The International Financial Crisis: the Case of Iceland – Are There Lessons to Be Learnt? Jón Baldvin Hannibalsson

Working Papers on Global Financial Markets

No. 3

The International Financial Crisis: The Case of Iceland – Are there Lessons to be Learnt? Jón Baldvin Hannibalsson

GLOBAL FINANCIAL MARKETS

University Jena Carl-Zeiss-Str. 3 D-07743 Jena

University Halle Universitätsplatz 5 D-06099 Halle

Tel.: +49 3641 942261 +49 345 5523180

E-Mail: [email protected] www.gfinm.de January 2009

Working Papers on Global Financial Markets No. 3

The International Financial The ratings companies (Moody´s, Crisis: The Case of Iceland Standard and Poor´s etc.) moved swiftly to downgrade the creditwor- – Are there Lessons to be thiness of the Icelandic state, reflect- Learnt? ing the view that it was beyond the goverment´s means to stand by the banks´ obligations. The risk sur- I. Introduction charges imposed on loans to the Ice- landic banks rose sharply. The Ice- On Monday morning September landic bank system was teetering on 29th before the opening hours of the brink. Thus started a week that banks, the government of Iceland ended in the collapse of the entire (GOI) announced that GLITNIR, financial system of Iceland. one of Iceland´s three major commercial banks, had been national- On Monday October 6th the GOI ized. A few weeks earlier the finan- rammed a special emergency legisla- cial supervisory authority of Iceland tion through Althingi (Parliament). (FME) had given the bank a clean It gave extraordinary powers to the bill of health. What had happened? FME (Financial Supervisory Board) to take over the running of the A few days earlier, the chairman of banks. To avoid a run on the banks the board and the director of the law stipulated that all savings GLITNIR had secretly met with deposits with the Icelandic banks the Central Bank directors to tell were fully guaranteed by the gov- them that GLITNIR was in trou- ernment. The National Bank of Ice- ble. Although GLITNIR had long land (Landsbankinn) was next in line term contracts for refinancing their to declare insolvency. The National short term debt - a significant part Bank had branches abroad, in the had been with Lehman Brothers. U.K., Holland and elsewhere. The Now, Lehman Brothers no longer British government moved swiftly to existed. GLITNIR, therefore, was freeze their assets in the U.K. in or- in desperate need for foreign cur- der to safeguard their citizens´ inter- rency. Having rejected collaterals ests. By this time all Icelandic com- offered on GLITNIR´s behalf the panies abroad were under a cloud of Central Bank, in consultation with suspicion. The British government the government, decided to buy went so far as to apply the recently majority share in the bank. adopted “terrorist-law” to take over British registered companies owned Evidently, the Central Bank reck- by the Icelandic banks, including the oned that this action would reassure third and biggest Icelandic bank, the markets and restore confidence Kaupthing. The government of Ice- in the Icelandic banks. By hind- land (a NATO ally) and both the sight, they evidently miscalculated. Icelandic banks operating in London,

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were under this law blacklisted unrealistic. In the phase of easy ac- along with al Qaeda and other ter- cess to cheap money from abroad, rorist organizations. This was the double digit Central Bank rate last straw. Kaupthing fell and with turned out to be not only ineffective it the entire financial system was in in restraining inflation but had the ruins. unintended side effect of strengthen- ing the value of the króna. This had many adverse consequences. It II. Roots of the problem: Compla- stimulated excessive imports, con- cency and Exuberance sumption and debt accumulation as well as a balance of trade deficit, that The American bank crisis (with the spiraled out of control. When the fall of Lehman Brothers) can be interest-rate differential between Ice- said to have been the spark that land and abroad reached double digit ignited the fire that consumed the numbers, speculative capital started financial system of Iceland. Nont- flowing in, collecting quick profits in heless this national disaster can only currency speculation. This further be fully explained in terms of do- strengthened the exchange rate and mestic Icelandic policies of the past the imbalance of the overall econ- few years. Most economists agree omy. that coordinated macro-economic policy to restrain an imbalanced When foreign speculators, sensing economy had been conspicuously imminent danger, started withdraw- lacking. The government presided ing their money, the value of the over a major investment boom in króna fell. Collapse is actually a bet- the energy sector as well as letting ter word to explain what happened. loose a real estate bubble through From the beginning of the year 2008 easy credit. A rapid rate of growth until the fall of the financial sytem in (3.6% per year on the average since October, the value of the króna had the turn of the century) fueled by fallen by 70%. For a while the króna foreign loans and unrestrained con- was no longer an officially registered sumer spending, was reflected in currency and could only be traded in explosive balance of trade deficits. the black market. Iceland is thus suf- fering a twin crisis: A bank-crisis and The expansion of the public sector a currency crisis at the same time. And (from 36% to 48% of GNP during of those two, the currency crisis is the the boom) under a conservative more devastating. government, was a world record. The Central Bank since 2001 declared a floating currency regime III. Iceland and Ireland: A fateful and pretended to restrain inflation difference within 2.5% limit, plus or minus 4%. This turned out to be totally In this context it is interesting to

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compare the fates of the sister is- Else we might have been in the same lands of Iceland and Ireland. Both situation as Iceland”. He is right. Of island economies had been enjoying all the fateful policy mistakes made by sustained periods of rapid economic the GOI and Central Bank of Iceland growth. In both countries eco- in recent years – and they are many – nomic growth had been fueled by a the stubborn resistance against joining steady influx of foreign capital in- the European Union and adopting the vestments. In both countries the euro, were the gravest. real estate boom spiralled out of control and turned into a bubble. It is beyond doubt that had Iceland In both countries the standard of been a member of the eurozone rely- living and the level of consumption ing on the European Central Bank in exploded. Both economies were addition to the domestic authorities, thus feeling the strain of overheat- Iceland would not be in such dire ing. But that is where the compari- straits as it finds itself in now. Of son ends. The big difference is that course the Icelandic banks could Ireland is a member of the Euro- have gotten themselves into trouble pean Union and a partner in the none the less, just as individual banks European Monetary Union, using within the eurozone certainly have. the euro as a national currency. But it was not the lack of Icelandic Iceland, on the other hand, has krónur that made the Icelandic banks been experimenting with its own ultimately insolvent. It was the lack of króna, within the smallest currency foreign currency – euros – and the fate- area of the world, in an environ- ful weakness of the Icelandic government of a free flow of capital under ment and the Central Bank, that a regime of wide open financial caused the crash. markets. This has turned out to be a world of difference Had Iceland been a member of the European Union and a eurozone part- When the Icelandic commercial ner as well it would not have escaped banks expanded from having been the impact of the international finan- one third of the Icelandic GNP cial crisis any more than Ireland. But into becoming twelve times the it would not have been the helpless vic- GNP, the GOI and the Icelandic tim of both a bank – and currency Central Bank were unable to pro- crisis at the same time. This is the ma- vide the necessary back-up. The jor lesson to be learnt from the case of banks had grown too big for Iceland; Iceland, both for the Icelanders them- or Iceland was simply too small for selves and also for the smaller nations the banks. This explains why the within the EU, still trying to fend off Irish taoiseach, Mr. Brian Cowen, the impact of the financial crisis with said: “Thank God that Ireland is a their weak national currencies. member of the European Union and has long ago adopted the euro.

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IV. After the Crash: The Plight of heavier and bankcrupties are increas- a Nation ing daily. Unemployment – un- known in Iceland since the early Before the crash Iceland was classi- nineties – is rapidly spreading. The fied in OECD statistics as the 6th pensionfund system – a bastion of most affluent nation on earth in strength in the Icelandic economy – terms of per capita GNP. The crash suffered heavy losses through the fall will change all that. The question of the banks. Hard won pension remains if the debt burden will turn rights will foreseeably be severly cut. out to be way beyond the nation´s But the youngest generation – the ability to pay so that it will cripple best educated in the history of Ice- recovery through economic growth land - will be most severely hit by the any time soon. The immediate con- crisis. They are the most indebted sequences of the fall of the banking ones and they will lose their jobs dis- system are that the shareholders proportionately. Young professionals have lost their overvalued equity. are already seeking jobs abroad. The most severe long-term consequences But the crash of the currency has of the crash will be emigration of the immediate and severe consequences young – the best and the brightest. for the nation as a whole. Import prices are increasingly inflated. This is reflected in the consumer price V. A Failure of Preventive Action index (the measurement of inflation). Since all long-term loans in The rapid expansion of the Icelandic Iceland are price indexed, any infla- banks, coupled with the evident vul- tionary spurt is permanently pro- nerability of the króna, should have jected through every houshold sent strong warning signals to the mortgage. Foreign currency de- government and the Central Bank of nominated loans will double in a Iceland several years ago. What were short space of time. For heavily the options? One was to expand the indebted firms and households, this Central Bank´s foreign currency re- is beyond their ability to pay. And serves commeasurate at least with the the fall in real estate and other asset banks´ short term debt. This would prices precludes the possibilty of have been a very expensive solution relying on liquidity of assets as a as well as a risky one. Later, when solution. access to cheap money abroad became more difficult, this solution was An IMF stipulated bank rate of no longer feasible. 18% makes this debt burden unsus- tainable. The shock effect is being Another solution would have been to felt immediately throughout the have the banks, or at least the bigger economy: Purchasing power is fal- ones, relocate their headquarters to ling, the debt burden is getting the euro-area. Approximately 4/5ths

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of their activity was by then outside heavily indebted. Although the Ice- of Iceland, mostly within the euro- landic state was at that time relatively area. This would have removed the debtfree, Icelandic banks and house- present currency risk and brought holds were hugely indebted. Hence, the banks under the savings guaran- the rating agencies imposed heavy tee system of the relevant central risk-surcharges on loans to Iceland banks as well as secured the support which in the end became prohibitive. of the European Central Bank. Al- Ultimately the rating agencies down- though this issue was raised in pub- graded the credit- worthiness of both lic dialogue it was never seriously the Icelandic banks and the State as contemplated by the authorities. well. By that time, by mid-year 2008, Iceland had no option left but to The third option was for Iceland to seek help from abroad. join the European union and to seek fullfilling the Maastrict criteria Appeals for loan guaranties were for adopting the euro. This option made to the Nordic Central Banks, was never politically feasible due to to the Federal Reserve, the Bank of the anti-European instincts of the England and even to the European Conservative Party´s leadership Central Bank in Frankfurt. But by which was, and still is leading the this time Iceland was considered “too government. Their euro-sceptisism hot to handle.” The banks´ size is in part inspired by their soul- compared to the Icelandic economy mates among the British tories, in and their scale of indebtedness was part by the influence of American considered extraordinary and suspi- neo-conservative ideologues, who cious. After consultations the GOI look upon the European Union as was advised to seek help from the some sort of a socialist conspiracy, IMF. and in part by their nationalist heri- tage. The first perfunctory analysis of the Icelandic situation did not inspire By the year 2007 the warning sig- confidence in the capacity of the Ice- nals were already flashing both at landic government or Central Bank home and abroad. The American to handle the situation. Under the bank crisis, initially due to reckless circumstances an IMF rescue-plan subprime mortgage lending, was for Iceland was considered a precon- spreading fast. The fall of Northern dition for help from other central Rock in the U.K. was a milestone. banks. Thus Iceland became the first Access to cheap money for refinanc- so-called developed country to seek ing short-term debt was no longer shelter with the IMF in 36 years. easy. The rate of interest was rising. There was no other option left open. Ultimately the rating agencies had a Since then other European countries second look at countries and finan- have had to follow into Iceland´s cial institutions that had become footsteps. By now the IMF has be-

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come a major player on the interna- to borrow in the market. The Ice- tional scene in dealing with the landic fund had nowhere near the international financial crisis. resources required to guarantee all the savings deposits in the Icelandic banks´ subsidiaries abroad. The rele- VI. The Ice-save Dispute: David vant EEA-directive stipulates a vs. Goliath minimum amount (20.887 euros) to be guaranteed to individual savings Iceland´s appeal for help to the depositors. IMF, urgent as it was, was none the less delayed for many weeks. The This raised several questions for legal reason was the so called “Icesave” - interpretation: Was the amount dispute between the Icelandic and guaranteed actually dependent on the the U.K. governments. What was at fund´s resources? Or was it the issue? The National Bank of Ice- minimum amount defined in the land (Landsbankinn) had estab- EEA-directive? Was there an effective lished branches in the U.K. and in state guarantee, although it is not Holland, offering a competitive rate clearly defined in the text of the di- of interest for savings deposits. rective? Did the directive apply only Other Icelandic banks did the same when individual financial institutions but in the form of daughter com- failed or was it meant to apply as well panies that were under the surveil- in the case of total collapse of a na- lance authorities and savings guar- tional financial system? What about antee system of the relevant coun- national emergency rights? These are tries. This was the Icelandic Banks´ some of the impertinent legal issues method to solve their liquidity raised in this dispute. Also, the U.K. problems in foreign currencies. government´s application of the “terrorist–law” against Iceland, which When the Icelandic banks went ultimately brought down the Ice- down, the question rose immedi- landic financial system, raised the ately who should guarantee the sav- question of the legality of the U.K. ings deposits. Under the EEA- government´s action and indemnities agreement bank branches abroad in case they were deemed illegal. are under the surveillance authority and the savings guarantee systems The Icelandic prime minister initially of the home country. Each country insisted that the two issues, the Ice- is obliged to run a savings guarantee save dispute and Iceland´s applica- fund which is financed by contribu- tion for IMF support, were unre- tions from financial institutions. lated. He even gallantly declared that This fund is an independent entity he would not submit to British without a formal state guarantee. If threats on this issue. Instead he of- this fund had insufficient money to fered to have the issue solved by in- stand by its obligation it was meant dependent arbitration. In the end it

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was France, in her capacity as act- of this sort. The IMF calculates that ing presidency of the European Iceland´s debt burden in the wake of Union, who solved the issue. Ice- the crisis will amount to 80% of land was simply told that the EU GNP. This is many times the would prevent the implementation amount Sweden had to borrow to of the IMF rescue-plan, unless Ice- bail-out the banks, as a percentage of land accepted to pay the minimum GDP, during Sweden´s financial cri- guarantee as defined by the EU sis in 1992-95. directive, and decreed by the Commission. The IMF, it seems, takes it for granted that the Icelandic banks´ At the same time the EU made sure assets, meeting their debts, will main- that Iceland would receive loans tain their nominal value after the that enabled the government to pay crash, despite weak markets. This is up. The EU argument was that any hardly realistic. Some of those assets doubt shed on the validity of the have already been sold at fire sale EU-wide savings guarantee system prices. The global recession is also could undermine the stability of the negatively affecting such asset prices. financial system of the EU as a Thus authoritative chartered count- whole. Also, Iceland was told that ants reckon that the outstanding as- since the government of Iceland sets of the National Bank of Iceland had in the emergency legislation of have by now lost half their value. October this year guaranteed all savings deposits of Icelandic citi- The Icelandic authorities are still in zens, the same rule should apply to the process of sorting out the net all citizens of the EEA-area. Non- position of the bankrupted banks discrimination on the basis of na- and negotiating with their foreign tionality is a fundamental rule that creditors. The overall picture is applies without exemption therefore far from clear yet. But the throughout the EEA area. worst case scenario, taking into ac- count expected discounts in asset prices and a serious contraction of VII. A Crippling Debt-burden? Iceland´s GNP indicates, that the debt burden may reach one and a This settlement raises two funda- half GNP. This would amount to a mental issues: One is if Iceland´s per capita debt burden at least twice debt burden in the near future will the per capita debt burden for Ger- be beyond the country´s ability to many after World War I. In the case pay and thus destroy the country´s of Germany, the post war debt bur- prospects of recovery any time den imposed by the victors was so soon. The other is the classical issue heavy as to cripple the German of moral hazard that always presents economy for many years, leading to itself in the wake of financial crisis hyper-inflation and political up-

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heaval that in the end led to a new entire country is already down and world war. In the case of Iceland out. The question is: Why should Ice- the consequences may not be so far landic taxpayers be forced by foreign reaching. But they may be tough governments or international institu- enough to kill off any hope for re- tions to pick up the bill left over by covery in the near future. Icelandic venture capitalists? The answer seems to be, because they have no other choice left – apart from VIII. Moral hazard: Private gain – emigrating. That is actually what a Public loss sizeable proportion of the younger generation of Icelandic professionals In economic theory hefty gains is preparing to do. Iceland is now in from risky investments are justified the not so enviable position to be at as a reward for venturing capital the mercy of the IMF. under uncertain circumstances. High risk brings generous rewards because the danger of loss is ever IX. Enter the IMF: A Rescue-Plan present. This means that when or Collective Punishment? risky investments fail, the investors themselves should cover the loss. If During the last two decades both the not, the entire capitalist system is World Bank and the IMF have been undermined by moral hazard. Why working under the heavy infulence of should any investor remain pru- the so called “Washington Consensus”. dent, or even play by the rules, if he This means they have been guided by can count on others, i.e. the tax- the neo-conservative ideology that payers, to come to the rescue? In the state is always a part of the prob- the United States, the present-day lem but never a part of the solution. citadel of capitalism, the funda- Countries should for their own bene- mental rule applying to bail-outs of fit open up for free trade and free venture capitalists is, that since they capital flows, without any restraint or enjoyed all the profits, justified by government interference. All prob- risk, they should also bear the bur- lems should be left for the markets to den of failure. The big exception is solve since they are also by nature when the failing capitalist is big meant to be self-correcting. Those enough to threaten to bring down countries that play by the rules will the whole system with him. This is be rewarded by dynamic innovation what happened in the case of Long and rapid economic growth, that will Term Capital (LTCM) in 1998 gradually trickle down to the general and it has applied to a few cases in public. Those countries that disobey, the current crisis. will be punished by stagnation and unemployment, since they will turn This justification does not apply to out to be non-competitive in the Iceland. The financial system of the global market place.

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Many of the poorest countries of taining some hope that they had the world have, because of heavy learnt from their mistakes. In the indebtedness, been forced to accept current crisis it is remarkable that no this medicine. The ideological developed country has applied the prejudice against the proper role of standard IMF austerity medicine. On the democratic state in economic the contrary Governments are com- developement has led to a serious peting with each other in administer- neglect of investment in infrastruc- ing stimulative packages, based on ture and human capital, making deficit spending, and even resorting domestic production hopelessly to outright nationalization. The rich non-competitive in the face of im- world is certainly not practising what ports, leading to balance of pay- they have so far preached to the ments problems and further in- poor. debtedness. Far from keeping the promise of economic growth, those Since Iceland is the first so-called countries have been locked up in a developed country that has ended up vicious circle of stagnation, deterio- under IMF tutelage in 36 years, there rating living standards, and general is every reason to ask: Has the IMF misery. learnt from its past mistakes? The answer, it seems, is both yes and no. In the case of the Asian crisis 1997- The three pillars of the rescue- 98 the IMF applied its austerity program for Iceland are the follow- program to the countries inflicted ing: (1) To stabilize the exchange by massive capital flight. The main rate. (2) In the name of “safeguard- pillars of the program were a steep ing international relations” to force rise in the bank rate (to prevent Iceland to pay foreign creditors more capital flight and maintain the than strict legal obligations would value of the currency) and a fiscal demand, according to the govern- austerity program, involving deep ment view. And (3) to impose “a cuts in social expenditure, both for medium-term fiscal sustainability”. investment and welfare. It is gener- Remarkably, the IMF has accepted ally accepted that the IMF misread the fact that the Icelandic króna has the situation and applied the wrong lost all credibility. In relaunching it medicine. In the case of South- they therefore allowed “capital out- Korea for instance, the program flow restrictions” in the near term. failed to prevent capital flight and This is realistic. But imposing a Cen- maintain the value of the won (it tral Bank rate of interest of 18%, said fell by 49%) and it made the eco- to be necessary to maintain the value nomic and social situation much of the króna, and to keep the re- worse than was needed. mainder of speculative capital still within the system, will only make a Later on the IMF formally apolo- bad situation worse. gized for their mistakes, thus enter-

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The Icelandic economy is by now consequences. The government re- in a deflationary spiral. Raising the acted helplessly to events rather than rate of interest beyond 20% will initiating any preventive action in indeed be highly effective in bank- time. After the event, attempts at rupting what is left of indebted damage control have been fumbling companies still in operation in the and erratic. The handling of the Ice- country and thus increasing unem- save-dispute was slow and ineffective. ployment and general misery. This Work on the restoration of the bank- goes contrary to what central banks ing system, now under state owner- are doing all over the world, namely ship, has been secretive and con- lowering the bank rate in the hope spicuously lacking in transparency. of stimulating the economy. By under-estimating Iceland´s long- General lack of concrete information term indebtedness the IMF may be on government action in mitigating crippling the economy and thus the consequences of the disaster, for putting at risk any recovery in the both businesses and households, has near future. On the other hand the created an atmosphere of suspicion fiscal austerity program must be and mistrust. The government and considered relatively mild since it the Central Bank have been unable does not really begin to bite until to conceal their differences on major the year 2010. But even that is a issues, such as the IMF rescue plan, doubtful strategy as the former foreign debt obligations, the rate of prime minister of Sweden, Göran interest and the relaunching of the Persson, has pointed out, but he króna. There is a divergence of opin- administered the Swedish rescue- ions on all of those issues and more. program during the Scandinavian financial crisis in 1992-95. To add further to the confusion, the coalition partners are entirely at odds on basic issues. The Social-democrats X. Future Prospects have officially denied any responsibil- ity for the Central Bank director´s Iceland´s prospects in the near fu- actions and utterances. It is a lamen- ture are bleak, to say the least. The table anomaly in this situation that present coalition government of the Central Bank director is a former Conservatives and Social-democrats chairman of the Conservative party seems to have been caught com- and ex-prime minister, without any pletely off-guard by the crisis. By academic qualifications in monetary hindsight it is beyond dispute that economics. Despite his position as the government, the Central Bank Central Bank director he is generally and the supervisory authorities all seen to be playing politics as the de disregarded the warning signals and facto leader of the anti-European Un- failed to act in advance to prevent ion faction of the conservative party. the crash or to stave off the worst

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This is the crux of the matter: The XI. A Political Upheaval? coalition parties are entirely at odds on the fundamental issue for the The demand for new elections is get- future of the country: Should Ice- ting louder day by day. Thus the land apply for membership in the economic crisis has generated politi- European Union or not? The Con- cal turmoil and uncertainty about the servatives say no (applauded by the future. The demand for new elec- left-wing opposition); the Social- tions, early in the year 2009, can democrats say yes (supported by hardly be resisted much longer. The now by the middle-of-the road overriding issue to be settled by new Progressive party). According to elections is the European issue. Dur- opinion polls a vast majority of the ing the boom years it was easy for the population now wants Iceland to political leadership to sidestep the start membership negotiations and issue. Iceland seemed to be doing to adopt the euro as soon as possi- pretty well on her own, admittedly to ble. According to those same polls a large extent on borrowed money. the Conservative party´s following Therefore most Icelanders felt little has fallen from almost 40% down incentive to make up their minds on to approximately 20%. But to con- this issue. The crash has changed all fuse the situation further still, the that. The majority of Icelanders anti-European Left-green opposi- seem, at least for the time being, to tion party has doubled its following have drawn the lesson from their from 15% to above 30% and is by economic misfortune, that this would now seen to be the biggest party, not have happened, if Iceland had followed by the Social-democrats joined the European Union and with a little less than 30%. adopted the euro while the going was good. This seems to be the main les- In short: Super-imposed upon the son to be drawn from the crisis. economic crisis there is a political paralysis. The Conservative Party But even European Union member- leadership is trying to gain lost ship within a year or two will not ground by convening an extraordi- help Iceland a lot in her present dire nary party congress at the end of circumstances. What Iceland needs January 2009 where the party will beyond anything else, to help her try to redefine its policy on the recovery, is a stable currency. Unfor- European issue amidst a serious tunately the prospect of being able to threat of a party split. Should they adopt the euro seems to be receeding fail to unite on a pro-European far into the future. The Icelandic program the days of the govern- economy is in a terrible shape. With ment are generally considered to be a weak and volatile currency the numbered. prospects for recovery any time soon look dim. Despite the strong long- term fundamentals of the economy

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(recovering fish stocks and plenty of from Iceland´s debacle, surely they clean and renewable energy) the will have to include the following: short-term outlook is grim: Ram- pant inflation, serial bankruptcies 1. In a world of massive and un- and subsequent unemployment, fettered capital movements coupled by heavy fiscal deficits and across national borders, a tiny a crushing debt burden. The crucial “independent” currency area question on the future of Iceland does not have a chance of sur- therefore remains unanswered: Will vival in a financial hurricane the debt burden cripple the econ- of the present (and future) omy´s potential for recovery? Or fortitude. will the strong fundamentals of the economy and the traditional resil- 2. Had Iceland shown the fore- ience of the Icelandic people enable sight, like Ireland, of joining them to pay off their debt and full- the EU and adopting the fill the preconditions for joining a euro, following in the foot- stable currency area? steps of her former EFTA- partners (Finland, Sweden This is what early elections will be and Austria) in 1995 or the all about. But the political line-up period thereafter, Iceland remains uncertain: On the one would surely have had to face hand there will be the Social- the domestic bank-crisis, - but democrats and the Progressives, would have escaped the devas- propagating a pro- European fu- tating currency crisis which ture. On the other hand there will threatens to make Iceland´s be the Left-green anti-European foreign debt burden unbear- movement with the question of the able. Conservatives hanging in the balance. Will they split at the extraor- 3. For the other small nations of dinary party congress in January, Europe, in central and eastern with the right wing joining the na- Europe, the lesson seems to tionalist anti-European forces, and be to speed up disciplinary the more liberal wing joining the economic programs with the Social-democrats on the road to aim of fullfilling the Maastrict Europe? Or will the increasing po- criteria for adopting the euro. litical turmoil split all the existing parties and create new ones with 4. For the EU it is time to re- the possibility of opening up an consider the regulatory abyss of anarchy and confusion? framework for surveillance of financial markets as well as to XII. Lessons to be learnt? coordinate the EU-wide guarantee systems for savings de- If there are any lessons to be learnt positors.

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5. For the world at large the Minister of Finance 1987-88 and Minis- lessons to be learnt from the ter for Foreign Affairs and External Trade current spectacle of financial 1988-1995. He led Iceland’s negotiations markets run amock by greed with the EU on the European Economic and recklessness is to reim- Area (EEA) 1989-1994. In the years pose discipline through an 1998-2006 he served as Ambassador of international agreement on a Iceland in Washington D.C. and in Hel- sinki, also accredited to the Baltic Coun- new regime of tough regula- tries. Since then he has been a visiting tion and surveillance – with scholar and a guest lecturer at several uni- harsh diciplinary powers versities at home and abroad. He is an against errant actors. honorary citizen of Vilnius, Lithuania.

6. The final lesson to be learnt by the international com- munity is to put an end to the shady operations of tax havens in faraway places, operating as money launder- ing shelters, beyond the reach of the rule of law.

The text of this working-paper is an elaborated version of a lecture given by the author at a seminar held by the Graduate School “Global Financial Markets” at the Friedrich Schiller Uni- versity at Jena in Germany November 27, 2008. The text has been revised to bring it up to date as of end of year 2008.

The author studied economics and re- lated subjects at the Universities of Ed- inburgh and Stockholm 1958-1963 and was a Fulbright scholar at Harvard 1976- 1977. During his career he has been an educator, journalist and editor of a newspaper. He was a member of Althingi 1982-1998, a leader of the Social-democratic party 1984-1996; a

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