FIN 405: Financial Crisis of Iceland

Introduction:

The current economic turmoil in Iceland is part of a complex global financial crisis and is by no
means an isolated event. Governments around the world have introduced emergency measures to
protect their financial system and rescue their banks, as they suffer from a severe liquidity
shortage. Thus far, Iceland has been hit particularly hard by this unprecedented financial storm
due to the large size of the banking sector in comparison to the overall economy. The Icelandic
Government has taken measures and is working hard to resolve the situation. Iceland is
cooperating with its Nordic and European partners and is currently consulting with the IMF on
measures toward further stabilization of the Icelandic economy.

About the Country:

Iceland is a European island country in the North Atlantic Ocean on the Mid-Atlantic Ridge. It
has a population of about 320,000 and a total area of 103,000 km2 (39,769 sq mi). The capital
and largest city is Reykjavík, with the surrounding areas in the southwestern region of the
country being home to some two-thirds of the national population. Iceland is volcanically and
geologically active. The interior mainly consists of a highland characterized by sand fields,
mountains and glaciers, while many glacial rivers flow to the sea through the lowlands. Iceland
is warmed by the Gulf Stream and has a temperate climate despite high position just outside the
Arctic Circle.

Until the 20th century, the Icelandic population relied largely on fisheries and agriculture. In
1994, the nation became party to an agreement that established the European Economic Area,
thus allowing it to diversify from fishing to economic and financial services. According to the
Freedom of the Press (report), Iceland has the freest press in the world.

Iceland has a free market economy with relatively low taxes compared to other OECD countries,
while maintaining a Nordic welfare system providing universal health care and tertiary education
for its citizens. In recent years, Iceland has been one of the wealthiest and most developed
nations in the world. In 2010, it was ranked as the 14th most developed country in the world by
the United Nations' Human Development Index, and the fourth most productive country per
capita. In 2008, the nation's banking system systematically failed, causing significant economic
contraction and political unrest.

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FIN 405: Financial Crisis of Iceland
Iceland is a developed and technologically advanced society. Icelandic culture is founded upon
the nation's Norse heritage. Most Icelanders are descendants of Norse (particularly from Western
Norway) and Gaelic settlers. Icelandic, a North Germanic language, is closely related to Faroese
and some West Norwegian dialects. The country's cultural heritage includes traditional cuisine,
poetry and the medieval Icelanders' sagas. Currently, Iceland has the smallest population among
NATO members and is the only one with no standing army.

What Went Wrong?

A modern globalized economy, and an active participant in the EU´s common market, Iceland is
among the first nations to be seriously hit by the global financial crisis. The situation has hit
Icelandic households hard and many have lost a sizeable portion of their savings. Inflation is in
double-digit numbers, unemployment is on the rise and the currency, the Icelandic Krona, has
fallen to historical lows.

The large size of the banking sector in comparison to Iceland’s overall economy is doubtless a
driving factor behind the current economic turmoil. However, it should be underlined that the
Icelandic banks operated in full compliance with European banking laws and the strictest of
international regulatory standards. Nevertheless, as the liquidity crisis deepened, Iceland’s three
largest banks, Glitnir, Landsbanki and Kaupthing, whose balance sheets are several times larger
than the total output of the Icelandic economy, were no longer able to re-finance their operations.
As a response to these circumstances, the Icelandic parliament passed a new law, allowing the
Financial Supervisory Authority (FSA) to take over the operations of the banks. On the basis of
this new law, all three banks are now being restructured and the domestic operations are being
separated, re-capitalized and will be governmentally owned (at least for some period of time).

Background of the Crisis:

Through the centuries people of Iceland have lived off the land and the fisheries, which are the
main national income of Iceland. Usually it was in the neighborhood of 70 to 85 % off the
national gross income. Last 100 years or so the only merchandise they have sold to other
countries in any quantity to get currency in exchange, is FISH. This foreign currency has made it
possible for them to buy everything they have wanted and needed to buy, from other countries.

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The fishermen up until 1983, could freely go to sea and fish, and earn their living, and they
always had enough food. In the year 1983 a great change happened, not accidentally, but by
implementing a diabolical secret plan to seize the fisheries stocks and make the so called fishing
quota system out of it. This system was utilized to distribute the national wealth, the fisheries, to
selected few. Politician’s of all parties at that time found this to be ideal and justified the quota
laws on the grounds that they needed to preserve the fisheries stock. This system has been
running for over 25 years, and the fishing stock quota has been getting smaller and smaller year
after year, until now it has never in the history of Iceland been less. Most people believed this
scam, but many did not, and soon a strong protest against these fascistic laws arose and many
good men fought against it. Many of them have lost everything they owned due to counter law
suits of the government, or due to the punishing laws of the quota system laws.

Things got worse in 1990 or there about, the government and Althingi, made new special laws
which handed over to the quota “owners” at that time, the right to sell at their will to others the
fishing quota, and actually now it was their property, which their ancestor would inherit. The
nation’s largest natural wealth was now the property, of the few selected quota “owners”. After
the finance crash happened now in 2008, the so called quota is now huge dept in the nationalized
banks, thus the taxpayers are made responsible, and to pay these depts. Meaning actually that the
nation is buying at a great price back the fishing quota which it already owns. This is a political
fraud, of its worst kind. The Icelandic politicians are all responsible for this scam, since most of
them are having a personal interest in the fishing quota system.

It is a known fact in the world today that the backbone of all nations’ currencies is each nation’s
natural resources and production capability in industry or other production. In light of this fact, it
is a crime against the Icelandic nation to actually steal the back bone of the currency, from the
people of the nation. In fact this is an economical fascism of its worst kind.

The quota owners that sold their quota quickly transferred their (stolen money) to other foreign
country’s banks. Countless billions have been transferred this route, undermining the currency.
The new quota owners that bought took loans in the banks to buy this quota. A large part of the
dept in the bankruptcy of the Icelandic nation, are the fund that was stolen this route.
Consequently the value of krona dwindled fast down and is now actually worthless. Against this
outflow of stolen money, the government and the banks got many large loans, to keep up the

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standard of living, and keeping the people more or less ignorant of what was happening. Though
the United Nations Human Rights Committee has ruled against these quota laws, as illegal, but
the Icelandic government, ignores it. And now when the smoke begins to clear a little, after all
the turmoil in Oct. and Nov. 2008 the “Quota” owners are seeking to get their depts. written off
in the new banks! They are demanding that the taxpayers of Iceland pay their depts. Since now
the banks are nationalized, and the citizens actually own the banks.

The “quota owners” have given the fishing quota as collateral for loans in past, (the common
property of the nation) and now they can’t pay, and want the tax payers to pay this dept too,
amongst all the other depts.

Reasons behind the Crisis:

Iceland has been hit especially hard by the ongoing late 2000s recession, because of the failure of
its banking system and a subsequent economic crisis. Before the crash of the three largest banks
in Iceland, Glitnir, Landsbanki and Kaupthing, their combined debt exceeded approximately six
times the nation's gross domestic product of €14 billion ($19 billion). In October 2008, the
Icelandic parliament passed emergency legislation to minimise the impact of the financial crisis.
The Financial Supervisory Authority of Iceland used permission granted by the emergency
legislation to take over the domestic operations of the three largest banks. Icelandic officials,
including central bank governor Davíð Oddsson, stated that the state did not intend to take over
any of the banks' foreign debts or assets. Instead, new banks were established around the
domestic operations of the banks, and the old banks will be run into bankruptcy. The Icelandic
economic crisis has been a matter of great concern in international media.

On 28 October 2008, the Icelandic government raised interest rates to 18%, (as of August 2010,
it was 7%) a move which was forced in part by the terms of acquiring a loan from the IMF. After
the rate hike, trading on the Icelandic króna finally resumed on the open market, with valuation
at around 250 ISK per Euro, less than one-third the value of the 1:70 exchange rate during most
of 2008, and a significant drop from the 1:150 exchange ratio of the week before. Iceland has
appealed to Nordic countries for an additional €4 billion in aid to avert the continuing crisis.

On 26 January 2009, the coalition government collapsed due to the public dissent over the
handling of the financial crisis. A new left-wing government was formed a week later and

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immediately set about removing Central Bank governor Davíð Oddsson and his aides from the
bank through changes in law. Oddsson was removed on 26 February 2009.

Impacts of the Crisis:

Currency:

As previously explained, there are problems with payments and settlements of international
transactions between Iceland and other countries as the Central bank imposed temporary
restrictions on currency outflows. There is, however, no reason for foreign stakeholders to be
concerned. Firstly, as it is expected that the currency restrictions are a temporary remedy to the
current situation. Secondly, because all commercial terms recognized within the EU are also
recognized in Iceland, both Inco terms and other terms. The Icelandic customs Authority is a
member of the World Custom Control (WCC), and the Icelandic Customs control is fully in line
with customs control in other countries. Furthermore, it should be noted that trading partners of
Iceland have numerous remedies at their disposal for a potential breach of contract. The
Icelandic legal framework is in line with that of other countries as Iceland is a member of the
WTO and the EEA-agreement, which provides Iceland with access to the EU’s market.
These circumstances have created many and convoluted problems for Icelandic businesses
involved in international trade. Unfortunately, because of the complexity of the situation, the
government has not been able to publish reliable information on the restructuring timeframe.
Therefore, it has been hard for Icelandic businesses to give detailed information to their business
counterparties about the progress. However, these circumstances are temporary and on behalf of
our members, the Iceland Chamber of Commerce kindly asks foreign counterparties and
stakeholders to show patience and flexibility while these issues are being resolved.

The Icelandic króna had declined more than 35% against the euro from January to September
2008. Inflation of consumer prices was running at 14%, and Iceland's interest rates had been
raised to 15.5% to deal with the high inflation.

On the Wednesday night, 8 October 2008, the Central Bank of Iceland abandoned its attempt to
peg the Icelandic króna at 131 krónur to the euro after trying to set this peg on 6 October. By 9
October, the Icelandic króna was trading at 340 to the euro when trading in the currency

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collapsed due to the FME's takeover of the last major Icelandic bank, and thus the loss of all
króna trade 'clearing houses'. The next day, the central bank introduced restrictions on the
purchase of foreign currency within Iceland. From 9 October to 5 November, the European
Central Bank quoted a reference rate of 305 krónur to the euro.

The Central Bank of Iceland set up a temporary system of daily currency auctions on 15 October
to facilitate international trade. The value of the króna is determined by supply and demand in
these auctions. The first auction sold €25 million at a rate of 150 krónur to the euro. Commercial
króna trading outside Iceland restarted on 28 October, at an exchange rate of 240 krónur to the
euro, after Icelandic interest rates had been raised to 18%. The foreign exchange reserves of the
Central Bank of Iceland fell by US$289 million during October 2008.

During November, the real exchange rate (discounting inflation) of the Icelandic króna, as
quoted by the Central Bank of Iceland, was roughly one-third lower than the average rate from
1980–2008, and 20% lower than the historical lows during the same period. The external rate as
quoted by the European Central Bank was lower still. On the last trading day of the month, 28
November, the Central Bank of Iceland was quoting 182.5 krónur to the euro, while the
European Central Bank was quoting 280 krónur to the euro.

On 28 November, the Central Bank of Iceland and the Minister for Business Affairs agreed a
new set of currency regulations, replacing the central bank's restrictions imposed early on in the
crisis. Movements of capital to and from Iceland were banned without a license from central
bank. It is estimated that foreign investors hold some €2.9 billion in króna-denominated
securities, popularly known as "glacier bonds".

The foreign exchange rules also oblige Icelandic residents to deposit any new foreign currency
they receive with an Icelandic bank. There is anecdotal evidence that some Icelandic exporters
had been operating an informal offshore foreign exchange market, trading pounds and euros for
krónur outside the control of any regulator and starving the onshore market of foreign currency.
Hence the central bank had to sell €124 million of currency reserves in November 2008 to make
up the difference, compared with an estimated trade surplus of €13.9 million.

The last currency auction was held on 3 December. The domestic interbank foreign exchange
market reopened the following day with three market makers, all of them government-owned.

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On the first two days of domestic trading, the króna climbed to 153.3 to the euro, up 22% against
the last currency auction rate.

In January 2009, the exchange rate of Icelandic króna (ISK) against Euro seemed to be more
stabilized compared with the situation in October 2008, with the lowest rate at 177.5 ISK per
EUR on January 1, January 3, and January 4, 2009, and the highest at 146.8 on January 30, 2009.
In the meantime, however, Iceland's 12-month inflation in January 2009 climbed to a record high
of 18.6%.

Banks:

Case Study 1:

Case Study 2:

Current States:

On 26 January 2009, the coalition government collapsed due to the public dissent over the
handling of the financial crisis. A new left-wing government was formed a week later and
immediately set about removing Central Bank governor Davíð Oddsson and his aides from the
bank through changes in law. Oddsson was removed on 26 February 2009.

Thousands of Icelanders have moved from the country after the collapse and about half of those
moved to Norway. In 2005, 293 people moved from Iceland to Norway, while in 2009 this figure
was 1,625 Icelanders to the same country. In April 2010, the Icelandic Parliament‘s Special
Investigation Commission published the findings of its investigation, revealing the extent of
control fraud in this crisis.

Government Steps:

Progress has been achieved in ensuring continued functioning of the Icelandic financial system.
The Icelandic government has prioritized the tasks facing the economy based on their importance
for the general public. The first task was to secure the functioning of the domestic banking,

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payment and settlement systems. The stock market has been re-opened even though the
operations are obviously limited considering that the financial companies were the majority share
of the total market capitalization of the stock exchange. The next priority is to stabilize and
secure the functioning of international payments and settlement system as well as the foreign
exchange market.
Furthermore, Iceland is working closely and constructively with other countries to address
problems that have arisen in connection with the government takeover of Iceland’s three largest
commercial banks. The government of Iceland has clearly stated that it intends to honor its legal
commitments and seeks close cooperation with other countries’ authorities.
In order to prevent a potential shortage of foreign currency, the Central Bank of Iceland has
implemented temporary restrictions on foreign exchange transactions with the Icelandic krona.
These restrictions have inevitably resulted in problems with payments and settlements of
international transfers between Iceland and other countries. Furthermore, as a measure to restore
balance in the currency market, the Central Bank has drawn on its swap facility arrangements
with the Central Banks of Norway and Denmark, a total of €400 million.
On October 24th, Iceland’s prime minister announced that the government had reached an
agreement with the International Monetary Fund (IMF) on a comprehensive stabilization
program, which will include a two billion dollar loan from the IMF. The deal still needs to be
approved by the IMF’s executive board, but it is nonetheless a positive step toward restoring
economic stability in Iceland.
International Assistance:

 IMF stabilization program

The Icelandic government has reached an agreement with the International Monetary Fund
(IMF) on a comprehensive stabilization program, which will include a 2.1 billion dollar loan
from the IMF. The deal has now been approved by the IMF’s executive board. There are three
main objectives of the IMF supported program: To contain the negative impact of the crisis on
the economy by restoring confidence and stabilizing the exchange rate in the near-term; to
promote a viable domestic banking sector and safeguard international financial relations by
implementing a sound banking system strategy that is nondiscriminatory and collaborative; and
to safeguard medium-term fiscal viability by limiting the socialization of losses in the collapsed
banks and implementing an ambitious multi-year fiscal consolidation program. Significant

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progress has been made towards attaining these goals as is confirmed in the IMF’s most recent
progress report, which was issued in the first week of February. According to the IMF’s
economic forecast for Iceland, the Icelandic economy is expected to adjust sharply in the near
term under the program. Given the high leverage in the economy and significant dependence of
the private sector on foreign currency and inflation-indexed debt, the economy is expected to
enter into a serious recession in 2009-10. The anticipated large import compression will,
however, lead to a rapid swing of the current account into surplus, providing significant support
to the exchange rate going forward. Once confidence is restored and balance sheets readjusted,
domestic demand—both investment and consumption—is projected to rebound strongly in 2011.
Long-term growth prospects are favorable, in line with Iceland's very strong fundamentals, not
least its highly educated labor force, favorable investment climate and rich natural resource
endowment.

Conclusion:

Despite the current economic setbacks, Iceland’s future is bright. Iceland is a dynamic,
technology driven society with a young and well educated workforce. The country is endowed
with abundant natural resources, which include rich fishing grounds, vast renewable energy
sources (of which only a third has been harnessed), a plentiful supply of clean water and a
natural environment and culture that draw an increasing number of tourists to the country each
year. Other major strengths of the economy include diverse export industries, a flexible labor
market, a strong fiscal position, an efficient pension