Reflections on Iceland and the financial crisis - Part 4
By Peter Ewart & Dawn Hemingway
Monday, October 31, 2011 03:45 AM
Photo of Strokkur Geyser courtesy of “Visit Iceland”- http://www.icetourist.is/DiscoverIceland/
Part 4 - The financial geyser
By Peter Ewart & Dawn Hemingway
(Click here for previous articles in series).
From the Second World War onwards, Iceland had followed a social democratic model of a "mixed economy" with an expanded social safety net, and a social contract between capital and labour. This was the same model that all other "Western" industrialized countries followed to one degree or another. But by the 1980s, this "model" was in trouble, both economically and politically. To boost profits and improve their balance sheets, the financial oligarchy and the political elites were marching down the "new" road of "Thatcherism" and "neo-liberalism", and Iceland was no exception.
A new government came to power in the early 1990s with the aim of slashing corporate taxes, eliminating regulation, and privatizing state assets. Key to its agenda was the privatization and "freeing up" of the banking sector (which had been mainly publicly owned before), a longstanding desire of certain Icelandic bankers and neo-liberal politicians. Iceland was to become a "global financial hub" that would soon rival Switzerland.
The possibilities were endless, and the sky the only limit. As the President of the Kaupthing bank, Sigurdur Einarsson, who would later become a fugitive from justice, claimed in the best new age jargon: "If you think you can, you can" (1). And so, a process began that culminated in the formation of a gigantic financial bubble the size of which this hardworking, small country had not imagined even in its wildest dreams.
And the economy did expand, slower at first during the 1990s, then picking up momentum and skyrocketing after 2000. The privatization of the banks resulted in the country being flooded with new foreign investment. The currency strengthened and interest rates rose. "Nouveau riche" Icelandic investors in league with foreign financiers engaged in a flurry of acquisitions, hostile takeovers, and consolidations that busted up the old Icelandic business elite. As later investigation would reveal, cronyism, fraud and insider manipulation were rampant, but for now the economy was booming.
Traditionally solid and profitable enterprises like Icelandair had their assets sold off and were transformed into "investment companies". Longstanding domestic businesses became multinationals, and, of course, leading the pack, were the three major Icelandic banks that aggressively expanded both at home and abroad. Freed of regulation, the banks pressured ordinary Icelanders to take out large mortgage and consumer loans with low down payments; abroad, in Britain, Scandinavia and elsewhere, these same banks rapidly piled up acquisitions and opened up new subsidiaries. Through all of this, the Wall Street credit rating agencies gave Icelandic banks top ratings just as they had done for Wall Street’s Bear Stearns and Lehman Brothers.
As deregulation took effect, foreign financiers and hedge funds circled, then glided into the Icelandic economy. It was as if the glass walls of the country's little "aquarium" had been broken down once and for all, and now Iceland was part of a much larger economic "pool", one that had new species swimming in it, including, as was later discovered, some very large sharks and barracudas.
The results of all this frenzied activity were phenomenal. In 2003, total bank assets were 200% of the Gross Domestic Product (GDP) of the entire country. By 2007, bank assets had ballooned to over 900%. For its part, the Icelandic stock market jumped by over 500% between 2002 and July 2007 (2). Real estate prices in Reykjavik rose 72% in the same time period.
Traditionally, Iceland had been relatively egalitarian in terms of income disparities, and those who did have wealth tended not to flaunt it. But all this changed very quickly. Inequality increased dramatically and a small number of tycoons grew fabulously rich. As Magnus Helgason notes, "The average income of people in the wealthiest 1% went from being roughly five times the average income in 1993 to being 27 times higher in 2007" (3).
In the latter stages of the bubble, the new Icelandic tycoons became atavistic, dredging up the most backward features of the old Norse society, casting themselves as "corporate Vikings" who, like the Vikings of old, would "strike fear" abroad and raid the world for plunder (4).
Domestically, the financiers and politicians promoted the idea that all this new wealth would eventually "trickle down" to ordinary Icelanders. And, indeed, it appeared to be doing just that. Icelanders consumed 29% more in 2008 than they did in 2002. However, there was a catch. Actual incomes only went up 15%, while household debt skyrocketed by 77%. As in other countries, pensioners, single mothers and other low income earners were left far behind during the "boom" (3).
The banks, aided by the government and the corporate media, mounted a relentless campaign to goad traditionally cautious and conservative Icelanders into using their homes as "giant ATMs". After all, housing prices were continuing to climb and everyone was ahead of the game. It was a "win - win situation" for everyone.
And why shouldn't ordinary Icelanders believe them? International bodies ranked Iceland as the "least corrupt society" in the world. Many Icelanders believed they lived in a country where "fair play, equality and - above all - honesty" prevailed, and that included leading politicians and business people (5).
But then in 2006, what is now termed the "Geyser crisis" hit. The name was appropriate. The economy, like superheated water, had built up enormous amounts of pressure. Then some financial analysts in the U.S. and Britain issued warnings about the Icelandic economy. Sensing blood, billionaire hedge funds and currency manipulators in New York, London and elsewhere leapt into action. Using "weapons of financial mass destruction" such as Credit Default Swaps, they ganged up and tried to "short" the Icelandic banks and currency, betting that these would crash. As Asgeir Jonsson points out, "hedge funds, like wolves, hunt for yield in packs. The force of numbers increases the chances for their trading strategy's success, especially in smaller markets" (1).
While, as the U.S. sub-prime crisis later revealed, investment banks like Goldman Sachs were shorting their own customers, other Wall Street and London-based financiers, acting in concert and spreading false rumours, tried it on an entire country; in this case, Iceland. For these hedge funds, "taking down a whole country [was] more gratifying to the ego ... than taking down a mere corporation." One British financier even boasted that he wanted to be "known as the man who bankrupted Iceland" (1).
For two months in 2006, the Icelandic stock market and currency took some big hits, but the crisis eventually seemed to fizzle out. A huge amount of excess liquidity in international markets poured into Iceland and disaster was averted, at least temporarily. The Icelandic economy took off again with banks leading the way. "Icesave", the newly-launched online venture of the Icelandic bank Landsbanki, became wildly successful in just a few months attracting many British and Dutch depositors with its rock bottom fees and competitive interest rates. "Spoiled as gamblers," Jonsson writes, Iceland's bankers "were unable to quit while ahead" (1).
Iceland had appeared to escape the Geyser crisis. However, as anyone visiting the geysers of Iceland's famous Haukadalur site knows, avoiding being drenched by one geyser, such as Strokkur, doesn't mean that you will escape the original old "Geysir", which slumbers nearby but which, once in a while, still blows, shooting a column of hot water and steam high into the air.
And so it was that, in the fall of 2008, Lehman Brothers, the Wall Street investment bank and a mainstay of the global financial community, collapsed, triggering a huge crisis in financial markets. Much of the world was drenched, but Iceland was swept away in a torrent.
The results were swift and brutal. The three main Icelandic banks - Landsbanki, Kaupthing, and Glitnir - collapsed and the country's currency plummeted. 75% of Icelandic stock market value was destroyed in a financial “Twilight of the Gods”.
And even worse things were yet to come.
Next article in series: "Part 5 - A terrorist state"
(1) Jonsson, Asgeir. Why Iceland? New York: McGraw-Hill, 2009.
(2) Helgason, Magnus. "Bubblicious!" Reykjavik Grapevine. Online. http://grapevine.is/Home/ 4 Aug. 2010.
(3) Helgason, Magnus. "The consumer's republic of Iceland". Reykjavik Grapevine. http://grapevine.is/Home/ 1 June 2011.
(4) Helgason, Magnus. "The corporate Vikings". Reykjavik Grapevine. Online. http://grapevine.is/Home/ 21 July 2010.
(5) Helgason, Magnus. "The decade of failure". Reykjavik Grapevine. Online. http://grapevine.is/Home/ 26 Jan. 2011.
* Photo of Strokkur Geyser courtesy of “Visit Iceland”- http://www.icetourist.is/DiscoverIceland/
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Posted by: socredible on October 31 2011 8:04 AM
Who picks up the tab?
A German.