What can Greece learn from Iceland

13th March 2012

But was this the right thing to do for Iceland's economy, and is this a model for other debt- stricken European nations? What are the lessons to be learnt?

ExpatInBG commented on a post from Mindful Money's economist blogger Shaun Richards: "Yes, a default will be awful for Greeks who depend on government money…But look at Iceland's economy bouncing back with prosecutions in the pipeline for some bank directors. Creative destruction of failing banks and accountability for bankers is what Europe needs."

This month Iceland's former prime minister Geir Haarde went on trial for failing to prevent the country's financial crash. Haarde is the only global political leader to face prosecution over the crisis which engulfed the world economy.

So what happened?

Iceland's top three banks collapsed in late 2008 after years of debt-fuelled expansion – and the country was forced to borrow £6billion from the International Monetary Fund (IMF) and other lenders.

The banks owed more than a staggering six times the country's GDP in debt, and they became insolvent when the world's credit markets dried up. 

They couldn't pay their loans back, and ended up defaulting on more than $85 billion.

This had a multitude of implications. While Iceland transferred domestic loans and savings into new banks, it did not transfer foreign assets and debts into the new banks, leaving them behind.

In two separate referendums, Icelandic citizens voted that Iceland should not have to repay foreign creditors the money they lost when Icelandic banks defaulted. The UK and the Netherlands pushed for Iceland to pay back the $6 billion its citizens lost when Icelandic banks failed.

The UK and the Netherlands sued Iceland for failure to repay these debts in the European Court of Free Trade.

However, defaulting did not cause catastrophe

In the words of the IMF, as reported on the BBC, "the most adverse effects (of the country's sweeping capital controls) have not materialized." 

In fact, Iceland's basic economic indicators are now stronger than countries that received bail-outs.

Iceland's economy will have shrunk 0.75% a year in the 4 year period of 2008-2012, according to the OECD's survey of Iceland. But for comparison, Ireland's economy has declined at a rate just under 2% while Greece will have decline 1.6% a year.

So should Greece let its banks default?

Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York, says in a Bloomberg report: "Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks. Ireland's done all the wrong things, on the other hand. That's probably the worst model."

Paul Krugman praised Iceland for defaulting in the New York Times, saying that it's better off than countries that followed the IMF/EU bailout model to solvency like Ireland did.

Meanwhile, Greece and other Eurozone nations involved in the on going debt crisis should consider taking similar steps to how Iceland handled its crisis in 2008, a former Icelandic investment banker told Business Insider.

The banker said Greece should just go ahead and let its banks default just like Iceland did. "The biggest problem is everyone thinks we can add to government liability and roll it forward."

However, there is no doubt that the Icelandic citizen has suffered. The collapse in the Icelandic krona means that prices for items that have to be imported soared. Icelanders who took out loans in foreign currency have had their mortgages double or triple because of the fluctuation in their currency. Icelanders saw an 18% slump in their disposable income in 2009, according to the BBC.

But how does Iceland differ from Europe?

It's all very well to say that Greece should take note of Iceland's actions, but the countries and economies differ dramatically.

"Too big to fail" didn't apply to Iceland. But perhaps "too big to be rescued" did.

Iceland was not too big to fail. Its population is 329,000, about the size of St Louis. Also, unlike Ireland, Greece or Portugal, Iceland has its own currency – the kronur. Iceland can devalue its currency in a way that Eurozone members cannot.

Icelandic Finance Minister Steingrimur J. Sigfusson said in a Bloomberg report that: "People should be careful when it comes to drawing comparisons between Iceland on the one hand, and Greece, Portugal, Spain and Ireland on the other. Iceland didn't have the ability to save the banks. Trying to rewrite the events that led to that eventuality as some sort of an export product is irresponsible."

There are those who wish to see Iceland join the eurozone. The OECD argues that currency shocks would be easier for Iceland to withstand if it were part of the eurozone.

Yet despite going through a horrific financial crisis, Iceland&#3
9;s economy is expected to experience 3% growth by 2012, according to the OECD

While they are vastly different countries, the point is Greece has to deal with its problems now rather than later.


More from Mindful Money:

Is Germany's economy a perfect storm?

The UK's great depression

Are the Greeks now worse off than before they joined the Euro?

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