Icelandic Meltdown

It’s been a dramatic couple of weeks for tiny Iceland. The land of free-wheeling multimillionaires (even a billionaire), low-interest loans, and high-yield savings accounts tumbled into financial ruin and was branded a terrorist nation by the United Kingdom — all in the space of 10 days.

Some 600 miles northwest of the United Kingdom, Iceland, which had rapidly transformed itself from one of the world’s poorest nations to one of the wealthiest, is pretty much bankrupt, the first national victim of the global credit crisis.

Iceland’s troubles started when the financial crisis emanating from the United States caused two of the country’s three private banks to collapse. At the time, the assets of these banks totaled more than 10 times the country’s gross domestic product. In other words, since the government was unable to guarantee loans, they were exposed.

The Icelandic banks were popular with the British. Municipalities, hospitals, and charities were attracted by savings account interest rates as high as 7 percent. But when depositors started to get nervous amid the global financial shake-up, they found their accounts temporarily blocked. Alarmed by a perceived lack of action by Reykjavik, British Prime Minister Gordon Brown branded Iceland a terrorist nation and invoked the U.K.’s antiterrorism law, freezing the assets of the country’s last remaining bank and of its U.K.-based companies.

Brown’s move, seen by many Icelanders as politically motivated to boost his poll numbers, brought the small country to its knees. Iceland’s banks have since been nationalized, the majority of its leading businesses are in meltdown, the value of its currency has been reduced by more than half, and thousands are unemployed. Iceland spent the past week knocking on neighbors’ doors for help, which could have security implications for the United States. The Nordic country, with a population of 300,000, is poised to receive a $6 billion rescue package from Russia, the International Monetary Fund, and several other Scandinavian countries. Deep recession is on the horizon.

How did this happen? And what can Iceland’s story teach the United States? BU Today spoke with Michael Corgan, a College of Arts and Sciences associate professor of international relations, who specializes in Icelandic affairs. He also teaches in the political science department at the University of Iceland.

BU Today: Can you explain how a country goes bankrupt in a matter of 10 days?
Corgan: The way the country went bankrupt is that its banks got into the international financial networks and started lending money to various enterprises after a lot of individuals made money in Russia following the fall of communism. Icelanders found that with very little regulation back home, they could open up bank branches and entire banks in various places, like the United Kingdom. They made sound, reasonable loans. They were the only banking system in Europe that did not buy into subprime mortgages the way other European banks did. Icelanders made a lot of money. It had its first billionaire about two years ago. That had never happened before. But by 2007, the assets of its banks were 10 times the GDP of Iceland. In other words, they really had a lot of money out there. As long as the system was working right and there were no bumps or slackening or loss of confidence, they were doing fine. But if the banks ever went bad, there’s no way the government could back them up. And things went bad. The mortgage meltdown in the United States was like a volcano erupting under the water, and there was a tsunami.

What was Iceland’s financial system like before deregulation?
The system was highly regulated, with tight currency controls. Even into the 1980s, it used to be that if you had a credit card, you could use it to buy things only in Iceland. Or if you bought something overseas, you couldn’t transfer it to Iceland. However, Iceland opened up its international airport in a big way and got completely modernized. The power elite in the dominant political party had very entrepreneurial free market ideas, and they prevailed upon the Parliament to cut back corporate taxes and deregulate, following what the United States had been doing with deregulation. They essentially bought our system completely, and their banks expanded enormously.

The United Kingdom and Iceland until recently had a very close relationship. Why did Britain suddenly pronounce Iceland a terrorist nation?
The whole thing sort of snowballed. The British had lots of deposits in Icelandic bank branches in the U.K. A bank called Icesave, which was paying high rates, was suddenly saying, "We’ve got a problem, and we’re not quite sure how we’re going to handle it." The chairman of the central bank in Iceland made some unguarded comments on a TV interview show, saying, "I’m not sure how we’re going to deal with this." Well, that’s the equivalent of [Federal Reserve chairman] Ben Bernanke getting up on Face the Nation or Meet the Press and saying, "I’m not sure how we’re going to deal with the problem." It just caused all sorts of consternation.

Now, the Icelanders are used to this kind of thing. Like most Nordics, they expect that their government, in the long run and even in the short run, will more or less take care of them and won’t do anything outlandish. However, the British were not reassured at all, and they started panicking and demanded that their government do something. So Gordon Brown, who is, by the way, lagging in the polls for the parliamentary elections in Britain, invoked this 2001 antiterrorism law. He essentially branded the nation of Iceland as terrorist because it was threatening the economic security of Britain, and froze its assets. What this did was bankrupt the one remaining solvent Icelandic bank.

Iceland has negotiated with Russia for financial help. Does this have security implications for the United States?
Oh, sure. The United States rather peremptorily pulled its forces out of the base in Iceland in 2006. There are no NATO forces in Iceland now. It doesn’t have its own military. So now Iceland’s looking for help. It went to the United States and didn’t get it and has now gone to Russia.

Does this raise the specter of Russian troops in Iceland?
No, I think this is more of a “gotcha” move by Putin. But it means that if the United States wants to get back with Iceland for any security reason, that’s unlikely to happen. In fact, the Icelandic government is thinking about suing the British for their actions in invoking the terrorist law.

What is the mood on the street?
Iceland itself right now is relatively calm. My friends in Iceland say all these multimillionaires and the billionaire have made themselves very scarce in society. The mood on the street is resignation to the fact that the standard of living is going to take a hit. Hundreds of people in the banking industry, and thousands overall, which is enormous for Iceland, are out of work, and they’re unlikely to find jobs like they had anytime soon. There’s no hoarding or stockpiling or shortages, just anger at the new millionaires and multimillionaires who don’t seem to want to face the music. There’s almost the Scandinavian stereotype of the calm, phlegmatic, fatalistic, if you will, approach of, "Well, we got in over our head." Most Icelanders recognize that times were a little too good, and now they’re going to have cut back quite a bit. Things are going to be much more expensive than they used to be.

What lessons can the United States draw from Iceland?
In a sense, not many, because the scale is so different. The lesson I draw for the United States is that we’ve got to be careful how we try and export our economic systems and our deregulated capitalism, saying that it’s the best thing for everybody, because it may not be. We keep saying free trade is it, deregulation is it, that’s how the world should work. That’s how the big boys can work, but smaller countries, maybe not. There are 55 countries in the U.N. with less than five million people. We should be a little bit cautious. And if that’s the truth, maybe we ought to also watch how we try to export our version of democracy. It may not be right for other countries, either. This isn’t about corruption or lack of transparency in Iceland. It’s overextension. Small countries just can’t play the game the way the big countries can.

Caleb Daniloff can be reached at cdanilof@bu.edu.