2008–2011 Icelandic financial crisis

Former headquarters of Landsbanki in Reykjavik and current headquarters of Nýi Landsbanki, founded by FME on the ruins of Landsbanki.

Economic growth in Iceland, Denmark, Norway and Sweden in 2007. Iceland is highlighted red.

The 2008 Icelandic financial crisis involves all three of the major banks in Iceland and their seizure by the government. In late September, it was announced that the Glitnir bank would be nationalised. The following week, control of Landsbanki and Glitnir was handed over to the Financial Supervisory Authority (FME). Soon after that, the same organisation seized Iceland's largest bank, Kaupthing.

According to the Associated Press, Iceland "is on the brink of becoming the first 'national bankruptcy' of the global financial meltdown." Prime Minister Geir Haarde has stated that the actions taken by the government have ensured that the Icelandic state will not go bankrupt. At the end of the second quarter 2008, Iceland's external debt was 9,553 billion Icelandic krónur, more than 80 percent of which was held by the banking sector: This value compares with Iceland's gross domestic product of 1,293 billion krónur (2007). The assets of the three banks taken under the control of the FME totaled 11,353 billion krónur at the end of 2007.

The effects are being felt in various other European countries. In the United Kingdom and the Netherlands, customers of Icesave (the local trade name of the former Landsbanki) found on 7 October that they were unable to withdraw their funds. Many UK local authorities, charities, police authorities and other organisations had funds in Icelandic banks. Many European banks had hundreds of millions of euros' exposure to the Icelandic banks.

Development

Currency

The Icelandic króna has declined nearly 50 percent against the euro during 2008. Inflation of prices in the economy is running at 14 percent. Iceland's interest rates have been raised to 15.5 percent to deal with the high inflation and the króna's decline is reportedly only beaten by that of the Zimbabwean dollar. This depreciation in currency value has put pressure on banks in Iceland, which are largely dependent on foreign debt.

On Wednesday night, 8 October, the Central Bank of Iceland abandoned its attempt to peg the Icelandic króna at 131 króna to the euro after trying to set this peg on Monday, 6 October. By Thursday, 9 October, the Icelandic króna was trading at 340 to the euro when trading in the currency collapsed due to the FME's takeover of the last major Icelandic bank, and thus the loss of all króna trade 'clearing houses'.

Banks

File:Iceland-Reykjavik-Skolavordustigur-SPRON.jpg

Local branches of an Icelandic savings bank SPRON.

On 29 September 2008 a plan was announced for the bank Glitnir to be nationalised by the Icelandic government with the purchase of a 75 percent stake for €600 million. The government stated that it did not intend to hold ownership of the bank for a long period, and that the bank was expected to carry on operating as normal. According to the government the bank "would have ceased to exist" within a few weeks if there had not been intervention. However, the nationalization of Glitnir never went through, as Glitnir was taken over by the Financial Supervisory Authority before the initial plan of the Icelandic government to purchase a 75 percent stake in the bank had been approved by the bank.

The Financial Supervisory Authority (FME) took control of Landsbanki on 7 October. A press release by the FME states that all of Landsbanki's domestic branches, call centres, ATMs and internet operations will be open for business as usual, and that all domestic deposits are fully guaranteed. The Government had moved quickly to use the sweeping powers granted by the Icelandic parliament, the night before. The same day, FME took control of Glitnir.

On the same day, it was announced by Russian ambassador to Iceland, Victor I. Tatarintsev, that Iceland will receive a €4 billion loan from Russia. The loan will be given across three or four years, and the interest rates will be 30 to 50 points above LIBOR. According to RÚV, prime minister Geir Haarde had been investigating the possibility of a loan since the mid-summer. Iceland's Central bank Governor Davíð Oddsson later clarified that the loan was still being negotiated.

On 8 October, the UK's Prime Minister, Gordon Brown, announced that the UK government would launch legal action against Iceland over concerns with compensation for the estimated 300,000 UK savers after the FME's takeover of Landsbanki and its online brand, Icesave. Chancellor of the Exchequer Alistair Darling announced that the UK government would foot the entire bill, estimated at £4 billion, and that he was taking steps to freeze the assets of Landsbanki. Under the Landsbanki Freezing Order 2008, passed at 10 a.m. on 8 October 2008 to come into force ten minutes later, the Treasury went on to freeze the assets of Landsbanki in the UK, and assets belonging to the Central Bank of Iceland, and the Government of Iceland relating to Landsbanki. The freezing order took advantage of provisions in section 4 of the Anti-terrorism, Crime and Security Act 2001. Icelandic Prime Minister Geir Haarde said at a press conference on the following day that the Icelandic government was displeased and outraged that the UK government applied provisions of anti-terrorism legislation to it in a move they dubbed an "unfriendly act". It is reported that more than £4 billion in Icelandic assets in the UK have been frozen by the UK government.

On the same day, the Sveriges Riksbank, Sweden's central bank, made a credit facility of 5 billion Swedish krona (€520 million) available to Kaupthing Bank Sverige AB, the Swedish subsidiary of Kaupthing Bank, the largest bank in Iceland. The loan was to pay "depositors and other creditors".

On 9 October, Kaupthing was taken over by the FME, following the resignation of the entire board of directors. This came about when Britain transferred control of the business of Kaupthing Edge, its Internet bank, to ING Direct and put Kaupthing's UK operations into administration, placing Kaupthing in technical default according to loan agreements. Over £2.5 billion of deposits for 160,000 customers were handed over to ING Direct. Iceland's Prime Minister, Geir Haarde, has stated that the British government brought down Kaupthing unnecessarily by abusing their power. Kaupthing's Luxembourg subsidiary asked for, and obtained, a suspension of payments (similar to chapter 11 protection) in the Luxembourg District Court. Kaupthing's Geneva office, which was a branch of its Luxembourg subsidiary, was prevented from making any payments of more than 5000 Swiss francs by the Swiss Federal Banking Commission.

On the same day, all trading on the OMX Nordic Iceland Exchange was frozen by the government temporarily for two days, according to the BBC: "in an attempt to prevent further panic spreading throughout the country's financial markets". The decision was made to do so due to "unusual market conditions". The closure was extended through Monday 13 October due to continuing "unusual market conditions".

On 12 October the Norwegian government took control of Kaupthing's Norwegian operations, including "all of the bank's assets and liabilities in Norway."

Sovereign credit ratings

Ratings of Icelandic sovereign debt
(long-term foreign currency)

Agency	29 Sept.	10 Oct.
Fitch	A+	BBB–
Moody's	Aa1	A1
R&I	AA	BBB–
S&P	A–	BBB

The four credit rating agencies which monitor Iceland's sovereign debt all lowered their ratings during the crisis, and their outlook for future ratings changes is negative. The Icelandic government has a relatively healthy balance, with sovereign debt of 28.3 percent of GDP and a budget surplus of 5.5 percent of GDP (2007).

In addition, the value of foreign currency bonds which mature in the remainder of 2008 is only $600 million, and foreign currency debt service in 2009 is only $215 million, well within the government's ability to pay. However the agencies believe that the government will have to issue more foreign currency bonds, both to cover losses as the banks' overseas operations are liquidated and also to stimulate demand in the domestic economy as Iceland goes into recession.

A team of experts from the International Monetary Fund (IMF) arrived in Iceland at the start of October 2008 for talks with the government. Industry Minister Össur Skarphéðinsson, who is also acting Foreign Minister, was said to be "favourable" to help from the IMF to stabilise the krónur and to allow interest rates to be lowered.

Causes

The crisis came about gradually as banks became unable to refinance their debts. It is estimated that the three major banks hold foreign debt in excess of €50 billion, or about €160,000 per Icelandic resident, compared with Iceland's gross domestic product of €8.5 billion. As early as March 2008, the cost of private deposit insurance for deposits in Landsbanki and Kaupthing was already far higher (6–8½ percent of the sum deposited) than for other European banks. The króna, which was ranked by The Economist as the most overvalued currency in the world in early 2007, has further suffered from the effects of carry trading.

Coming from a small domestic market, Iceland's banks have financed their expansion with loans on the interbank lending market and, more recently, by deposits from outside Iceland (which are also a form of external debt). Icelanders also took on a large amount of consumer debt, equivalent to 213 percent of disposable income, which led to inflation.

In response to the rise in prices—14 percent in the twelve months to September 2008, compared with a target of 2.5 percent—the Central Bank of Iceland has held interest rates high (15.5 percent). Such high interest rates, compared with 5.5 percent in the United Kingdom or 4 percent in the eurozone for example, have encouraged overseas investors to hold deposits in Icelandic krónur, leading to monetary inflation: the Icelandic money supply (M3) grew 37.8 percent in the twelve months to August 2008, compared to 5.0 percent GDP growth. The situation was effectively an economic bubble, with investors overestimating the true value of the króna.

As with many banks around the world, the Icelandic banks found it increasingly difficult or impossible to roll over their loans in the interbank market, their creditors insisting on repayment while no other banks were willing to make fresh loans. In such a situation, a bank would normally have to ask for a loan from the central bank as the lender of last resort. However in Iceland the banks were so much larger than the national economy that the Central Bank of Iceland and the Icelandic government could not guarantee the repayment of the banks' debts, leading to the collapse of the banks. The official reserves of the Central Bank of Iceland stood at 374.8 billion krónur at the end of September 2008, compared with 350.3 billion krónur of short-term international debt in the Icelandic banking sector.

Effects

Within Iceland

The current economic climate in the country has affected many Icelandic businesses and citizens. With the creation of Nýi Landsbanki, the new organisation which replaces the old Landsbanki, around 300 employees will lose their jobs due to a radical restructuring of the organisation which is intended to minimise the bank's international operations. Similar job losses are expected at Glitir and Kaupthing The job losses can be compared with the 2,136 registered unemployed and 495 advertised vacancies in Iceland at the end of August 2008.

Other companies have also been affected. For example, Icelandair has noticed a significant slump in domestic demand for flights. However, the airline states that year-on-year international demand is up from last year. Guðjón Arngrímsson, a spokesman for the airline, said "we're getting decent traffic from other markets... we are trying to let the weak [króna] help us." He has also stated that it is impossible to predict whether the company will be profitable this year.

Morgunblaðið, an Icelandic newspaper, is cutting some jobs and merging parts of its operations with the media corporation 365. The newspaper 24 stundir has ceased publication due to the crisis, resulting in the loss of 20 jobs.

The assets of Icelandic pension funds are, according to one expert, expected to shrink by 15–25 percent. The Icelandic Pension Funds Association has announced that benefits will in all likelihood have to be cut in 2009.

Iceland's GDP is expected by economists to shrink at least 10 percent as a result of the crisis, putting Iceland by some measures in an economic depression.

Outside Iceland

It emerged on 9 October that over £840 million in cash from more than 100 UK local authorities is invested in Icelandic banks. Ministers from each council are meeting to try and persuade HM Treasury to secure the money in the same way that customer's money in the now insolvent bank Icesave was fully guaranteed. Of all the local authorities, Kent County Council has the most money invested in Icelandic banks, currently £50 million. Transport for London, the organisation that operates and coordinates transport services within London, also has a large investment at £40 million. Local authorities were working under government advice to invest their money across many national and international banks as a way of spreading risk, which stated that the Icelandic banks had been given a "double A" rating. Some charities and other public bodies (such as universities) also have considerable sums invested in the same banks, and the security of their cash is currently unknown. Other UK organisations said to have invested heavily include police services and fire authorities.

Gordon Brown condemned what he saw as Iceland's refusal to secure the deposits of UK customers of Icelandic banks as "completely unacceptable" and "effectively illegal", and that the regulators have failed "not only the people of Iceland, they have failed people in Britain". Geir Haarde replied that the remarks made by Brown were "not a true description" and that he would not be sanctioning any illegal behaviour.

In an emergency sitting of the Tynwald on 9 October, the Isle of Man government raised compensation from 75 percent of the first £15,000 per depositor to 100 percent of £50,000 per depositor. The Chief Minister of the Isle of Man, Tony Brown, confirmed that Kaupthing had guaranteed the operations and liabilities of its Manx subsidiary in September 2007, and that the Manx government was pressing Iceland to honour this guarantee. Depositors with Landsbanki on Guernsey found themselves without any depositor protection.

On 11 October, an agreement was reached between the Icelandic and Dutch government on the savings of about 120,000 Dutch citizens. The Icelandic government will cover the first €20,887 on savings account of Dutch citizens held by Landsbanki subsidary Icesave, using money lent by the Dutch government. The total value of Icesave deposits in the Netherlands is €1.7 billion. At the same time Iceland and Britain reached an agreement on the general contours of a solution: Icesave deposits in the UK total £4 billion (€5 billion) in 300,000 accounts. The figure of €20,887 is the amount covered by the Icelandic Depositors' and Investors' Guarantee Fund (IDIGF; Tryggingarsjóður in Icelandic): however, the IDIGF had equity of only 8.3 billion krónur at the end of 2007, €90 million at the exchange rates of the time and far from sufficient to cover the Dutch and British claims. Residents of Guernsey are not covered in any way so could lose their entire deposits.

Comic relief – eBay auction

Online auction and shopping website eBay has reported that one seller has put up Iceland for sale. Auction started with 99 pence but had reached 10 million pounds (US $17.28 million). However, singer Björk was "not included" in the sale. The notice read Located in the mid-Atlantic ridge in the North Atlantic Ocean, Iceland will provide the winning bidder with — a habitable environment, Icelandic Horses and admittedly a somewhat sketchy financial situation. Bidders' questions included: "Do you offer volcano/earthquake insurance?"

See also

• Economy of Iceland
• Financial crisis of 2007-2008
• List of bankrupt or acquired banks during the financial crisis of 2007–2008
• Banking in Iceland

External links

• What happened to Iceland?
• Kreppanomics
• Time Magazine: A Meltdown in Iceland
• Time Magazine: Iceland Suspends Trading, Creates New Bank
• Time Magazine: Iceland: Britain's Credit Crunch Scapegoat