The Road Less Traveled: Iceland’s Response to the 2008 Financial Crisis

By: Peter Veldkamp

While many remember the 2008 financial crisis and the rocky road to recovery in the United States, few are aware that the impact on Iceland was worse than any other country relative to its economy’s size.[1] Historically, Iceland had been a fiscally sound nation with modest debt relative to its size.[2]  Like the United States in the early 2000’s, Iceland rapidly expanded its debt portfolio, loosened regulation on the mortgage industry, encouraged private loans with minimal collateral requirements, and stood by as housing prices grew at an unsustainable rate.[3] But unlike the United States, Iceland’s solution to a failing economy notably promoted the idea of banks being “too big to save,” prosecuting responsible individuals, and leveraging a powerful tourism industry to aid in recovery.[4]

The three largest banks in Iceland at the time - Glitnir, Landsbanki and Kaupthing – stated combined assets that were ten times larger than Iceland’s annual gross domestic product.[5] The banks’ lending, although a powerful short-term stimulant, resulted in Iceland becoming overextended and precipitated concerns among foreign investors of excessive exposure risk.[6]  The collapse of the Lehman Brothers triggered market-wide margin calls on outstanding loans that Iceland’s banks were unable to provide the necessary collateral, resulting in a desperate plea to the Central Bank of Iceland.[7] When no bailouts were provided by the Icelandic government, the banks were taken over under the Emergency Act 125/2008 and other federal legislation.[8] The Central Bank of Iceland defaulted on all obligations to foreign creditors of these banks, claiming an inadequate foreign currency reserve. [9] However, other countries such as the UK and The Netherlands were forced to use taxpayer money in order to compensate losses sustained by their citizens who held savings accounts with banks in Iceland.[10] Although effectively relieving Iceland of a substantial debt obligation, any credit worthiness the country experienced was quickly eliminated.[11] In only three days, ninety-seven percent of the country’s banking sector had failed, and the remainder of the stock market fell eighty percent. [12]By shifting losses to the countries where the foreign investors resided, Iceland retained the necessary capital to insure the domestic deposits of its own citizens – a key component in setting the stage for its recovery.[13]

A second unique feature of Iceland’s recovery involved the sentencing of responsible financial players.[14] Thirty-six bankers, mostly directors of the previously mentioned banks, were sentenced to a combined prison sentence of ninety-six years in prison.[15] Although the sentences are mostly nominal in length, the act symbolized closure of a devastating event for citizens in Iceland and a future intolerance of any abuses within the banking system.[16] Special prosecutor Olafur Hauksson stated the prison sentences will likely lead to a lesser chance of future scandals.[17] There have been no similar incidents of widespread abuse within the banking system since this event in 2008.[18]

Finally, a weakened Krona – as a result of the collapse of the nation’s economy – allowed tourism and exports to flourish.[19] Combined with a marketing effort to highlight Iceland as a desirable travel destination, foreign travelers were able to leverage the strength of their own currency against the depreciated Krona and double the amount of tourism experienced just ten years prior.[20] This phenomena has allowed the Icelandic government to slowly begin reducing capital control and begin adjusting interest rates; however, some citizens of Iceland still experience a significantly reduced earning capacity.[21] Gross national income per capita was approximately $62,290 prior to 2008, but fell drastically in the aftermath of the financial crisis.[22] Five years later, the gross national income per capita still remained at only $46,350.[23] But with a sharp increase in tourism, consumption of leisure activities, and restaurant dining drove prices to a level unattainable by residents of Iceland.[24] Moving forward, Iceland will need to develop a policy that not only reduces the nation’s debt and increases capital surplus, but also assists in bringing living wages of its residents to levels proportionate with the price increases caused by tourism.[25]

While Iceland’s recovery is, in some circles, considered “textbook” due to its predictable timeline, it is also undoubtedly unique in some ways.[26] A devaluation of one’s currency can result in rampant inflation and higher commodity prices, but Iceland was able to use its weakened Krona and abundance of natural resources to market itself as an attractive tourist destination and a chief exporter.[27] Likewise, opportunities for future abuse within the banking system were mitigated by government imposed capital control on banks and prison sentences for banking executives.[28] Iceland’s ability to navigate future economic terrain will turn on its ability to maintain a sustainable debt portfolio and ensure it’s success in the tourism industry does not come at the expense of it’s own residents.

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[1] Garyn Tan, The 10 Year Recovery, and Lessons Learned from Iceland, Asia & the Pacific Policy Society, (Jan. 15, 2018), https://www.policyforum.net/10-year-recovery-lessons-iceland/.

[2] Anh Nguyen, Case Study: Iceland’s Banking Crisis, Seven Pillars Institute (Jun. 13, 2017), https://sevenpillarsinstitute.org/case-study-icelands-banking-crisis/.

[3] Id.

[4] Tan, supra note 1.

[5] Id.

[6] Nguyen, supra note 2.

[7] Id.

[8] Id.

[9] Tan, supra note 1

[10] Nyuyen, supra note 2.

[11] Id.

[12] Id.

[13] Tan, supra note 1.

[14] Valur Grettisson, 36 Bankers, 96 Years in Jail, The Reykjavik Grapevine (Feb. 7, 2018), https://grapevine.is/news/2018/02/07/36-bankers-96-years-in-jail/.

[15] Id.

[16] Id.

[17] Id.

[18] Id.

[19] Karin Hammar, IMF Survey: Iceland Makes Strong Recovery from 2008 Financial Crisis, International Monetary Fund (Mar. 13, 2015), https://www.imf.org/en/News/Articles/2015/09/28/04/53/socar031315a.

[20] Gwladys Fouche, Iceland's Tourism Boom Fuels Recovery, Lays Bare Locals' Plight, Reuters (Jun. 13, 2016), https://www.reuters.com/article/us-insight-iceland-economy/icelands-tourism-boom-fuels-recovery-lays-bare-locals-plight-idUSKCN0YZ1H5.

[21] Id.

[22] Id.

[23] Id.

[24] Id.

[25] Id.

[26] How Iceland Dealt with a Volcanic Financial Meltdown, Knowledge@Wharton (Sept. 12, 2018), https://knowledge.wharton.upenn.edu/article/icelands-economic-recovery/.

[27] Id.

[28] Valur, supra note 14.