Icelandic Crisis Timeline

The above is a short visual presentation on a few key dates of important events that took place during the Iceland Crisis. Enjoy!

The Future?

Iceland is on its way to recovery but its future is uncertain with rising house prices and other warnings from the IMF such as the Housing Finance Fund. However, its growth rate for the last year was hovering on average at 2.5% which is one of the highest for the European Union. It would be a most interesting case to note and monitor due to the unorthodox approaches used and the unlikely results from such measures. Iceland is unique; there is no doubt about that! One can only observe as to if the future leads them back into recession or to a much better economic climate. Time would tell as their future unravels with respect to the economic policies implemented and the resulting impact.

The Uncertain Future

Iceland seems to be doing well all things considered especially when compared to economies such as Spain, Greece and Portugal.

It has repaid in ahead of schedule monies owe to the IMF. Growth for the year 2012 was approximately 2.5% as can be seen below, which in comparison to other developed countries is above average for post 2008 recession. The unemployment rate has also fallen by half; just below 5%. The investment ratings for Iceland were also restored by February of 2012, (IMF Report 2012).

In comparison to the rest of the developed world, Iceland’s recovery is very interesting and quite shocking due to their unorthodox approaches used to tackle the situation. It was the only country to allow its big 3 banks to fail of which the bank were later split up into smaller divisions.

The people affected are still at unease. They now have mortgages to repay that they certainly cannot afford. Since interest rates were so high in Iceland, the trend became to borrow in the foreign market and save in the local one. Therefore, in the aftermath of the Icelandic crisis and a deflated currency, many home owners now have mortgages that are too high in comparison to the value of the house.

As on family The Magnusson's quoted, "I've been paying every month for 150 months and I owe much more than I borrowed," says IT specialist and reindeer hunter Theodor Magnusson. "I borrowed 6m Krona (£28,850) and I now owe 9.7m Krona (£46,642). And I've already paid around 5m Krona (£24,000) in these twelve-and-a-half years," (Lynam, J. 2013). This coupled with increased taxes and salaries being frozen or not moving by any significant amounts is enough to cause a strain on the people.

Another area of concern is the current housing prices which are almost back to the same level as they were pre 2008 crisis just 1.7% below their 2008 values, (McCormack, R. 2011).This is a bit worrying since, Iceland’s house prices did not fall as much in comparison to other countries experiencing a housing bubble. Furthermore, housing bonds seem to be increasing in popularity since it is one of the few long term investment avenues available in Iceland. The Housing Finance Fund (HFF) was set up by the Government tocover about 60% of Iceland's mortgage market. However, the new banks that emerged from the failed banks are currently trying to expand their market share thereby increasing competition and the Housing Finance fund according to Moody's is at increased risk of missing future payments to creditors.

A Senior analyst at Moody’s by name of Oscar Heemskerk, told Bloomberg that; “The risk is that there may potentially be a default at the Housing Finance Fund, which is not paid for in time by the government.” However, according to Heemskerk, it is in the best interests for the Government  to act as guarantee and as a consequence, investor monies would be safe, (McCormack, R. 2011).

The impact on the people

In Iceland, because of the rising interest rates, persons found it lucrative to borrow money on foreign markets and deposit in the local banks thereby, gaining higher interest rates there.  Because of this, Iceland saw common towns people for a lack of a better word, such as fishermen, ordinary tradesmen etc. being transformed into investors of sorts. They begin investing monies borrowed into the high yielding Icelandic banks with interest rates of over 10%. Before the crisis the interest rates averaged 9.4% and went as high as 18%, (IMF Report 2010). Therefore, it stands to reason that a lot of money can be made simply by depositing currency into their local banks.

Furthermore there was also a housing bubble because of the extended credit my Icelandic Banks. Homeownership increased and or persons decided to get larger accommodations they could not really afford in normal economic circumstances.

When the bubble burst and the Icelandic banks came crashing down, along with the closing of the Icelandic stock market, the people were in despair.They were left with higher taxes, decrease in spending, a period of repossessions and mortgages they could not afford. They took to the streets to protest and demand answers from their politicians and other persons in high authority. The people made the entire Government resign through mass protests as seen below. 

Source: www.therightperspective.org

Source: www.addictinginfo.org

Source: www.thedailybell.com

There was also a referendum held  as a result on the 20th October 2012, so that the people could decide upon certain economic decisions of which they won on all six questions posed. And most recently, the people are of the opinion that those responsible for such reckless decision making should be incarcerated. The new Government has then commenced an investigation to bring to justice those parties that were responsible for the financial crisis including past Government officials and bankers. Since then, many high ranking officals and bankers have been arrested.

The downfall of the banks

Glitnir Bank was one of the first Icelandic Banks to experience difficulty in 2008. With a significant amount of debt securities maturing in late 2008, the bank tried to issue more debt. However, the market was unresponsive to a new offering. They also tried selling off some of its assets but again this was not adequate. 

Furthermore, the bank was also denied two loan extensions from the Bayerische Landesbank.

Eventually the government decided to use 600 million Krona to purchase 75% shares of Glitnir Bank since they had 1.4 billion outstanding that was to be due in just a few month’s time in 2008, (Ivester, 2010). Unfortunately, this also sent a bad signal to the financial markets and depositors in Landsbanki and Kaupthing banks began to lose faith in the banking system and withdraw their monies. Icelandic banks began to experience a deposit drain.

Icelandic Banking systems did not include a lender of last resort since the central bank of Iceland did not provide this facility. Additionally, the Icelandic Krona had depreciated so low that the central bank could not have just printed more currency to increase foreign capital reserves. These would have been used to lend to the troubled banks to replay obligations that was becoming due, (Ivester, 2010).

What Iceland did that was different

Unlike most European countries that were in crisis back in 2008, Iceland has tackled its rehabilitation process quite differently and in a very unusual and shocking manner. Iceland allowed its three major banks; Kaupthing , Landsbankinn and Glitnir Banks to fail  and default on their debt instead of trying to bail them out. However, they did ensure that local depositors were compensated and assisted with debt relief for struggling small businesses and home owners. From the video below we can see exactly what they did. 

Olafur Ragnar Grimsson, Iceland's president explains it in this short informative interview with Steven Cole of Al Jeezera.

As explained in the clip and above concerning the compensation of domestic depositors by the Government, this facility was not extended to foreign accounts in the United Kingdom and the Netherlands. These accounts at the foreign subsidiaries were known as Icesave acounts which were with the Landsbanki Bank. When the bank in question completely failed, approximately 6.9 billion euros were lost in these foreign accounts at the time.

What happened in Iceland shocked the world just as the collapse of Lehman Brothers did. For a country with such high standard of living and high GDP per capita to suddenly collapse, was unheard of. Allowing the banks to fail and defaulting on their debt obligations added to the sinking of this ship. Popular media personnel and artist began to describe Iceland as Icelantis and can be seen depicted below.

Source: www.toonpool.com

A further look at the Banks

The Icelandic economy began major expansion back in 2003. Its GDP growth rate was on average above 4 percent and in some cases exceeding it twice as much as in the case of 2004 and 2005. This can be seen from the graph below.

 Source: http://bilbo.economicoutlook.net/blog/?p=7161

When the Iceland Economy collapsed in 2007/08, everything went downhill from there. The Icelandic currency; the Krona (ISK) was devalued by over 35% and they were forced to seek help from the International Monetary Fund (IMF) for a 2.1 billion dollar loan bailout. It is agreed by many economists that the Icelandic financial crisis was cause greatly by the rapid expansion of its three largest Banks.

The Role the Banks played

The Icelandic banking system was extremely large and growing in comparison to the economy. The balance sheets of these banks were up to approximately 10 times larger than the Icelandic economy as can be seen in the figure below,(Vidar Ingason, 2012) . It is these large banks that inevitably contributed to the eventual downfall of the Icelandic economy. The Mortgage and Lending portfolio of these large banks were so huge that the Financial Supervisory Authority (FSA) could not keep up with this rapid expansion to properly deal with the amounting high risk that these banks were engaging in.

Furthermore, it is argued that the privatisation of these banks in late 1998 to 2002 contributed to their rapid growth, reckless behavior and speculative trading. Prior to 1998, the Government  owned Iceland's three largest banks namely;  Glitnir, Kaupthing  and Landsbanki Banks. The new domestic owners of these banks had no previous experience in running a bank and incidentally, they were also some of the largest borrowers of these institutions. Therefore, they had much easier access to credit and there was little to be done to stop them from using these funds at their careless disposal.

To add fuel to their reckless behavior, the period of privitisation  was coupled with deregulation. This allowed the banks to become even larger by mergers and acquisitions  taking place in early 2000's. Furthermore, since the population of Iceland is only 320,000 persons, with such rapid growth of these banks, they soon outgrew the economy of Iceland and in order to continue growing at the rate they currently were at, these three large banks had to look at international markets for financial opportunities. In so doing, these banks were in a way transformed from traditional domestic banks to international investment banks. This give rise for the banks' increasing risk appetites and to make matters worse, higher rewards for such risk taking, so long as the returns were substantial. The banks created an international presence all over northern Europe with the purchase of smaller subsidiaries in Luxembourg  Denmark  and Norway for example. Large amounts of foreign debt was incurred in order to finance their expansion. as much as over 700% of GDP as seen in the graph below.

Source: http://www.debtonation.org/2009/05/iceland-%E2%80%93-a-country-of-proud-indebted-people/

The banks and their investment subsidiaries began investing in large companies in the United Kingdom and Europe. Companies such as Debenhams,  House of Fraser, Karen Millen, Hamleys and All Saints, (Ivester, Wilson, 2010).  The banks even went further as in with their largest shareholders, to allow persons to purchase their shares by extension of credit to these individuals by the banks themselves. This in effect caused the shares to be overvalued and inflated since credit was being extended quite easily for the purchase of shares. As a result, the credit ratings of these three banks went to triple A since its share prices went skyrocketing. With such high credit ratings, this allowed the banks to go even further and get involved in even more risky speculative trading. 

In summary of the banks' changing financial positions, Richard Portes, a professor of economics at London Business School, quoted that  “two-thirds of their financing came from domestic sources and one-third from abroad. More recently, until the crisis hit, that ratio was reversed.” Basically, the Icelandic debt crisis emerged from the substancial amounts of foreign debt piled up on the banks balance sheets. These banks rose from being domestic players to international financial intermediaries within the space of less than 10 years.  Their rapid growth, risky behavior and accumulation of excess foreign debt was what lead to the eventual failure of the economy and the banks themselves.

An Introduction to the Icelandic Crisis

Iceland is a relatively small country in the North Atlantic Ocean measuring approximately 39,770 square miles in area. Iceland’s population as of April 2012 is 320,000 inhabitants and its capital and largest city, Reykjavik , amounts to approximately 118,000 persons, (World CIA Factbook).

Iceland was primarily known for its fishing industry which accounted for over 90 percent of exports back in the 1960’s. However, as with most primary industries, the fishing industry was in decline due to realizable profits to be made in various tertiary sectors, primarily the financial sector. Today, Iceland’s fish exports accounts for approximately only 40 percent of exports, (World CIA Factbook).

From 2000 on-wards, Iceland’s Financial Sector has been expanding due to an expansion of credit and  especially high interest rates which attracted large amounts of foreign capital to Iceland’s three largest banks. These banks namely, Kaupthing Bank, Landsbankinn Bank and Glitnir Bank accounted for 75 percent of the country’s stock market capitalisation. The largest being Kaupthing Bank, increased its assets from 208 billion Kronur to 6.6 trillion Kronur by the middle of 2008, (Vidar Ingason, 2012).

Other notable expansions were within the energy sector of the country. Since Iceland sits on the mid Atlantic ridge, it is a haven for geothermal energy. Foreign investment facilitated the development of infrastructure to capture this energy source and along with hydro power  which now accounts for over 80 percent of the island’s energy supply.

Iceland within the space of 7 years was one of the world’s richest nations per capita right before the crash in 2007. They were also ranked with the highest living standards according to the United Nations in that same year. The country also had excellent infrastructure,  low unemployment, and  low Government debt. As with other countries experiencing the 2008 financial crisis, Iceland also experienced a housing bubble.The problem worsened when many fishermen now turned to banking especially speculative banking to earn higher returns as compared with traditional fishing. Luxury goods were now heavily sought out and consumption and inflation increased. The video below taken from the movie "Inside Job," 2010, best summarises what took place in this island nation.