Gambling for resurrection in Iceland
Friðrik Már Baldursson, Richard Portes 06 January 2014
In 2008, Icelandic banks were too big to fail and too big to save. The government’s rescue attempts had devastating systemic consequences in Iceland since – as it turned out – they were too big for the state to rescue. This column discusses research that shows how this was a classic case of banks gambling for resurrection.
The demise of the three large Icelandic banks, just after the fall of Lehman Brothers, was a key event in the spread of the financial crisis. A couple of weeks before its collapse in October 2008, Kaupthing bank announced that the Qatari investor Sheikh Mohammed Bin Khalifa Bin Hamad al-Thani had bought a 5.01% stake. This briefly boosted market confidence in Kaupthing (Financial Times 2008). What market participants did not know was that Kaupthing illegally financed the deal, which was without risk to al-Thani.
Iceland, financial crisis, moral hazard, banking, banks, gambling for resurrection
Capital controls and the resolution of failed cross-border banks: The case of Iceland
Friðrik Már Baldursson, Richard Portes 12 November 2013
Iceland’s 2008 capital controls are still in place to prevent outflows of domestic holdings in failed cross-border banks. However, it is important for the country’s future economic prosperity to lift the capital controls without endangering financial stability. This column discusses the risks of capital controls and gives policy recommendations for cases of the three former major Icelandic banks.
A large amount of carry trade was drawn to Iceland in the boom leading up to the crisis of early October 2008 (Danielsson and Arnason 2011, Baldursson and Portes 2013a). As pressure mounted on the Icelandic banks, investors increasingly chose to exit the krona, which depreciated by 25% during the week before the banks collapsed. As the banks went down, the krona depreciated even further.
Europe's nations and regions Global crisis
Iceland, capital controls, cross-border banks
Iceland’s post-Crisis economy: A myth or a miracle?
Jon Danielsson 21 May 2013
Icelandic voters recently ejected its post-Crisis government – a government that successfully avoided economic collapse when the odds were stacked against it. The new government comprises the same parties that were originally responsible for the Crisis. What’s going on? This column argues that this switch is, in fact, logical given the outgoing government’s mishandling of the economy and their deference towards foreign creditors.
When the Global Crisis struck in September 2008, all eyes were on the US (Eichengreen and Baldwin 2008). Iceland, however, was the first country to really suffer. Its three major banks collapsed in the same week in October 2008, and it became the first developed country to request assistance from the IMF in 30 years. GDP fell 65% in euro terms, many companies went bankrupt and others moved abroad. At the time, a third of the population considered emigration as a good option (Danielsson 2008).
Iceland, Eurozone crisis
Deposit insurance after Iceland and Cyprus
Anne Sibert 02 April 2013
Depositors in Eurozone banks are facing a steep learning curve on just exactly what deposit insurance means. This column points out that the precedents set in Cyprus and Iceland show that deposit insurance is only a legal commitment for small bank failures. In systemic crises, these are more political than legal commitments, so the solvency of the insuring government matters. A Eurozone-wide deposit-insurance scheme would change this.
This reposted column corrects an error, due to the editor, that was in the first posting.
The facts are now well known. The largest banks in Cyprus are insolvent, but too big for the government of Cyprus to save – at least if it wanted to avoid the ‘double drowning’ fate of Ireland. The government, trying to rescue banks, found itself needing a rescue.
EU institutions Financial markets Macroeconomic policy
Iceland, deposit insurance, bank bailouts, Cyprus, bail-ins
The capital controls in Cyprus and the Icelandic experience
Jon Danielsson 28 March 2013
Cyprus has imposed temporary capital controls. This column sheds light on how temporary and how damaging they are likely to be, based on Iceland’s experience. The longer controls exist, the harder they are to abolish. Icelandic capital controls, which have been ‘temporary’ for half a decade, deeply damage the economy by discouraging investment. We can only hope the authorities that created the chaos in the first place realise that temporary really needs to mean temporary.
The Cypriot government, European authorities and the IMF have concluded that capital controls are the best way to prevent a total collapse of the Cypriot financial system. Motivated by the obvious fear that anybody with money left over in Cyprus will seek to take their money out as soon as possible, temporary capital controls are to be put in place to prevent this. We are told that they will be limited in scope and temporary. Hopefully, for the Cypriots’ sake, that is correct.
EU institutions Macroeconomic policy
Iceland, capital controls, Eurozone crisis, Cyprus
Constitution making in action: The case of Iceland
Thorvaldur Gylfason 01 November 2012
Iceland is in the middle of a major constitutional overhaul. This column looks at the unorthodox use of a referendum in drafting the constitution and argues that this democratic element could lead to its long-term success.
Strangely, democratic states often allow tiny minorities to get away with murder by exploiting the masses, big time. In Europe and the US, there is presently a fairly widespread feeling that this is what many bankers have done (Johnson and Kwak 2010). So let’s begin with a counterfactual thought experiment. What if the Roosevelt administration and Congress had introduced the Glass-Steagall Act of 1933 as a constitutional amendment rather than as an ordinary piece of legislation? Clearly, it would then have become that much harder to reverse Glass-Steagall half a century later.
Politics and economics
Finance and constitutions
Thorvaldur Gylfason 11 April 2012
Most economists would agree that the global financial and economic crisis was at least partly caused by a failure in the regulation of the financial sector. While regulatory reform is now being debated throughout the world, critics argue that it is only a matter of time before any new regulations are removed by powerful interest groups. This column asks whether prompt corrective action belongs in constitutions.
In his 2009 book, The Regulatory Response to the Financial Crisis, Charles Goodhart discusses the financial crisis, what went wrong, and what needs to be done (Goodhart 2009). The standing assumption is that regulatory reforms will rest at their current level of law, namely regulatory bodies and rules approved by lawmakers. But, as I explore in this column, perhaps prompt corrective action belongs in constitutions.
Global crisis International finance
Iceland, financial regulation, Eurozone crisis
Capital controls are exactly wrong for Iceland
Jon Danielsson, Ragnar Arnason 14 November 2011
The IMF has emerged from the global crisis bigger and more powerful. But this column argues that the capital controls it required Iceland to adopt in 2008 are not of the soft and cuddly modern type that slow hot money flows. Instead they are akin to the draconian controls common in the 1950s. They violate the civil rights of Icelanders and significantly hamper economic growth.
There is a curious difference between how foreign and local economists see the wisdom of capital controls in Iceland. In a recent IMF-government of Iceland conference1, two Nobel Prize winners in economics, along with senior IMF representatives, expressed strong support for the capital controls. The Icelandic economists addressing the conference were not as enthusiastic.
Europe's nations and regions Global crisis International finance
IMF, Iceland, capital controls
Iceland’s programme with the IMF 2008–11
Friðrik Már Baldursson 08 November 2011
During the global crisis, Iceland was hit by the biggest banking crisis any country has ever suffered. This column reviews the role of the IMF in Iceland’s recovery. It argues that the IMF programme was not perfectly designed but successful. Iceland re-entered capital markets less than three years after the crisis.
When Iceland’s three main banks collapsed on 7–9 October 2008 it became obvious that Iceland would suffer a balance-of-payments crisis unless it could get outside support. A currency crisis was already under way (Figure 1). After some initial doubts it became clear to the government that it had no other option than to seek help from the IMF. The fund would not only provide financing and expertise, but also some much-needed credibility.
Figure 1. Trade-weightedexchange rate of the krona and Iceland’s CDS spread
Europe's nations and regions
IMF, Iceland, global crisis, capital controls
Was the IMF programme in Iceland successful?
Jon Danielsson 27 October 2011
According to the IMF, Iceland has graduated from its Fund-supported programme with unqualified success. This column begs to differ.
Iceland has just become the first industrialised country to graduate from an IMF programme in over 30 years. The IMF claims the programme has been an unqualified success:
Iceland has successfully completed its Fund-supported programme. Key objectives have been met: public finances are on a sustainable path, the exchange rate has stabilised, and the financial sector has been restructured. Strong policy implementation has underpinned this success (IMF 2011).
Europe's nations and regions Global crisis
IMF, Iceland, global crisis