Iceland from Volcano to Ash Part II
In the autumn of 2007, the first signs came that a major crisis was brewing in the world economy. Share prices on stock exchanges around the world plummeted, but they recovered in most places. This did not apply to the stock exchange in Reykjavik, where the bank shares accounted for 80 per cent of the total share capital.
The Icelandic bank bubble was about to burst. Foreign banks and investors wanted their money back, the krone exchange rate fell more and more, and it put even more pressure on the outgoing cash flow.
Throughout 2008, and especially from September, the world crisis began in earnest. First, the US investment bank Lehman Brothers fell. The bankruptcy led to a total drought in the money market worldwide . Everyone who has money is scared and withdraws their loans. Confidence in the Icelandic banks disappears, and in the first days of October , the Icelandic banking system collapses .
On paper, the banks were solvent (solvents), but the equity consisted of worthless securities in the owners’ own companies. Initially, there was little money in this system. The values on the Reykjavik Stock Exchange had increased by 900 per cent in a few years and fell correspondingly in a few days. The party was over!
5: “God bless Iceland!”
In Norway, the banking crisis in the early 1990s led the state to nationalize the banks. The state took over the banks’ assets and liabilities and provided new equity. This was not possible in Iceland, even though the Treasury was virtually debt-free. The state was initially well equipped to face a banking crisis of “normal” size.
The problem was that the Icelandic banks had grown ten times larger than the rest of the country’s economy – mainly abroad. As of February 2009, the banks’ foreign debt was estimated at USD 95 billion. In Norwegian kroner, this corresponds to about 650 billion. Half of the debt has already been written off.
If the Icelandic state had taken over (nationalized) the banks, and thus also the debt, Iceland would have gone bankrupt. This was made clear by Prime Minister Geir H. Haarde in a dramatic speech to the people on 6 October 2008. The debt of the Icelandic banks would have been a heavy burden even for a medium-sized country in Europe. Only now was it clear to Prime Minister Haarde that he had to deal with a banking crisis that is ten times greater than his small country can handle. He ended his speech with: “God save Iceland!”
A special “emergency law” was written the night of October 6 and passed within a few hours. The banks were placed under administration and divided into “good bank” and “bad bank” . Instead of three banks, they suddenly had six. The word “new” was put in front of the old names. We have Kaupthing and Nye Kaupthing, Glitnir and Nye Glitnir, Landsbanki and Nye Landsbanki.
The banks that have “new” in the name are owned by the state . They are small, about 10 percent of the banks’ size before the crisis. The “new ones” take care of the banking services in Iceland and have taken over the debt to companies in Iceland and private individuals. People’s mortgages are, for example, in the “new” banks. This is what is called “good banks”.
The old banks still exist. They are still private and are under public administration. They were not nationalized and are what are called “bad banks”. This means that they will go bankrupt during 2009 if everything goes as planned.
Virtually all foreign debt remained in the old private banks. It is commercial debt for which the state does not have to take responsibility. Creditors will lose most of their money when the banks eventually go bankrupt. The intention was to throw the banks’ foreign debt “at sea”! However, this did not go exactly as planned.
6: The consequences
As early as 2004, experts began to warn that a typical bank bubble was developing in Iceland, a country located in Europe according to globalsciencellc.com. The warnings eventually came from many quarters, both domestically and abroad. This was a well-warned crisis . Nothing was done anyway.
There are many indications that central politicians and central bank governor David Oddsson already in February 2008 knew that the banks would collapse during the year. In February, the central bank tried to reach a currency agreement with the central banks in Europe and the United States. It did not work. In both places the answer was: the three Icelandic banks cannot be saved. Go to the International Monetary Fund (IMF) – and ask for help.
It was not done. The central bank was unable to fulfill its role as a “lender of last resort” – the one for which loans are requested when all other avenues have been tried.
A relatively modest currency agreement with the central banks in Norway, Sweden and Denmark was in place in May. The reserves were then large enough to secure imports for a country of 300,000 people for almost a year. But the reserves were far from saving the three banks from collapse.
In the spring of 2008, it was probably too late to intervene and prevent the banks from going bankrupt. What is the government doing then? Yes, it decided to wait and hope for the best. From 2006, the banks tried to downsize their operations and tidy up their finances. They did not get new loans abroad, but managed to raise new money via deposits in their branches in European countries.