Global financial crisis overwhelms tiny Iceland

Protests in the capital escalated Tuesday and Wednesday with calls for the prime minister and Central Bank head to resign.

Colin Woodard
A woman protests in Reykjavik outside the headquarters of one of troubled Iceland's banks, which was nationalized last fall.

In the depth of winter, the sun shines about four hours a day here. But thousands of Icelanders – more than 1 percent of the entire country – have sacrificed much of their precious few hours of daylight in recent weeks to protest the financial darkness that now shrouds their island.

From dapper senior citizens to masked anarchists, an eclectic group gathers every Saturday to demand the resignation of their government. On Tuesday and Wednesday, they clashed with police in increasingly violent demonstrations that suspended Parliament.

They’re furious over Iceland’s recent plunge from the world’s fourth richest nation – and the best in the world to live in, according to the United Nations – to global financial crisis roadkill. Its banks are ruined, the currency devastated, and one of the country’s closest allies recently named it a terrorist state.

“This has been very hard for the nation,” says protester Rosa Eyvindardottir, eight months pregnant and carrying a red socialist flag in her hand during a recent Saturday protest. “Maybe this is a lesson that we need to wake up and see what’s been right and wrong with our minds.”

Harbinger of trouble?

As the world holds its collective breath, worried that a global recession will become another Great Depression, Iceland is being seen as the canary in the coal mine, an early warning system that might indicate what other countries could face. With the dust beginning to settle from the banking system’s collapse, Icelanders are taking stock of the mistakes.

“The banks were expanding too fast, they were taking excessive risks, and the government didn’t do what had to be done to keep them in check,” says Gunnar Haraldsson, director of the University of Iceland’s Institute of Economic Studies.

Iceland’s banks were relatively new players on the international stage. Indeed, they were based in a remote, sub-Arctic country that had spent much of its history in a state of grinding poverty. Constrained by a short growing season, battered by storms and volcanic eruptions, Icelanders were one of the poorest peoples in Europe when they achieved independence from Denmark in 1944. Their national dishes – singed puffin, putrefied shark carcass, charred lamb’s head – reflect past necessity to avoid starvation.

After World War II, Icelanders harnessed the fish in the frigid sea and the lava-heated steam beneath their feet, investing the proceeds in infrastructure, education, and healthcare. By 2000, it was a society nearly devoid of poverty, where almost everyone is fluent in a foreign language, where homes and even the capital’s streets are heated with geothermal heat. Health care and education are virtually cost-free.

Iceland went global

In recent years, Iceland embraced the world economy, integrating with (but not joining) the European Union, floating its tiny currency on the open market, and, in late 2002, deregulating its sleepy banks. The banks rapidly expanded overseas, buying English soccer clubs, offering high-interest Internet savings accounts to Dutch and British families, and foreign-currency mortgages to Icelanders.

“The whole world was suddenly open to us and this new generation of young people had taken over the banks and they looked like they had the know-how to deal with this new reality,” says the Rev. Karl Sigurbjornsson, bishop of Iceland’s state-sponsored Lutheran church. “Ordinary people like myself couldn’t understand what was really happening and when we asked questions we were told that we were just ignorant of the great new world of the free market.”

Halla Tomasdottir, a former head of the national chamber of commerce and cofounder of Audur Capital, says the economy was defined by “extreme risk-taking, short-term orientation, paper profits, and a lack of regard for transparency and the human being.... We looked around and said: This is going to burst.”

By 2006, many worried that the banks had become too big and globalized for an economy of 300,000 people to backstop. The balance sheets of the three big banks – Glitnir, Landsbanki, and Kaupthing – exceeded Iceland’s gross domestic product (GDP) by more than five times. A report from Copenhagen-based Danske Bank warned that the banks had outgrown the country.

“The Icelandic banks, media, and officialdom saw the report as part of a conspiracy by representatives of the old colonial power,” recalls the report’s coauthor, Lars Christensen, who says the crisis could have been headed off if the banks had been reined in at that point.

“We were worried, but it’s difficult when you are in a competitive environment to take responsibility for macroeconomic solutions,” says Landsbanki chief economist Yngvi Orn Kristinsson. “Somebody else has to do that: the Central Bank.”

Bank controls were weak
But, the Central Bank and government regulators didn’t rein in the banks. By October, their liabilities had reached twelve times Iceland’s GDP. The banks had borrowed heavily to make these investments and were dependent on short-term loans to continue operations. When Lehman Brothers collapsed and global credit markets froze in September, the banks had nowhere to turn for help.

At the end of September, Glitnir executives turned to the Central Bank for a bridge loan. Instead, Central Bank chief David Oddsson – a former prime minister with no banking background – announced he would nationalize the bank.

Mr. Kristinsson, of Landsbanki, recalls: “We knew immediately that we wouldn’t have more than one or two weeks. It was a dangerous miscalculation, because analysts and credit institutions abroad believed that it was too much for the government to take on.”

Ratings agencies downgraded the value of Icelandic bonds, dragging down the currency, and cutting Landsbanki’s credit lines, triggering its failure. Mr. Oddsson then suggested that Icelandic banks might not pay British depositors, prompting British Prime Minister Gordon Brown to evoke antiterrorism laws to seize their British assets – a move that took down Kaupthing.

Icelanders were shocked to see Landsbanki listed alongside Al Qaeda and North Korea on Britain’s list of sanctioned “regimes.”

“We conceived of ourselves as a very peaceful, peace-loving people,” Bishop Sigurbjornsson says. “Being labeled as terrorists was something we could never have imagined.”

Most British and Dutch deposits will be guaranteed, largely by Iceland’s citizens using money borrowed from abroad. Many here are upset that they are left paying an enormous tab run up by wealthy bankers. Some economists compare the debt burden to the crushing one imposed on Germany after World War I.

Protesters want new leaders

The protesters’ main demand is for Oddsson and his longtime political ally, Prime Minister Geir Haarde to resign, which organizers say is the first step toward rebuilding public and investor confidence. Both have resisted.

“They want to be able to lead the nation out of the mess,” Mr. Haarde’s spokesman, Kristjan Kristjansson explains. “Walking away from the problem now would be to surrender to it.”

Tomorrow: How Iceland is trying to preserve its social safety net.

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