In These New Times

A new paradigm for a post-imperial world

Iceland: The Land Without An Economy- The worst is yet to come.

Posted by seumasach on February 11, 2009

Arsaell Valfells


9th February, 2009

Iceland has won a “full house,” with political crisis piling up on a debt, banking and currency crisis. As Icelanders are now for the first time in 60 years protesting in the streets, the full impact of the collapse is being felt. In short, the economy has hit a wall. The labor market has, in a year, changed from importing workers from Poland to 10% unemployment. The worst is yet to come.

The vulnerability of Iceland’s financial system was to be found in its enormous size relative to gross domestic product (GDP); the poisonous mix of FX-linked debt with revenues in local currency; its volatile small national currency; and the unpardonable neglect of the central bank to build up currency reserves.

So in 2007, when the liquidity dried up in the capital markets, the Icelandic banks were the first to hurt. Then they were severely wounded as Lehman, a large counterparty with two of Iceland’s big banks, was made to collapse. The banks were finally beheaded by Gordon Brown, the U.K. prime minister, when he used anti-terror law to freeze the assets of an Icelandic bank and Icelandic companies wherever he could. The U.K. Financial Services Authority stormed Kaupthing Singer and Freidlander Ltd., a U.K.-based and FSA-regulated bank, and forced it to sell Edge, the online savings operation, to ING-Direct. Interestingly, two weeks later, ING-Direct got a $13.4 billion bailout from the Dutch Government and did not get the same treatment from the U.K. authorities. The rumor in Iceland has it that even the currency reserves of the Icelandic Central Bank were frozen temporarily as an effect of one of the country’s largest banks being put on the U.K. Treasury anti-terror list.

The reason for Gordon Brown’s offensive against Iceland was that the Landsbanki’s IceSave online deposit scheme was insured by a private deposit guarantee scheme in Iceland in accordance with E.U. law. The fund had about 1% coverage ratio compared with the E.U. average 0.52%. By Icelandic law and the E.U. custom, the Icelandic Government has no legal obligation to insure or pay for the DGS.

In the fallout after the unravelling of the banks, the government of Iceland sought to secure funding to restore its defunct currency by requesting a standby agreement from the International Monetary Fund. Coincidentally, the request was not processed until after Iceland agreed under pressure by the E.U. and the U.K. government to withhold Deposit Guarantee Directive 94/19/EC. That meant that the U.K. successfully forced Icelandic officials, under duress, in principle to agree that Iceland would guarantee the 20,000 euros insurance per depositor to IceSave in the U.K. The cost of this is estimated to amount to $5 billion foreign government debt for Iceland. That equates to a whole year’s worth of net exports.

It is interesting that the British Government was quite happy to collect up to 40% tax on the interest income from the IceSave accounts, a privilege the Icelandic Government did not enjoy. The British government collected all the revenue but demanded that the Icelandic taxpayer should absorb the risk. In contrast to this, the U.K. government does not guarantee bank deposits in subsidiaries of a British bank operating in the Isle of Man and Guernsey. Its argument was that the U.K. did not receive tax revenue on those operations.

Further, the British government refused to have this dispute settled by a European court.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: