The Iceman Cometh

It is good to know that the personal is still political, because a major international finance story has linked very closely with my own local politics this week.

In the midst of the excitement over David Cameron opening his mouth and saying something you might have missed the news that European Free Trade Court delivered an important ruling on 28th of this month in the case between those huge bastions of the global economy the EFTA Surveillance Authority and the European Commission.

According to the website of the Committee to Oppose Third World Debt,

'The judgement clearly states that it is not the responsibility of the parent nation of a banking company to cover the costs of the guarantees to their banking system, and the safety net structure must be financed by the banks themselves. This implicitly confirms that the normal liquidation process, as applied to Landsbanki (Iceland mother company) is quite correct when a bank, even too big to fail, has greater liabilities than assets. Which would be the case for most of the big European banks if the toxic assets on their balance sheets were counted at their real value.'

The case was brought on behalf of the UK and Netherlands, whose citizens has been the target of aggressive selling by the Icelandic bank as it began to fail. These loans were not covered by national guarantees, meaning that savers were set to lose all their money. You may recall Gordon Brown's use of terrorist legislation to seek to freeze Iceland's assets to force the country to pay debts its banks had incurred that had already bankrupted it ten times over.

This ruling cuts right to the heart of the decisions of governments in all the world's leading capitalist countries to provide massive bailouts to support their banks, arguing that they had a legal responsibility to do so. Surely this strengthens the case for arguing that debts incurred to fund such bailouts are odious.

And the personal aspect? Well before I became elected to Stroud District Council a very unwise investment of £2.5m was made in Icelandic bank Glitnir. That money was recently returned and has been a windfall in the recent budget-setting period. As Green members of the administration we have been managed to argue for half a million to be invested in a hydro generation scheme at our district council offices.
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The Iceman Cometh

I probably should have divided loyalties about Iceland's decision to get tough with its creditors. After all, the council I am a member of still has £2m tied up in the interminable legal process that always follows a bankruptcy, public or private. But I can't help rejoicing about the escape by the Icelandic people from the debts that their Viking traders pushed them into.

According to a recent Bloomberg article, Iceland's decision to allow its banks to default has done it very little harm - and a great deal of good:

'The island’s steps to resurrect itself since 2008, when its banks defaulted on $85 billion, are proving effective. Iceland’s economy will this year outgrow the euro area and the developed world on average, the Organization for Economic Cooperation and Development estimates. It costs about the same to insure against an Icelandic default as it does to guard against a credit event in Belgium. Most polls now show Icelanders don’t want to join the European Union, where the debt crisis is in its third year.'

Iceland has suffered economically, with a contraction of 6.7% in 2009, but was back to growth last year and is now growing more rapidly than the Eurozone.

The different with Greece is, of course, that it was part of the vast euro currency area, and so could not make decisions in its own national interest. That, and the fact that Iceland is a tiny economy (GDP of £13bn.) and so its people could never have been good for the debt. Greece, by contrast, has a large and skilled workforce who work harder than the Germans. That makes it good for the extraction of value, as do the tasty public assets which are currently being put into a firesale.
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Bringing Economies Down to Earth

What was so disturbing about the recent history of Iceland, and in this it merely represents a microcosm of the globalised economy, is the way that there needed to be no apparent connection between the size of the real economy and the size of the financial economy. Nominally Icelandic businesses could use each other’s collateral to borrow many times more than the country where they were based was worth. But the unravelling of the story demonstrates that this disconnect is more apparent than real.

When the financial intermediaries can no longer borrow the credit consider that the government of the country where the bank is registered has a duty to take on the losses and repay the creditors. Hence when British depositors in Iceland’s banks lost their deposits, Prime Minister Gordon Brown immediately insisted that the Iceland government should repay, leading to a lengthy legal battle the outcome of which is still undecided.

The myth of deterritorialisation was created by the Vikings of various national origins who had found ways to create money from thin air by the process of mutually supportive bank credit. But when the bubble burst the creditors ignored this myth and targeted national governments to support the debts that had been taken on by companies registered in their territories. Far from floating free in a globalised world without governmental authority, those seeking repayment reverted to nationally based legislative frameworks.

The legally enforceable contracts between banks and the national governments who register them are, it seems, still valid in the post-geographical world of globalisation. The lesson that was learned from the collapse of financial institutions, in Iceland and elsewhere, was that geography matters very much indeed.
And beyond the question of where the bank is registered and who should pay, comes the question of how the economic value that the money can make a claim on is to be generated.

Robert Wade has written of the Icelandic economy as Icarus, the Greek mythical hero whose hubris caused him to fly too close to the sun, and who was destroyed by his own arrogance. Following the bursting of the financial bubble in 2008, every economy that has lived through finance creation was forced to come down to earth with a bump. The apparent severing of the link between finance and the real economy was only ever apparent. Now that those who are left holding credit come to make a claim for real goods and services it is the citizens of those countries whose banks generated the artificial financial value who have to pay for it, with their work, and the resources of those countries that have to be exploited to produce those goods and services.
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What Happened to the Icelandic Banks?

I have been following the story of Iceland on this blog for some time. Now an academic paper has emerged which tells in a better referenced form the story told by Gunnar Sigurdsson in his film Maybe I Should Have. It is a story of political corruption, as well as of greed, and of the co-option of regulators by politicians. It is, in microcosm, the story of the financial crises that have swamped Western democracies and left us facing economic depression and massive public-spending cuts.

The paper is by Robert H. Wade and Silla Sigurgeirsdottir and is published in the latest issue of the Post-Autistic Economics Review. Iceland is a classic case because it is so extreme: shortly before the crash the value of its banks was 11 times the size of its GDP. It was a huge financial pyramid standing on a tiny rock, and supported, unwittingly, by its 300,000 people.

Wade and Sigurgeirsdottir include some interesting details about how naive UK savers were sucked into filling the void left when the financial markets recognised the vulnerability of the Icelandic market and withdrew. The banks, Landsbanki and Glitnir, hoovered up the savings of UK investors who did not question the unfeasibly high interest rates and believed the words of the best-buy websites. When the banks went bust our government then repaid these savers for their risky behaviour, and has now sent the bill to Iceland.

There is corruption here as well as stupidity. Even after the collapse of Lehmans three UK local authorities invested £33 million in their Icesave accounts, 'as though their expensively paid finance directors were fast asleep' (p. 65). And as for corruption, following the rule that 'the best way to Rob a bank is to own it', in its last few months of life Landsbanki lent 36% of its capital to a few of its main owners, while Glitnir did the same with 17% of its capital. After years of avoiding the consequences of their actions, several Icelandic bankers are now facing prosecution.

The authors conclude:

'Iceland is the story of Icarus in modern dress. Icarus sought to escape from exile in Crete using a pair of wings fashioned from feathers and wax. He was warned not to fly too close to the sun. But overcome by the excitement of flying, he flew too close, the wax melted, and he tumbled into the sea. As of early 2011 his Icelandic counterpart is still in the water, paddling hard but a long way from land, and the direction of the current is unclear.'

The same conclusion could be drawn for all the post-bubble economies, and of course it is important that we 'learn the lessons of Iceland' in terms of crony capitalism and financial instability. But for a green economist the most important lesson is the need to reconnect finance with the real economy. When finance runs out of control the consequence in unsustainability as well as instability. An economy in a steady state would return money to its proper role as a medium of exchange. As Mary Mellor argues, it is this sort of money we should be moving towards to support a sustainable, provisioning economy. Tweet

Gunning for the Money Men

I'm recently back from the Association for Heterodox Economists annual shindig, held this year in a sunny and astonishingly beautiful Bordeaux. It was the usual hot-bed of vibrant conversation amongst economists who, having long ago eschewed the neoclassical orthdoxy and therefore any hope of an exalted career path, see no risk in embracing and enjoying a plurality of opposing views about economic life.

I had the usual temptation to engage in some impromptu ethnographic research, especially when sharing a meal with a bunch of fellow economists, who use game theory to work out who should tip and by how much, and watching the World Cup semi-final in what the French considered an English pub with a people of mixed nationalities and prejudices was also highly entertaining.

One of the greatest pleasures was meeting Gunnar Sigurdsson, who claimed to have personally overthrown one Icelandic government and be well on the way to destroying a second. This gives you a clue to the sort of person he is, and I imagine that the negotiating skills needed by a politician are well beyond his skill-set. He himself admitted that his greatest mistake was standing for election.

But then, what else are you supposed to do when your country and everybody in its has been put onto the baize cloth by a small number of irresponsible young men? In Gunnar's case what he decided to do was to make a short and entertaining film of his personal take on the Iceland banking crisis and subsequent bankruptcy.

You will not be surprised to learn that the City of London was highly implicated in the fraud, by supporting the Viking Raiders as they bought up a range of high-street names which they could not realistically support. (Surely the purchase of supermarket Iceland was just a little joke on their part?) Gunnar also noted the support by 'respected' economists Mishkin and Portes, who he claims were paid to say that there was no problem with Iceland's stability. In effect, 'the were hired because they were willing to get it wrong'.

I have previously suggested the Icelandic case as an object lesson in what goes wrong when an economy becomes detached from its real, physical base. It seems that the reality was murkier, with a tiny elite corruptly supporting each other in an anti-democratic network that stretches back to the founding of a US military base on the rocky island in 1951. Too many Icelanders enjoyed the good times without asking questions: they have wised up since and Gunnar says that all Icelandic people are now economists, as are many of his best friends!

Gunnar's own journey since his decision to follow the money has involved considerable air miles as he trekked from Guernsey to Tortola in the British Virgin Islands to track down the movement on the non-existent money on which the Iceland miracle was based. There he discovered 600,000 financial companies were registered, with no regulation whatsoever, including 120,000 in just one small office block. His deeper journey of disillusion and loss of trust is one we are all embarking on, whether we choose to or not. Tweet

You Pays Your Money . . .

I'm struggling to understand what has happened with the Icesave debacle. It seems to me a fairly open-and-shut case. A bunch of naive but self-interested investors, egged on by internet and media commentators who made their living from touting risky financial ventures, put their money into banks outside our national jurisdiction. It is the first rule of money that the higher the return the higher the risk. Their gamble did not pay off and they lost their money.

This much makes sense. The bit I find hard to follow is why anybody who did not take the same risk, who did not enjoy the same returns, who invested their own money closer to home, perhaps in a secure, mutual savings institution now has to contribute to recompensing the high-risk investors for their loss. How is this different from innocent bystanders having to club together to repay a drunken gambler for a misguided punt on the National?

Now let's look at it from the Icelandic side. The ordinary people of Iceland have no doubt going about their ordinary business - catching fish, wallowing in hot pools, enjoying mud massages applied by lowly paid Baltic workers, whatever they get up to to keep themselves sane through the long dark winters. They had no democratic control over the activities of their Viking raiders, who sucked massive amounts of capital into their country from the unstable global economy. Anybody daft enough to invest anything significant in a company apparently domiciled in such a minute and wind-blown volcanic island was surely due for a catastrophic fall at some point.

But now these same self-respecting Icelanders are expected to put their hands in their pockets to compensate foreign governments whose foreign citizens made bad choices. And this is no small amount of compensation. If you add together the £2.3bn. offered to the UK government in the latest negotiations and the £1bn. offered to the Dutch and divide the total by Iceland's tiny 300,000 population you soon realise that every pensioner, worker, and child has to find £11,000 to support this compensation. I wonder how many of the individual investors in the UK and Netherlands lost so much.

The prime lesson from the past two years of credit crisis has been that the gains have been privatised while the losses remain with the public. The Icelandic public are rebelling against this law; we should do the same. Tweet

So Long, and Thanks for all the Fish

I feel tempted to begin in the immortal words of E. J. Thribb, 'so farewell then Iceland'. The country has overreached itself and been forced to learn the lessons of hubris. I had a conversation with my son in which I said 'Iceland is bankrupt' and he asked, 'What? The supermarket?'. That is the nature of the global economy - it is quite simply beyond belief.

What is the difference between Iceland and the UK or US? For once, in economics, there is a simple answer to that question: we have reserve currencies; Iceland does not. The viking raiders who bestrode the globe arranging impossible deals failed to grasp this fact about the global economy. Only those who are part of the charmed circle can get away with this sort of behaviour.

In a world of global finance, who is really backing up anybody's savings? If your bank is owned by a country with international clout it will be defended by others when the crunch comes. Iceland found itself left exposed - and rather smartly turned to Russia for help. This leverage appears to have resulted in 'support' from the IMF: the terms of this remain to be clarified.

Iceland is an object lesson in what is wrong with capitalism. Like all capitalist economies it grew exponentially and using debt rather than saved value. It ignored the fact that, with few resources other than hot water and fish, and with a population barely larger than the size of Bristol, it was always on borrowed time in its competition with the big boys of global capitalism.

But let us not be deceived by the 'one bad apple' mantra that is used to explain away capitalist disasters. Iceland was not an economic basket-case - it was just a country that played by the rules of the system without knowing its place and ignoring the crucial rule - if you are not at the top table you have nowhere to go when the creditors come to call in their debts. Tweet