Ísland Kreppa

1. ÍslandKreppa

2. 1 Causes Juan Suarez 2 Gov’t response Andrew Fincham 3 IMF response Bradley Feingerts 4 Lessons Guillaume Briant

3. Iceland at Risk • Iceland is Tiny • Population: 319,000(U.S. Population: 308,000,000) • GDP (2008 est.): US$12.97 Billion (U.S. GDP: $13.84 Trillion) • 70% of export earnings are derived from fishing • Rapid Privatization of Banking Sector in 2000 • Heavy reliance on external debt • finances hot local mortgage market foreign acquisitions • Iceland’s banks grow through foreign internet bank deposits – outpacing currency reserves and deposit insurance • 2006: Loans of Iceland’s three main banks exceed $150 Billion, 8 times GDP • the U.S. equivalent: $110 Trillion • 3 largest U.S. banks ≈ $6 Trillion in assets • Rapid Growth Bubble • Investments fuel rapid economic growth in Iceland from 2000 to 2008 • GDP growth outpaces growth in Denmark, Norway, and Sweden by 2-4% in 2003-06 • Easy access to mortgages increased home investment and personal debt • household debt grew to 213% of disposable income by 2006 (U.S. household debt: 169%) • Inflation rises to 14% by 2008

4. Feb–Apr 2006: First jitters as concern about overextended banks leads to them facing difficulty in refinancing 6 Oct 2008: Much interbank lending ceases; Althing passes emergency legislation authorizing intervention in financial system. 24 Oct 2008: IMF agreement in principle to $2.1b loan. Not finalised. • 19 Nov 2008: • Final agreement on IMF loan package: • $2.1b IMF, • $2.5b Scandinavia, • $6.3b UK, Germany, Netherlands for depositors. Timeline OMX Iceland 15 1998-Oct 2008 (logarithmic scale) 9 Oct 2008: FME places Kaupthing into receivership; trading on ICEX suspended; kr: € at 340:1 14 Oct 2008: ICEX reopens with a 77% fall in the OMXI15(eventually falls by 95.6%) • Step 1. The subprime mortgage crisis spreads • Foreign banks become increasingly unwilling to finance Icelandic banks. • Confidence in Iceland banks falters Early Oct 2008: Adverse media (esp in UK) starts run on banks 3 Dec 2008: kr: € at 150:1 Step 3. Iceland Takes Control of Banks 2006 2008 2009 • Step 4. Crash: • Stock market crash. • After bank receivership, currency trades grind to a halt as no domestic bank can act as a clearing house for the Krona. • The gov’t announces efforts to peg Krona to Euro but currency crashes. • Huge debt fuels inflation; gov’t responds with heightened interest rates 26 Jan 2009: Gov’t resigns. Sep 2008: kr:€ has fallen 35% since Jan 2008, from 90:1 to 131:1. 9–12 Oct 2008: UK Gov’t suspends Landesbanki assets in UK using anti-terrorism law; guarantees UK depositors; Governments in Luxembourg, Manx, Switzerland, Finland similarly seize assets. 15 Oct 2008: Norway, Denmark make €400m loan available to ICB. 20 Oct 2008: New Landesbanki, Glitnir, Kaupthing banks established, take over domestic operations. 7–8 Oct 2008: FME places Landesbanki and Glitnir banks into receivership; Glitnir nationalization cancelled. All domestic savings guaranteed under deposit insurance and domestic branches to remain open; foreign accounts frozen; RB member says foreign depositors likely to recover only 5%–15%. • Step 2. Banks begin to fail • Frozen credit markets hamper banks’ ability to finance debt • It becomes obvious that Iceland’s Central Bank is utterly incapable of making emergency loans necessary to cover the gigantic debt burden of the domestic banks Late Nov 2008: $650m loans from Poland, Faeroe Is, Russia. 29 Sep 2008: Government announces taking 75% stake in Glitnir.

5. Evaluation: Government • Response 1: Announcing 75% stake in Glitnir: • Although this set off the run, wasn’t avoidable. Just the news that burst the bubble. • Should have known that news would set off a run on banks and currency. Yet couldn’t afford to bail out all three banks and stabilize currency. So had to change plans within a week. • Probably should have been talking to IMF earlier to arrange standby facility; but would IMF have been willing to set this up secretly? • Response 2: Placing banks in receivership, suspending foreign accounts while continuing/guaranteeing domestic: • Banks clearly insolvent (or soon to be, given run) so a bankruptcy-style asset freeze makes sense. • But local economy probably would have stopped without access to banks, so local unfreezing probably necessary. • Difficult to say whether ex post 100% local a/c guarantee necessary; justified on standard bailout “national interest” grounds? • Should gov’ts bailing out treat non-taxpayers and taxpayers alike? • 1. Non-issue here as gov’t couldn’t afford anyway. Private insurance available for Icelandic bank deposits. • 2. National interest arguments: If local insurance explained as a bailout (avoiding counterfactual harm), then little reason for foreigners to qualify, except on basis of reputational effects? • 3. Arguments against this kind of economic nationalism. • Response 3: Agreeing to terms of IMF/foreign loans: • Should gov’t had agreed to underwrite foreign depositors ex post? Probably would not have gained loan otherwise. • Even if possible, see arguments above.

6. Goal 1: Stabilize the Krona • Raise the policy interest rate to 18 percent. • $10 billion from IMF loan and bilateral loans • Massive capital controls • SUMMARY: Short-term success • Goal 2: Restructure the Banks • FME to review business plans of each of the new banks. By Jan 15, 2009. • Status: As of Dec 2008, 2 of 3 banks had submitted plans. • Int’l Auditing Firm to value old and new banks in accordance with int’ l best practice. Complete by end-Jan 2009. Evaluation: IMF$2.1 billion - strings attached • Goal 3: Fiscal Consolidation • Establish a committee comprising reps from PM’s Office, FME, Central Bank of Iceland, Min. of Finance & Min. of Commerce to coordinate policy input. • Status: Completed • Improve medium-term fiscal framework to reduce go’t deficits and debt accumulation. By end-Jun 2009. SUMMARY: Progress, but results are mainly to be determined • Status: Behind schedule due to disagreement over accounting methodology. Delayed until the end of Feb or early Mar. • Capital injection into the three new banks, using tradable government bonds on market terms, to raise the capital adequacy ratio to >10%. By end-Feb 2009. • Status:Delayed due to asset valuation issues. • Hire an experienced banking supervisor to assess the regulatory framework and supervisory practice. By end-Mar 2009. • Status: Expert hired and report expected on time SUMMARY: Delayed.

7. Iceland Conditionality under the 2008 Economic Program Main Idea: (i) Place a floor on international reserves; (ii) Limit the government deficit; and (iii) Limit the creation by the central bank of liquidity

8. 1. Iceland’s economic prospects • International assistance provided Iceland with some relief • However, Iceland’s financial problems are not resolved yet • Huge debt relative to Iceland’s size. • Crisis’ cost exceeds 80% of Iceland's GDP • By comparison: • the S&L crisis cost the U.S. taxpayer about 3% - 5% GDP, • the reparation demanded from Germany by the Treaty of Versailles after WWI was 85% of GDP. • One third of the population is considering emigration. • Possible solution to promote Iceland’s economic stability despite its small size:  joining the Euro currency • Pros: currency stability. • Cons: • Iceland, currently a member of the European Economic Area will have to join the European Union first. The process will take a few years and face some internal political opposition, • the Euro-membership/currency does not prevent small countries from being in crisis: Greece.

9. 2. Increased financial nationalism • Failure of Iceland’s banks Iceland’s deposit insurance fund did not compensate foreign depositors. Foreign governments stepped in by (a) freezing offshore assets; and (b) blocking the IMF loan until Iceland guaranteed their depositors. • Political agenda: keep bailout money at home • Free rider problem. • “Buy American” clause debated for the stimulus bill. • Protectionism: • Risk of a less efficient cross border banking system. • The U.S. Smoot-Hawley Act of 1930 raised import duties on foreign products. Retaliation from other countries aggravated the effects of Great Depression.

10. 3. IMF reform Global crisis highlighted the lack of coordination in policy responses around the world. IMF’s weakness in responding to the Icelandic crisis. Need to reform IMF: • “Crisis lessons for the IMF”, speech by John Lipsky, First Deputy Managing Director, on Dec 17, 2009. • Committee on IMF governance reform will publish its report in April 2009. • Reform axes: • Increase the IMF’s resources • Increase IMF fund from $250 billion to $500 billion. • Japan offered up to $100 billion in emergency loan. • 2. Reform the Fund's governance and increase convergences with other international organizations • Improve balance between members’ voting rights (developed v. emerging countries). • Convergences with the G-20. • Working closely with the Financial Stability Forum (joint letter on November 13th, 2008). • 3. Explicit financial stability role • Prudential analysis. • Early warning of vulnerabilities and advice on remedial policies to reduce global risk and increase system stability.