Nothing is as fragile as the financial markets

15.06.2010 hrs 11:14
There are lessons to be learned for everyone from the Icelandic banking crisis

Lessons to be learned from the Icelandic crisis


Björn Sundell´s article in the publication “Kreppa – What We Should Learn From the Icelandic Crisis”, was published by five Nordic think tanks in June 2010.


At some point in time every country wants to show off its importance. Big countries are assisted by their sheer size and can use brute force when they decide to put their mark on history. Small countries like Iceland have to be more careful.


Business expansion is a means for a nation to improve its image, enhance the living standards of its citizens and increase the tax revenue of the state. If pursued wisely, this strategy can be very successful. The size of the nation affects the choice of strategy. Big countries have big companies with great resources, and they may meet misfortunes with a smile. For small countries one mistake can be disastrous.

The rapid international expansion of Nokia and some other Finnish industries in the 1980´s nearly ended in disaster when the companies became too indebted and thorny, with dozens of totally different product lines. Corrections where made in the eleventh hour and today Nokia is an international success. Its stardom improved the image of Finland and benefited the standard of living of the Finns.

Expansion in the financial world is much more dangerous than it is in manufacturing. There is less transparence in the financial markets and processes evolve faster as money moves around the world in a fraction of a second, whereas it takes a year to build a factory. For some reason Iceland chose the fast but dangerous track when the modern Vikings set out to conquer the world.

This book is about the Icelandic crisis and the lessons to learn from it. There are many lessons, as the articles show. I wish to point out one factor which probably better than any other explains why things went wrong. In Iceland, the government, the bankers, businessmen, individual politicians and the central bank together, in great harmony, guided the country on the road to rapid expansion disregarding the risks, apparently with the support of many journalists. This rare form of national consensus is highly dangerous. To transform Iceland into a big player on the financial markets became the common goal for those in power. Nobody was supposed to kill the dream and not even the parliament set any limits whatsoever to this raid into the unknown.

The decision-makers aimed at making the country and/or themselves rich by expanding on the financial markets. By concentrating all efforts and by taking great risks the country experienced some kind of miracle. It took the Icelandic banking sector only ten years to grow from a modest size into something gigantic, corresponding to 900 per cent of GDP before the crash. Iceland tried to do in only ten years something that had taken the Swiss generations to accomplish.

Any driver knows that when he drives much too fast he misses the details on the way.


A special investigation


On the 12th of April 2010 the Special Investigation Commission delivered its report to the Althingi, the Icelandic Parliament. The commission, with the ominous acronym SIC, had got the task of analyzing “the processes leading to the collapse of the three main banks in Iceland”. These three banks in fact formed the banking sector. For political reasons there were no major foreign banks in Iceland. Thus, there were no different foreign business strategies to view, only an all-embracing Icelandic expansion saga that faced no competition in the minds of people.

In its 2,000-page report the SIC lists several reasons for the collapse. Some of them are similar to those recognized in many other countries in recent years. Incentive schemes in banks encouraged risk-taking. High leverage and failure of the supervisory authorities to act in time deepened the crisis.

The report presents other reasons more specific for Iceland, such as the incredible growth of bank lending. The commission notes that the annual growth in lending of the banks´ parent companies was 50 per cent from 2004 until the bitter end. Such a breath-taking annual growth leaves any company susceptible to risk. Another factor mentioned by the commission was the high level of foreign loans in relation to GDP. This high proportion is hardly surprising for a small but fast-growing country with limited resources, but the influx of high amounts of foreign currency made it possible for many Icelanders to live beyond their means. This fact was one reason for the relative popularity of the expansive economic policy of the government.

Highly dangerous was the close relationship between many politicians, business people and bankers – and the general lack of transparency and good corporate governance. The commission notes that the largest owners of the banks had “abnormally easy access to the credit at the banks they owned”. Many owners, thus, used “their” banks whenever they needed funds for their pet projects. The close friendship between the tightly knit and small Icelandic elite, such as representatives of the government and the Central Bank, impaired the control functions of the banking sector. The commission notes the lack of any written records, documents and minutes from several important meetings. The participants obviously knew each other so well and trusted each other to such an extent that they felt no need for any documentation.

Finally, the banks invested a substantial proportion of their funds in their own shares, a procedure that undermined their strength as the global financial markets got shakier. And, as difficulties started to arise internationally, the prime minister, the government, the central bank and the parliament did not react to international signals indicating danger to the Icelandic financial sector. There was, according to the SIC-report, no joint governmental contingency plan available. Things simply could not go wrong.

In short: Influential Icelanders worked together with the aim of making the banking sector strong and Iceland more influential. The press seldom questioned this risky strategy. The living standards of the citizens rose for a long time, which resulted in popular support. And when the alarm bells started to toll, the banks, the government and the central bank felt they were still in control. There was never any need for a plan B.

Or so they thought. The Icelanders lived in a different reality.


Five lessons


Today several small countries are fighting off the effects of the financial crisis – Iceland, Greece, Ireland and many more. All cases are unique, because important domestic factors interact with the international ones. What, then, should the international community learn from the Icelandic crisis?

The first lesson is that very fast growth tends to be hazardous, because at top speed the details get blurry and the vehicle easily runs out of control. As a goal for a business organization several years of double-digit growth is risky both for those who pursue it and for others in the vicinity.

The second lesson is that small countries ought to encourage debate when designing their growth strategies. Otherwise those criticizing the strategy will be too easily silenced in close-knit societies and, accordingly, only one universal truth will prevail. Small countries with small resources must be careful with expansionary strategies, because they may not be able to afford a second try.

Thirdly, small nations may lack some of the expertise necessary for international expansion. A country should not grow faster than the human resources allow.

The fourth lesson points at the danger that looms in the lack of foreign competition. This reduces the number of alternative views and paves way for a local brotherhood that nobody dares to question.

The final lesson concerns the popular vote in Iceland regarding the responsibilities of Iceland´s taxpayers with respect to the Icesave affair. The March referendum gave the citizens a vote on banking affairs. Will the bankers of the world see the sign in the sky?


The taxpayers’ dilemma


When times are good and profits are growing bankers want to expand internationally and wish to know nothing of national borders impeding growth. When times turn bad and banks start stumbling, national borders matter again and the local taxpayers are called upon to clean up the mess. This we have seen time and again during the banking crises of the past, and we see it now in Iceland.

Taxpayers seldom have a choice, because supporting the banks is considered to be a lesser evil than accepting bankruptcies and experiencing the pain of a bank run. Therefore, governments automatically use the taxpayers´ money to support banks in dire straits.

In the case of Iceland the issue became more complicated than usual, partly because of the huge size of the banking sector in relation to GDP and partly because of the need to repay Britain and the Netherlands the 3.9 billion euros lost in the failed Icesave bank. There was considerable opposition among the people of Iceland. The economic burden was considered too heavy, the terms of the deal grossly unjust. Iceland’s president Ólafur Ragnar Grímsson triggered a referendum when he blocked the law defining the terms of repayment and the responsibility of the Icelandic people. The situation was unique. Suddenly there was a display of people power against economic injustice. The taxpayers got the chance to say no to cleaning up the mess the bankers had created.

Well, the people had a choice in theory, at least.

An overwhelming majority voted “no” to the deal. Of course this will only slightly change the course of the repayment process because in the end the Icelanders cannot defy the will of powerful creditors. They can only get a better deal.

The important lesson here is that a nation can question the traditional procedures. In the future bankers and governments cannot be sure of the taxpayers´ willingness to take full responsibility for the clean-up process if it seems to become very expensive.

A people who votes “no” to supporting the banking system will not escape the pain. On the contrary, a financial meltdown will be extremely painful for everyone. But the fear of a future popular uprising should make today’s bankers think again before embarking on new risky, expansionary raids.

The population of tiny Iceland has spoken. Listen carefully, bankers!
















Björn Sundell


Head of Research at think tank Magma, Finland, 2009-2015. Mr. Sundell (M.Sc.,Econ.) has previously worked as editorial writer and business editor of Hufvudstadsbladet, the main daily paper in the Swedish language in Finland. He has held positions as communications manager in industry (Wärtsilä Corporation and Abloy Security) and banking (Nordic Investment Bank). He has also been a business journalist in various kinds of media - television, radio, magazines and newspapers. Mr. Sundell is the author of two books.

Björn Sundell