Last week I spoke in Iceland (.pdf of slides) about the similarities and differences between our two countries.
Both countries had experienced booms caused by inflows of cheap credit, and both had experienced societal upheaval as a result of the inevitable crash. Iceland differed sharply from Ireland in its approach to resolving the crisis. Where we are currently floundering, praying for a deal on our banking debt from Brussels, Iceland is moving on, with a set of relatively clean bank balance sheets, a falling unemployment rate, an increase in economic output, and a national sense that the economy and the society is healing.
What can we learn from the Icelandic experience? Should we even compare ourselves to them? I think there are many lessons to learn, but you have to look a bit beyond the numbers.
Iceland is a tiny Island nation, with about 320,000 people in the country. Iceland has plentiful geothermal energy, an export base of aluminum and fish—especially mackerel—and a thriving tourism industry. More than 700,000 people visit Iceland each year. It is one of the most beautiful countries I have ever visited. Of course, Iceland has its own currency.
Like Ireland, Iceland was caught in a wave of speculation brought on by low interest rates following 9/11. A wave of privatizations and opening up of previously protected markets exposed Iceland to the vagaries of the international market. Iceland took full advantage.
Unlike Ireland, there actually wasn’t much of a speculative boom in housing. Icelanders speculated on their stock market and other financial assets. From 2001 to 2008, Iceland’s three biggest banks grew by a factor of 20, financed by cheap cash from foreign banks.
Dodgy practices, helped along by weak regulation, contributed to the boom. For example, the banks’ directors were using their banks in exactly the same way as Anglo Irish and Irish Nationwide were used: for personal gain and political patronage. An expose by WikiLeaks showed that huge loans were made just before the crash to the owners of one bank, Kaupthing, and to firms owned by them “with little or no collateral”.
Things were out of control.
The nearly 2000 page post-mortem report on the crisis noted sharply that “When it so happens that the biggest owners of a bank, who appoint members to the board of that same bank and exert for that reason strong influence within the bank, are, at the same time, among the bank’s biggest borrowers, questions arise as to whether the lending is done on a commercial basis or whether the borrower possibly benefits from being an owner and has easier access to more advantageous loan facilities than others. This is, in reality, a case of transfer of resources to the parties in question from other shareholders and possibly from creditors.”
One standard trick was to set up a holding company, which would buy shares on the open market. If the shares rose, the directors of the company paid themselves a handsome dividend. Once the value of the shares fell, the company folded, leaving the losses behind. Once investors got the smell of a downturn, the banks’ seemingly rock solid balance sheets turned to rubble overnight.
The Icelanders were warned. In 2001, Nobel Laureate Joseph Stiglitz wrote a report for the Icelandic government describing exactly what would happen if the increases in private sector lending facilitated by the banks was allowed to continue. Stiglitz wrote:
“the pace of expansion of credit for a credit institution is related to the likelihood that it will face problems in the future. Given these beliefs, very large changes in interest rates may be required to dampen the demand for credit; and these changes in interest rates themselves impose enormous stresses on the economy.”
Then he told them exactly how small open economies should respond to surges of capital in or out of their country by regulating banks heavily, restricting capital inflows and outflows and managing interest rates accordingly.
Icelanders are extremely polite, so Stiglitz was presumably thanked profusely for his report, which was binned about ten seconds after he delivered it. No one wants to hear from naysaying economists during the good times.
The boom continued, with cheap credit fueling a consumption bust that has left roads built to nowhere, ‘summer houses’ dotting the landscape, and large vanity project buildings upsetting the skyline of the tiny capital, Reykjavik.
The boom ended for Iceland because of the withdrawal of credit worldwide after the collapse of Lehman Brothers. Like Ireland, the weaknesses of the banking system were exposed almost immediately.
There the similarity ends. The Icelandic government could not guarantee the assets and liabilities of the banking system as we had—the banking system was just too large relative to the economy. The ratio of bank assets to national income was over 7. The banks and their assets had to be let go. This did not go down well. The economy imploded.
Well over 70% of the private businesses in Iceland became insolvent immediately, a wave of bankruptcies followed, the unemployment rate rose, the IMF was called in in November 2008 for a loan, capital controls were instituted, stopping many foreign creditors from getting their money back. Iceland’s economic crisis is considered to have destroyed wealth equivalent to seven times its national income.
Icelanders voted twice not to repay its foreign creditors in the Icesave controversy.
I think this is the key lesson Ireland can take from Iceland: in solidarity they removed the political parties associated with the boom and the bust, and in solidarity they prosecuted those responsible. This, combined with an increase in regulation of large banks, is what allows many Icelanders to hope that things will get better. This is not to say Iceland got away scott-free. At the end of the day, their personal and public debt levels are still very large, and emigration has returned to Iceland.
The worst is behind them.
Ireland has no such luck. We guaranteed the assets and liabilities of some of the worst banks in the history of modern banking in the name of EU banking stability, and received the largesse of the Troika as a result.
We must see those responsible for Ireland’s collapse pay for the damage they caused. We must see bankers and politicians held to account and punished. We didn’t all party.
We must balance our government’s spending and its taxation revenue, but unlike in Iceland, no one feels the pain is worth it in the end. The government cannot square this popular sense of injustice with the behavior of Ireland’s elite. There is no closure, as it were, to the crisis. Ours rumbles on while Iceland can move on. We can learn at least this much from Iceland.
(Published in the Irish Independent on the 17 of September, can’t find the link online yet.)