Home The Washington Diplomat March 2012 Iceland’s Busted Economy Slowly Puts Back the Pieces

Iceland’s Busted Economy Slowly Puts Back the Pieces

Iceland’s Busted Economy Slowly Puts Back the Pieces

Why is Greenland called Greenland and Iceland called Iceland — especially when tiny Iceland is relatively green but gigantic Greenland is 80 percent ice?

Guðmundur Árni Stefánsson, Iceland’s new ambassador in Washington, is ready with an answer to this age-old riddle.

“The fact is, the first settlers came to Iceland in 874 A.D., but then tried to sail further west and north,” he explained, pointing to an antique map of the North Atlantic on his office wall. “One of them, the father of Leif Eriksson [an explorer regarded as the first European to land in North America], discovered Greenland. He came back and told Iceland’s inhabitants, ‘I’ve located this beautiful country north of us, and it’s completely green.’ He was our first PR man. He was, of course, lying.”

That same sort of snow job could also explain how Iceland’s 317,000 citizens came to believe — even as world financial markets edged closer and closer to chaos in 2008 — that their country’s bloated banks would never fail, and that Iceland’s per-capita income of $39,700 a year, already the 11th highest in the world, would just keep heating up. This mentality allowed these modern-day Vikings to drive expensive Range Rovers and generally live way beyond their means.

When Iceland’s house of cards finally collapsed, the nation — and Europe — was in for an ice-cold shower.

Photo: Larry Ruggeri
Ambassador Guðmundur Árni Stefánsson

The national currency, the króna, lost more than half its value against the euro, inflation jumped to 18.6 percent, and thousands of citizens — many of them suddenly jobless— marched on Iceland’s parliament, the Althingi. Relative to the size of its fishing, energy and tourism-based economy, Iceland’s financial crisis made history as the largest ever suffered by any nation.

“Our people say the banks should have seen it coming and should have prepared them for the crisis. Bankers told them until the final day that everything was hunky-dory,” the ambassador complained. “Why didn’t they do something when they saw what was happening in other countries? That’s the million-dollar question, and still is.”

Despite its wealth, Iceland — whose population is only one-thousandth that of the United States — has always lived in the shadows of its much larger Scandinavian neighbors. Once united with Norway, the Kentucky-size island was a Danish territory until 1944, and its Georgetown embassy is located inside the House of Sweden on K Street.

Fittingly, Stefánsson was Iceland’s ambassador in Stockholm for six years before coming to Washington last October. (In his younger days, the 56-year-old diplomat also worked as a Reykjavik police officer, journalist at the weekly newspaper Helgarpósturinn and radio producer at the Icelandic State Broadcasting Service.)

Stefánsson was born and raised in Iceland’s third-largest city, Hafnarfjördur, whose 26,000 inhabitants put it roughly on par with Herndon, Va. In 1986, he became mayor of Hafnafjörtur, eventually becoming active in the center-left Social Democratic Party, which along with the Left Green Party now maintains a narrow majority in parliament.

The ambassador is proud to point out that Iceland’s Althingi is one of the world’s oldest parliaments, having been established by the Vikings in the year 930.

“The reason I quit politics after 15 years is that for 10 of those years, I was in the opposition. That’s a very long time,” he told The Washington Diplomat, noting that Iceland’s current foreign minister was chairman of the Independence Party, and therefore his political opponent. “So I said to myself, why not take the next step? And I think I made the right decision.”

It’s probably not a great time to be a politician in Iceland anyway.

Even though the country is clearly recovering, with per-capita GDP at just over $38,000 last year, Stefánsson said people are still furious about Iceland’s economic meltdown and the events that led up to it.

“In the decade leading up to the crash, Iceland transformed itself from an economy fueled by fishermen to a center for wealthy financiers,” Washington Post correspondent Brady Dennis reported from Reykjavik in mid-January. “It privatized its banks, and they grew larger and larger, gobbling up assets around the globe and luring thousands of overseas depositors with promises of high interest rates. Businessmen came and went from Reykjavik in private jets. They bought showy yachts and multimillion-dollar vacation homes. Bankers became a popular and swaggering breed; after all, they were handing out a slew of high-paying jobs and providing a fortune in tax revenue…. An air of invincibility set in, a sense that Icelanders had mastered a powerful form of financial alchemy.”

Photos: Robert Walzer
Visitors tour Iceland’s geothermal wonders in a stretch of mountainous lava desert several miles outside Reykjavik. Iceland’s economy is gradually bouncing back from its collapse in 2008 in part because the value of its currency dropped, making the scenic country more affordable to tourists.

But once the global credit markets began to freeze in mid-2008, investors demanded their money back. By then, Iceland’s three largest banks had accumulated assets of 14.437 trillion krónur (about $209 billion) — 11 times the country’s 2007 GDP of 1.293 trillion krónur.

“It was impossible for Icelandic authorities to save the banks, so we just let them go,” said Stefánsson. “The government said from the beginning that we’d secure the savings accounts of Icelanders who had money in the banks, but many others lost heavily. The banks went into bankruptcy and we have been selling their assets ever since.”

The ambassador added that “in reality, they never closed. Now the government owns Landsbanki, and the two others are owned by the debtors. We also borrowed money from our Nordic friends because there was a lack of foreign currency. They backed us up in a friendly and efficient manner.”

Yet other neighbors didn’t exactly react in a friendly manner — namely the British and Dutch, whose governments demanded that Iceland repay the roughly $5.8 billion that their depositors lost when Landsbanki went under.

The Icelandic government initially agreed, but when the issue was put to a referendum, taxpayers refused to foot the bill for foreign creditors — which would’ve entailed relinquishing an amount roughly equal to half the country’s GDP.

The voters’ rebuke remains a sore spot in Iceland’s relations with Britain and the Netherlands, yet Reykjavik’s success in averting a protracted economic calamity is undeniable — and, according to the ambassador, shows that governments should let failing lenders go bust and protect their citizens instead. Financial experts have generally agreed.

“The lesson that could be learned from Iceland’s way of handling its crisis is that it is important to shield taxpayers and government finances from bearing the cost of a financial crisis to the extent possible,” Islandsbanki analyst Jon Bjarki Bentsson told the French news agency AFP. “Even if our way of dealing with the crisis was not by choice but due to the inability of the government to support the banks back in 2008 due to their size relative to the economy, this has turned out relatively well for us.”

Arni Pall Arnason, 44, Iceland’s minister of economic affairs, told Bloomberg news recently that the decision to make debt holders share the pain saved Iceland’s future. “If we’d guaranteed all the banks’ liabilities,” he said, “we’d be in the same situation as Ireland.”

a5.iceland.country2.storyNobel Prize-winning U.S. economist Paul Krugman echoes that sentiment. “Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net,” Krugman wrote in a recent commentary in the New York Times. “Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver.”

And Iceland had more room to maneuver than other larger economies. Because its currency wasn’t tied to the eurozone, the government could allow the value of the króna to drop. As a result, exports went up, as did tourism thanks to cheaper prices. Capital controls kept money from leaving the island. And Iceland received loans not only from Nordic countries, but also the International Monetary Fund, completing an IMF program last summer.

“The IMF here in Washington says Iceland is a textbook example of how their program works in reality,” said Stefánsson. “The basic thing about Iceland is our island mentality. Throughout the decades, we’ve had our ups and downs, and being a fishing nation, we know we can’t count on anything. Fish come and fish go. So we’re well-prepared for the bad years, always hoping for better times.”

Icelanders are also well educated and quite young compared with other European nations, he noted.

“The fact is, we’re a small nation, so when we need to tackle issues, you don’t have to go through many layers. That’s why we go down very rapidly, but up very quickly as well. And we didn’t owe a lot of money compared to Greece, which is heavily indebted. The most hurtful thing is that we lost jobs. We are not used to unemployment, which is now almost 8 percent.”

Still, that rate has been gradually falling, as has inflation, while investment and economic growth have been gaining steam. The opposite is happening in other troubled European Union nations such as Greece and Spain, which are tethered to the euro and lack monetary flexibility. And many economists such as Krugman credit the króna for Iceland’s recovery, warning against the notion that adopting the euro can protect against economic imbalances.

Iceland doesn’t belong to the 17-member eurozone, or even the 27-member European Union. Rather, it’s a signatory to the European Economic Area, which allows Iceland — along with Norway and Liechtenstein — to participate in the EU’s internal market without conventional EU membership. In exchange, the three countries must adopt all EU legislation related to the single market, except laws on agriculture and fisheries.

“In a sense, we are inside the EU but not formally in it,” the ambassador explained. “We don’t attend the decision-making process in Brussels, but in June 2009 we formally applied for membership, and we are in the process of negotiating a membership agreement.”

A big sticking point remains fishing rights, which sparked Iceland’s so-called “cod wars” with Britain in the 1960s and 1970s. The result, said Stefánsson, was global recognition of Iceland’s 200-mile economic exclusion zone, which he says has worked to Iceland’s advantage, “along with a quota system in place that’s working fairly well.”

Stefánsson says that today, about 60 percent of Iceland’s citizens oppose EU membership, while 40 percent support it. “Icelanders are afraid we would be swallowed up by Europe,” he said. “The government has promised we’d have a referendum when we conclude an agreement, probably at the beginning of next year. After that, we’d have to see how it goes.”

Despite its lingering problems — debt, unemployment and residual anger remain high — Icelanders remain the happiest people on Earth, if the latest Capacent/Gallup poll is to be believed. The 2012 survey, released in January, showed that 73 percent of Icelanders report being satisfied with their lives, compared with 33 percent of North Americans, 25 percent of East Europeans and only 20 percent of Arabs.

Besides being happy, Icelanders are also generous — and that generosity will likely continue even in the face of financial difficulties. In 2011, the country allocated 0.21 percent of its total budget to overseas development aid — down from 0.37 percent in 2008 — though parliament wants to increase such aid gradually over the next few years, aiming for a record 0.7 percent in 2019.

Stefánsson said Iceland currently gets about 40 percent of its export revenues from fishing, while another 35 percent comes from the energy, aluminum and information technology sectors. Tourism brings in the remaining 25 percent.

To that end, the ambassador is doing his best to promote U.S. tourism to Iceland. Glossy color brochures and DVDs highlight the country’s spectacular geysers, volcanoes, hot springs and fjords, while magazines rave about Reykjavik’s restaurants — featuring exotic seafood and lamb dishes — as well as the capital’s pulsating nightlife.

It helps that Reykjavik is only a five-hour direct flight from Washington’s Dulles International Airport on Icelandair — and that the króna’s devaluation (it’s now trading at 123 to the dollar) makes Iceland a better travel bargain than it’s been in years.

“For sure, that’s been very helpful for tourism. Iceland is definitely not as expensive as before,” Stefánsson said. “And Eyjafallajökul volcano [which erupted in 2010, spewing ash miles into the sky and disrupting air traffic over most of northern Europe for days] also put our country on the map, so to speak.”

In fact, tourist arrivals by air jumped by 18 percent last year, when 540,000 foreigners landed at Keflavik International Airport just outside the capital. Roughly 70,000 more arrived via cruise ship. Even more impressive was the jump in U.S. tourists — from 52,000 in 2010 to 78,000 last year.

On Jan. 24, Stefánsson hosted a reception at his residence marking the 70th anniversary of diplomatic relations between Iceland and the United States — a little premature, perhaps, since Iceland has only been independent for 68 years.

The United States, which established an airfield at Keflavik in 1942, was the first country to recognize Iceland’s sovereignty. “After World War II, the base was kept and the Americans had a fairly large presence in Iceland until 2006,” the ambassador said. “So defense cooperation has been long-lasting, and that’s one of the reasons the two countries have a very close relationship.”

In addition, the United States is home to 42,000 people of Icelandic descent, with the largest populations in North Dakota, Minnesota, Wisconsin, Washington and Utah.

“We have only 20 embassies throughout the world, so we count on our honorary consuls,” said Stefánsson. “Here in the States, we have 45 of them — mostly unpaid people who have some relationship with Iceland.”

These consulates are spread across the far reaches of the United States, from Anchorage, Alaska, to San Juan, Puerto Rico — and they include places like Fort Lauderdale, Minneapolis, Phoenix and Seattle. Perhaps the most remote locale on the list is Mountain, N.D., a settlement of 92 people founded in 1884 by Icelandic immigrants.

During a 2007 visit by then-Prime Minister Geir Haarde to this one-horse town about 20 miles south of the Canadian border, municipal officials told him of their plan to raise $1.3 million for a community center. The politician generously sent Mountain a check for $75,000.

But that, of course, was before the big crash.

These days, the once-admired Haarde huddles in a small office, one block from where he and his Independence Party once led Iceland. The Washington Post, calling him “the first world leader to face criminal charges related to the financial crisis,” notes that “he’s on trial for what he didn’t do, rather than for what he did.”

Whether that’s fair or not is another matter, said Stefánsson, suggesting that it’s unjust to pin Iceland’s economic collapse on one man alone.

“Our parliament set up a truth commission after the crash, with a wide spectrum of people trying to figure out what really happened,” he said. “This commission said the current government wasn’t on top of it, that they should have been regulating, so a narrow majority decided to prosecute the former prime minister through a special prosecutor’s office, but this takes a lot of time. That’s one reason people are angry. They say it takes too long to get these people to acknowledge their mistakes, and that they have to pay for it. They say if they don’t have the money, they’ll have to go to jail.”

Haarde, who has an economics degree from Brandeis University and a master’s from the Johns Hopkins School of Advanced International Studies, faces up to two years in prison. But whether he’ll actually serve time is doubtful, since the main charges against him have already been dropped, and a new proposal now before parliament seeks to dismiss the case altogether.

“I guess my blame lies in the fact that we did not see it coming,” Haarde told the Post. If anything, said the disgraced former prime minister, he helped salvage Iceland’s economy by refusing to put taxpayers on the hook for rescuing the nation’s biggest banks, and by forcing foreign investors to swallow huge losses.

But even if Haarde’s name is cleared, that doesn’t mean other officials will get off scot-free. The special prosecutor commands a 90-member team of police detectives, former bankers, auditors and economists that has publicly named more than 150 people, including former top banking officials, as suspected offenders.

“Most probably,” said the ambassador, “some of them will end up behind bars.”

About the Author

Larry Luxner is news editor of The Washington Diplomat.