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  The Credit Crunch Lab: Iceland's Warning to the World

The Credit Crunch Lab Iceland's Warning to the World

By Ralf Hoppe

Part 2: 'The Cleanup Work Will Be a Bloodbath'

New names are suddenly on everyone's lips, now praised as heroes and saviors in the face of disaster, although they were generally ignored until recently.

It is late afternoon, dark and icy, as Vilhjalmur Bjarnason drives to his university office in Saemundargata to do some more work. He's in a grim mood despite the fact that he is one of the most sought-after men in the country -- praised, interviewed, quoted in blogs, magazines and talk shows.

Vilhjalmur, 56, a former banker, works as a university lecturer for macroeconomics, serves as the chairman of the Association of Small Investors and is a keen runner. Lately, he has been extremely irritated because he predicted everything that is now happening. He has always remained politically neutral because he believes that an economist should preserve his independence -- although it has also put the brakes on his career. Now he is under consideration to become the new head of the central bank or an adviser to the finance minister. "We've placed our economy in the hands of criminals," he says, "and the cleanup work will be a bloodbath."

He knows some of the perpetrators very well. "They were my students," he says. After completing their studies they rushed into the banking business, "and that's when things got out of hand and we veered off the solid path."

For centuries, Icelanders lived in poverty and hardship: sod houses, misery and epidemics were facts of life. Then, says Vilhjalmur, they learned to tap into their unique natural surroundings, damming waterfalls to generate energy and using the hot water from geysers as a source of heat. According to Vilhjalmur, things could have continued that way -- but Iceland was infected by greed.

Kristin Gunnarsdottir and many of her comrades-in-arms see the decision to launch one of the largest hydropower projects ever as the main factor that triggered a veritable orgy of borrowing. She says that the beginning of construction on the Karahnjukar power plant, which was to further boost the production of aluminum, was cleverly marketed around the world. "Suddenly Iceland was an insider tip for investors and received top ratings."

The Icelandic krona soared by 20 percent and, although the central bank raised interest rates to cool down the market, an increasing number of Icelanders and companies promptly took out loans in foreign currencies, in yen, dollars and whatever the banks could arrange for them. These loans were relatively cheap as long as the value of their own currency continued to rise. Just before the crash, the central bank only had currency reserves of $5.1 billion and was unable to fulfill its role as watchdog of the country's banks. Capital flowed into the country because Iceland seemed incredibly safe.

"That's when holdings were founded everywhere," says Vilhjalmur. "And holdings are minefields."

It was so easy, he says. A few ambitious businesspeople would get together with bankers and young business graduates to pool their money and contacts. They would raise, say, €10,000 and the holding was established. Then they went to one of the three large banks, which were formerly state-owned banks that had been privatized. The financial wizards were good friends with the banks' owners, but the banks were still considered solid. With a stake of €10,000, loans were taken out worth a hundred times that amount, in other words, theoretically €1 million. Afterwards, €990,000 of that amount was paid out to them and they bought shares in these same Icelandic banks, which in turn took out loans of their own and bought shares in companies and retail chains. "This is where reality comes into play," says Vilhjalmur. "Before that everything was virtual."

Now all the holding founders had to do was wait, perhaps a year, until the price of their shares rose, since the Icelandic business model was seen as a hot tip. "All of a sudden their shares were worth €1.5 million, minus interest of, say, €100,000, leaving them with €400,000 in profits," Vilhjalmur explains.

Vilhjalmur says that this borrowing frenzy gripped people from all walks of Icelandic society. However it was the ordinary people who were left saddled with debt while the tycoons kept their new yachts.

Who were these tycoons?

"I have a list of names on here," Vilhjalmur says, typing on his laptop. "Thirty men and three women. They are the main culprits. I can prove it. We could rescue a lot of money. They have to be brought to trial."

Will this happen?

"I'm not a policeman" he says with an irritated look on his face. "And I'm also not too optimistic."

In the microcosm that is Iceland, the financial debacle can probably be more accurately traced than anywhere else: how greed flares up, how easily livelihoods can be destroyed, how popular anger can erupt -- and who is responsible, who suffers the brunt of the crisis, and how a society very slowly finds its way to a new moral foundation.

Kristin, the writer, sits in front of her fireplace. "We believed the bluffers, we put too much trust in people," she says, shaking her red curls. "Now we have to develop a culture of healthy mistrust."

Translated from the German by Paul Cohen

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