Iceland's Temptation

Starting in the 1990s, Iceland's three largest banks.. Landsbanki, Kaupthing and Glitnir.. began loaning out vast sums of money in relation to their size and became quite profitable. Foreign investors.. notably British and Dutch.. rushed in to invest and get their piece of the pie after Landsbanki set up a Continental wing named Icesave. After all, it was guaranteed by the Icelandic government if all else failed.

Sure enough, by 2008, these three entities had leverage ratio's exceeding 75-1 (thats 75 dollars loaned out for every dollar in the vault). Predictably, these held up about as well as the Metrodome's roof did last nite as the snow piled on.. it collapsed. In late September 2008, the Icelandic authorities took control of Glitnir and Kaupthing. Two weeks later, their partner in greed and stupidity Landsbanki also bit the dust. The Icelanic currency, the Kroner, fell dramatically as well.

The Icelandic government, essentially unable to borrow money and with collapsing tax revenues, decided on a two-fold strategy: let Glitnir, Kaupthing and Landsbanki completely collapse and begin printing money to fill the budget deficits. An IMF loan agreed upon a couple months later helped. But the effects were profound for Iceland.. as well as over 500,000 British, Swedish and Dutch depositors, who were unable to get their money out of Icesave (Landsbanki's operations on the Continent) and Kaupthing, which had operations in Sweden.

The British and Dutch governments were understandably upset and asked the Icelandic government to make good on the deposits of UK and Dutch depositors of Icesave. Indeed the UK's Chancellor of the Exchequer Alistair Darling issued an order freezing the assets of Landsbanki, the Icelandic Central Bank and Icelandic Government.. using a 2001 anti-terrorism law as the pretense. The UK and Netherlands also opposed IMF loans to Iceland until their government agreed to financially compensate Icesave depositors. Nine months later, an agreement was reached, promising to pay UK and Dutch depositors €3.8 billion was passed by the Icelandic legislature under intense EU pressure. The Icelandic Volcano Gods showed their displeasure with the eruption of the Eyjafjallajokull volcano in late 2009, spewing ice and ash over the Ccontinent, with Britain getting the lions share of it's anger. More was to come.

Shortly after the vote, the people of Iceland began marches and strikes in protest, enough to force Iceland's President Olafur Grimmson to refuse to sign it until the matter came before a national referrendum. The Icesave Referrendum was held on March 6th, 2010 under the ash cloud of Eyjafjallajokull.. with 93% of the population opposed and only 2% in favor. In short, Iceland's people gave their foreign creditors the middle finger. The eruptions ceased shortly thereafter.

But how has tiny Iceland fared ? It's been a little over two years since the collapse of Landsbanki. In the beginning, it was indeed awful: the currency fell sharply in value, foreign currency exchanges were essentially halted, the stock market closed for roughly three weeks after dropping 90% in value. Unemployment skyrocketed, beginning with Landsbanki and Glitnir employees. Food prices soared. 2009 and 2010 were miserable.

But something has happened recently.. the Icelandic economy is showing some very real signs of life again. In the third quarter of 2010, their economy grew by 1.2%. Their budget deficit for 2010 was only 6.3% of GDP. For 2011, more robust growth will lead to.. get this.. a budget surplus. Their unemployment rate has fallen from a high of 9.7% to 7.3% this year. The stock market is on a modest upswing again. Now lets take a look at Ireland: their unemployment rate is 14.1% and rising. Their budget deficit, including the backstopping of bad banks, is 32% of GDP. Unlike Iceland, they are Euro members and cannot simply print money as did Iceland. Ireland will soon join Greece and Spain in the deflationary death spiral, though it must be said that although the Irish budget has been approved, the IMF rescue package has yet come up for a vote. Irish PM Brian Cowen's popularity is on par with the Potato Famine for agreeing to it.

Iceland's President Grimmson last week had this to say comparing Iceland to Ireland.. much to the displeasure of EU officials: "The difference in Iceland is that we allowed the banks to fail. These were private banks and we did'nt pump money into them in order to keep them going. The state should not shoulder the responsibility". A tempting course of action indeed.