Iceland is all but officially bankrupt
By Eric Pfanner
International Herald Tribune
Thursday, October 9, 2008
REYKJAVIK: People go bankrupt all the time. Companies do, too. But countries?
Iceland was on the verge of doing exactly that on Thursday as the government shut down the stock market and seized control of its last major independent bank. That brought trading in the country's currency to a halt, with foreign banks no longer willing to take Icelandic krona, even at fire-sale rates.
As the meltdown in the Icelandic financial system quickened, with the government seemingly powerless to do anything about it, analysts said there was probably only one realistic option left: for Iceland to be bailed out by the International Monetary Fund.
"Iceland is bankrupt," said Arsaell Valfells, a professor at the University of Iceland. "The Icelandic krona is history. The IMF has to come and rescue us."
Prime Minister Geir Haarde, who had warned this week of the threat of "national bankruptcy," said Thursday that Iceland's finance minister, Arni Mathiesen, would be in Washington this weekend for the autumn IMF/World Bank meetings. He declined to say whether Iceland was seeking a rescue package from the international lender.
"We will certainly keep this option open, but we have not yet made a decision," Haarde said Thursday at a news conference.
The IMF managing director, Dominique Strauss-Kahn, said in Washington that he had activated an emergency funding system, last used during the Asian financial crisis of the late 1990's, to help countries in crisis. Though not mentioning Iceland by name, he said: "We are ready to answer any demand by countries facing problems."
Iceland has approached Russia about a loan of 4 billion, or $5.5 billion, to help see it through the crisis, but Haarde said no agreement had been reached.
An IMF intervention in Iceland, which would necessarily involve accepting a series of harsh measures to restore fiscal and monetary stability, would underline the extraordinary reversal in the country's fortunes after a decade-long, debt-fueled binge by the country's banks, businesses and some private citizens. The banks, while avoiding the toxic mortgage securities that have humbled Wall Street, expanded aggressively at home and abroad. When credit tightened and the krona fell this year, they were unable to finance their debts.
In these circumstances, going to the IMF "is probably the only thing Iceland can do," said Richard Portes, an economist at the London Business School.
Events have moved so fast that the full import of national bankruptcy has yet to sink in here. It's happened before, of course, but in places like Argentina and Thailand, not a country that likes to think of itself as close to Europe.
And on an island raked by icy North Atlantic winds and dotted with volcanoes and geysers, where people live with the threat of earthquakes and maritime disasters, few residents seem to be losing their cool over the financial crisis - yet. But some have suffered deep losses, and others are simply bewildered at how things could have gone so wrong so quickly.
"There is a lot of fear in society and there are people who are losing everything," Bubbi Morthens, an Icelandic rock favorite, said Wednesday after singing at an impromptu midday concert in central Reykjavik intended to lift people's spirits.
Like many of his compatriots, Morthens did well when Iceland was riding high, accumulating considerable wealth. But when the government seized control of Iceland's third-largest bank, Glitnir, last month, Morthens said he lost his life savings, which he had invested in the bank's stock.
On Thursday, the government seized Kaupthing Bank, the country's largest lender, effectively completing the nationalization of the banking system after the previous takeover of Glitnir and the No.2 lender, Landsbanki.
Meanwhile trading in the currency froze up Thursday, according to Bloomberg News, citing dealers at Nordea, a big Scandinavian bank. The last trade was made at 340 krona to the euro, Nordea said - less than half what the Icelandic currency was worth at the start of the week.
Haarde said the Central Bank of Iceland had set up a special system to handle currency transactions, so that Icelandic companies could conduct international business.
"We are gradually moving through this crisis," he said, sounding surprisingly unworried for the leader of a country facing economic and financial disaster. "There are still a few issues to resolve but that is the nature of these kinds of things."
Problems with the krona have been at the core of the government's inability to control the crisis. Without a viable currency, there is no way to support the banks, which have done the bulk of their business in foreign markets. There is also no way to bring down inflation or interest rates, both already in double digits before the crisis intensified in recent days.
Valfells and Portes said that once the situation is stabilized, the best way forward would be for Iceland is to give up on the krona and adopt the euro instead.
How could Iceland, which is not even a member of the European Union, adopt the currency?
One option would be to simply "peg" its currency to the euro. In that case, Iceland would also hand over control of monetary policy, including the setting of interest rates, to the European Central Bank in Frankfurt.
But fixing the currency to the euro could be difficult for Iceland, given that its central bank probably lacks the necessary reserve to defend such a level if the currency were to come under renewed attack, Portes said.
That leaves another option: applying to join the European Union and adding Iceland to the euro zone. Because Iceland is already part of the European Economic Area, a looser trading bloc, it already abides by many EU rules.
Still, such a move would be politically challenging. The conservative Independence Party, headed by the prime minister, has been dead set against it. Another member of that party, which is governing in a coalition with the pro-EU Social Democrats, is the central bank chairman, David Oddsson, a former prime minister.
They are supported by the powerful fishing industry, which mostly wants to stay out of the euro and to keep Europe at a comfortable distance. Fishing has been the focus of many clashes between Iceland and its European neighbors - most heatedly with Britain, in what became known as the Cod Wars of the 1950s to the 70s. The two countries clashed repeatedly over Iceland's move to extend exclusive fishing rights into waters that had long been trawled by British vessels, too.
Tension with Britain has flared anew during the current crisis. It centers on accounts, worth an estimated 8 billion pounds, that Britons hold in the Icelandic banks; while the British government has guaranteed private savers' accounts, charities and local government organizations fear that they will lose their money. The government of Prime Minister Gordon Brown of Britain has used powers granted under anti-terrorism laws to freeze British assets of Landsbanki until the standoff is resolved.
"We do not consider this to be a particularly friendly act," Haarde said, adding that he had tried to defuse the situation in a telephone call with Brown on Thursday.
For all the worries, this capital city of 120,000 people still displays the fruits of the decade-long economic boom that followed the deregulation of Iceland's financial sector in the 1990s - hip cafés, lobster restaurants and stylish shops selling outdoor gear.
But the days when the economy seemed capable of gravity-defying feats are gone. So are the days when investors went on an international buying spree, adding some of the biggest names of the British and American retailing industries to their portfolios. Gone too, are the days when ordinary citizens effortlessly joined in the fun, taking out second mortgages to finance their own trips abroad or at least to the Laugavegur, the main shopping strip in Reykjavik.
"It's difficult; the landscape is very difficult," said Franch Michelsen, a watch dealer in central Reykjavik, as he took a break Wednesday from cleaning his shop window.
Some ordinary Icelanders face a similar problem to the one that brought down the banks. In recent months, many mortgages were taken out in foreign currencies - marketed by the banks as a way to benefit from lower interest rates abroad, as rates in Iceland rose into the double digits.
Now, with the Icelandic krona plunging, homeowners suddenly have to pay back far more expensive euro or dollar values of their mortgages. At the same time, house prices are falling.
The Reverend Karl Sigurbjornsson, the bishop of Iceland, who leads the state-sponsored Lutheran church, says he worries about how the prospect of financial suffering will affect a society that "was led to believe that it was unlimited growth forever."
"What will happen when the dust settles?" he asked. "A lot of people will be very angry. It will be a challenge for our society."