The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (15 page)

Ordinary Icelanders tended to take out mortgage loans that were indexed against inflation or in another currency entirely. It was a disaster in the crisis as the value of debts shot up while the króna dived and inflation surged. Property prices typically fell too. The end result was that a 90 per cent loan-to-value loan ended up at 140 or 150 per cent, leaving homeowners stranded in massive negative equity. Some argued for an across-the-board debt write-down of 20 per cent, but that was too unfocused for the new government. Instead, Iceland targeted householder debt relief to write off everything above 110 per cent of the value of the property. The IMF called it the most effective debt-relief programme since US president Roosevelt’s plan in 1933 kept 800,000 Americans in their homes at an eventual profit to his government. There were several other schemes to support householders. The IMF called a special conference to learn lessons from Iceland’s unorthodox policies. ‘Iceland set an example by managing to preserve, and even strengthen, its welfare state during the crisis,’ concluded the IMF’s Nemat Shafik.

So Iceland bailed out its own people rather than the moronic foreign creditors of its insane banks. And the result, to date, is a growing economy. But the bailout has come with a caution. ‘I can promise you,’ Sigfússon told me, ‘we would be watching very carefully to make sure the things that happened in Iceland in 2008 will never repeat themselves. For example, we will put restrictions on foreign-currency loans for a household if its income is solely Icelandic króna.’

Iceland’s banking catharsis goes well beyond this. There was retribution as well as recovery.

Sandwiched between India’s embassy in Reykjavik and an Indian restaurant is a unique office in world finance. On the one hand it’s the typical Nordic, high-design, wood-finished, funky workspace. But there are security keypads and giant steel doors that seem more appropriate to a high-security prison. In the airy loft meeting room, Ólafur Hauksson scribbles onto a whiteboard a complicated spider diagram of cross-ownership and apparent corruption. He is the Icelandic special prosecutor of financial crimes, a genial bear of a man, but a man on a mission. He was elevated from district tax enforcement in the sleepy town of Akranes to become the Judge Dredd of Iceland’s financial collapse.

Policing and prosecution occur in the same office. A rogues’ gallery of Iceland’s financiers have been dragged in for questioning by a staff of 110. ‘We have all powers of police: arrest, hearings, searches,’ Hauksson tells me. ‘And we do not need a court order to enter a financial institution to look for information, because bank secrecy has been lifted towards us, so we do not need a warrant to look at the financial institutions that have been [helped] by the state – which is most of them.’

The cases are complex and detailed – and remarkable. Progress has been slow, but even after his bank investigation winds down, Hauksson expects cases will still be processing through the Icelandic court system for years to come. He has none of the fears expressed in London or New York about damaging the image and stability of a hallowed financial-services sector. ‘The “Too-big-to-jail” phrase describes a fear of entering big cases,’ he tells me, ‘but then you’re leaving a part of society without proper policing. You need to have the rule of law, and regulations apply to everyone.’

A large part of the legal difficulty comes in proving individual culpability. It would be simpler to establish corporate negligence, but Hauksson says there’s no point in pursuing bankrupt state-owned banks on corporate charges. ‘It’s very difficult to point to the precise time they stepped over the line. Was it part of a process or a conscious decision?’

Hauksson’s biggest scalp was Larus Welding, the ex-chief executive of Glitnir, who, together with one of his colleagues, was sentenced to two months’ jail for a fraud involving a loan to a Glitnir shareholder. (Welding is appealing this.) Another case, still to be heard, questions Kaupthing’s emergency pre-collapse cash call from the Gulf in September 2008. The money for the purchase by a Qatari sheikh of a large stake in Kaupthing ultimately came from a bank in Iceland called… Kaupthing. The charge is that the bank lent the money to instil confidence in itself just ahead of the massive bank crisis. It is certainly documented that the companies connected to Qatari investors were granted large loans by Kaupthing around the same time as buying a 5 per cent stake in the bank. The defendants in the case deny the charges.

But whatever happens to Hauksson’s cases, the process has been instructive. The excesses of Icelandic financiers are seared onto the national consciousness, and the special prosecution process is now tattooing it on their foreheads. Iceland will not allow such a catastrophic fiasco to happen again.

Part of the process of Iceland’s recovery has been the appointment of several high-flying women. In 2013 I was invited to the Althing, Iceland’s millennium-old parliament, to meet the new finance minister. Katrín Júlíusdóttir is 38 years old, and has recently returned from maternity leave. She laments the bad decisions of the banks, and the cross-ownership that made the system ‘fall like a domino’. ‘There was a blind eye from the right-wing government who wanted to be a financial centre of the world,’ she tells me. ‘It’s a crazy idea when you have a 300,000 population and your own currency.’

Norwegian colleagues could not understand why Iceland had not reined in the cronyistic cross-ownership that had felled Norwegian banks in the 1990s. It was not widespread corruption, she said, but ‘more the belief in the market and this belief in neoliberalism’. Those who had argued for stronger financial supervision were met with accusations that they were in favour of the ‘surveillance industry’.

Ms Júlíusdóttir’s government has been fiscally austere, cutting a 14.6 per cent deficit down to 0.2 per cent in four years. But other shibboleths of the market have been dispensed with. As the króna tumbled, capital controls were introduced by the Central Bank as an emergency measure. Iceland has to move delicately in her plan to lift capital controls. About a quarter of the value of the entire economy in Icelandic króna is owned by foreigners, but trapped by capital controls, and waiting for a route off the island. The amount of capital that will potentially leave Iceland will surge once the likes of Kaupthing are unwound. The controls will be slowly lifted for individuals, but Iceland will need tools to control the potential outflow. The ultimate tool for Júlíusdóttir was to join the European Union and the Eurozone, but after losing the April 2013 general election, this seemed off the agenda.

In the absence of the EU option, other economic thinkers on the island think that the way forward for a small open economy like Iceland is to copy the Asian countries. Iceland should have a managed floating exchange rate, and a large build-up of foreign-exchange reserves. ‘It has served the Asians well,’ says Guðmundsson at the Central Bank. So that’s an end to inflation targeting, and for the banks an end to the European single market. A single market without a single safety net in banking was one of the causes of Iceland’s excess. ‘All of this was nonsense because there’s a huge difference between growing tomatoes or making shoes and banking. Banks make money out of maturity mismatches [e.g. between lending long-term and borrowing short-term]. It’s risky.’

The ethnic homogeneity of the population of Iceland makes it a much sought-after testing ground for genetic experiments. Iceland’s plunge into financial calamity, and its subsequent recovery, have also turned out to be important experiments for the rest of the world – experiments involving burning bondholders, capital controls, welfare, currency regimes, financial regulation and the criminal prosecution of bankers. The nature of the collapse has also shone a light on some of the most questionable practices in global finance. That could be because Icelandic bankers really were more devious, more cunning and on occasion more fraudulent than their counterparts elsewhere. Or perhaps only in Iceland, on that barren, beautiful island in the middle of the North Atlantic, has a clear picture emerged of what financiers and governments around the world really got up to in the go-go years and the crash that followed.

Nowhere else in the world is such detail available. ‘The Althing Special Investigative Committee, and its 3,200-page report, lists loans to certain individuals in addition to close scrutiny of everything the banks did. Icelanders know more – much much more – about the operations of its banks than any other nation,’ says the economic commentator Sigrún Davíðsdóttir. In the UK and Germany, for example, I shudder to imagine the equivalent tales, emails and desperation as financiers crossed the line of default. Are we really to believe that none of the cronyism and fraud revealed in Iceland occurred in larger financial centres? The world has been looking at this island through a lens, but I suspect in truth that that lens is really a mirror.

Standing next to Oddsson’s bat-cave by night, half a decade on, I can see that Iceland has changed. A spectacular light show sparkles on the side of Reykjavik’s new Harpa concert hall, completed since the crisis. The concert hall was meant to be the showpiece gift from Landsbanki’s largest shareholder, anchoring a development that would have included hotels, shopping centres and a new headquarters for Landsbanki. The crisis put paid to that, so now Harpa stands majestically alone against a backdrop of Mount Esja, and, on occasion, the northern lights.

Davíð Oddsson was not all wrong. Capital controls remain in place. ‘Our’ money may not have been safe in 2008. But five years on, ‘their money’ might just be escaping at last from the danger zone.

Dramatis personae

Deng Zhi, a 24-year-old Chinese, one of 262 million ‘migrant workers’

Zhang Youwen, who works in Dong Guan in a rubber factory

His wife Li Chun Rong, an unemployed migrant worker

Yi Bin, a migrant worker from Sichuan province

Emperor Qianlong, fourth Qing emperor of all-China (1735
–96)

Lin Zexu, nineteenth-century Chinese administrator, scholar, and writer of a letter to Queen Victoria

Jin Liqun, chairman of the supervisory board of the Chinese sovereign wealth fund; Shakespeare scholar

Lindsey Ashworth, development director at Peel Holdings in Liverpool

Psy, Korean popstar, singer of ‘Gangnam Style’

David Wei, former chief executive,
Alibaba.com

Lizzie Lieng, manager of Shanghai Union lighting factory

Professor Justin Lin, former World Bank chief economist

12/11 didn’t merit much attention. In the closing months of 2001 the world was preoccupied with the immediate aftermath of 9/11. But on 11 December 2001, precisely three months after the attack on the World Trade Center in New York, the World Trade Organisation (WTO) was at the centre of an event that was to cast an even longer shadow over the twenty-first century, changing more people’s lives around the world than Osama Bin Laden’s attacks on America. Yet few know it even happened, let alone its date.

China’s admission to the World Trade Organisation changed the game for America, Europe and most of Asia, and indeed for any country in possession of industrially valuable resources, such as oil and metals. It was a largely unnoticed event of epic geopolitical and economic importance. Up until this point China’s global economic role had been principally as one of the world’s biggest manufacturers of plastic gubbins and cheap tat. Important, yes, but neither world-beating nor world-changing.

China’s accession to the top table of world trade heralded a massive global transformation. A powerful combination of China’s willing workforce, its super-high-tech factories, and the special relationship between the Chinese government and Western multinationals has changed the face of the planet. An army of cheap Chinese labour began to produce the goods that underpin Western living standards, as China seamlessly inserted itself into the supply chains of the world’s biggest companies.

Economists call it a ‘supply shock’, and its impact certainly was shocking. Its effects are still reverberating around the world, from China’s rural backwaters to the world’s most powerful central banks, and to every home in Britain.

It is more than 1,500 kilometres from the lush hills of Zhugao County in Sichuan Province to the factories on China’s coast. It’s a long journey repeatedly taken by Deng Zhi, a 24-year-old migrant worker. Since the age of 17, he has been regularly making this twenty-six-hour journey from farm to factory. Typically that has meant working twelve-hour days, six days a week, at an electronics factory in Dong Guan, on the Pearl River Delta. Deng Zhi is paid the equivalent of £100 a month.

‘How much can you earn from farming?’ he asks himself. ‘Working in the cities, you make at least 1,000 renminbi [£100] a month. How many kilos of rice can you buy with this money? It just doesn’t pay to farm.’

Of his £100 factory wages, Deng Zhi sends back about £30 to his family to pay for health, education and pensions, none of which are adequately provided by the state. That still leaves him with at least four times what he would have earned in the fields. Part of his family’s land in Sichuan goes uncultivated. ‘I don’t even think of farming the land. I don’t know how to hold a hoe. As long as you have skills, you’ll find work. Even if I can’t find any work in the city, I won’t come back to farm,’ he says.

Deng Zhi is not a slave. But he is paid less than the equivalent of what it cost to hire a slave labourer in the American South in the era of slavery. And, in effect, Deng Zhi works for you. Or at least he did work for you, up until around 2008. Then he started to moonlight for the Chinese government, filling the coffers of its massive sovereign piggy bank. So right now he wants to work mainly for himself. Factory labour whose surplus value has been expropriated by rentier capital, just as Marx and Engels said of Europe’s rapid industrialisation. Except in China the ultimate rentier capitalist is the Chinese Communist Party. From farm to factory to sovereign wealth fund and back to free spirit, Deng Zhi’s story is also the story of how China kept the West rich, and itself became richer. Now China faces severe growing pains in managing the desire of the mass of its people for a fair share of such riches.