The Wall Street Journal has an article by Charles Forelle about the decline and precipitous fall of Iceland:
A boy charged to the front of an angry crowd here recently and tossed a carton of skyr, a popular local yogurt-like snack, at the Parliament building. It splattered on the rough-hewn stone. He and thousands of Icelanders were protesting one of the strangest economic failures of the global financial crisis. This past fall, every bank that matters in this tiny nation— that is, all three of them— failed. Iceland's currency, the krona, became worthless beyond its shores. The country's financial system stopped working. "We are pissed off at the government," said one young man, pausing between fusillades of eggs. A roll of toilet paper arced across the Nordic sky.Rico says poor Mr. Madoff ran a Ponzi scheme for $50 billion and went to jail. The Icelanders tried the same thing, and didn't even get voted out of office...
Iceland is an extreme casualty of an era in which it became extraordinarily easy to borrow money. But it was more than that: an examination of the nation's banking system, which collapsed over about ten days this autumn, reveals the degree to which Iceland was one of the international financial bubble's most enthusiastic players. Home to fewer people than Wichita, Kansas, Iceland became so leveraged and so deeply intertwined with the global financial infrastructure that its collapse has rattled the world from Tokyo to California to the Middle East.
In Japan and Hong Kong, bond buyers got stuck holding all-but-worthless debt. In Beverly Hills, a real-estate developer was forced to default after teaming up with an Icelandic bank to build condos near Wilshire Boulevard. A German regional lender, Bayerische Landesbank, suffered big losses on its Icelandic investments contributing to its need for a €30 billion ($42 billion) bailout package.
And in recent weeks, Naomi House, a hospice in southern England, had to cancel a service in which aides made house calls to give the parents of dying children a helping hand. Some £5.7 million ($8.7 million), two-thirds of its available cash, is frozen and may never be fully returned. It was deposited in an Icelandic bank.
Khalid Aziz, chairman of the hospice trust, says he didn't think twice back in 2005 when Icelanders bought the local bank. "With the globalization of markets," he says, "everybody owns everything these days, don't they?"
Until very recently, the 21st century had smiled on Iceland. Last year, it boasted the highest standard of living of any country, according to the United Nations, outranking the US, for all its McMansions and drive-through coffee shops, and Sweden with its government-paid parental leave and other generous social benefits.
High interest rates set by the central bank kept foreign money flowing onto the island, strengthening the krona and making imported goods easily affordable. Iceland's ports unloaded ships full of swank Scandinavian furniture, building materials for new houses, and sport-utility vehicles. Imports were boundless: recently, cape gooseberries were a common adornment on the plates of Reykjavik's chic restaurants.
Iceland has long had many valuable natural assets. It sits amid some of the world's best fishing grounds, and that industry sustained the local economy for centuries. It is a wild, beautiful place where some people still believe in alfar, or elves.
The cinematic landscape of fjords, glaciers, and reindeer attracts adventurous tourists and their dollars. The earth's innards bubble to the surface in volcanoes and geysers, a product of Iceland's location atop the violent meeting point of the North American and Eurasian tectonic plates.
But in the early 1990s, some people felt Iceland could be more than a showcase for nature and a producer of salt cod. Leading the charge was David Oddsson. A shaggy-haired former mayor of Reykjavik, Mr. Oddsson was an Icelandic character: a writer of short stories and religious hymns, the one-time host of a comic radio program and, as a youth, an aspiring actor who dressed as Santa Claus to earn pocket money at Christmas.
He was known for his wit, says Hannes Gissurarson, a member of Mr. Oddsson's inner circle at the time. When Shimon Peres, the Israeli politician, visited Iceland, Mr. Oddsson jokingly said to him: "You are the chosen people, we are the frozen people," according to Mr. Gissurarson.
Mr. Oddsson became prime minister in 1991, promising to bring an end to the country's boom-and-bust cycles tied to the fish catch. He blamed the trouble on the state-controlled economy, which put bureaucrats in charge of fishing, the media, even a travel agency. Within a few years, Iceland had sold off companies worth a combined $2 billion, a big sum for the small economy, says Mr. Gissurarson. For Mr. Oddsson, what most held Iceland back was government control of banking, which put politicians in the position of determining how capital should be allocated. "The crucial factor," he said in a 2004 speech, "was the iron grip that the Icelandic state had on all business activity through its ownership of the commercial banks." He sold them all.
Icelanders embraced change. The highly educated populace launched biotechnology and software companies. Ossur hf, an Icelandic maker of artificial limbs, grew into a global supplier of high-tech prosthetics. At this year's Beijing Paralympic Games, the South African sprinter Oscar Pistorius won three gold medals wearing Ossur's Cheetah brand legs, running the hundred-meter dash in 11.17 seconds. Industrialists harnessed the energy of volcanoes and waterfalls to power aluminum smelters. Alcoa built a giant smelter among Iceland's eastern fjords. But Iceland's biggest foray was into banking. Almost immediately, the newly privatized banks started looking overseas for growth. There was a simple reason: The local economy is small. With only 300,000 citizens, there aren't enough Icelanders to open new accounts. In 2000, Kaupthing Bank, Iceland's biggest, had assets of just 208 billion kronur. By 30 June of this year, its assets had ballooned some 30 times, to 6.6 trillion kronur. By earlier this year, the three main banks had grown so much that they accounted for around three-quarters of Iceland's stock-market value. Their loans and other assets totaled about ten times Iceland's gross domestic product.
Central Reykjavik has a small-city feel: rows of gabled houses and lamplit streets. But, driven by banking, it became a mini-financial capital. Icelandic tycoons held court at hotel bars and hip eateries that overshadowed the port city's seafood shacks. At one, Sjávarkjallarinn, or Seafood Cellar, chefs put Icelandic fish in outré combinations with exotic ingredients. Its signature appetizer: a Mason jar of lobster, cauliflower, and a truffle-flecked foie gras sauce.
Universities lured the children of fishermen and trained them in finance. In 2005, Silja Sigurdardottir, 26 years old, was an engineering student, then switched to financial math. "The banks were really big, and everything was going up," she says.
Ms Sigurdardottir got her masters in 2007, and worked for Kaupthing for one year. During that time, "I didn't really worry about money," she says. Those days are over. She was laid off in October. Next year she plans to begin studying for a new degree, in sustainable development. "Now I have to go back to being a poor student," she says.
Much of Iceland is on a similar trajectory. After years of growth, Iceland's GDP is forecast to shrink by 8% next year. Inflation, at 18% and expected to rise, is gutting the value of regular Icelanders' assets and crimping their once-flush household budgets.
"We have a major macroeconomic problem on our hands," says Geir Haarde, the country's prime minister. To a degree, the wealth Iceland enjoyed during the boom years was a mirage. It was conjured by high interest rates, which attracted vast sums of foreign money.
Iceland became a paradise of high returns, even for individual foreigners simply looking for a bank account. For instance, in July, Kaupthing's Isle of Man subsidiary offered 7.15% on one-year deposits. High interest rates kept the currency, the krona, strong. The strong krona, in turn, made the prices of imported goods— flat-screen television sets, SUVs— low. So Icelanders went on an epic shopping spree. They dodged the expense of borrowing at those rates, though, by instead borrowing at lower interest rates in foreign currencies (Japanese yen, Swiss francs) to finance homes and other big purchases.
Like Americans who rode a housing bubble thanks to the Federal Reserve's maintaining low interest rates for years, Icelanders had found a cheap source of borrowing to finance their consumption. As long as foreign money kept flowing into Iceland, everything remained fine. But an outflow would dangerously reverse the equation, and set the stage for calamity.
Iceland isn't the only small country to be whipsawed by foreign money flooding in, then gushing out. Hungary and Latvia were similarly hit. What makes Iceland different: It tried to build a global banking center on top of a tiny currency. So when foreign investors tried to pull out— converting kronur back into dollars or euros en masse— its currency fell like a rock, spurring more withdrawals.
Amid Iceland's euphoria, there were warnings. In 2006, analysts at Danske Bank wrote a paper titled Geyser Crisis, saying that Iceland's banks had grown too much, and the country was dangerously reliant on the willingness of foreigners to keep sending money. Hedge funds attacked the Icelandic krona. The banks weathered the assault, and the krona bounced back. Fatally, Iceland viewed its successful defense as proof of the banks' resilience. But the Danske Bank team wasn't wrong, just early. Meantime, Iceland's new breed of tycoons was living large.
Among them was Jón Ásgeir Jóhannesson. He traveled by yacht, jet, and helicopter all emblazoned 101, the name of a chic Reykjavik hotel owned by his wife. Mr. Johannesson, who parlayed a discount-grocery business into a empire that spanned frozen food and high-end retail, went on a global acquisition spree. In 2006, he scooped up famed London retailer House of Fraser. His holding company also owned a big chunk of Iceland's third-largest bank, Glitnir Bank hf. One of Glitnir's predecessor institutions had been the state's Fisheries Investment Fund, which helped fisherman buy trawlers. In recent years, Glitnir became much more complex, borrowing heavily from European banks to finance a global expansion. It financed Mr. Johannesson's House of Fraser deal. By mid-2008, strains in Iceland were starting to show. As the financial crisis simmered in the US, banks world-wide were getting warier of lending to each other. They particularly worried about the remote and deeply indebted island nation of Iceland. In a matter of just days, starting in late September, Iceland's entire banking system failed. This account of the final days is based on documents and interviews with a dozen or so people close to the banks and the government.
Inside Glitnir's headquarters in mid-September, CEO Lárus Welding and his deputies faced a problem: the bank had issued bonds five years earlier, to pay for its expansion, that were now coming due. Glitnir had to make a payment of €600 million on 15 October. Glitnir feared it didn't have the cash.
Mr. Welding, silver-haired at age 32, had taken his job just a year earlier. Previously, he ran the London branch of Iceland's second-biggest bank, Landsbanki Islands hf, and helped run one of its most-popular products, Icesave, a service that led Britons to sock away money at high interest rates. Hundreds of thousands of them did, pouring in billions of pounds.
Glitnir, however, didn't have access to piles of pounds or euros to pay back creditors. Unlike Landsbanki and Kaupthing, Glitnir hadn't bulked up on foreign deposits. Mr. Welding's bankers tried everything to raise cash: They attempted to sell Norwegian subsidiaries. They tried to borrow foreign currency. But no one wanted the krona-denominated mortgages and car loans that Glitnir could offer as collateral. Indeed, suddenly no one wanted kronur at all. The exchange rate was in freefall.
The mid-September collapse of Lehman Brothers in New York had panicked financial firms world-wide, bringing lending between banks to a standstill. Given Glitnir's acute need for a loan, that was very bad news. Glitnir hoped Bayerische Landesbank would let it be late with a €150-million payment on a loan, freeing up some cash for the bond repayment. No dice. On 24 September, the Germans asked to be paid on time. Mr. Welding phoned Glitnir's chairman, Thorsteinn Már Baldvinsson. "This has not been a good day," he said. Iceland was beginning to be cut down to size.
Mr. Haarde, the prime minister, spent 24 September in New York City at the United Nations General Assembly. The talk there was of the financial crisis then laying waste to Wall Street. Yet, while Lehman Brothers had just gone bankrupt, Europe hadn't yet felt the full force. The Icelandic delegation headed across town to Nasdaq headquarters, where Mr. Haarde, smiling for the photo op, rang the closing bell. Back in Reykjavik, however, Iceland's own Glitnir bank was flirting with disaster. With Mr. Haarde out of town, Messrs. Welding and Baldvinsson turned for help to Mr. Oddsson, the former prime minister. In 2005, Mr. Oddsson had moved across town to another position of power: chairman of the central bank's board of governors. The Glitnir men said they could need between €500 million and €600 million. Mr. Oddsson didn't commit. "Let's keep in touch," he said, according to a person familiar with the matter.
There was a problem: Iceland's central bank— which is supposed to act as a lender of last resort when banks get into a bind— hadn't stockpiled very many euros to lend. By the middle of this year, it held just €2 billion in foreign-currency reserves. By contrast, Iceland had more than $70 billion (€49.9 billion) in debts to foreign banks. It had plenty of kronur. But nobody wanted those.
That weekend, Iceland's political and banking leaders scrambled to avert cataclysm. The chiefs of the three banks met at the offices of the state banking regulator to hammer out a shotgun merger. The most likely deal— a tie-up of Landsbanki and Glitnir— would still require the government to provide euros so Glitnir could make its payments. Euros, of course, were just about as scarce in Iceland as cape gooseberries had once been. Within the government, a split emerged about what to do with the few euros Iceland did have. Some advocated in effect lending Glitnir the money. But central-bank officials said a loan would be a waste: Glitnir would just be back later for more, they argued.
Instead, they proposed the government make a large investment directly in Glitnir, in return for equity. This had its risks. The prime minister's chief economic adviser, Tryggvi Thor Herbertsson, worried that diluting Glitnir's shareholders would torpedo other banks' shares.
The evening of Sunday, 28 September, Mr. Oddsson summoned the top Glitnir officials. As Messrs. Welding and Baldvinsson arrived at the central-bank headquarters to learn Glitnir's fate, Mr. Welding turned to his colleague. "Do you realize," he said, "It's over." Mr. Oddsson said the government would be willing to take a 75% stake in Glitnir for €600 million. Monday morning, when the deal was announced, bank shares collapsed. Rating agencies knocked down the debt ratings of Glitnir, Iceland's other banks, and Iceland itself. The krona dropped like a stone.
In Spain, watching television at his home, Daniel Herzberg caught a news report about Iceland's banks. He got worried. A few years ago, he and his wife had deposited £10,000 in the Guernsey branch of a British savings bank. A year later, Landsbanki bought the branch. Mr. Herzberg, a 39-year-old expatriate Briton who organizes bicycle and walking tours, emailed the bank to ask whether his money was safe. He and his wife, Lucy, were saving for home renovations to accommodate their 2-year-old, Oliver. On Friday, 3 October, Mr. Herzberg got an encouraging reply: Landsbanki would back foreign depositors. The email also pointed out that Icelandic bank regulators just a few weeks earlier had found Landsbanki "strong enough to withstand a severe shock to the financial system".
"Everything's fine," Mr. Herzberg said to his wife. Except it wasn't.
The bad news about Iceland had startled many Brits with money in Landsbanki's Icesave accounts. That weekend, they withdrew some £200 million. Alarmed, British banking authorities told Landsbanki it had until Monday afternoon to replenish the London branch with about the same amount. The UK Financial Services Authority declined to discuss the Icesave sequence of events. A couple of hundred million pounds was something Landsbanki didn't have just lying around. Like any bank would, it had lent or invested the deposits it had taken in over the years.
Landsbanki had little choice but to turn to its lender of last resort, Iceland's central bank. On Saturday, major shareholder Björgólfur Thor Björgólfsson paid a visit to Mr. Oddsson to ask for a loan. Mr. Björgólfsson and his father, Björgólfur Gudmundsson, are perhaps Iceland's most prominent tycoons. In 2006, the father purchased West Ham United, a top British soccer club. Meantime, Prime Minister Haarde and other top officials— bankers, regulators, labor-union leaders, parliamentarians, and pension-fund administrators— scrounged everywhere for euros that might be used to prop up the banks.
Around midnight on Sunday, there was a burst of hope. Mr. Haarde told a small crowd gathered in the lobby of Iceland's Parliament building about a new plan taking shape: Iceland's pension funds would sell some overseas investments to raise foreign currency, then let the government buy the foreign currency for kronur. By Monday morning, that idea was dead. The pension funds weren't eager to sell assets at fire-sale prices into a global crisis. Iceland had run out of moves.
Monday afternoon, a weary-looking Mr. Haarde addressed his countrymen. He warned that the banks' grave troubles threatened the whole island. "The Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool," he announced on television.
The solution: Iceland would seize the banks. That evening, Parliament passed a new law enabling this to happen. The next morning, Tuesday, 7 October, Landsbanki was nationalized. Iceland's depositors would be protected from losses, the government said. In the UK, banking authorities didn't like the sound of that. British depositors had billions of pounds in Icesave, and no one was saying anything about protecting them. In a heated phone call, British Treasury chief Alistair Darling asked Iceland's finance minister if British depositors were getting left out in the cold. "Do I understand that you guarantee the deposits of Icelandic depositors?" Mr. Darling asked, according to a transcript published in the Icelandic press. "Yes," replied Arní Mathiesen. "But not the branches outside Iceland?" Mr. Darling asked. "No," Mr. Mathiesen said, not beyond the €20,000 minimum prescribed by European regulations. Later in the call, Mr. Mathiesen said Iceland probably didn't even have enough money to meet the €20,000 minimum. "Well," said Mr. Darling, "that is a terrible position to be in."
Despite the Landsbanki debacle, executives at Kaupthing remained hopeful about survival. Kaupthing hadn't seen massive outflows from its own British deposit service (which, luckily, didn't have "Ice" in its name). And Iceland's government had agreed to give Kaupthing the €500-million loan it needed.
Working late Tuesday at the bank's headquarters, an airy glass building with a waterfall in the atrium, they hammered out a proposal to take over Glitnir and sell its foreign assets. Thus, two of Iceland's three banks would pull through. Early Wednesday morning, Kaupthing's chairman was working with his bankers to try to sell some UK assets, when bad tidings flashed across his TV screen: British authorities, worried about the solvency of Kaupthing's UK subsidiary, had seized its assets and transferred them to the Dutch bank ING.
The seizure would trigger a cascade of defaults for Kaupthing, blows it simply couldn't survive. The next morning, Iceland's government took over what was left of Kaupthing. Glitnir, too, was eventually brought under government control.
In Iceland, the reaction has been shame and anger. Popular targets are British Prime Minister Gordon Brown and Mr. Darling, blamed for precipitating Kaupthing's collapse. They are also reviled for using an anti-terror law to seize other Icelandic assets. Also attracting a helping of blame is Mr. Oddsson. In a brief telephone interview in October, Mr. Oddsson said Iceland's foreign-currency reserves, per capita, were greater than most other countries. And in a spirited October interview on Icelandic television, he said it was the banks that should have been made smaller, not the currency reserves larger. In a November speech to an Icelandic business gathering, Mr. Oddsson rejected blame for the crisis, saying the central bank had limited supervisory authority over banks, and that he had, in fact, warned of the banks' profligacy.
Blaming Mr. Oddsson is "totally unjustified", says his friend Mr. Gissurarson, also a member of the central bank's supervisory board. "The currency crisis was brought about by Gordon Brown," he says. When the UK seized Kaupthing's assets, that ended Iceland's best hope keep that institution alive itself. Mr. Brown has vigorously defended Britain's moves, saying they were necessary to protect British savers after Iceland signaled it would back local depositors but not foreigners.
One thing that might have saved Icelandic capitalism was joining the euro. Appealing to national pride, Mr. Oddsson long resisted moves to join the European Union and adopt the common currency. Perhaps most crucially, joining the EU would have meant bureaucrats in Brussels would then regulate Iceland's use of its fishing stocks, a political third rail in Iceland. In the October TV interview, Mr. Oddsson was unbowed in his views of the euro. "If we were tied to the euro, for instance, we would just have to succumb to the laws of Germany and France," he said.
The growth of Iceland's banks abroad was astonishing. When they fell, they left a mess to clean up that spilled across the globe. Glitnir owned two Norwegian banks. Landsbanki took deposits across the Atlantic in Nova Scotia, then spread halfway across Canada to open a private-banking office in Winnipeg. Kaupthing launched operations in Luxembourg, and raised an investment fund and bought a power plant in India. Two weeks before it collapsed, Kaupthing also wooed a Qatari sheikh, Mohammed Bin Khalifa Al-Thani, into buying a 5% bank stake for 25.6 billion kronur. A spokeswoman says the stake is now virtually worthless. Kaupthing also hired a real-estate banker to drum up business. Among the resulting projects was the Beverly Hills condo development. Kaupthing teamed up with land developer CPC Group, and borrowed $365 million to help finance the purchase of eight acres of land abutting Wilshire Boulevard. The loan was due 9 October, the day Kaupthing was seized by Iceland. CPC was unable to make the whole payment. The project is in turmoil. In most countries, deposit-protection schemes cover at least some money lost by savers, at significant cost to local treasuries. Britain and the Netherlands are putting up billions of euros to cover their depositors. Iceland will reimburse some funds, but not for years.
Mr. Herzberg and the 2,000 other depositors in Landsbanki Guernsey have been paid thirty percent of their £120 million in deposits. But the bank's court-appointed administrator isn't optimistic that they'll get the rest back. Guernsey has no deposit-guarantee protection. Account holders with large balances, like Naomi House, the British children's hospice, are out of luck. Some 250 children suffering from cancer and other diseases come to Naomi House each year. Many pass through its doors only for a temporary stay. Others come there to die. In better times— just three years ago— Naomi House decided to start building a second facility, for teenagers. Construction isn't finished, so to keep the project going, Mr. Aziz, the charity's chairman, says the trust may be forced to sell its stocks and other investments. Mr. Aziz hopes the government can help his charity, given that it is spending billions on bank bailouts. "Against the eye-watering sums that are being bandied around," Mr. Aziz says, "this is nothing."
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