. Real output is still 10 percent below its pre-crisis peak. GDP growth, which reached 2.9 percent in 2011, slowed to 1.6 percent in 2012 amid private sector deleveraging and weak external demand.”

IMF gives a rather more nuanced picture of the slowing growth:

Deleveraging is constraining consumption and investment. Private consumption weakened in the second half of 2012, as one-off supporting factors (early pension withdrawals and mortgage interest subsidies) waned and households and firms continued paying down debt (Box 2). Fiscal consolidation, while necessary to reduce high public debt, is limiting the public sector contribution to growth.

            Slow progress in removing the capital controls is undermining confidence. While the controls safeguarded external and financial stability during the crisis, slow progress in lifting them is undermining confidence and inhibiting investment. At the same time, uncertainty about exchange-rate developments following the lifting of controls has hindered the anchoring of inflation expectations.

            Legacy risks in the financial sector are holding back credit expansion. Banks are still burdened by bad assets and continue grappling with uncertain loan valuations and risks stemming from their reliance on captive funds locked in by capital controls.

            The challenging external environment is weighing on exports. In 2012, less favorable terms of trade and weak external demand for real goods exports more than offset the improvement in services exports, notably tourism.

According to Sanati “domestic consumption and investment in Iceland are both down 20% from their pre-crisis levels and continue to fall. Icelanders are instead choosing to pay down their debts, which, while positive, comes at the expense of economic growth. And despite the debt paydown, household and corporate debt remain high, coming in at 109% and 170% of GDP, respectively.”

Again, the IMF report gives a more nuanced overlook:

Unique characteristics of Icelandic household debt complicate the deleveraging process. Household debt consists largely of home mortgages that are CPI-indexed, implying that the debt stock rises with inflation. Moreover, 85 percent of mortgages were issued in 2005–07 and have long maturities and back- loaded repayment profiles.

High private sector debt weighs on consumption and investment. Consumption is still 20 percent below its pre-crisis peak and 10 percent below trend, somewhat stronger than in euro area program countries but weaker than in other advanced economies. Domestic investment is about 20 percent below trend despite significant corporate debt deleveraging, likely reflecting factors such as capital controls. Growth will therefore likely remain modest for some time. To illustrate, average private consumption growth in Sweden and Finland hovered around 1 percent during the deleveraging period before rising to 21⁄2 percent post-deleveraging. Cross-country comparisons also show a negative relationship between private sector balance sheet stress and growth.”

The IMF report points at the comparison with crisis-struck Sweden and Finland in the 1990s:

International experience, however, suggests that further household adjustment should be expected. Peak-to-trough deleveraging of Swedish and Finnish households in the 1990s took as long as 8 years with debt declining by 30 percentage points.

Pointing only at the capital controls is an over-simplification. For the economy as a whole it does matter that Iceland’s largest trading partners, countries in the European Union, have been struggling. A returning growth in Europe is good news for Iceland. – And Icelanders, always great spenders, keep on spending, happily not restricted to Icelandic-only goods as Sanati seems to think.

Normalised household debt-to-disposable income peaked at 100% in 2010 in Iceland and is now ca. 85%, as shown in the IMF report.

So what now? According to Sanati “The new government promised during the campaign to lift the capital controls and to force banks to cut people’s mortgage principals. This has understandably shaken the rating agencies. S&P lowered its outlook on Iceland to negative in June on concern that the new government will go through with its plans. The IMF has expressed similar reservations.”

This is a rather misleading description of the latest event. The new government did not promise “to force banks to cut people’s mortgage principals.” It aims at getting money out of foreign creditors of the two collapsed banks, Glitnir and Kaupthing. What has shaken S&P is the lack of clarity as to how the government is going to fulfil its promises of extensive debt relief and its effect on the economy. The IMF is worried about these same promises and its possible effect on the state finances and the economy as a whole. In an earlier Icelog I have gone into some detail re the capital controls and possible ways of abolishing them. The CBI has published extensive reports on these same issues.

As are some Icelanders, Sanati is worried about the perspectives in Iceland. “Iceland has few good options. If it keeps the capital controls in place its economy will continue to shrink; lift them and asset values will fall as Icelanders ship their cash out of the country. The new government says that foreign direct investment will make up for the capital outflows, but they are either extremely optimistic or completely misguided. The lifting of capital controls will cause housing prices and other Icelandic assets to fall dramatically leading to yet another bank panic. In the wake of this chaos the Icelandic government believes foreign investors will come strolling in?”

It is true that Iceland has few good options but the new government isn’t planning on solving the problem of the capital controls with foreign direct investment. That would indeed be insanely optimistic as FDI has always been low in Iceland. The core of the capital control in Iceland is, as I have explained earlier (see the above Icelog link), that ISK exposure to foreigners is higher than the currency reserves can serve. The CBI is working hard on coming up with viable solutions as is the government and the foreign creditors whose kronas are stuck in Iceland.

Back to Sanati’s sense of importance of Iceland in Europe:

Iceland is facing many of the same issues afflicting much larger economies. For example, capital controls have been instituted in several European nations amid the fallout from the sovereign debt crisis. How and when those nations choose to lift such controls will have a profound impact on the value of the euro and thus the economic integrity of the entire continent.”

Eh, in Europe only Cyprus has capital controls and its economy amounts to 0.2% of the Eurozone. But that Iceland, neither part of the EU nor the Eurozone, and tiny Cyprus are both grappling with capital controls is unlikely to have the impact Sanati surmises.

Then there are further dizzying claims regarding the significance of Iceland:

Furthermore, Iceland’s banks are not unlike those in Spain as they both financed housing booms gone bust. How Iceland’s banks deal with the problem of its bad loans after capital controls are lifted could have a major impact on the way investors choose to look at Spain and its bank issues. Iceland’s banks are expected to force losses of around to 75% to 100% on their investors and large depositors, many of which are hedge funds that also buy and sell sovereign debt and the insurance linked to it. How these hedge funds will retaliate could be replicated in Italy or in France where sovereign debt continues to mount relative to the size of their economies.

The housing boom in Iceland bears little resemblance to the building boom in Spain nor did it cause the same kind of trouble for the Icelandic banks. I’m sure few investors will make the same assumptions Sanati does. Given that Spain has different kind of banking problems and no capital controls I doubt the major impact Sanati is expecting.

No, Icelandic banks are not expected to force any direct losses on their investors and certainly not on large depositors. The question of further write-down regards the creditors of the two failed banks and their ISK assets as mentioned above. Selling or buying of sovereign debt has nothing to do with the Icelandic sovereign. The foreign creditors are creditors to the two failed private banks, not the sovereign and this has no bearing on Italy (most of Italian sovereign debt is actually held by Italians and Italian institutions, unlikely to launch a financial terrorist action against their state) or France.

I rather agree with Sanati that “Iceland shouldn’t be ignored” but not for the reasons he lists:

After all, it was the first country to implode during the financial crisis and was one of the first ones to see its GDP rebound. Its small size and simple economy means that it is less able to bury its problems under a pile of confusing monetary actions. This forces Iceland to face the music much sooner than larger nations in similar predicaments. As such, investors will be watching what Iceland’s new government does intently. If it begins to falter, the rest of Europe could be next.

The problems in Iceland have been pretty clear from the beginning, also thanks to the fact that Iceland was in an IMF lending programme, consequently monitored by the Fund. And yes, everyone interested in Iceland, most of all Icelanders themselves, will of course closely follow what the government does.

But not even Icelanders with a healthy sense of self-importance think that it might take the rest of Europe with it if it falls. There might have been fears for the destiny of the country as Ireland, UK and other countries were fighting to keep their financial systems afloat in September and October 2008. But the fear in Iceland has long abated.

So far, with growth and lower unemployment, Iceland has something to be content with but there is no room for complacency. The capital controls are the most serious issue to solve and until they have been abolished Iceland can’t “graduate” from the financial crisis. But events in Iceland won’t shake the world – unless there is another volcanic eruption.

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If anyone is in doubt what matters in Iceland, the answer can be found in who are the top earners in Iceland. Now we know: fishing matters, again – and fishermen are the highest earners. It also indicates the strong standing of Icelandic fisheries and how well this business is going.

When the Icelandic banks collapsed in October 2008 the news went around the world that now Icelandic bankers were turning fishermen. The reason was that some journalists had indeed found a banker or two who had secured a place on a trawler or a fishing boat. Since then, I don’t know how often I have been asked if this was indeed the case – that Icelandic bankers were turning to fishing en masse. No, it isn’t. Though there certainly may have been bankers who secured themselves a place on a fishing boat (most likely through family relations) this was not a general trend.

But if it had been a general trend, ex-bankers would be doing just fine. It turns out that fishermen are indeed the group with the highest income in – and yes, they beat CEOs… and bankers.

Every year, the Icelandic business magazine Frjáls verslun (Free trade), publishes an issue entirely devoted to income – of social groups and well known individuals from all walks of life, i.a. politicians, media people, artists and business men. In total, the issue publishes the earnings of 3500 individuals. This is possible because the Inland Revenue in Iceland publishes every year, around this time, what every individual in Iceland pays in tax. (Yes, this may sound incredible to foreigners but this is transparency the Icelandic way: the overview is only open for a few days and only in books one has to visit in person at the Inland Revenue offices). From the tax, it is possible to calculate income, i.e. the ISK people get into their pockets. Thus, these numbers tell a certain story of salary but not the whole story of assets, income from dividends etc.

This year, the Frjáls verslun income issue publishes this week, shows that fishermen have superseded CEOs in terms of income. The general salary reference in Iceland is not a year’s income but the monthly income. The top 200 fishermen earners now have ISK2.5m, €15.6000, a month, compared to CEOs’ ISK2.3m, €14.400.

This is interesting in terms of salary, social groups and their social leverage. But it of course is also an interesting indication of Icelandic fisheries. Whereas fisheries are heavily subsidised in many countries, almost political pet projects, Icelandic fisheries are a booming industry.

What is clear from the Frjáls verslun data is that salary of CEOs, bankers and fisherman is rising much more rapidly than inflation. This may bode ill for the Icelandic economy since there will be wage negotiations for large groups in the labour market later this year. The tendency among these three groups will set the tone for these negotiations. Already, some are pointing out that CEOs and bankers are showing great irresponsibility, unavoidably egging other groups to irrational and unreasonable wage demands.

No, no one is blaming the fishermen because their salary is set, to a great degree, by what they fish and the value of their catches. Their catches, mostly sold abroad, went up in value with the collapsing krona, in addition to price increases due to improved marketing. And in general, fishermen tend to have a brahmin stature in Iceland: they are rarely criticised and certainly, politicians do not make disparaging remarks about fishermen since in many ways fishermen are seen as pillars of society. In Iceland, fishermen are talked of as “heroes of the oceans.”

As to public figures, the president of Iceland Ólafur Ragnar Grímsson now earns ISK2m, €12.5000, a month, up by ISK400, €2.500, from last year. The prime minister earns ISK1.5m, €9.400, a month.

As to social groups the average monthly salary of the top 200 earners in every group is the following:

                                                        2012       2013 
Fishermen                                   ISK2,4 m        ISK2,5 m
CEOs                                             ISK2,2 m        ISK2,3 m
Financial companies               ISK 1,6 m        ISK1,7 m
Managers (below CEOs)         ISK2,0 m        ISK1,6 m
Top 100 in education               ISK0,9 m.       ISK1,0 m
Health services                          ISK1,5 m        ISK1,4 m

*Here is an overview of the income issue, in Icelandic, from Frjáls verslun.

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Cyprus is struggling with its capital controls, with no fixed abolition date in sight. Iceland has also discovered that the best way forward is to have a plan with benchmarks but no time limit. Here are some facts on the Icelandic controls, what is at stake and for whom. As Cyprus might find out – and Iceland is already experiencing – the longer the controls are in place, the stronger the forces against abolishing them.

Capital controls come in many shapes and sizes and capital controls in Iceland and Cyprus are of different nature, set to solve different problems. In Iceland, the controls were put in place end of November 2008. At the time, more capital was flowing out of Iceland than could ultimately be converted into foreign currency. The problem stemmed from ISK600bn, €3.76bn, owned by foreigners (or entities abroad), hence the name “offshore krona/ISK” – there was no way the Central Bank of Iceland could find enough foreign currency to convert these ISK investments into foreign currency. Like in Asia in the 1980s these investments, in Iceland called “glacier bonds,” were made to profit from high interest rates in Iceland.

With time, new sources of ISK that need to be paid out in foreign currency have piled up, in total creating a problem amounting to about ISK1200bn, €7.52bn, ca. 70% of the GDP of Iceland. The core of the problem is ISK assets, needing to be converted into foreign currency at some point and kept firmly in place for now by the capital controls. With the controls in place there are various restrictions on movement of assets in out and of the country. I.a., every Icelandic citizen in Iceland has to hand over to the CBI whatever they earn in foreign currency.

The situation in Cyprus, part of the Eurozone, is different. The Cypriot capital controls were needed to prevent a run on the banks, i.e. hindering that deposit holders would empty the banks. Consequently, the controls were more invasive and much more felt, with maximum withdrawal etc. The controls have gradually been eased but there is now, as far as I can see, no certainty as to when or exactly what conditions need to be in place to abolish them.

The laws on capital controls in Iceland expired last year but there is now no time limit. The CBI has certain benchmark needed to be reached.

In Icelandic, one way of describing a short-lived blessing is “peeing in one’s shoes” – it is a quick warmer but the effect does not last and ends up as a messy problem. That is exactly what capital controls are: a quick blessing, which in time turns out to be costly and eventually costlier than the benefits. It is well established that the longer capital controls are in place the greater the damage: they tend to create an asset bubble as too many currency units chase too few investment opportunities, they distort the business environment and eventually they are inductive to criminal behaviour and corruption and – as anecdotal evidence now shows in Iceland: capital controls create unjustified privileges.

The ISK1200bn problem held in place by capital controls

In Iceland, the capital controls now hold three more or less equally large batches of ISK seeking to be paid out in foreign currency. The glacier bonds now amount to ca. ISK400bn, €2.51bn. Those who own them may to a certain degree be patient investors, happy to enjoy Icelandic interest rates, still quite a bit higher than in the Eurozone.

The second ISK400bn batch consists of ISK exposures with direct or indirect state guarantees. The largest part, ISK270bn or €1.69bn, are bonds exchanged between the new and the old Landsbanki when the new one was set up. Other exposures here are loans of state owned companies like Landsvirkjun, the energy company.

The third ISK400bn batch consists of ISK assets in the estates of Glitnir and Kaupthing, which need to be paid out in foreign currency. Ca. 90% of these assets are owned by foreigners but Icelandic creditors like the CBI and Icelandic pension funds own ca. 10% of these assets, meaning that 10% would float back into Iceland when/if these assets (and the estates’ foreign assets) are paid out. It also means that whatever happens to these creditors (i.e. whatever measures used to dissolve the estates and pay out creditors), does not only apply to foreigners but also to Icelandic creditors. And 10% is not a trivial figure in proportion to the Icelandic economy.

In order to lift the capital controls it is necessary to solve the problems that keep the controls in place. This means that in Iceland the size of the problem is roughly 70% of GDP. That in itself would be no mean feat – but in addition, the government (or at least the Progressive Party) has declared that this process has to create a windfall of ca. ISK300bn, €1.88bn, which it wants to use for further debt relief for those who are too well off to have benefitted from earlier debt relief (which so far is the most extensive debt-relief in any debt-hit European country).

Basically every one who does not have debt at stake thinks this policy, first launched as an election promise by the Progressive Party before the election in April, is a bad idea (i.a. potentially inflation-fuelling; funds would be better used to pay down sovereign debt, i.e. benefitting the whole population), amongst them the CBI, OECD, and the IMF. As reported earlier on Icelog, Prime Minister Sigmundur Davíð Gunnlaugsson does not take seriously criticism from foreign “acronyms,” meaning the OECD and IMF – but that is another story.

The glacier bonds and the state-guaranteed assets – 2 x ISK400bn

Though the two estates pose the trickiest problem, the two other batches also need to be dealt with. The glacier bondholders may well get some offer inducing them to stay, such as unfavourable exchange rate/levy. Also, as mentioned above, some of these investors may be in no hurry to leave.

The CBI and others have indicated that the real problem of state-guaranteed ISK assets, though ISK400bn in total, is thought to be ISK250bn because there are ca. ISK150bn worth of foreign assets/revenues to offset it.

Part of the solution would be to extend the maturity of the Landsbanki bonds, now the topic of intense negotiations between the Landsbanki estate and the new Landsbanki. Due to Icesave, the Dutch and the UK guarantee deposit schemes are the estate’s largest shareholders. Dutch and British officials have a thing or two to say on this matter and they are not necessarily dripping with milk of human kindness after the EFTA Surveillance Authority and the EU unexpectedly lost the Icesave case at the EFTA Court.

The trickiest ISK400bn batch

It is clear that the funds for the debt relief should not come from just any of the three problem batches but from the one that mainly regards foreign creditors, i.e. the Glitnir and Kaupthing batch. Politicians, mainly from the Progressive Party, hoping for a windfall here, seem to hope that although the ISK400bn assets are not trivial, the foreign creditors might be willing to negotiate a write-down – or some other measure that would result in funds for the government (though these are assets of private companies) – in order for the creditors to get their hands on the foreign assets in these two estates, the equivalent of ISK1500bn, €9,40bn, close to 90% of Icelandic GDP.

These foreign assets are sitting there, ready to be handed over – ca. ISK1000bn, €6.26bn, in cash, the rest in assets. It is clear though that the CBI, which by law needs to agree to the estates’ composition (or whatever happens to them) will not grant any asset payout until the destiny of the ISK assets is decided. No piecemeal service here.

The possible measures and solutions re Kaupthing and Glitnir are now being furiously pondered on and discussed among those who have a skin in this game – meaning the administrators of the two estates, the creditors (or their ad hoc creditor committees and their representatives), the CBI and the government, probably mostly within the ministry of finance.

Bjarni Benediktsson minister of finance and leader of the Independence Party is well positioned to make an enlightened choice since he has all relevant experts at his fingertips. Also, IP is traditionally well connected to the ministerial administration. Gunnlaugsson, who no doubt will want to follow this closely – given the election promises at stake for him and his party, ultimately his credibility – might find himself in a more difficult position in terms of access to the same kind of expertise, if he wants to make his own independent assessment. The PP, out of government from 2007 to 2013, might not have the same access as the IP.

Why postponing a solution may be a costly option

Foreigners, who have had dealings with Icelanders, often mention that it is notoriously difficult to get Icelanders to make up their mind and commit to a final decision. The estates might be one such problem where the government will find it very difficult to make up its mind, not least because the PP, after their rhetoric and promises, have to present a solution that looks like a victory over the foreign creditors, with the funds to show.

These problems have been clear to everyone concerned for a long time and clearly all those involved with the two estates have been problem-crunching for months now. One of my sources pointed out to me that if this problem is not solved relatively quickly, i.a. a solution presented in the coming month (though the fine and final details make take some mulling-over) this might drag out for quite a while because it would suggest a fear to bite the bullet rather than a lack of informed options.

But can’t the government just wait around until it has found the perfect solution for the two estates? Not necessarily because without a solution the capital controls stay in place. And the longer it takes to solve the issues of the two estates the harder it is to solve. Delays of half or whole years might burden Iceland with added costs of the capital controls.

A delay can have two-fold effect on the estates: the assets will change – and claims will most likely be sold to a different category of investors compared to present creditors.

As to the assets, unsold assets give scope for negotiation of value. The more assets sold and turned into cash, the less scope to negotiate on value. The thinking among some in Iceland is that the creditors of Kaupthing and Glitnir could just solve the problem by giving the ISK assets to the state (for example, handing the over the CBI), in order to get at least the ISK1500bn foreign assets. Negotiating a write-down is more or less the rule in this situation but a pure gift sounds more than wishful since all creditors have to maximise their recovery. Amongst them are the CBI and Icelandic pension funds, which might find it difficult to justify this kind of magnanimous action.

That said, the creditors may in due time well show some creativity and present a solution that indicates they understand the problems Iceland faces. Remains to be seen.

As time passes, it will be more difficult for creditors to show any kind of creativity because more assets will be sold and converted to cash, leaving only the currency rate to be negotiated.

Thus, it can be argued that time is not on the side of the state. The creditors will not be happy to wait but they can get out of the situation if they want to and they, being professional investors and institutions, have seen all of this before.

Here is what delays might do to the creditor group. For now, the original bondholders in Kaupthing and Glitnir own more or less half the claims, with the other half having been sold off to those who specialise in distressed debt. The division is not quite clear-cut because banks and big creditors often invest with the buyer when they sell off their claims in order to get a cut of the up-side if there is any.

If creditors start to think that the assets will be dealt with “sub specie aeternitatis” they will sell their claims – and the more hopeless it seems the more the write-off and the more virulent the buyers. The vulture kind, prepared to sue everyone to hell in order to get as much out of the claims as possible. – This potential change of creditors will of course not happen over night but yes, over time if creditors start to lose hope and just want to get however little out of what they have.

Consequently, the longer it takes to find a final settlement re Kaupthing and Glitnir the greater the difficulties in finding a solution, bringing on losses for domestic creditors as well. And, worst of all, the capital controls stay in place.

The destructive effect of capital controls and the rise of a new Icelandic nomenklatura

In several reports, i.a. on financial stability, the CBI has in no unclear terms spelled out the cost of capital controls for the Icelandic economy brought on by a potential asset bubble and distorted business behaviour. The CBI deems that these are potential risks, which have not yet happened.

It is notoriously difficult to tell when there is bubble, i.e. when assets are mispriced and asset prices have been rising fast in Iceland, i.a. property prices and shares of listed companies. Both the CBI and financial analysts say that so far, these price increases are in tune with the economy, not a bubble.

The no less worrying effect is, I think, that capital controls are potentially fertile ground for corruption. With time, they create a booming industry seeking to avoid the controls. And with time this industry will do what it can to keep the controls in place.

This is a general course of events in countries with some kind of capital controls. In addition, the capital controls in Iceland are slowly creating its own special kind of a privileged nomenklatura that can buy assets at a cheaper price than other Icelandic mortals.

In order to relieve the pressure of the offshore ISK, the CBI came up the with the idea of offering offshore ISK owners a way of investing this money, given certain terms and conditions, if they bring in foreign currency in addition to the offshore ISK. This seemed like a reasonable way to attract foreign investment to Iceland. The problem is that this has, apparently, not attracted foreign investors but gives Icelandic investors, with foreign assets (which have to be since before the capital controls) and offshore ISK, the possibility of buying assets in Iceland, be it property or financial assets, at a ca. 20% discount to Icelanders who have nothing but their hard-earned not-worth-much ISK.

This new nomenklatura is now pretty clear and known to everyone though it is hardly ever mentioned in the Icelandic debate. I can certainly not remember ever having heard a politician mention this (but here I might be wrong since I don’t follow the Icelandic debate in detail).

Another sneakier way is less well known but indeed existing, I’m told.

It is always presumed that the glacial bondholders are foreigners. That is probably how it was in the beginning of time, i.e. when these investment objects were created and up to the collapse. What I now hear from various sources is that there are Icelanders in this group. No, not necessarily the notorious billionaire “Viking raiders” but wealthy Icelanders, in Iceland, who have bought the bonds after the collapse and now hold them through foreign companies or “nostro” accounts of foreign banks. Out of the total ISK400bn these may not be high sums but, again in Icelandic context, quite a bit of money.

Here is the trick: the law on capital controls allow glacial bondholders to convert the interest rate of glacier bonds into foreign currency and move them abroad. Icelandic glacial bondholders can then take this foreign currency and bring it back to Iceland through the CBI investment offer, to buy Icelandic assets, meaning they get the Icelandic assets at ca. 20% discount, as mentioned above.

It would be very interesting to know who these alleged Icelandic glacial bondholders are. It would throw light on how privileges are meted out in the regime of capital controls and clarify the stance that certain individuals may take in the public debate.

Waiting is not an option – if the cost of capital controls matters

As argued above, there are various reasons why waiting is costly, why waiting compounds the problem of the capital controls and makes the ensuing problems more engrained over time. Needless to say it is extraordinarily difficult to say exactly at what point the cost is greater than the benefits of the controls. Also, assessing the cost of the corruption the capital controls create is particularly hard to evaluate.

The capital controls in Iceland have been in place for the best part of five years – in Cyprus only for five months. Although the controls in the two countries are of different nature, put in place to solve different problems, Iceland can be an interesting example for Cyprus – and possibly, with time, an example of what to avoid.

*Here are some earlier Icelogs on capital controls.

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Now that Germany is such a heavy-weight in Europe, non-German European politicians should do more of traveling in Germany in order to understand the Germans a bit better. After just a few hours in Berlin I had understood that it’s not just German politicians who like to tell their foreign counterparts how to do things – this is indeed very much a German character trait and it’s well-intended

Asking the bus driver at Schönefeld airport if there were other buses going into Berlin he pointed at an info point a few meters from the bus where I could study the various travel options. Having done that, I opted for the bus. Once again on the bus, I asked for a ticket. Sighing, the bus driver pointed at the ticket machine next to the info point – I could have bought the ticket there, he said; then he would not have to sell me the ticket and lots of good things would have ensued from it, which did not happen now that I had not had the foresight to buy the ticket from the machine.

The following day, a taxi driver to whom I made some comment about the Berlin traffic gave me a long lecture on how best to drive in Berlin. Unfortunately for the traffic and Berlin travellers, not so many drivers were as enlightened as my driver.

I came to think of all the media coverage where various European non-German politicians have aired their irritation with their German counterparts lecturing them on economic prudency and other virtues Germans feel they are better endowed with than most others. This is generally taken as German politicians being arrogant. My first 24 hours in Berlin taught me otherwise – the willingness to lecture others is a German trait in general. If non-German European politicians spent a few days in Germany they would understand the Germans better – and, most of all, understand that it is well meant, not just arrogance.

That said, I warmly recommend spending some time in Berlin. I adore living in London but Berlin has some great things to offer – and most of all, it can teach us (yes, a bit of lecturing here) some interesting things about what makes a city an interesting city.

What the indies tell us about Berlin – and London

On the corner of Unter den Linden, facing one of the tourist magnets of the city – Brandenburger Tor – there is a Starbuck café. Otherwise, the city is full of independent coffee shop. My favourite part of Berlin is where I happened to be staying this time, Die Mitte and it is, as other parts of the city attracting youngish crowd, full of very tempting cafés. This being such a great neighbourhood, I spent most of my time there, as well in Kreuzberg, around Bergmannstrasse.

The cafés hark back to the pre-war times and the city’s cultural life. But it is also a sign of the fact that although property prices have gone up quite a bit in the last few years it still seems possible to make a living by running just one café in the centre.

Another sign of the same are all the antiquarians. For anyone who loves books, Berlin is a wonderful place to peruse. And prices are low. I picked up an Insel Verlag book with a great selection of Otto Dix’ work for €3 – no need to read German to enjoy it.

Then there are the small shops of fashion and design – again, shows that small can be done in Berlin.

In London, independent places like these can be found almost nowhere in the centre. The number of independent coffee places might be going up in central London but it seems that these places are quite often a hopeful first in planned mini-chains and chains. Second-hand books are now mostly found in charity shops in central London. Very few second-hand bookshops are run by dedicated book lovers any more, as the Berlin shops in the centre.

Yes, London has benefitted from being the favoured place of bankers, oligarchs, wealthy entrepreneurs and other billionaires. But this influx of money has killed off everything that makes Berlin a vibrant and quirky place. And part of the vibrancy and quirkiness comes from the artists, both German and foreign – quite a number of British artists among them – who find Berlin such a congenial place to live and work in.

Berlin house-prices – upward movement but still on a human level

My Berlin friends tell me that house prices have gone up a lot in the last four or five years. However, the square-metre in Mitte, one of the more expensive parts of central Berlin, is around €3.500. A four-room flat (three bedrooms, one living room) with one bathroom can be rented for €700 a month, in Mitte. A four-room flat (two bedrooms, two living rooms) with two bathrooms in Kreutzberg costs €1400 a month. And so on. Compared to London, this is heaven.

Ever since Berlin replaced Bonn as a capital there has been talk about an imminent property boom in Berlin. But in spite of recent up-ward trend it has not really happened. Not on the scale of London, not even on the scale of Paris. The bureaucrats who moved from Bonn to Berlin, used to the leafy villa quarters in Bonn, opted for the Berlin suburbs and did not move prices in the centre.

The bankers are still in Frankfurt – Gott sei Dank, from the point of view of those with less well-paying jobs, such as the artists that flock to Berlin. Creative industries such as design and advertisement are also increasing their presence. What could move the prices are people from pharmaceuticals and other industries that are increasingly settling down in Berlin.

Russians are now flocking to buy property in Helsinki, moving the market there. So far, nothing like this has happened in Berlin. Eric Schmidt chairman of Google, preparing to fork out £30m for a suitable London home, could buy a whole quarter of Berlin Mitte for that sum.

But then, some of the most fantastic flats in Mitte can’t be bought for ready money at all – the city itself owns some stunning flats in Mitte, true “Herrschaftswohnungen,” and offers artists to live there for a very decent rent.

Where the UK does not exist

It was an interesting experiment reading the German papers en masse every day. Plenty of coverage of all things Europeans, usually with some focus on the stance of other leading EU countries on the various issues. Britain was hardly ever mentioned except there was some weird news about Prince Charles and his tenants. So much for the British political relevance on the continent.

Germans do politics differently from the British. In so many ways. One thing is that German politicians are not afraid of serious culture like opera. Chancellor Angela Merkel attends Wagner operas in Bayreuth and the press invariably covers her visits as those of other politicians. For the last many years, I cannot remember ever having seen news of a leading UK politician going to Glyndebourne or the Royal Opera (and if they do, they seem to go incognito). Germans are not afraid of art and culture nor are German politicians afraid to show their interest in the kind of culture the British call posh.

There is just a much more ingrained interest in culture in Germany than there is in Britain. It shows in the newspapers – plenty of serious culture-related articles. Earlier this year, Die Zeit published a 40 page supplement where leading philosophers wrote on various topics.

In addition, there are all the German regional papers, can’t remember if Berlin has two or three and they are good. Much more substantial than just real estate ads and short news on a blotter being seen in a park. But Germany doesn’t have anything like the BBC – but then, the BBC is pretty unique.

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Mainstream shopping is not my thing (Kurfürstendamm is i.a. the street for that in Berlin) but there are certain very interesting shops in Berlin.

I don’t hesitate to say that The Different Scent, at Krausnickstrasse 12 in Mitte, must be one of the most interesting and exciting perfume shops in the world. Not only does it sell the best of young labels like the Geneva-based Ys-uzac (the maker of Pohadka, a stunningly intriguing and original scent as well as other of their interesting scents like Lale, Metabole and Monodie and its brand-new additions, Immortal Love and Satin Doll) but the shop owner has a fantastic insight and knowledge of the rarefied world of scent. This shop is just about scent and the discovery of the best made and most interesting scents and I love the fact that the décor is Spartan, firmly placing the attention on the essentials, the scents sold there.

For those interested in costume jewellery, Berlin is haven. At markets there are stalls with interesting offers, even at collectors’ level. Rianna, Grosse Hamburger Strasse 25, Mitte, has a fabulous selection of costume jewellery, also new pieces in a vintage shop with an extraordinary selection of clothes from labels such as Pucci, Yves Saint-Laurent and Dries van Noten, mostly echoing the Greek Rianna’s own love of interesting bling and riotous colours. As can be expected in a specialised shop the prices are in accordance with the pieces, not cheap, but for anyone interested this is a place that holds many wonders.

There are so many vintage shops in Berlin – one of its many attractions – and “No Name” at Torstrasse 62, Mitte, has a great selection of costume jewellery, as well as clothes, carefully chosen by its young owner with a great eye for quality and originality. The reasonable prices are part of the joy of visiting this small but excellent place.

The Barn is a café, on Koppenplatz, just off Auguststrasse with good coffee, great sandwiches and cakes (German cafés all seem to do cappuccino with soft froth whereas I prefer the Italian stiff, dry froth but the coffee in so many of the Berlin cafés is exceptionally good).

Bar+wine shop, Not just another Riesling Schleiermacherstrasse 25 (side street from Bergmanstrasse, Kreutzberg, by the market hall, great if you are buying food to cook) is a welcoming place where you get to taste wine before buying it and can have any bottle + €9 corkage to drink, also some nice cheese and charcuterie. Had a fabulously interesting Saignée from Josten & Klein, a lovely and fresh sparkling Mosel (I think) whose name I did stupidly not write down and one of the most interesting red wines I have had recently, the Spanish Bancal del Bosc 2011 – all of these wines around €15 or less.

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Loans in foreign currencies, widely issued by Icelandic banks during the boom, turned into a major liability when the banks collapsed, dragging the Icelandic krona down. But forex loans have been a liability elsewhere, i.a. in Croatia where borrowers formed an organisation and sued banks, issuing forex loans, for misleading information. The Franc organisation has now won a case against the banks but the case will now go to an appeal court.

Forex loans issued by the Icelandic banks during the boom times before the collapse in 2008 were popular because the interest were much lower than Icelandic interest rates, which mirrored the inflation in Iceland. These loans were mostly used for buying cars, less for mortgage though not unknown there. It seemed like a brilliant idea at the time since the Icelandic krona was strong. Historically, the strong krona was anomaly but the banks did not dwell much on that fact.

After many court cases it has now been established that it is illegal to bind interest rates in Iceland to anything but Icelandic interest rates, not to foreign rates but lending in foreign currency is legal. The thousands of loans issued were variously documented, some legal, others not. The banks have been obliged to recalculate forex loans, binding the interest rates to the CBI rates, much lower than the general lending rates. Some people got lucky there, others not.

In Croatia there were similar circumstances – domestic rates were higher than i.a. Swiss rates so banks started offering loans in Swiss francs. The the Croatian “kuna” collapsed these loans turned into serious liabilities. Contrary to Iceland, where the plight of forex borrowers caused great consternation among politicians, Croatian politicians have mostly been wholly unsympathetic to these borrowers, telling them squarely they should have been better informed and borrowing always implies risk.

In order to advocate their cause the borrowers formed an organisation, Franc organization and sued eight banks, on grounds of consumer protection, pleading that the banks had not informed people properly about the risk. People were given loan contracts of many pages but told they did not need to read it. After privatisation of the banks most Croatian banks are now owned by foreign banks, as can be seen by the eight banks sued: UniCredit – Zagrebačka Banka, Intesa SanPaolo – Privredna Banka Zagreb, Erste & Steiermärkische Bank, Raiffeisenbank Austria, Hypo Alpe-Adria-Bank, OTP Bank, Société Générale – Splitska banka and Sberbank formerly Volksbank.

Although the Croatian court system leaves much to be desired this case has already been ruled on – and Franc won. The case is not quite over though as will now go to an appeal court.

One thing that has made these loans such a liability, as pointed out to me by some of those involved with Franc, is Croatian law on bankruptcy, which has no time limit, meaning that once bankrupt, eternally bankrupt. Loans are not written off or written down and claims live forever. One thing Croatian politicians should definitely look into.

*Here is a report in Icelandic I did on the Croatian loans 17.8. 2012 after I had talked to Petra Rodik, one of Franc’s founders and Franc’s lawyer Nicole Kwiatkowski.

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After much effort by former clients of Landsbanki Luxembourg – mostly foreign pensioners in Spain and France who took out equity release loans at the bank – it now seems their efforts have caught the attention of authorities in Luxembourg. In France, a judge has halted the recovery of these loans by the Landsbanki Luxembourg administrator

According to the Luxembourg paper Wort, there are now two investigations ongoing in Luxembourg related to Landsbanki’s operations there. This surfaced in the Luxembourg parliament as the minister of justice Octavie Modert responded to a parliamentary question from Serge Wilmes, CSV. Ms Modert said that both cases related to alleged criminal conduct in the Icelandic banks and great progress was being made in one of them.

According to Wort the progress relates to the Landsbanki equity release scheme, extensively covered on Icelog. It is not clear if both investigations relate to Landsbanki or if the operations of Kaupthing and Glitnir in Luxembourg are also being investigated.

The website of the Landsbanki Victim Group is here. This group has hired lawyers both in Luxembourg and Brussels. Considering the fact that the banks collapsed in October and that there have been efforts in Iceland to investigate operations there, also with assistance from authorities in Luxembourg it can only be said that if there is much progress made now, little was done for a long time. It seemed that Luxembourg was more than reluctant to pay any attention to the financial sector this little Duchy lives so well off.

The latest move is that efforts by the Landsbanki Luxembourg administrator to recover assets from the equity release clients have now been halted. As an investigation is ongoing in France into this scheme sold through Luxembourg, a judge in Paris has thwarted the recovery efforts while the legality of the scheme is still unclear.

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This week, an Althing investigative commission delivered long awaited – or long dreaded – report on the Housing Finance Fund. It was even worse than expected, outlining greater than expected losses. It outlines how political connections – mainly the Progressive Party, now leading the government – systematically put the party’s interest before the HFF’s. The losses 1999-2012 could amount to ISK270bn, 16% of Icelandic GDP, possibly more. Add this to another blunder – the losses of the Central Bank of Iceland from repo deals with the Icelandic banks prior to the collapse – also causing a sovereign loss of 16% of GDP and it seems that Icelanders pay a lot for the political parties putting their own interests before the country’s.

,,… unfortunately, one can’t but sincerely admit that one had lots of doubt but this is what was agreed as the government was formed in 2003. If it hadn’t been done, that government would not have come into being.” This is how Geir Haarde minister of finance 2003-2007 (leader of the Independence Party 2005-2009, prime minister 2006-2009) described to the Special Investigative Commission on the financial collapse in Iceland how the 2003 coalition of the Independence Party and the Progressive Party came into being. In the elections that year, the Progressive Party campaigned on raising the mortgage level to 90% of the purchase price. In order to save the coalition of the two parties, led by the Independence Party, that party agreed to turn the Progressive campaign promise into policy. The vehicle was the Housing Finance Fund, HFF.

This policy turned out to fuel a boom that was already building up. Haarde was aware of the danger but, concludes the SIC report, his estimate was “that the expected loss for society (from this policy) was an acceptable cost to society for keeping the two ruling parties in power.”

We now know that the cost of this policy might be the somewhat unacceptable loss of ISK270bn, €1.68bn, 16% of GDP. Ironically, it now falls on the present coalition of these two parties, this time under Progressive leadership, to take a decisive step to end the Fund’s misery.

A new report (unfortunately only in Icelandic; not even an English summary), published earlier this week by an Althing investigative commission, tells the story of these huge losses and how the fund was used for political purposes. The report lays political networks bare, showing how political connections were favoured over merit and experience and how the fund continuously added to the coffers of companies connected to the Progressive Party. Regulators failed and foreign criticism, i.a. coverage in 21 reports by the OECD and the IMF, was systematically ignored. – The Fund itself disputes the numbers in the report, saying the losses are at most ISK64bn. However, the fund only put forth this number without any documentation in a press release and has not answered other matters raised in the report.

HFF, the Progressive power sphere and regulators who failed

The core of the problems was changes to the financing of the HFF and changed lending rules in 2004. The Independence Party had for some time worked on changing the issuing of HFF bonds so they would appeal to foreign investors. In 2003 the Progressive Party had campaigned on raising the mortgage level to 90% of purchase price. The changed issuance caused an immediate loss in 2004 of ISK21bn. A simple error in calculation added another ISK3.5bn, to the loss, bringing it to almost ISK25bn. Higher lending levels increased the risk and did over time cause higher levels of non-performing loans. The Fund started lending to property developers and companies, both increasing risk and losses.

The immediate loss of ISK25bn was just the beginning. Over the years, the faulty decisions taken in 2004 have caused snowballing losses, which now stand at ISK103bn of loss already on the books with the addition of foreseeable loss of 167bn, in total ISK270bn. The Fund claims the losses mainly stem from the collapse of the banks but according to the report the main losses stem from changes to the Fund in 2004. In a nutshell, it is a saga of the intertwining of political power and a public institution, the HFF.

The political connection surface in various ways. Fjárvaki, a subsidiary of Kaupfélag Skagfirðinga (once part of the Icelandic co-op movement, strongly connected to the Progressive Party and still part of the “Progressive sphere”), signed a deal to sell software to HFF. In the end the deal was terminated without Fjárvaki fulfilling it. Yet, HFF paid Fjárvaki an amount equal to the sales price. This is only one part of the HFF’s many highly questionable connections to Progressive-connected entities. And only one of innumerable similar stories in the report.

Then there is the glaring incompetence. With the 2004 changes in laws the Fund was obliged to have a proper risk management system. A Swedish consultancy, Capto, delivered the system and ran it to begin with. When the HFF staff took over it seems they neither understood it nor were able to run it, rendering the risk management useless. To make things worse, the Financial Services Authorities, FME, did not react to the Fund’s flawed risk assessment.

On the whole, all regulators and institutions, which were supposed to supervise and regulate the HFF failed. Part of the problem was that the fund was drowning in money as banks were venturing into mortgage lending, wooing clients with lower interest rates than the HFF. With changed rules, borrowers could pay up their HFF without penalties, meaning the HFF was drowning in money it could not invest at rates high enough to meet its own financing costs.

Through 2005, HFF lent ISK95bn to banks and other financial institutions, thereby financing the banks’ own mortgage lending, which was crowding out the Fund’s own mortgages – and in addition fuelling a boom. The report criticises the Central Bank of Iceland for not taking any action, thereby failing its role as a guardian of price stability.

The fervent denial of criticism

Although the extent of corrupt procurement and lack of expertise were first laid bare in the new report, the flawed public housing policy and the risk to the sovereign through the HFF’s state guarantee have been clear from the beginning and indeed heavily criticised by international organisations such as the IMF and the OECD.

The new report trawls through 21 reports from these two organisations from 1999-2012. The Fund’s clear problems and its compromising position has been a permanent fixture in reports from both organisations and still are. Yet, the various governments during all these years have ignored the warnings. And there is still no plan in place to end the Fund’s loss-making misery. The new report concludes that by not heeding the relentless warnings, Icelandic authorities have undermined their trust abroad.

In general and over all these years the intertia to solve the HFF’s problems has always been stronger than all reasoning and advice given by international experts. The question is why this inertia was so strong. The answer is twofold – there was the profound ignorance within the fund and lack of expertise. Secondly, political interests – mostly, though not solely, the interests of the Progressive Party – have been stronger than the general interest of the country. This is what invariably happens when political interest overrides merit and expertise. To the Irish and the Italians these will be familiar stories.

The present echo of ignored warnings

When Icelanders disapprove of foreign criticism of Icelandic issues, their standard answer is that foreigners do not understand the special circumstances in Iceland. The truth is of course that general rules of economics apply in Iceland as elsehwere. But it is difficult to follow any enlightened advise when political interests and connections subsitute normal reasoning.

There are now some disturbing similarities to events in 2003 and what later ensued. As then, the Progressive Party wooed voters in the spring elections with promises of debt relief almost every expert not connected to the Progressive Party warns against. The party’s promise of wide-spread debt-relief to those who are too well-off to have been eligible to earlier debt-relief offers draws criticism from the CBI as well as from the OECD and the IMF. The warning choir is loud and clear and singing from the same hymn sheet: these plans threaten financial stability and could cause inflation, all too familiar to Icelanders.

In a recent interview (in Icelandic) prime minister Sigmundur Davíð Gunnlaugsson said it did not worry him what the different “acronyms” (meaning international organisations such as the IMF and the OECD) thought of the planned debt relief. These organisations rarely welcomed radical actions such as those planned by the government, Gunnlaugsson said. In his speech on the Icelandic national day, June 17, the prime minister said that Icelanders would not let international organisations dictate what can be done for Icelandic households.

It is expensive to live in a country that is badly goverened or where corruption – difficult to avoid that word in relation to the HFF – is allowed to add its poisonous cost to every transaction. The corrupt practices, disregard for competence and expertise and political favours in HFF have so far cost Iceland 16% of its GDP and yes, more might be to come. Losses stemming from the CBI’s repo transactions with the banks before the collapse amount to another 16% of GDP. Consequently, these two mistakes have caused losses equivalent to about a third of Iceland’s GDP, the cost shared by Icelanders for bad political calculations.

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