The Credit Crunch Lab Iceland's Warning to the World

First came the financial crisis, then the uproar: Iceland is the first European country to suffer the full effects of the global financial crisis. Is this a taste of what's in store for the rest of the world?
Von Ralf Hoppe

It's snowing and soon it will be dark again. The evening begins here at about four o'clock in the afternoon, followed by a long, long night -- an Icelandic night here in Reykjavik, latitude 64 degrees north, just south of the Arctic Circle. If countries could export darkness, then Iceland would have nothing to worry about.

Kristin Gunnarsdottir parks her small car in front of her modest home in the city's Garbabae district, gingerly walks along the slippery path to the front door and knocks the snow off her boots. She's in the mood for some hot coffee and a seat by the fireplace. She has a new, exhausting pastime -- demonstrating. "We have to save Iceland," she says.

For the past three months, Kristin Gunnarsdottir has spent many of her days in downtown Reykjavik. Armed with a pot and spoon, she and her fellow protesters have taken up position in front of the Icelandic parliament, the Althing, accompanied by a few hundred or -- as is usually the case -- a couple of thousand other demonstrators. Recently, she says, the wrath of the people was so great that the crowd was on the verge of storming the Althing, dragging out the government, and hanging them from the huge Christmas tree. The tree is no longer there.

"Some of the demonstrators torched it," she says. "That was quite a fire."

Things are heating up in Iceland as a result of the financial crisis .

Kristin Gunnarsdottir grabs a thermos full of coffee, switches on the TV and is just about to settle down by the fireplace when she is stopped short. She stands there, awestruck, and points to the screen.

Kristin is in her mid-40s, red-haired and cheerful. She used to be a TV journalist, but is now a writer who has produced three bestsellers. But since the beginning of the financial crisis, she has been one of the leaders of a revolt the likes of which Iceland has never seen before, a revolution from below that aims to sweep away everything that existed before.

"Incredible," she says, pointing to the television.

Foreign Minister Ingibjörg Solrun Gisladottir is being interviewed. She is from the left-leaning Social Democratic Alliance, the smaller of the two coalition partners, and looks exhausted as she gazes into the camera and explains that she will only continue to support the government if a series of demands are met. Then come politicians who say that these demands cannot be fulfilled.

"That's it," says Kristin, "I guess we won't have a government soon -- it's better that way."

A few hours later, a government that once seemed unshakable collapses. The stronger of the two coalition partners, the conservative Independence Party, ruled the country for nearly 18 years. This party led a government that was responsible for some 315,000 Icelanders who are all related to each other in one way or another and are, for the most part, very blonde, very nice, educated, pleasant people. Now the financial crisis and the scandals that it has brought to light have cast Iceland into turmoil and chaos. On the surface, life continues, yet everyone is shaken to the core by an unfathomable feeling of uncertainty. In that sense, Iceland is like a crystal ball that reveals the future of the rest of Europe.

Iceland has become a kind of laboratory for the credit crunch: a small, compact country, closely linked to the international economy, without any safety buffer. It's a place where the effects of a crisis are felt intensely.

The first waves of layoffs have started to roll across the country. Everyone knows someone who has already lost his job or will lose it soon, everyone knows someone who knows -- and hates -- an investment banker. The coolest bars in downtown Reykjavik are conspicuously empty, like "101" and "b5", where financial high flyers were still enjoying wild parties during the midsummer nights of 2008. The country's image has been seriously tarnished. "How do we look now in the eyes of the world?" says Kristin. "Like the financial maniacs, the gamblers of Europe."

Where -- and, more importantly, who -- are the culprits responsible for this mess? No one in Iceland is sure. Since the collapse of the country's three large banks over three months ago, the government has presented no answers and has not even bothered to launch a serious investigation.

This has sparked wild rumors throughout the country. According to one story, the richest Icelanders left the country months ago, their bags packed with cash as they boarded a private jet bound for Portugal. Supposedly they will return soon to cover up their tracks. The Icelandic krona has lost a third of its value against the euro within one year and remains volatile. Nobody in the shops knows the current exchange rate anymore. An interim left-wing minority government, led by newly appointed Prime Minister Johanna Sigurdardottir, is now in charge of the country until new elections can be held, and it's very possible that the Left-Green Movement, with its Marxist leanings, will then emerge as the strongest party.

Nowhere else in the world, so it seems, is the crisis as visible as in Iceland, nowhere else is it so concrete. The small size of the country also means that every citizen can easily calculate how much debt has accumulated in his or her name. Before they were nationalized, the three large banks had amassed arrears of $166 billion (€130 billion), equivalent to 10 times Iceland's gross domestic product. That comes to an additional $527,000 for every man, woman and child. An Icelandic plumber or fisherman who has a wife and two children to feed would thus all of a sudden find himself $2 million more in debt. How can the current generation ever work off this debt? Economists anticipate double-digit inflation and predict that the economy will shrink by 10 percent.

'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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