The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (14 page)

In his book
Frozen Assets
, Armand Thorvaldsson, the CEO of Kaupthing’s London arm, reveals one remarkable rescue effort. Kaupthing presented the UK FSA with a plan to move its headquarters from Reykjavik to London. Even in the aftermath of the collapse of Lehman Brothers, Kaupthing’s deposits increased from £75–100 million per week to £150 million per week. There were more depositors, but volumes were below the £35,000 limit for deposit insurance. It was after the nationalisation of Iceland’s troubled third biggest bank Glitnir that the bank run on Iceland started. Thorvaldsson likened it to a ‘wildebeest being hunted by hyenas’.

The FSA declared a ‘code red’ after a net £37 million was withdrawn on 30 September 2008, indicating fears that Kaupthing would not have enough money to last a week. The FSA injected staff on to the office floors of both major Icelandic banks in London for daily monitoring of liquidity. The FSA demanded that over £1 billion in funding be transferred from Kaupthing’s head office to its UK subsidiary by the end of the following week. On Friday, 3 October 2008, the European Central Bank issued a margin call for €400 million to Landsbanki. Over the following weekend £318 million had been withdrawn over the internet from Icesave. The FSA demanded £253 million from Landsbanki HQ to cover liquidity shortfalls following the withdrawals. On the Monday, Icesave’s website closed down due to ‘technical difficulties’. It was the FSA’s doing. Landsbanki asked Mr Oddsson’s Central Bank, who declined because the bulk of the currency reserves had already been lent to Kaupthing. Amazingly, Barclays, Kaupthing’s clearing bank, attempted to stitch together a buyout of Kaupthing’s UK corporate loan book at a massive discount, with much of the risk falling upon the UK Treasury. There was no deal. Kaupthing had been trying to meet that demand for £1.6 billion in stages. It did not come. According to a 2009 UK High Court judgement, £150 million of the flow of funding from Reykjavik was blocked by the Central Bank of Iceland. There was however an invisible run, which saw 19 per cent of all Kaupthing Edge’s UK internet savings disappear in two days. Easy come, easy go.

Almost instantaneously, Iceland’s banks, stock market and currency all collapsed. In London, access to BACS (Bankers’ Automated Clearing Services) and CREST (a securities depository and settlement service) was stopped. Kaupthing London tried to sell itself to private equity, but that failed at three minutes past midnight on Wednesday, 8 October. Then at 7.49 a.m., an hour before its final FSA deadline to start increasing its liquidity, Kaupthing tried to participate in the recapitalisation of the UK banking system, announced twenty-seven minutes before, but it was rebuffed. There were actual bank runs – and fights – in Kaupthing branches in Reykjavik. High finance dried up for Iceland’s banks. The British government had used anti-terror legislation to seize assets of Landsbanki and the Icelandic Central Bank. International banking stability was not the intended application of the law, and there was no suggestion of actual links to terrorism, but it was the legal weapon to hand. Special financial powers were used with Kaupthing. Most of the Kaupthing internet deposits that had not disappeared into the mid-Atlantic were – with a certain irony – transferred to ING Direct. The US embassy cables at the time say that ‘virtually all international payments to Iceland stopped. Two days later the Icelandic Central Bank established rations of foreign currencies at a fixed price and gave priority to importers of food, fuel and pharmaceuticals.’ Solvent Icelandic businesses suffered from the collapse in the króna, and all their transactions had to be pre-paid. Businesses that had taken out loans in Japanese yen (to benefit from zero interest rates) now found that they were 136 per cent more indebted. Similar stories abound about ordinary Icelanders borrowing in euros and Swiss francs to buy cars. Sir Philip Green, the retail mogul, turned up on his private jet in the land of some of his favourite bankers, to see if he could snaffle back chunks of the British high street at a bargain price.

From the likes of Icesave arose a giant IceDebt. Each Briton was owed £40 by someone in Iceland. It was an iniquitous IOU that actually should have been owed by a handful of Icelandic bankers to a relatively small number of British bargain-hunting savers. Icesave had effectively used Iceland’s public finances as security. The vagaries of deposit protection and European treaties remade the whole sorry affair into a £2.4 billion intergovernmental spat between two island nations. The UK and Dutch governments had stepped in to ensure that depositors were compensated. In Britain, even the uninsured amount was compensated. Both countries then pursued Iceland for the money. It was entirely reasonable that so many ordinary Icelanders saw this burden as an odious debt.

Iceland at first tried to pay less than the full amount it owed, with no interest. The negotiations became entangled with an IMF financing deal and prospects for accession to the European Union. Treasury officials told US diplomats that the UK would find it ‘difficult’ to support an IMF review in the absence of an Icesave deal. Icelandic officials told the same people that every Icelandic household would have to have paid a fifth of their annual household income for the next decade just to service the interest on the Icesave debt. ‘If the UK had seized France’s sovereign gold reserves like they had Iceland’s, a war between France and the UK would have broken out by now,’ said the Icelandic official. Tens of thousands of Icelanders took pictures of themselves holding ‘I am not a terrorist’ signs to send to Prime Minister Gordon Brown.

Ultimately, of course, a huge chunk of the blame should have fallen on those ‘rate tarts’ who decided to chase high interest rates without appreciating the higher risk. Certainly those with savings above £35,000 who were discretionarily bailed out by the chancellor using taxpayer’s money can count themselves as incredibly lucky. It is difficult to justify the fact that UK savers lost none of their investments, potentially at the expense of completely innocent Icelandic taxpayers.

Why were they bailed out and not the depositors in BCCI (the Bank of Credit and Commerce International, which went into liquidation in 1991)? As former government pensions adviser Ros Altmann points out, ‘If all bank deposits are 100 per cent protected, but pensions and other long-term savings are at best 90 per cent safe up to a £35,000 cap, why bother with pensions?’

The answer is that the Icelandic banks happened to collapse at the same time as half the British banking system. Treasury officials cautioned against a full payout. UK chancellor Alistair Darling calculated that the risk to financial stability of letting any British saver lose their money at that time would be too much. The Treasury only admitted this a year later, when defending a judicial review against its seizure of Kaupthing’s UK assets. The UK deposit-protection fund was being bombarded with record numbers of calls from frightened savers. The FSA was concerned about a generalised run on weak banks by British savers. According to court documents, the FSA was worried that ‘financial stability would be threatened as more consumers moved deposits to Ireland, where the government had said they would guarantee bank deposits in full’. So the government repaid the savers from taxpayers’ money, even above the widely publicised deposit-protection limit. It then tapped Iceland for its share, and hoped to get the rest back from banks and our hard-up building societies, on whom this will fall as an appalling burden. Many UK building societies have had to pay out millions to fund the failure of a bank that used this same guarantee to acquire deposits at their expense. So the pain of the Icesave folly was socialised between Britain’s financial institutions, the UK taxpayer and Iceland’s taxpayers.

When a deal was done on repayment of the IceDebt, Icelandic MPs backing repayment received hate mail and thinly veiled death threats. Iceland’s president called a referendum – only the second in the nation’s history – on the repayment deal. On 6 March 2010 the people of Iceland voted ‘
Nei
’ to the repayment plan, after a quarter of the population signed a petition rejecting the ‘Icesave Bill’.

In the end Iceland got the IMF loan, but needed bilateral help too. The US strategic position was spelt out in a leaked State Department cable from the ambassador in Reykjavik. Until 2006, the USA had had a base near the airport, which was now used by NATO. The Chinese and the Russians were sniffing around oil reserves and new maritime trade routes opening up in the High North. ‘Assistance from the USA at this crucial time would be a prudent investment in our own national security and economic wellbeing,’ wrote the ambassador.

In the March 2010 referendum Iceland rejected the terms of the Icesave debt, risking international financial isolation, causing problems with the IMF, and jeopardising its negotiations to join the European Union. In fact Iceland did much more than just reject the pressure over Icesave.

In April 2010 financial calamity was almost matched by natural calamity. The Eyjafjallajökull volcanic eruption caused the largest disruption to air travel since the Second World War, stranding 5 million passengers in Europe and losing airlines £1 billion. Yet little more than 150 kilometres away from the eruption, Reykjavik’s International Airport remained open while airports across much of Europe were forced to close for the best part of a week. The volcanic ash dispersed, not over Iceland, but into the jet stream and out over Europe.

Something rather similar had happened with Iceland’s financial system a few months before, but that had been no fluke of nature. ‘When our banks collapsed, they only partly collapsed on Iceland,’ Már Guðmundsson, the new governor of the Icelandic Central Bank told me in January 2013. ‘They mostly collapsed onto the rest of the world, into the sea, if you like. A large share of asset losses fell on other countries.’

Iceland took measures to keep the domestic banking system running in an effort to temper an already awful recession. It set up ‘new banks’ to preserve the access of the common man to the banking system. The Central Bank was recapitalised. Contrary to popular belief, there
was
a bailout of Iceland’s banks. As Már Guðmundsson says, ‘It is a myth that Iceland allowed its banking system to fail. It allowed the international part of the banking system to fail.’ Mr Oddsson’s Central Bank lost the funding loans it had provided to the collapsed banks. It was a cost equivalent to 13 per cent of Iceland’s economy, a hit that sent the bat-cave into effective bankruptcy. Central banks cannot normally go bankrupt because of their monopoly on the presses that print the currency. Such technology counts for nothing if a crazed banking system is racking up liabilities in currencies it cannot print and for which the host central bank is unwilling to offer swap arrangements. Iceland’s government also shelled out to recapitalise the new ‘good’ banks. Icelandic economic commentators Sigrún Davíðsdóttir and Thórólfur Matthíasson calculate total costs at 20–25 per cent of Iceland’s GDP.

Steingrímur Sigfússon, the Left-Green Party leader elected into government in the aftermath of the crisis, put it like this: ‘Iceland took an unorthodox approach. We let the banks fail, but it was not a matter of free choice for Iceland. It would not be right to look at this as a calculated decision.’

There were consequences for ordinary Icelanders, however. Although they lived in a country ranked by the UN as the world’s wealthiest, they found that their credit cards temporarily stopped working abroad. But approximately 85 per cent of the losses – around €40 billion according to the Icelandic parliamentary investigation – fell on the world’s big banks, particularly in Germany and Austria. Unlike the similar situation in Ireland, foreign bondholders were fried, and have not yet recovered their money. Iceland put in controls on the movement of capital. The burden on the Icelandic people would have been intolerable without this.

An emergency law moved deposits and assets to new banks. Landsbanki – the name that featured in a novel by a Nobel prize-winner and which dates back to the nineteenth century – remained. Out of the ashes of Kaupthing came Arion, while Glitnir reverted to its old name, Islandsbanki. The end result is a banking system that now fits the country better. Construction was severely hit too. But other sectors – fishing, tourism, energy, creative industries, the ‘real economy of Iceland’ – were still there, and benefited from the devaluation. The franchisee running Reykjavik’s three branches of McDonald’s pulled out on account of being obliged to import now expensive beef patties from Germany. The imports were simply replaced by domestic beef, and the restaurants were renamed ‘Metro Burger’. Tourism was growing by 15–20 per cent per year, and more and more airlines were putting Iceland on their route maps. Using its abundant hydrothermal energy, Iceland is setting up new industries such as cheaply cooled data centres and silica purification for solar panels. ‘We financed new banks very strongly,’ the former finance minister Steingrímur Sigfússon told me. ‘The minimum capital ratio was 16 per cent, now they are up at 22 to 23 per cent. They are strongly financed to assist their indebted customers in the real economy of Iceland.’

The end result was a reasonably rapid return to solid growth. Iceland’s net government debt shot up to 60 per cent of GDP from below 10 per cent pre-crisis, but this was not a patch on Ireland, which is now 106 per cent. Severe and painful fiscal cuts were required. But Sigfússon says Iceland kept to its Nordic-style social contract. ‘We made a very clear promise to preserve a Nordic-style welfare system,’ he told me, ‘and I believe we have done all we can. We introduced a wealth tax and a three-bracket income tax designed to shelter low-income groups. There was no rise in tax burden for low-income families. What we did is not just socially the right thing to do but also economically successful. We did not cut unemployment benefits. One of the messages from Iceland is don’t overlook the importance of keeping up the purchasing power of low-income groups.’

Iceland completed its IMF programme early, repaying all outstanding loans in August 2011. It then dipped its toes in international financial markets to raise government debts. By 2013 the post-crisis double-digit deficits had been stopped.