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Debt and the People, Part I: The Cold

posted by Anna Gelpern

In earlier posts, I considered two trends:  first, the eroding boundary between chronically defaulting sovereign and risk-free government debt; and second, the comfy symbiosis among feckless rules, fudged government accounts and basic financial engineering.  I also considered the politics of erosion and symbiosis.  In this post and the next, I move to a third trend, perhaps the most overtly political of the lot: the resurgence of popular input in national debt matters.  The latest exhibit in this trend is Iceland, whose money troubles gave Michael Lewis the opening to set Beverly Hillbillies in Lake Wobegon.  The immediate predicate for this post is last weekend's referendum, where over 93% of the voters rejected a plan for Iceland’s government to guarantee payments to the United Kingdom and the Netherlands, compensating them for compensating their nationals who lost money in Icelandic internet bank accounts.  Curious referendum factoids include that (a) the deal voted on had long been superseded, and (b) “yes” votes came in third after empty ballots.  But the back-story is serious, complicated and revealing.

[The following background is mostly a lite retelling of the material in these two IMF staff reports, with my editorial asides.]

Over the bubble decade just past, Iceland’s banks borrowed money from all over the world and invested it in overpriced, increasingly loopy assets.  Reasonable readers might ask why anyone put money in, say, an internet banking outfit called Icesave.  There are two answers:  (a) why not (it was a branch of Iceland's top bank), and (b) it paid.  When Japan kept its interest rates low to grow its economy, you could borrow yen for free and invest the proceeds in Iceland at over 15%.  This was the über-bubbly “carry trade” (where “carry” is the return on holding the asset, not the act of carrying yen to Iceland).  And it was not just for prop traders with fancy screens; scores of regular citizens, with the Brits and the Dutch in the lead, carry-traded away … until the music stopped in October 2008.  When it did, Iceland’s banking sector was nine times the size of its economy, with huge domestic and foreign deposit liabilities.  The rest of the private sector was similarly massively over-indebted, notably including FX-denominated mortgage liabilities in the household sector.  Oh, and the Icelandic currency tanked, which made already unrealistic foreign currency debts unfathomable.

The government quickly intervened in the top three private banks, which represented about 85% of all banking assets going into the crisis and imposed capital controls, along with moratoria on foreclosures and FX mortgage repayments, among other measures.  But there was not nearly enough money in Iceland’s deposit insurance fund, and not enough cod in the sea to make good on all those deposits, not to mention other creditors, who normally take after the depositors.

And so Iceland did what most governments do, but rarely admit to doing:  it split up the banks into domestic (new) and foreign (old); put the old in liquidation proceedings, and proceeded to recapitalize the new.  This meant that foreign creditors, notably depositors, felt ill-used.  The British government first responded with Duck-Soup-worthy diplomacy, invoking anti-terrorism laws to freeze Icelandic assets, and prompting this early episode of video-democracy, which has since grown into an impressive movement culminating in the referendum.  In the end, the British and Dutch authorities could not afford to see their voters stiffed (so much for market discipline for retail deposits), and paid them off out of their own coffers, acquiring something of a claim against Iceland.  This is where it gets complicated.

Under EU law, members of the European Economic Area are responsible for supervising and insuring European branches of their deposit-taking institutions.  I have no view on matters of EU law, but Michael Waibel points out that it is far from clear that EEA member responsibility goes beyond establishing a deposit-guarantee scheme.  Funding the scheme, especially funding it to absorb losses of systemic proportions, is another matter.  So from one angle, the U.K. and the Netherlands might be holding claims against an unfunded shell, and negotiating for mercy with an already over-indebted government determined not to assume private liabilities.  At best, they might get a government guarantee to backstop what would become a long-term loan to the still-bankrupt deposit insurance fund.

But there is another angle.  Iceland has a stand-by program with the IMF, which—as all IMF programs—requires “financing assurances”.  This means that before the program is approved and the money is disbursed, the numbers must add up.  And for Iceland’s program to add up, they need to get funding from certain Nordic creditors, whose disbursements are in turn contingent on the resolution of the Icesave dispute with the Brits and the Dutch, which gives the latter quite a bit more leverage … unless Iceland or the Fund can come up with alternative funding sources.  (I will not go into the additional Euro accession angle, which is further complicated by the ongoing Euroworld mess.)

For now, domestic politics seems to dominate on all sides.  Iceland’s President vetoed the law approving the terms reached at the end of last year, and put the deal to a referendum, where it died … except that the negotiators had already agreed on more favorable terms for Iceland, including a lower interest rate and seven years’ grace.  Nevertheless, the talks have broken down.  On the other hand, the economy is sort of picking up, and private debt negotiating is going on here and there, complete with tensions over payment priority between depositors (and their successors) and non-depositor creditors.  Meanwhile, two out of the three “old” banks now in resolution proceedings have managed to buy the new banks.  (Don’t ask.)

Taking a step back, the Icelandic saga is worth watching for at least two reasons.  First, it highlights the way in which apparently private liabilities are really contingent fiscal liabilities, especially in banking, and especially in crisis.  (Dubai, which I may not have time to cover in the series, offers another twist with the debts of a state-owned enterprise that benefits from the presumption of separateness from general government operations.)  Second, the referendum is marks a new inflection in international debt politics.  It is different from our own debt clock and its permutations, which express generalized discontent with the level of public debt, not objections to the terms of a particular debt deal.  It is also different from the familiar IMF riots (a rather lurid take here), and today's Greek demonstrations, which go to economic policy conditionality, not debt terms as such.  And it is different from popular participation in the debt relief movement on the Jubilee model and those that came before, because it is primarily trying to block the government from incurring particular debt obligations to begin with, not seeking their reduction after the fact.

This move to specific, ex-ante direct popular approval—perhaps only possible in a country half the size of Washington, DC—adds a fascinating twist to the debate about legitimacy and responsibility in sovereign borrowing, to which I will return in the next post.


Country is swimming in debt - from corporations to consumers. Perhaps a national campaign to reinvent how Americans view money is required. THis entire spend at all costs view is what got us in this disaster in the first place.

Unless your definition of a "regular citizen" is limited to only the wealthy and well-connected, I beg to differ with the following statement:

"And it was not just for prop traders with fancy screens; scores of regular citizens, with the Brits and the Dutch in the lead, carry-traded away … until the music stopped in October 2008."

I am sure you did not mean to suggest that the ordinary Icelandic cod fishman (or British fish and chips shopkeeper) has even had the ability and credit to "borrow in yen". No, this is a game available only to the rich and well-connected. Oh, and let's not forget that these very same people were making their deposits in Guernsey Icesave accounts to avoid British taxes. Yes, I know they all claim to have paid their taxes in full, but it is common knowledge that such accounts are used to dodge UK taxes.

So the UK and Dutch government paid off wealthy tax cheats and are sending the bill to either the fish and chips shopkeeper (if the fisherman won't pay) or to the fisherman. Brilliant! While those working class stiffs lob political missles at each other, the Icesave depositors slip away quietly to Japan, where they repay their zero percent loans.

Jeffrey, thanks for your comment. I do mean regular citizens. See eg, below from The Times at http://www.timesonline.co.uk/tol/news/uk/article4905923.ece:

More than 300,000 British customers had around £4 billion deposited in Icesave accounts, with the average saver having about £15,000 with the bank. Some had much more than this, though. One saver, Peter Amodio, has told The Times that he had £180,000 on deposit with Icesave. Another saver had her £200,000 life savings there.
Steve, 48, a textile management agent from Derby, central England, said: "My wife and I need to pay up to £12,000 for renovations on our bungalow next week and I have no idea if we’ll be able to access our money to do so.

"I’ve been panicking this morning and I can’t concentrate on my work. I’m worried we’ll lose all the money if the Icelandic government doesn’t have enough in its coffers to guarantee everyone’s savings."

More similar stories in this WSJ report: http://online.wsj.com/article/SB123032660060735767.htm. And here are two stories about local government investments gone bad in Icelandic banks: http://www.independent.co.uk/news/uk/politics/councils-blamed-over-iceland-savings-1702152.html and http://www.independent.co.uk/news/business/news/article1843367.ece.

Of course most of this looks like straight up GBP taking advantage of higher interest rates offered by Icelandic banks looking for FX funding. However, there was also reporting of retail transactions in Yen and Swiss Francs. Cross-currency investing at the retail level is more common and accessible in some countries than in the United States. Of couse we have our own nightmare stories, especially of municipalities stuck in complex cross-border cross-currency deals that ended up right back in our own problem mortgage pools.

Iceland could be a beacon of light in the darkness if they reject this international debt which has been foisted on them by international banksters. Pick up the movie Zietgiest (you can download it free from the web ) to see what debt is really all about. Just a few questions:
1. What did the people of Iceland gain from those investments? That's right, absolutely nothing. So why should they pay when things went awry? If you're a truck driver (I am) and someone gambles on the debt market, do you really expect truck drivers (or anyone else) to pay for someone else's mistakes. Shit, if I make a mistake it could cost me my life, and frankly I don't want to make one because I'm worrying about paying even more taxes to support people/governments I don't even like in the first place.
2. What is the good of having a vote on something if it is not binding? I live in a country (Canada) where the only thing we get to vote on is who our 'leaders' will be; but it's not us who elect them - it's the media, who are controlled by big money and give not one damn about our interests. I think it is the same in the States.
3. If the people of Iceland agree to pay this debt, are they going to get anything out of it? Better roads, better education, better health care? No? Then don't pay it! Look at yourselves, if you please, as a corporation - your history, your culture, your reality... Why should you vote to impoverish yourselves for the superficial acclaim accorded you in a controlled media which will pass in the blink of an eye? Just asking.

In case you think I am out to lunch here is a link which may be of interest:

Let's go a step further; I don't know how it is in other countries, but here in Canada if you bank with a credit union, your deposits are guaranteed; not just up to 60,000 like with the banks, but for whatever you have invested in your credit union. Surely it can't be that much different in England?
And while I'm on the subject, who in their right mind would agree to pay interest to a foreign corporation when they could agree to pay interest to a community owned bank which had the interests of that community uppermost in their agenda?

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