IceSave: Weapon Of Massive Debt And Destruction

January 8th, 2010 → 5:40 pm @

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IceSave: Weapon Of Massive Debt And Destruction

Time will tell but maybe Olafur Ragnar Grimsson’s decision to stir things up in the IceSave matter will lead to a better deal for Iceland, and as a lesson to the world community that the global financial system has some extremely large holes which need to be addressed.

One thing is certain, if IceSave was only premium media material and political issue in Iceland until now, then that has changed. A glance at the world media reveals some thought-provoking and relevant commentaries on the whole matter.

The questions being asked might be one year late in the global discussion, is it fair to expect taxpayers to assume the debts of private businesses and financial institutions and how destructive is the power of debt to nations and individuals?

If voters in the US or the UK had been given a vote on whether their governments should inject trillions of dollars into their banks (in the form of loans, guarantees and investments), it is pretty likely that those referenda would have been lost.

Robert Peston at BBC, says that “We Are All Icelanders Now”

“And by the way, those of you who put your money into Icesave accounts for the extra increment of interest that wasn’t available from more mainstream banks: well, you too could well be charged with fecklessness and with receiving unsustainably high returns. Yet you have been bailed out, by Her Majesty’s Treasury – which is now insisting that Icelands’ beleaguered citizens pay it back. So let’s be honest, Icelanders’ reluctance to dig into their pockets to the tune of £3.4bn to repay Britain and the Netherlands is understandable. And for me what this saga illustrates is something I’ve been banging on about for ages, which is the democratic deficit between people and finance, between citizens and big banks. Icelanders now know, more than any nation on earth, that when banks run into difficulties, they have to be bailed out by all taxpayers.”

The Economist offers this perspective on international debt:

There is a recognised concept in international finance of “onerous debt”, which says that a population should not be responsible for debts run up by murderous or kleptocratic dictators. But it is hard to make that case for Iceland, a democracy that benefited from open markets in other countries to indulge in an acquisition spree. During the banking boom Reykjavik resembled a gold-rush town.

In a sense, however, the rights and wrongs of the case are neither here nor there. This is a classic example of what happens in a debt crisis. It is perfectly natural for the Icelanders to resent having to cripple their finances in order to pay “rich foreigners”. If they are unique, it is only that the costs of their defiance are clearer than normal. Fitch, a ratings agency, immediately downgraded Iceland’s debt and loans from international donors may be affected.

All too often in history countries have been allowed to become serial defaulters without suffering that much in the way of penalty. In “This Time is Different”, their book on financial crises, Carmen Reinhart and Kenneth Rogoff point out that Spain defaulted seven times in the 19th century and Portugal six. In the 20th century, European nations (including Russia) managed 16 defaults between them.

A more subtle way of getting rid of at least part of your foreign debt is to allow your currency to depreciate. This option is only available to the likes of America and Britain, which have been allowed to borrow in their domestic currencies and seem already to be exploiting this fact.

Creditors used to be alive to these dangers and insisted on international agreements that required countries to safeguard the value of their currencies. But this is mainly a world of floating exchange rates. Combine these with democracy and countries have a licence to abuse foreign creditors. They have always had the motive to do so. The credit crunch has given them the opportunity.

In an interview with Bloomberg today Olafur Ragnar Grimsson, revelling in his new-found role as the caped crusader against the big, bad international financial system hit home some hard truths about the wicked ways of the rating agencies such as Fitch Ratings which has downgraded Iceland into junk category:

“This rating agency that did that, Fitch, has a lot to answer for because its rating in the last two or three years has turned out to be completely wrong.  That is the same agency that gave the Icelandic banks in 2007 and 2008 top marks and we here in Iceland were perhaps foolish enough to think that this was a respectable agency, but it turned out to be completely wrong.”

Seriously, why would anyone trust Fitch Ratings? Look at their record in Iceland in the last few years and the results. Convincing or Arthur-Andersen style of misunderstanding the purpose of its operations?

That must surely be applauded as a deserved blow to the pillars of the system which brought us here. Is it fair that the Icelandic people should be stuck with the bill off the excesses of bankers protected by an inept government? The Financial Times weighs in with an argument that it might not be.

It is hard to fathom the need to make an example of Iceland. For the creditors, the loans are trivial: they sum to €3.9bn, one-hundredth of what the UK alone will borrow this year and next. Neighbourly generosity would cost Amsterdam and London next to nothing. They are also not innocent victims. British and Dutch banks benefited greatly from the rules. Had they failed on the same scale, it is delusional to think their governments would take on hundreds of billions in debt to rescue foreign savers, and odious to force a weak neighbour to do the equivalent. From the start, Iceland has been under the gun. Loans from Poland, Nordic neighbours and the IMF depend on successful IMF reviews that in turn hinge on an Icesave solution. A lifeline-grasping application for EU membership is hostage to British and Dutch goodwill. Landsbanki showed that Europe must reform its rules to achieve stronger common standards. This will not be done by putting Iceland in a debtors’ prison.

The Lex team in the same paper though offers another altogether more sombre and realistic outlook. Is the deal on the table really unfair? And on that note, isn’t this what states expect individuals to do when in debt, pay at a rate which is determined by the market and offered by the creditor?

But if Iceland refuses to repay the €3.9bn debt, it risks becoming an international pariah.

It still need not come to that. Most Icelanders acknowledge, albeit grudgingly, that they have to meet their international obligations; the president signed an earlier loan agreement to that effect last year. But the UK and the Netherlands objected to some of its terms and demanded changes. The new agreement is hardly punitive: a 15-year loan, with a seven-year grace period and a chance to renegotiate terms in 2024. While the 5.5 per cent interest rate is higher than current British or eurozone borrowing costs, neither country is pocketing a juicy spread: yields on 15-year Dutch government bonds are about 4 per cent, while UK bond yields are half a percentage point more. Perhaps these details can be tweaked; ultimately, all three governments need to do a better job of explaining to their people the costs of rejecting a deal.

Also in the Financial Times, Michael Hudson points out the ambiguity surrounding the international laws on which the IceSave wrap up is supposed to be based.

At issue is what the relevant European law says should be done – and, more to the point, what should have been done on October 6 2008, when Gordon Brown closed down the UK operations of Icesave, an online subsidiary of Landsbanki, Iceland’s second-biggest bank. Icelandic authorities were given no voice in how to resolve matters. Did the British prime minister let Iceland off the hook by jumping the gun in reimbursing depositors as though they were covered by UK insurance rather than following agreed-upon EU procedures?

Under normal conditions Iceland, a prospective EU member that had signed up to European deposit insurance rules, would have availed itself of the right to settle with depositors in an orderly manner. Article 10 of EU Directive 94/19/EC gave Iceland’s Depositors’ and Investors’ Guarantee Fund (TIF) nine months to settle matters after the failure of a financial institution. Privately funded by domestic banks (unlike Britain’s public Financial Services Agency), the TIF collected only a paltry 1 per cent of deposit liabilities as a risk premium.

The EU law did not anticipate a systemic failure, and hence made no provision for the government to be liable beyond its insurance agency. But the guidelines agreed by the Ecofin meeting of European Union finance ministers on November 14 2008 were clear: “These negotiating discussions shall be conducted in a compatible and co-ordinated manner and account will be taken of the difficult and unprecedented circumstances in which Iceland finds itself and the urgent necessity of deciding on measures which will enable Iceland to restore its financial and economic system.”

So the broader issue concerns Iceland’s ability to pay 250 per cent of its current gross domestic product – some $20,000 for each citizen – to settle its Landsbanki mismanagement. The International Monetary Fund did not think this was a realistic option when its team calculated in November 2008 that: “A further depreciation of the exchange rate of 30 per cent would cause a further precipitous rise in the debt ratio (to 240 per cent of GDP in 2009) and would clearly be unsustainable.”

What seems to puzzle the British is the lackadaisical approach that Iceland has taken towards the main perpetrators of the economic collapse. Remember the banking collapse of Iceland? That was what started the whole thing, and IceSave is only a small part of the mess the nation finds itself in. When the whole banking sector goes bust it is obvious that something wicked has been going on. While the US wheels off Bernard Madoff to jail, Kenneth Lay dies in prison and the Danes chase Stein Bagger until he is in jail, the only two people convicted of any financial misdemeanours in Iceland are two small time employees of Kaupthing.

Archie Bland at the Independent for one is surprised at this.

Consider, stranger still, the fate of those who cheerily paved the way for the bankers to bring Iceland to its knees.

Chief among them is David Oddsson, the prime minister who oversaw the privatisation of the banks that led to the meltdown in 2003, and then went on to spend four years as governor of the central bank.

If that transition seems unlikely enough for a man with no economic training, his more recent move is similarly perplexing: Oddsson is now editor of Morgunbladid, an influential national newspaper. It is as if Tony Blair had stepped down to succeed Mervyn King, only to jack it in in favour of the top job at The Independent.

Sure enough, Morgunbladid’s treatment of the country’s finances has caused some observers to raise an eyebrow. In a regular unsigned comment piece and in the newspaper’s editorials, Oddsson has evaluated the state of affairs in a rosier tone than many can share.

Yesterday was a case in point. As the country agonised over what most people have seen as a brutal foreign response to the news of the referendum, Morgunbladid saw things differently. “A harsh reaction abroad?” the editorial asked. “In light of the situation, the coverage has been incredibly positive.”

Oddsson’s voice could also be heard in the assertion in his paper that no one abroad is shocked at what happened in Iceland – that people overseas entirely understand the difficult circumstances the government faced, and to suggest otherwise is simply scaremongering.

Only slightly less remarkable than Oddsson’s story is the continued influence of one Hannes H Gissurarson, a professor of political science who was hugely influential in the staggeringly rapid liberalisation of Iceland’s economy.

In 2001, he wrote a book with the memorable and possibly ill-judged title, How Can Iceland Become the Richest Country in the World? His prescription was to privatise everything, including the fish; it was followed to the letter, and we all know what happened next. And here he is in The Wall Street Journal yesterday, almost entirely unrepentant. “Many Icelanders are dismayed by the feebleness of the present Icelandic government,” he reports poker-faced.

Gissurarson’s gobsmacking cheek, and the fact that so many of his countrymen agree, is perhaps a reminder of how short political memories are. But elsewhere in the piece he has a point that makes uncomfortable and plausible reading for British eyes.

“A lot of the damage done can be directly attributed to the actions of the British government,” he writes. “Should the British not solve the problem they themselves created?” That is a distorted view of reality, of course, but not without a grain of truth; and British officials may reflect, as their repayments appear in jeopardy once more, that with a less punitive approach the whole thing might have been settled by now.

Did the UK expect to find itself in a new “Cod War”? The Times awakens old ghosts from that dispute by bringing forth Roy Hattersley to describe the “Icelandic psyche”. The Viking myth is hard to shake, just as the fisherman myth. But this sentence offers a key to Icelandic foreign affairs in the last 60 years.

I offered some minor concessions. The Icelanders made new major demands. Deadlock again. Henry Kissinger sent me a quotation from Bismarck. “How great is the tyranny to which small nations can subject the great.” It was no consolation.

It is really hard for the UK to appear like anything but a bully when compared to the tiny nation of Iceland. Icelandic foreign affairs through the years are littered with major demands towards large nations. It is hard to argue over the last lolly pop when the other party is three years old and you are an adult and look anything other than silly in the process.

Lets give the last word to Michael Hudson on the most peculiar thing in the whole story as fair as Icelandic citizens go:

There is a special dagger hanging over the heads of Iceland’s homeowners: Mortgages and other debts are indexed to the consumer price index. For an import dependent country like Iceland, this means in effect the foreign exchange rate. Attempts to pay more foreign currency than the nation can generate in export earnings will cause the currency to depreciate. This will raise monthly mortgage bills for homeowners (almost 90 per cent of the population) whose wages are paid in local currency. Many will lose their homes. Many already are doing so. There is a moratorium on foreclosures, but it expires in February.

A pragmatic economic principle is at work in such conditions. Debts that cannot be paid, will not be. At stake, therefore, is how much can be paid without wrecking Iceland’s economy. How many Icelanders must lose their homes as carrying charges soar on mortgages indexed to the exchange rate? Emigration is accelerating, and many foreign workers already have left. How many more must depart? And if post-Soviet experience of a steep and sudden drop in living standards is relevant, by how many years must Icelandic life spans shorten?

Iceland’s government, opposition parties and financial institutions have so far offered little relief for Icelandic households which are indebted as no other households in the world. These parties are not willing to grant their citizens what they are asking of the UK and the Dutch. Fair negotiations and sustainable debt. Partly because IceSave hasn’t been resolved and it is hard to plan without it, but also because the people in charge of those parties are either of an age where they have little debt themselves (Johanna, Steingrimur and Geir Haarde) or billionaires born with a silver spoon (Bjarni Benediktsson and Sigmundur David Gunnlaugsson) or both (banking CEO’s).

Olafur Ragnar Grimsson’s decision to play chicken with the UK and the Netherlands on IceSave might have paid off so far. But if it hadn’t then a plunging currency and trade restrictions would have severely affected Icelandic households. It is easy for politicians to gamble with other people’s money. But I would like to stop being a personal hedge fund like other Icelandic citizens and see some stability for a change.

While I as a citizen am willing to accept my social responsibility for what happened in Iceland in the last decade, it is getting harder to convince my generation that there is a future worth pursuing in the country by the day. If you think that is a self-serving attitude, just wait until Barclay’s or ABN Amro start reeling.

It appears that the way we collectively built our system, it just might not be as impossible as you think.

Is the world finally taking notice that something really rotten has happened in Iceland at it might be spreading?

Or will it be forgotten next week and we return to thinking bailouts are great and leaving bad governments alone.

 

 

 

 

Related posts:

  1. IceSave: Really About Domestic Politics In Iceland – UK & Netherlands
  2. ATTENTION ICELAND IS NOT SAYING IT WON’T PAY ICESAVE (Video)
  3. A Weapon Of Massive Idiocy – Glenn Beck on Iceland (Video)
  4. IceSave Round II Might KO Government
  5. Was The IceSave Commotion Really About Local Power Struggles?
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