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Vol.
8 #2, November 2008
Icelandic Meltdown
The United States has been hit hard by the global credit crisis, but
not as bad as Iceland. The country that last year won the
U.N.’s “best country to live in” poll, with its
residents deemed the most contented in the world, has had to
nationalize its banks and apply for International Monetary Fund (IMF)
assistance. Home to just over 300,000 people and famous for its
cod fishing, hot springs, and volcanoes, Iceland owed its recent high
standard of living to a rapid expansion of its banking sector in the
mid-1990s. Market reforms transformed Iceland from a
conservative, inward-looking country to the home of a new generation of
internationally-educated young business peoples making acquisitions
across Europe. Icelandic banks expanded overseas, investors took
large positions in its high-yielding currency, and foreign firms poured
money into local projects. Over the past decade, Icelanders have
taken advantage of low interest rates offered by the country's banks to
finance rapid expansion beyond the island nation in numerous
industries.
The Icelandic banks were borrowing at the wholesale rate from other
banks around the world and lending at the higher retail rate. The
country’s top four banks held foreign liabilities in excess of
$100 billion, dwarfing Iceland's gross domestic product of $14
billion. When the global credit crisis hit, the highly leveraged
Icelandic banks were unable to maintain the flow of funds and could not
pay off their debts.
Icelandic banks had attracted huge inflows of deposits from British
investors by offering higher interest rates than their counterparts in
the U.K. Since its launch in October 2006, Icesave (a subsidiary
of Landsbanki), attracted U.S. $7 billion in deposits from 300,000
British customers. When Icesave went bust, the British government
was forced to step in and guarantee the deposits of all British retail
investors in Landsbanki and its subsidiaries. The British
government says it plans to sue Iceland to recoup at least some part of
the savings of British customers in Icesave.
The banking situation and the bad publicity have contributed to the
steep decline in value of the Icelandic currency, the krona, which has
last 90 percent of its value since January. The three largest
banks in Iceland - Kaupthing Bank, Glitnir, and Landsbanki - have now
been nationalized. Domestically, inflation is soaring, people are
losing buying power and jobs, and the country can no longer pay for
imports forcing them to search for lenders. Iceland has courted,
and is expecting a $6 billion rescue plan from the IMF, Scandinavian
countries, and Russia. To put this in perspective, the U.S.
bailout plan cost of U.S. $700 billion spread across a population of
300 million amounts to roughly U.S. $2,300 per person. Iceland,
with a suggested bailout plan of U.S. $6 billion, brings the amount
owed per capita to U.S. $20,000.
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