The Icelandic Financial Crisis

Opinion Pieces>The Icelandic Financial Crisis

Iceland remained largely uninhabited until the late 9th century, when Viking explorers settled in the area. By 930, the settlers had already established a formal government through the alþingi (anglicised as althing) – which is now the oldest surviving form of parliament in the world alongside Tynwald, the primary authority on the Isle of Man. Representatives from all 32 of the clans that had settled on the island would convene each year in what is now Pingvellir National Park, 45 kilometres from the capital of Reykjavík, to set laws and settle disputes. Although some form of regional government had always existed throughout medieval Scandinavia, the alþingi represented the first form of national government and its establishment marked a conscious move away from the battles that had been commonplace amongst early Viking tribes. The primary law-making committee of the alþingi was the lögrétta, which was led by a lögsögumaðr or law-speaker, who was elected for a three-year period. Although a highly prestigious position, the lögsögumaðr had no official power to make decisions and was instead allowed to vote on important matters as a normal citizen. However, the lögsögumaðr was considered the highest expert on the laws of the land and was required to recite these as required during meetings of the alþingi.


In many ways, David Oddson was the ideal version of a modern lögsögumaðr. He studied law at the University of Iceland before becoming the Mayor of Reykjavik from 1982 to 1991, and then went on to be the longest serving Prime Minister of Iceland to date, in office from 1991 to 2004. However, unlike the earlier lögsögumaðr, as Prime Minister, Oddson had the power to enact largescale regulatory changes. During his prolonged term in office he made full use of his influence to revive Iceland’s economy and its potency in the world order, both of which had been greatly diminished when Iceland came under the rule of Denmark in the 14th century. Under Danish governance, the Danish-Icelandic Trade Monopoly was established in 1602, severely restricting Iceland’s international trade by granting Danish merchants exclusive rights to trade in Iceland. During this period, Iceland also experienced several volcanic eruptions known as Móðuharðindin or the “Mist Hardships”, which destroyed agricultural land, killed livestock and left many Icelanders dead. Both the population size and the economy declined severely. In 1800 the alþingi was also suspended by the Danish king, Christian VII, and replaced by a High Court in Reykjavík. However, during the 19th century an independence movement emerged, resulting in the reinstatement of the alþingi in 1844 and Iceland gaining complete independence from Denmark in 1944.

Although the Icelandic economy had experienced some growth since 1944 – predominantly through its fishing and agricultural industries – Oddsson was adamant that radical reform was required to propel Iceland out of obscurity and into the mainstream world economy. His was a nation in which nearly half the population had completed tertiary education and Oddsson was determined that the country should modernise its economy through a focus on finance. Driven by an unflappable confidence in both himself and his small nation – Iceland is the smallest country in the world with its own currency and monetary policy – Oddson overhauled outdated regulations and privatised several state companies, including Iceland’s three biggest banks, Kaupthing, Glitnir and Landsbankinn. Initially, his plan was highly successful and Iceland experienced an economic boom. An article published in The Economist in 2001 claimed optimistically: “The economy has grown by a quarter since 1995. Real wages have risen and – more remarkably – the poor have gained most. Iceland expects to be free of public debt by 2004.” However, instead, by the end of 2008, Iceland had experienced thelargest systemic banking collapse in relation to the size of its economy of any country in history, sending the nation into a severe economic crisis.

With the deregulation of the banks in 2001 under Oddson’s regime, Icelandic banks began to borrow significant amounts from international wholesale money markets. Iceland’s big three banks soon collectively held foreign debt that was more than 10 times the country’s GDP and 20 times the state budget. The financial sector boomed, becoming the lifeblood of the Icelandic economy, and banking suddenly became the career of choice for many people. As they grew, the banks extended easy credit, granting loans en masse, and Icelanders went on a spending spree. There was a sudden uptick in the purchase of both stocks and property, which in turn pushed up the value of both, and using their newly bought homes as security, Icelanders began to indulge in luxury items such as cars and snowmobiles and went on lavish holidays. Icelandic businessmen sought to extend the international reach of their enterprises, acquiring as many foreign companies as possible, and earning themselves the title of the “Viking Raiders” in international markets. Interest rates were kept at 15% to prevent inflation and this also attracted billions in investment in Icelandic króna from foreign investors, considering that interest rates were only 5% in the UK and 4.4% in Europe. This led to monetary inflation, with Icelandic money supply increasing by 56.5% between 2007 and 2008, compared to 5% GDP growth. From 2003 to 2008, the Icelandic stock market multiplied nine times – whereas the US stock market had only doubled – and real estate prices tripled. By 2006, the average Icelander was earning three times more than he or she had in 2003, and so the spending continued.

Then, on 15 September 2008, Lehman Brothers filed for bankruptcy and internationally, stock markets plummeted. The Icelandic banks, like those all over the world, could no longer rollover their funding in the interbank market and their creditors were demanding payment. All three banks were on the brink of collapse and by this point they had grown too big to be bailed out by the Central Bank of Iceland – as Matt O’Brien of the Washington Post put it, they were “too-big-not-to-fail”. Unlike other Western countries, Iceland’s government therefore had no option but to let the banks collapse.

Following the financial crisis, Iceland entered a severe economic recession that would continue until 2011, when the country’s GDP showed growth for the first time since 2008. In October 2008, Iceland’s Financial Supervisory Authority took control of the banks and guaranteed all the deposits of Icelandic citizens, but foreign depositors lost access to their Icelandic accounts. To pay domestic depositors, the Icelandic government further had to rely on a loan of approximately $4.6 billion from the International Monetary Fund and other Scandinavian lenders. It was not only a massive financial loss, but an embarrassment for the country, which suddenly became something of a pariah on the international stage. The aim of Oddson’s grand experiment in free market economics had been to see his country raised to a position of global dominance, and instead, by leaving the banks to go about their business unchecked, Iceland had been left weaker than ever before.

In ancient Viking society, the worst sentence that the alþingi could give was to declare an individual an outlaw – someone with no claims to property and who could legally be killed by anyone in the community. In this way, the government avoided having to enforce a death penalty and social justice was instead encouraged. It is perhaps this sense of social justice that prevailed in the wake of Iceland’s financial crisis. There was no doubt that Iceland’s demise had been brought about by the ethos of excess that the banks had championed, but the public’s outrage turned quickly to the government that had failed to restrain the greed of these private institutions, with angry crowds marching to the Parliament Buildings in Reykjavík to demand that someone answer for the economic ruin that they now found themselves in. And Oddsson was determined that it would not be him. He had been replaced as Prime Minister by the former Minister of Finance and a fellow member of the Independence Party, Geir Haarde, in 2005. Haarde was left to shoulder the blame when he was charged with gross negligence for failing to rein in the banks and guard against financial crisis. Haarde and his cabinet resigned in 2009, and in 2011, Haarde became the first Icelandic minister to appear before the Landsdómur – a special high court that up until that point, had never had cause to convene since its establishment in 1905 – as well as the first politician in the world to be prosecuted for his role in the 2008 financial crisis. Haarde was cleared of all charges of negligence but was found guilty of a minor infraction – failing to hold emergency cabinet meetings as the crisis unfolded. However, he faced no jail time.

Meanwhile, Oddsson, who had taken up the position of Governor of the Central Bank, insisted at Haarde’s trial that he had been warning government for years about impending financial crisis, but that nobody had been willing to listen to him. In media interviews, he further refused to acknowledge that it had been the deregulation of the banks under his leadership that had led Iceland into an economically dangerous position in the first place. Despite his protests, he was forced to resign from his position at the Central Bank under pressure from both the public and Iceland’s new Prime Minister, Jóhanna Sigurðardóttir. Having always had a passion for writing and drama – at various points in his career, before becoming Prime Minister, he had worked at a newspaper, a publishing house, and a theatre – Oddsson became editor of what was formally one of the largest newspapers in Iceland, the Morgunblaðið. However, since he was appointed editor the newspaper has experienced a sharp drop in circulation as many Icelanders refuse, on principle, to read it any more. Despite widespread contempt for the man who many believed had led Iceland to its demise, Oddson nonetheless decided to stand as a candidate during Iceland’s 2016 presidential elections. Perhaps unsurprisingly, he received only 13.54% of the votes, losing to Guðni Jóhannesson.

But although Oddson had avoided taking any responsibility for his part in the crisis, the Icelandic public would get true justice some years later when the leaders of the big three banks were found guilty on criminal charges. In December 2008, the alþingi established a Special Investigation Commission to investigate the financial crisis. Following the delivery of the Com mission’s report in 2010, Hreiðar Már Sigurðsson, former CEO of Kaupthing, received a sentence of five and a half years, Sigurjón Árnason, former CEO of Landsbanki, received three years, and Lárus Welding, former CEO of Glitnir Bank, received five years. In addition, several of their subordinates were also charged with market manipulation and breaching their fiduciary duty. In total, 36 bankers received jail sentences for their roles in causing the Icelandic financial crisis. In this respect, the small country that is so often disregarded because of its geographical obscurity and small population, has proven itself to be leagues ahead of the rest of the world. Iceland may have made some of the biggest mistakes in financial history, but it has also been the only country to ensure that those responsible for leading it astray have been held accountable for their actions.

This article is from the Monocle Quarterly Journal, A Short History of Banking. Visit our "Journals" section to read the full issue.