President refuses to bail out banks, saves country!

Lessons For Europe: Why Iceland Bounced Back So Fast

By Henryk M. Broder, Die Welt, July 5, 2012
REYKJAVIK—What kind of a crisis can you neither see nor smell, touch nor taste?

Here, in fact, the hotels are booked solid, cafes are full, the stores full of merchandise, although a visitor may be surprised that an Icelandic tomato costs twice as much as an imported Italian one. The new opera and concert venue called the Harpa in Reykjavik, which cost 170 million euros to build, is featuring Jethro Tull, with its iconic lead singer Ian Anderson performing “Thick As A Brick” in its entirety. The big 1,800-seat hall is completely sold out even with tickets costing between 50 and 60 euros each.

“You really don’t notice anything,” says Olafur Isleifsson, a professor at the Haskolinn i Reykjavik, the country’s largest private university. It trains economists, computer scientists, engineers and jurists. Olafur, 57, earned his Bachelor degree in mathematics at the University of Iceland, and his Masters in economy at the London School of Economics, then worked for the International Monetary Fund in Washington, Iceland’s Central Bank, and as advisor to Prime Minister Thorstein Palsson. Since 2003 he’s been teaching economics and statistics at the Haskolinn.

“And do you know why you don’t see anything?” Olafur makes a face like a poker player about to reveal his hand. He recalls Oct. 5, 2008, when then-Prime Minister Geir Haarde called a state of emergency and ended his speech to the nation with the words ‘May God bless Iceland’. “It was as if an atomic bomb had exploded,” he recalled. “But it turned out to be not an atomic bomb but a neutron bomb. And a neutron bomb doesn’t destroy houses: it only destroys paper assets.”

In early 2008, the total assets of the three largest Icelandic banks were ten times the country’s gross national product. No government in the world would have been in a position to save these banks. Within days they were nationalized. How things could have come to that is something Icelanders are still asking themselves four years later.

“It became a chain reaction. Businesses couldn’t get credit and went bust, unemployment rose to nearly 10%, and the Icelandic krone was devalued by 50%.” Which among other things resulted in disaster for Icelanders who’d let their banks talk them into taking out cheap euro or dollar mortgages—loans that they could now no longer afford to service. Somebody who had borrowed 10 million kroner suddenly found themselves with a debt of 20 million kroner—often, sums that were greater than what their property was worth.

Olafur favored an “American solution.” This meant that instead of spending a lifetime paying for a house or apartment that would never belong to you, “you cleared your stuff out, sent the key to the bank, and moved elsewhere.” The solution didn’t catch on, and the now nationalized banks ended up writing off part of what they were owed.

The ones who really took a beating were the 300,000 British and 120,000 Dutch who, attracted by high interest rates, deposited their savings in the country’s largest bank, the Landsbanki. The program was known as “Icesave” and was anything but risk-free. The British ended up losing some five billion euros, and the Dutch 1.7 billion.

The Icelandic government said that it was willing to pay partial compensation to those who had lost money, and parliament approved a law—albeit by only a tiny majority—to that effect.

And then something happened that absolutely no one had expected. President Ólafur Ragnar Grímsson refused to sign the law into being. While the British and Dutch raged and threatened sanctions, Icelanders were delighted and called for a referendum—a first in the country’s history.

And on March 6, 2010, 93% of voters rejected the compensation law. The government, anxious to preserve its credibility, put a modified version of the law before parliament which was approved by a large majority. Until 2046, it would have paid out on a yearly basis no more than 5% of state revenues. President Grimsson refused to sign that law too, and at a referendum on April 9, 2011, 57% of voters also rejected the law.

“It was a morally sound and economically sensible decision,” says Olafur. “Investors who let themselves be seduced by high interest rates have to accept the higher risk involved.” Icelanders also didn’t see why they should be liable for bank speculation. After all, “when things were going well, the bankers didn’t share their profits with us.”

The idea that has established itself in Europe—that profits stay private but that losses have to made up by society at large—is something that doesn’t sit with Icelanders, who set great store by individual responsibility. One can have success, but one can also fail—and responsibility for either should not be passed off onto others. In this regard, Icelanders could be seen as lagging behind the Europeans, or as way ahead of them.

“We’re doing well,” says Olafur: unemployment is on the decline, although at around 5% it’s still a little higher than it was in 2008; for a year now the economy has been improving and economists are predicting growth of 2.5% in 2012. However, inflation—at around 6%—is worrisome. Nevertheless: “We’re in the process of pulling ourselves out of the swamp.”

The country’s banks have stopped operations outside Iceland, and now only serve Icelanders. Turnovers at the fisheries are substantial and profits large. The construction industry, which came to a standstill in 2008, is gearing up again. And since the krone was devalued the country has become more attractive to tourists—not cheap, exactly, but not much more expensive than Italy or Austria. “We’re back in reality,” says Olafur.

Though it will still be several years before the consequences of the 2008 financial crisis are fully overcome, one thing is already clear: nobody in Iceland is talking about joining the EU or introducing the euro. They haven’t forgotten the malicious and vindictive remarks they heard from Europeans during the crisis. But that doesn’t mean they’re holding a grudge. They know they depend on the European market. Who else is going to buy their fish, read their writers, and worship singer-songwriter Björk?

“We really sincerely wish Europeans well,” Olafur says.