Hannah Ransom

May 12, 2010

Dr. Sampanis

Comparison of the Icelandic and Greek Financial crises

Today there are many economists, politicians, and individuals’ worldwide who

are examining the financial crisis in Greece and wondering how it compares to the

financial meltdown that Iceland experienced. While the two financial crises had

somewhat different impetuses a comparison can be made in regard to how the

international scene reacted to their financial woes. In the case of Iceland Britain played

the largest role in helping them to begin to regain their footing. However, in the case of

Greece the wealthiest EU state, Germany, has been reluctant to shoulder most of the

economic burden. Although without a doubt the primary cause of the Icelandic and Greek

financial crises was economic, political factors such as their respective relationships with

Britain and Germany exacerbated their already dire financial situations.

The financial crisis in Iceland and eventual bankruptcy of the country has left

Iceland and the rest of the world reeling. In retrospect Iceland was essentially operating

like a firm with a highly unviable growth model. However, the political relationship

between Iceland and Britain also greatly added to the economic downturn and financial

crisis. Britain’s use of anti-terrorism laws, in an attempt to protect their economic

investments in Iceland, essentially labeled Iceland as a terrorist state which only

continued to stagnate the inflow of foreign capital.

Iceland began as an isolated, fairly impoverished country whose survival was

based largely on its fishing trade.1 However, in recent years Iceland had been successful
1
Sarah Lyall, “Iceland, Mired in Debt, Blames Britain for Woes,” New York Times 2
November 2008.
at establishing itself as a premier offshore banking hub. At one point Icelanders were

ecstatic and celebrated the fact that their tiny country of about 300,000 people had 3

banks in the worlds largest 300 banks.2 The Icelandic government was able to entice

foreign investors by setting interest rates very high, which encouraged foreigners to

invest largely in financial assets. The large inflow of foreign capital associated with such

mass foreign investment caused the krona to greatly appreciate. Since the krona was

greatly overvalued it made all imports in both goods and services very inexpensive for

Icelanders; the overvalued krona also made it a lot easier for Icelanders to borrow money

from abroad.3 The high interest rates, gargantuan capital inflow, and an appreciated

currency all aided in creating the economic boom that Iceland enjoyed for many years.

This economic boom encouraged Icelanders to borrow from abroad and many failed to

foresee that such economic prosperity was limited and that a bust is inevitably going to

follow a boom.

The lack of government oversight on the banking system also was an economic

factor that led to the financial crisis. One large problem with the Icelandic banking sector

is that the banks became so large that the Icelandic government was unable to operate as

a lender-of-last-resort simply because Iceland with its mere 300,000 people has a very

small tax base.4 At the end of 2006 the total assets of its banks grew to be nine times as

large as the countries GDP.5 It would have been less of a problem for the banks to be so

large if they had not remained domiciled in Iceland. It was perhaps too large and ideal of

a goal for such a small country like Iceland to become an international financial center.
2
Robert Wade, “Second Draft Notes For Talk In Reykjavik”, 12 January 2009
3
Robert, Wade, “Talk in Reykjavik”
4
Robert, Wade, “Talk in Reykjavik”
5
Eric Pfanner “Iceland Takes Drastic Steps to Right Itself” The NY Times 10-8-2008.
Iceland was essentially acting like a firm when indeed they should have been looking

after the economic stability of their whole country. The Icelandic government simply

lacked the ability to financially sustain their banks in times of economic crisis. If some of

the banks in Iceland had foreign lenders-of-last-resort they might have been able to

weather out the economic storm.

Iceland’s economic growth model was mainly built upon foreign

investors being able and willing to keep on giving. However, due to the global economic

crisis foreign capital ceased coming in and when it did the myriad of public and private

debt became quite evident.6 Some analysts argue that problems with the krona have

prevented Iceland from being able to control the financial crisis. Since Iceland does not

have an effectual currency to manipulate they are largely unable to support the banks and

have no practical ways to bring down the inflation and interest rates, which have been

staying in the double digits.7 This is just one of the many economic situations currently

affecting Iceland.

Without a doubt the prime cause for Iceland’s financial crisis is largely the

economic circumstances previously discussed. However, political factors such as

Iceland’s relationship with Britain also played a role in exacerbating the crisis and

preventing Iceland from any chance it might have had of financial viability. In the past

Icelandic-British relations have been tumultuous which is evidenced by the Cod Wars of

the 1950s through the 1970s. Yet more recently Iceland and Britain have had a very

mutually beneficial friendship, which could be seen in that they were NATO allies and

frequent trading partners. However, as the global economic crisis began to take hold this
6
Robert, Wade, “Talk in Reykjavik”
7
Eric Pfanner, “Iceland in Financial Collapse, Is Likely to Need I.M.F. Help,” The New
York Times 10 October 2008.
friendship became tenuous at best. The problems between Iceland and Britain began in

late 2008 when Britain, in an attempt to protect its financial assets in Iceland, invoke its

2008 anti-terrorism laws to freeze the British assets of a failing Icelandic bank.8

Specifically Britain froze the assets of Landsbanki and seized the assets of Kaupthing

Singer & Friedlander.9 The British seizure of Kaupthing Singer & Friedlander was

followed shortly by the collapse of its parent bank, Kaupthing, which the Icelandic

government had desperately been trying to keep viable. In many Icelanders eyes and

certainly in the eyes of the Icelandic government Kaupthing was the last of the Mohicans

and its demise signaled the end of the Icelandic banking system.10

The political decision to invoke anti-terrorism legislation against Iceland

essentially branded it as a terrorist state, which in the eyes of every Icelander was a

thorough abuse of a small neighbor. Due to this one political action Iceland was listed on

the British Treasury Department’s page with terrorist groups and states such as Al Qaeda,

Sudan, and North Korea.11 At this point in the crisis the foreign capital inflows into

Iceland were already dismal but this British action triggered an immediate freeze on any

remaining banking transactions between Iceland and abroad. Essentially no one wants to

do business with a terrorist state. President Olafur Ragnar Grimsson stated that, “It

(Britain) was absolutely being a bully against a small country because I am absolutely

certain that if it was the case of France and Germany, the British government would not

have acted in the same way- absolutely not”. The Icelandic Prime Minister at the time,

8
“Iceland hits back at UK jibes” BBC News 18 January 2008
9
Sarah Lyall, “Iceland, Mired in Debt, Blames Britain for Woes,” New York Times 2
November 2008.
10
Sarah Lyall, “Iceland, Mired in Debt, Blames Britain for Woes,” New York Times 2
November 2008.
11
“Iceland hits back at UK jibes” BBC News 18 January 2008
Geir H. Haarde, believed that Gordon Brown had “sacrificed Iceland for his own short-

term political gain thereby turning a grave situation into a national disaster”.12 From the

perspective of the Icelandic government their once cordial, neighborly relationship with

Britain had been thoroughly abused to the point that a British foreign policy decision

played an integral factor in the meltdown of the Icelandic financial sector.

Undoubtedly Britain’s political decisions affected the financial crisis in Iceland,

yet, the Crisis in Iceland also greatly impacted Britain’s economic conditions. Like the

rest of the world, thanks to the downturn of the global economy Britain has been

suffering its own financial woes. When foreign capital inflows ceased in Iceland this

caused the krona’s value to fall, which led Icelandic banks to be unable to finance their

debts most of which are in foreign currency. This realization by all of the foreign

investors who were once so eager to invest created a mad rush to get their money out of

the failing Icelandic banks. Unfortunately, Icelandic banks did not have proper reserves

to cover the massive withdrawals leading all three of Iceland’s banks to be nationalized.13

Regrettably many British universities, municipal governments, charities and hospitals had

been lured in by the high interest rates to invest in Icelandic accounts. Cambridge

University had $20 million invested in Icelandic accounts while 15 British police forces

have approximately $170 million frozen in Iceland.14 Many groups that had invested in

the Icelandic banking sector had done so in the convenience of their own home states

through the use of online investing sites such as Icesave.co.uk. On their website Icesave

now displays the message that “We are not currently processing any deposits or

withdrawal requests through out Icesave Internet accounts. We apologize for any
12
“Iceland hits back at UK jibes” BBC News 18 January 2008
13
Thomas Friedman, “The Great Iceland Meltdown,” New York Times 19 October 2008.
14
Thomas Friedman, “The Great Iceland Meltdown,” New York Times 19 October 2008.
inconvenience this may cause our customers”.15 Certainly for large investors such as

Cambridge University this is much more than a small inconvenience.

At the center of Iceland’s financial troubles is that their banking sector was highly

dependent upon a continued inflow of foreign capital. In turn, Iceland’s foreign investors

were also very dependent upon Iceland’s banks to maintain their viability. However,

when the inflow of capital stopped the interdependence of Iceland and its investors

became very clear. This is exemplified by the Icelandic-British relationship. British

citizens and companies alike had been ensorcelled by the call the of high interest rates in

Iceland. The viability of the banks was based largely on the ability to keep foreign capital

coming into the country, which allowed the krona to appreciate. When the foreign credit

market froze and investment decreased drastically the financial interdependence of

Iceland and Britain manifested itself.

Like Iceland, the Greek economy has also been affected by the lack of available

foreign credit. One might have thought that since Greece is a member of the European

Union they would have been somewhat sheltered from the affects of the credit crunch.

However, the financial crisis that started in 2008 has been hard on all currency and the

Euro is certainly no exception. Countries in the EU with larger economies such as

Germany and France have been able to ride out the crisis and maintain their economic

viability. Smaller countries such as Greece and Portugal have had a much more difficult

time adjusting to the financial crisis.16

Theoretically Greece’ should have found the European Union to be a nice safety

15
Thomas Friedman, “The Great Iceland Meltdown,” New York Times 19 October 2008.
16 Steven Erlanger, “French and German Ties Fray Over Greek Crisis,” New York
Times 12 April 2010
net in their time of economic distress. However, the European Union has been at best

resistant and slow to act. The EU instead of acting as a coherent and able unit has largely

sat back and left the International Monetary Fund holding the bag. This has not only

exacerbated the Greek crisis but has also potentially damaged the credibility of the EU.17

Part of the EU’s lack of action can be blamed on the fact that a lot of countries

within the EU, such as France, believed that Germany should step up and absorb the costs

of making sure that Greece maintains its economic viability. However, Germany has

been incredibly reluctant to take on this burden. This is clear evidence of Germany’s

unwillingness to be the de facto regional hegemon of the European Union. Their lack of

willingness to maintain their hegemonic position in the European Union is troubling

because no other EU country is seemingly willing to step into the role. This lack of

leadership within the EU during such turbulent economic times is leaving troubled EU

countries, such as Greece, with minimal friends to turn to in their time of need.18

However, perhaps Germany’s lack of desire to maintain their regional hegemonic role is

not the only variable to blame for their inaction.

Historically, (much like Iceland and Britain) Germany and Greece have not had

the best political relationship.. The tension between Greece and Germany goes back to

WWII and the German occupation of Greece. Many Greeks feel resentment to this day

about how brutal the German occupation was. Indeed in 1995 the Prefecture of Voiotia in

Southern Greece and individual plaintiffs brought suit against the German state for the

willful murders and property damage caused by German occupation forces in June 1944.

17
Steven Erlanger, “French and German Ties Fray Over Greek Crisis,” New York Times
12 April 2010.
18
Steven Erlanger, “French and German Ties Fray Over Greek Crisis,” New York Times
12 April 2010.
Germany refused to take part in the trial on the basis that it violated their sovereignty.

However, the Greek court awarded individual plaintiffs a total of $30,000,000 for the

actions perpetrated against them by the Germans. The resentment is therefore two-sided.

The Greeks are not going to easily forget the German atrocities committed against them

during WWII while the Germans likely feel some resentment towards the Greeks for the

legal action that they took.19

The primary impetus for both the Icelandic and Greek financial crises were

economic. However, political factors such as their relations with Britain and Germany

have also played a hand in exacerbating their financial woes. For the Icelandic their

financial practices had sown the seeds of their own destruction but the political actions of

Britain ensured that it would be a long time before Iceland’s financial sector would

germinate once more. In the case of Greece it was not necessarily action, but rather

inaction on the part of the European Union, and principally Germany, that exacerbated

their crisis. Germany and the European Union sat back and watched while the Greek

economy spun out of control. Now that they are finally at the point of taking action, one

must wonder if it is too little FAR too late.

19
John R. Schmertz and Mike Meier, “Sovereign Immunity,” International Law
Update Volume 5 Number 5 May 1999