[Pen-l] The Bear Stearns of the Atlantic

[Louis Proyect <lnp3@xxxxxxxxx>]

The New York Times, October 9, 2008
In Flailing Iceland, Disbelief and Regret
By ERIC PFANNER

REYKJAVIK, Iceland ? People go bankrupt all the time. Companies do, 
too. But countries?

The global financial crisis has laid waste to some major banks and 
other financial institutions in the United States and Europe, but 
Iceland may be the first country to face the prospect of going bust 
along with them.

After a decade-long binge in which Iceland's banks, and some of its 
citizens, expanded beyond their means, the bill has come due. While 
the full effects of the potential crash have not hit yet, some 
Icelanders like Bubbi Morthens are already feeling the pain.

"There is a lot of fear in society and there are people who are 
losing everything," Mr. Morthens said Wednesday after singing at an 
impromptu midday concert in central Reykjavik intended to lift 
people's spirits.

Mr. Morthens is a former fish industry worker turned rock singer who 
is now known as the Elvis of Iceland. Like many of his compatriots, 
he did well when Iceland was riding high, accumulating considerable wealth.

Then, the financial crisis gripping his country intensified last 
month. The government seized control of Iceland's third-largest bank. 
Mr. Morthens said he lost his life savings, which he had invested 
mostly in the bank's stock.

"What is important at a time like this is not picking out whom to 
blame," he said. "We have a government that is trying to do their 
best, but we will have to see what they come up with. Maybe it is a 
new dawn for Iceland."

The government's attempts to get ahead of the problems cascading 
through its financial system have not restored confidence. In just 24 
hours, for instance, it abandoned an effort to peg its currency to a 
basket of others.

In a country raked by icy North Atlantic winds and dotted with 
volcanoes and geysers, where people live with the threat of 
earthquakes and maritime disasters, few seem to be losing their cool 
over the financial crisis ? yet.

Still, with the country facing the imminent threat of "national 
bankruptcy," as Prime Minister Geir H. Haarde put it earlier this 
week, many people are talking about an epochal change. The only 
problem is that nobody knows what that might mean.

Nations have gone bankrupt before, of course, but countries like 
Argentina ? not a country that thinks of itself as closer to Europe 
than the developing world.

What it means for Iceland so far, people here say, is that the days 
when the economy seemed capable of gravity-defying feats are gone. So 
are the days when Icelandic investors went on an international buying 
spree, adding some of the biggest names of the British and American 
retail industries to their portfolios.

So too, they conclude, are the days when ordinary citizens 
effortlessly joined in the fun, taking out second mortgages to 
finance their own trips abroad or at least to the Laugavegur, the 
main shopping strip in Reykjavik.

"It's difficult; the landscape is very difficult," said Franch 
Michelsen, a watch dealer in downtown Reykjavik, as he took a break 
from cleaning his shop window on Wednesday.

People are still buying watches costing up to 100,000 Icelandic 
kronur, or about $900, he said. Above that price, there is a flight 
to quality similar to the one that has galvanized the financial 
markets. Buyers are apparently interested only in the biggest name, 
the most liquid investment, Mr. Michelsen said ? in this case, Rolexes.

"People want something they can take anywhere in the world and sell 
it," he said.

This capital city of 120,000 still displays the fruits of the 
decade-long economic boom that followed the deregulation of Iceland's 
financial sector in the 1990s ? hip cafes, lobster restaurants and 
stylish shops selling outdoor gear.

After the government nationalized Mr. Morthens's bank, Glitnir, in 
September, some people rushed to grocery stores, worried about 
possible shortages on a remote island where fish is one of the few 
foods that does not need to be imported.

But the shelves are still stocked, and any such hoarding this time 
around seems to have eased.

Instead, the financial situation is playing out in a parallel 
universe inside the offices of Glitnir and the other two big banks, 
Landsbanki and Kaupthing.

The government had originally planned to take a 75 percent stake in 
Glitnir, but said Wednesday that the bank was in even worse shape 
than it had thought and would be handed over to financial regulators. 
Landsbanki, the nation's second-largest bank, was nationalized on Tuesday.

And on Thursday, the government seized Kaupthing Bank, the country's 
largest lender, effectively completing the nationalization of the 
banking system.

But not just bankers are getting hurt. Some Icelanders with recently 
acquired mortgages face a double threat. Home prices have been 
falling, and analysts expect them to decline further. But many of 
these mortgages were taken out in foreign currencies ? marketed by 
the banks as a way to benefit from lower interest rates abroad, as 
rates in Iceland rose into the double digits over the last year.

Now, with the Icelandic krona plunging, homeowners have to pay back 
suddenly far more expensive euro- or dollar-value of their mortgages 
? a kind of negative equity, squared.

The Rev. Karl Sigurbjornsson, the bishop of Iceland, who leads the 
state-sponsored Lutheran church, says he worries about how the 
prospect of financial suffering will affect a society that "was led 
to believe that it was unlimited growth forever."

"What will happen when the dust settles?" he asked during an 
interview in his office. "A lot of people will be very angry. It will 
be a challenge for our society," which in the past placed a premium 
on cohesion rather than the pursuit of wealth.

What will happen next? Analysts say events in the financial sector 
are moving too fast to make useful economic forecasts.

Some in this country of 300,000 think the economy will prove to be 
resilient, regardless of what happens to the banks or even the 
country's finances. They point to Iceland's recent prowess in heavier 
industries like aluminum production ? Alcan and Alcoa both have 
plants here ? and alternative energy.

For instance, Eyjolfur Rafnsson, chief executive of Mannvit 
Engineering, which designs geothermal and hydroelectric power plants, 
said he had seen no negative effects on his business from the 
financial crisis. The company plans to open an office in Budapest 
next week, adding to international sites in Germany and Britain.

He said he even saw some possible benefits for his company, if not 
for Iceland as a whole. Because of the fall in the value of the 
krona, he said, "today we can compete anywhere in the world, except 
maybe India."

To Bishop Sigurbjornsson, the silver lining in the financial crisis 
is the prospect that it will bring Icelanders, steeped in the sagas 
of the Vikings, back in touch with traditional values.

In his office, he points to a picture from 1908, showing an isolated 
country church. Villagers gather for a Sunday service at the wooden 
church, whose roof is covered with turf ? a cheap form of insulation.

"Other countries build houses with brick and stone," he said. "These 
good times, these times of wealth, are a fairly short part of our history."

Meanwhile the prime minister, Mr. Haarde, was drawing some practical 
conclusions, as Fitch Ratings downgraded the country's debt and 
Iceland awaited a possible loan from Russia.

"What we have learned from this whole exercise is that it is not wise 
for a small country to try to take a leading role in international 
banking," he said at a news conference.

----

http://www.newyorker.com/talk/financial/2008/04/21/080421ta_talk_surowiecki
The Financial Page
Iceland's Deep Freeze
by James Surowiecki April 21, 2008

By now, we're all familiar with the major victims of the subprime 
meltdown: greedy mortgage brokers, overleveraged hedge funds, 
feckless banks and brokerages, incautious homeowners, and so on. But 
the crisis is also wreaking havoc in places that, on the surface, 
might seem to have nothing to do with the price of foreclosed homes 
in Miami. Places, that is, like Iceland.

Insofar as Americans think about Iceland at all, it's as a land whose 
remoteness belies a vibrant cultural scene featuring hipster titans, 
like Björk and Sigur Rós, and exceptional social conditions?it's the 
top-rated country in the U.N.'s most recent human-development index. 
But in the financial world Iceland is now a hot topic of discussion 
for a different reason: many people suggest that it could become the 
"first national casualty" of the ongoing credit crunch. Until last 
year, Iceland's economic track record in this decade had been 
phenomenal?its annual growth rate averaged close to four per cent 
over the past decade, and its per-capita gross national income is now 
higher than that of the U.S. This year, though, the country's 
currency, the króna, has fallen twenty-two per cent against the euro; 
the economy has stagnated; and a global rating agency has put the 
nation's three major banks on a credit watch. Now analysts are 
wondering whether the new Nordic Tiger will end up, instead, as "the 
Bear Stearns of the North Atlantic."

So how did Iceland get in so much trouble? That's the odd part of the 
story: it isn't because its banks gambled on the worthless subprime 
securities that helped undo Bear Stearns and so many others. 
Iceland's banks prudently avoided the subprime market, even as they 
embarked on a lending boom at home and expanded abroad. What got 
Iceland in trouble was something more subtle: its banks got their 
money primarily from international investors, making the Icelandic 
miracle heavily dependent on foreign capital.

In normal times, this might not have mattered, given the country's 
solid economic fundamentals. But these aren't normal times. The 
subprime crisis, in which investors realized that they had greatly 
underestimated the risks of lending to people with bad credit, has 
spawned a wider credit crunch: investors now suspect disaster behind 
every door, and even seemingly solid borrowers find credit much 
harder to come by. The subprime crisis was an earthquake that caused 
a tsunami: the quake has done plenty of damage on its own, but the 
tsunami looks set to do even more.

Iceland has been swamped by that tsunami because it trusted in the 
availability of global credit in time for that credit to evaporate. 
And the fact that Iceland has been so dependent on foreign investors 
makes those investors even more skittish about investing there: in 
markets, weakness often begets weakness. Further, the country's 
troubles have made it a potential target for speculators seeking to 
drive down the value of its currency and perhaps cause a run on the 
banks. In 1998, hedge funds purportedly worked together to attack 
Hong Kong's currency and its stock market, an attack that was foiled 
only when the government bought up a sizable chunk of the stock 
market. It's not clear that a similar cabal is gunning for 
Iceland?the governor of its central bank insists that one is?but the 
notion is certainly plausible: with a population the size of 
Pittsburgh and a central bank whose total reserves are less than five 
billion dollars, the country makes an easy target for hedge funds 
flush with cash.

Iceland's current woes teach a useful lesson about the 
interconnectedness of global markets: trouble can come from anywhere. 
Homeowners default on mortgages in San Diego, and suddenly people in 
Reykjavík are paying more for gasoline and wondering if their bank 
deposits are safe. That doesn't mean that Iceland is an innocent 
victim. The country went overboard with spending and 
borrowing?between 2000 and 2007, domestic credit in the Icelandic 
banking system more than quadrupled as a share of G.D.P. And relying 
on foreign money to fuel that kind of frenzy is foolish, since it 
puts you at the mercy of fickle foreign investors. But Icelanders can 
be forgiven for wondering if they've really been any more reckless 
than many other countries?most obviously the U.S., which relies 
heavily on foreign capital to fund home buying and profligate 
consumption, and whose banking system is rife with reckless lending.

And that's the second lesson of Iceland's plight: even in a flat 
world, there are different rules for different players. In order to 
prop up the króna, and keep foreign capital from fleeing, Iceland's 
central bank has had to raise interest rates to an astounding fifteen 
per cent, a move that will slow the economy to a crawl. By contrast, 
the dollar, while weak, has evaded the króna's precipitous fall; the 
Federal Reserve, far from raising interest rates, has slashed them; 
and Congress is borrowing a hundred and fifty-two billion dollars to 
hand out tax rebates. Iceland's government has been forced to inflict 
pain; the U.S. is doing everything possible to avoid it. If Iceland 
were to attempt to emulate America's approach, its currency would be 
demolished, and foreign investors would almost certainly head for the 
exits. The U.S., by contrast, remains the beneficiary of the world's 
generosity?no matter how bad our financial situation looks, countries 
like China and Japan keep pouring hundreds of billions of dollars 
into U.S. securities. They're doing this not out of kindness, of 
course, but because the U.S. is a colossal market and they need us to 
keep buying stuff. The world can't afford to have the U.S. fail, and 
so we are able to get away with behavior that would wreck smaller 
countries. Great for us, but when we look at Iceland's predicament we 
should say that there but for the grace of China go we. ?

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