Iceland downgraded to junk as it heeds 70% of the electorate on Icesave debt

The latest piece of big news in the sovereign debt crisis comes, remarkably, from Iceland. The country collapsed into depression after its experiment as an open economy with a large banking sector went pear shaped.

After a debt-fuelled boom and a huge influx of hot money due to high interest rates, its currency and banks collapsed under a fleeing of foreign money and huge losses. The government nationalized the banks’ debt, only to find the banks were too big to bail. The Icelanders rioted on the streets, a sovereign crisis ensued, and the government was toppled.

Iceland was rescued and it seemed all was well. They was even talk of fast-tracking Iceland into the EU. Then, suddenly, the population balked at the prospect of bailing out the banks. Now, the sovereign debt crisis is on again. At issue is Icesave, an Icelandic bank that operated in the UK and the Netherlands whose bust caused great hardship amongst British and Dutch savers who were attracted by high interest rates.

See the video below on why Fitch is now downgrading the country’s debt status to junk despite the lack of immediate liquidity concerns.

Icelandic President Grimsson blocked the legislation proposed by the new government under prime inister Jóhanna Sigurðardóttir after the last government was thrown out of office. This is significant since his is a largely ceremonial role and it was only the second time the President has ever done so in Iceland. Last year, I was in a small forum led by the Icelandic President Grimsson. You could see his violently visceral reaction to the bank issue as he spoke about it. His anger reflects that of the larger populace. Defending his decision, he said:

It is the cornerstone of the constitutional structure of the Republic of Iceland that the people are the supreme judge of the validity of the law.

I think this is big news and have a number of sources on this story below. Watch the Dutch and British stories for signs of European tensions as this is where the affected Icesave savers reside. The FT headline says it all.  The Financieele Dagblad headline says “Iceland threatened to become next Cuba.” Ambrose Evans-Pritchard’s commentary is the most comprehensive and balanced in my view. The Norwegian headline, on the other hand, is “Iceland not on the verge of collapse” in huge typeface. The fault lines are definitely opening in Europe. I will discuss this later on the latest story on Greece and the likelihood of EU help. It’s because of the implications in other European countries that the Icelandic situation is significant.

Michael Hudson had this right when he said Iceland simply can’t pay. I have bolded the most significant part of his piece because it applies not just to Iceland:

Under normal conditions Iceland, a prospective EU member that had signed up to European deposit insurance rules, would have availed itself of the right to settle with depositors in an orderly manner…

The EU law did not anticipate a systemic failure and made no provision for the government to be liable beyond its insurance agency. But guidelines agreed by the Ecofin meeting of European Union finance ministers on November 14 2008 were clear: “These negotiating discussions shall be conducted in a compatible and co-ordinated manner and account will be taken of the difficult and unprecedented circumstances in which Iceland finds itself and the urgent necessity of deciding on measures which will enable Iceland to restore its financial and economic system.”

So the broader issue concerns Iceland’s ability to pay 250 per cent of its current gross domestic product – nearly $20,000 for each Icelandic citizen – to settle its Landsbanki mismanagement. The International Monetary Fund did not think this was a realistic option when its team calculated in November 2008 that: “A further depreciation of the exchange rate of 30 per cent would cause a further precipitous rise in the debt ratio (to 240 per cent of GDP in 2009) and would clearly be unsustainable.”…

A pragmatic economic principle is at work in such conditions. Debts that cannot be paid, will not be (unless one pays back Peter by borrowing from Paul). At stake, therefore, is how much can be paid without wrecking Iceland’s economy. How many Icelanders must lose their homes as carrying charges soar on mortgages indexed to the exchange rate? Emigration is accelerating, and many foreign workers already have left. How many more must depart? And if the post-Soviet experience of a steep and sudden drop in living standards is relevant, by how many years must Icelandic lifespans shorten?


Reykjavik warned of political isolation – FT

Iceland can refuse debt servitude – FT

Iceland faces crisis after Icesave rejection – Reuters

Iceland leader vetoes bank repayments bill – BBC News

Iceland’s president blocks £2.3bn Icesave deal to compensate the UK – Telegraph

Angry Iceland defies the world – Ambrose Evans-Pritchard, Telegraph

Icelanders to vote on whether to repay UK over bank bailout – Guardian

Poll: Should Iceland be forced to pay? – Guardian

President IJsland verwerpt Icesave-akkoord – NRC Handelsblad

IJsland isoleert zich met veto Icesave-akkoord – NRC Handelsblad

IJsland dreigt ‘soort Cuba’ te worden – Finacieele Dagblad

IJsland houdt referendum over omstreden Icesave-akkoord – Financieele Dagblad

Island ikke på randen av kollaps – E24

Islands hårde krise – Berlingske Tidene

Islands parlament hasteindkaldes – Berlingske Tidene

Les Islandais consultés sur le remboursement de la dette – Figaro

  1. LavrentiBeria says

    And here the difference between a public servant that serves the public and a whore that sells his office to the highest bidder. Would that we had someone like Grimsson in the White House. No, hardly possible in the USA. Our political leadership is simply too lost in depravity to attain to anything like this. Let the bankers kvetch and the corrupt rating agencies lower the boom. Let ’em eat cake.

  2. Jamisia says

    I think Bill Mitchell gave the best commentary: Iceland should be allowed to pay back in kronor…

  3. Angry Voter says

    Goldman Sachs got $35B in bailout money in the past 2 years and paid out $39B in bonuses.

    Yes, go read their own SEC paperwork.

    Without paying themselves such piggish bonuses, they would have turned a profit of $4B for the past 2 years.

    We should not pay anything until the bankers and their families are squeezed dry for everything they stole and then thrown into forced labor camps.

  4. Marino says

    I think that this article is premature. It is trying to tell a story that the author does not understand fully. It is like the author heard it through the Grapevine, a gossip or speculated rumor. Stick to the facts about matter and if you don’t have the facts, don’t publish your speculations. And why has the author not added to the list of references more recent articles with deeper understanding of the situation, articles that actually agree with the Icelandic president. Perhaps it is not politically correct to take a stance against the ‘big and mighty roaring lion’ and its partner. I actually find these two countries being pitiful.

    1. The Icesave issue is not about who is paying or not. It is about the terms UK and Holland are forcing on Iceland in case the bank in question does not have enough assets to repay the depositors.
    2. On October 2008 the Icelandic Parliament passed an emergency law changing the priority of claims in case of bank going burst. Prior to that deposits were regular claims but their status was changed to priority claims. This basically means that a bank must be in very bad situation not to be able to repay the deposits or at least the minimum payment the EU directive requires.
    3. The Icelandic Depositors Guarantee Fund (IDGF) will cover up to EUR 20,887 if the banks assets are insufficient. That would be very unlikely if it had not been that the UK and Dutch governments bullied Iceland to accept that depositor’s claims above EUR 20,887 would have the same priority as claims below that figure. This basically means that if you had 35,000 euro on account and the bank’s assets could cover up to 30,000 the Dutch/UK guarantee fund would get everything back, but the IDGF would have to cash out 5,000 euros! The reason is that for every euro the IDGF gets repaid, the other two get also 1 euro (combined). But of course it should be the Dutch/UK guarantee fund that should loose 5,000 euros.
    4. The Icelandic parliament passed a law in September that approved the repayment scheme with conditions. The UK and Dutch governments only had to accept these conditions, but they were like schoolyard bullies that were not happy with getting this week’s pocket money but also wanted next week’s.

    The situation is very strange. Two big countries are bullying a small country for a cash that a bank is paying. These two countries without asking paid depositors up to 50,000 pound and 100,000 euros an now they want their money back by their terms. It is ridiculous that because they paid more than required that they get the same priority to the money to cover their extra expenditure as the IDGF gets to cover the minimum guarantee.

    Iceland is by no mean trying to get easily off. We just want a fair and just solution so we can get on with the rebuilding of the economy after some irresponsible bankers had a party that ended badly.

    1. Edward Harrison says

      With all due respect, Marino, you are completely off base.

      The articles I presented as background were both current and a comprehensive spectrum of views on the issue from the past day before I published this post. The fact that I scan news from different countries gives my readers a better perspective of what’s happening.

      Moreover, I am very sympathetic to what the Icelandic President did – and therefore to the opinion you, as an Icelander, pose. Why else would I write the title as “heeds 70% of the electorate on Icesave debt.”

      I don’t know what you’re reading into the post but you really should re-read it, especially what Hudson says to end the post

      At stake, therefore, is how much can be paid without wrecking Iceland’s economy. How many Icelanders must lose their homes as carrying charges soar on mortgages indexed to the exchange rate? Emigration is accelerating, and many foreign workers already have left. How many more must depart? And if the post-Soviet experience of a steep and sudden drop in living standards is relevant, by how many years must Icelandic lifespans shorten?

      1. Marino says

        Perhaps I was a bit harsh but the inclusion of this interview with Mr. Rawkins just made me angry. I have been following what this man has been saying about Iceland for the past years and he never seems to be able to find any balance in his words. Actually I think that all the rating agencies have to go into a deep meditation rethinking their situation. You most likely remember the SEC report that was published in summer of 2008 where it came clear that they had not a faintest idea what segregation of duties stood for. Lets also bear in mind the about two years ago one of the Icelandic banks got AAA rating on bonds they issued. Triple-A for a bank in Iceland and they are in no way accountable for this nonsense.

        So, sorry if I went off line.

        1. Edward Harrison says

          I understand fully. I have written often about the ratings agencies and their duplicity. The reality is that the government never should have taken on any promises for Icesave. They are legally British and Dutch institutions, not Icelandic. Only the parent company was Icelandic.

          Moreover, Gordon Brown already bailed the savers out. Then he uses gunboat diplomacy to bring a country to heel. His coercive foreign policy of bullying a smaller country is positively American.

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