So how did the li’lest economy get frozen first?
How they got there is interesting, and also a pointer to how they’ll get out.
(this is my perspective, from the outside, I am not a financial analyst)
Iceland deregulated in the late 80s and 90s, moving from an economy hinged on a single line of export, to an aggressive modern anglo-american style post-industrial economy, tech heavy, and heavily leveraged making aggressive finanical investments in niche markets.
Iceland got very rich. Or some people did, wealth disparity increased to a level not seen since danish monopoly merchants strutted around Reykjavik.
There was also a lot of trophy investing – big name danish shops (like foreigners buying Harrod’s in the UK), UK football clubs – but the money continued to be made, even off the danish investments after some modern management was introduced and the work ethic improved
So… how did the Icelandic banks get trapped in the current crisis?
The underlying reason is high leveraging, the big investments were made with cheap money – the proximate reason, at least so far, is liquidity not solvency, the money was made but is not churning to serve the loans.
The money… it was reinvested (ok, sometimes in Surrey mansions and very fine bordeaux cellars) and kept out there, not cashed out. So the property and the profit is highly illiquid. The bills were paid, modern style, with rolling lines of credit, not cash reserves. The trigger for the current panic was Glitnir losing their short term lines when Lehmans went under, and because of the US crisis, nobody wants to lend.
So the Icelandic banks are solvent, they own assets, but they are illiquid, they can’t get cash to serve short term obligations.
There is an immediate solution, which is what seems to have been negotiated under the table, because the government just announced there would not be a formal bailout package this weekend beyond extending an individual depositor guarantee – everyone in Europe has to do that, because the Germans blinked and now everyone has to follow suit.
The solution is repatriation of assets to provide foreign currency and cash – in particular the pension funds, which are heavily over capitalized are selling assets and moving money back, and, it has also been suggested to the banks that they should pull back and liquidate assets.
To convince them to do this, which will cause losses because of distressed sales, I presume the government:
a) appealed to the companies patriotism and love of the greater good. Heh, just joking.
b) hinted at restoring 70s era currency controls and banning unnecessary or frivolous purchase of foreign currency
c) pointed out to them that the alternative was bankruptcy, seizure of their assets and eternal scorn of their cousins and neighbours, even if they stayed in the second home in Surrey
This will work, for now, and may work long term – there will be opportunity losses and real losses of profit, but the currency reserves will be restored and people out there will still buy fish, especially since everyone else has destroyed their stocks – so Iceland recapitalizes, with hard cash, over the next decade or two.
An alternative long term solution is to abandon the króna and go into the
eurozone – but, I think that window is closed, it was briefly open and Iceland wouldn’t join, for reasons that hold true. Basically asset owners, merchants and people living on unearned income in Iceland want the Euro adopted, but exporters and labourers would probably be better off without the Euro.
Point is moot though, the EU is not opening any doors, too much risk of those inside deciding to leave…