Iceland Saga - how corporate debt became sovereign debt

On Sunday afternoon, Reuters was reporting that 93 percent of those voting had voted not to reimburse. Discussions between the three governments had been progressing days before the vote and are expected to resume very shortly but such a resounding rejection has implications for all parties and will no doubt mean further deliberations which all, at government level at least, are anxious to draw to a satisfactory outcome.

The referendum came about because Iceland's President Olafur Grimsson, in the first week of January refused to sign into law a bill authorising reimbursement that had been passed by the Althing, Iceland's parliament, on 30 December 2009. Mr Grimsson acted within his constitutional authority and may well have reflected upon the very small parliamentary majority authorising reimbursement.

The collapse of Iceland's banks in October 2008, though dramatic, had not come so unexpectedly in all quarters. During early spring 2008, Iceland suffered a currency crisis and on 01 April, USA Today ran the headline "Bank Default worries slam Iceland's currency" with reporter David J Lynch commenting: "Iceland's economy is minuscule, and its population is smaller than that of Pittsburgh, but its banks are deeply involved in global markets." The same article goes on to quote some harrowing statistics for Iceland's economy with a very telling paragraph:

"Amid the continuing financial turmoil, Iceland has drawn increasingly critical reviews. In February, Moody's downgraded the debt of the major banks and earlier this month lowered to 'negative' from 'stable' its outlook on the country's banking industry." This on 01 April 2008!

The attraction of opening investment and savings accounts in Iceland with very enhanced returns at a time when the same funds invested in Europe or USA offered so poorly is easy to understand. For Iceland, the rapid expansion of its banking and finance sector was done with full government support as a means to diversify the economy away from its dependence on the fishing industry, still some 40 percent of export earnings. Banking gave the country hi-tech and well paid jobs. With hindsight, it appears to have been too lightly regulated by Iceland's financial authorities.

When the crisis did break, on and after 06 October 2008, emergency legislation was passed allowing the Financial Supervisory Authority of Iceland to take over the domestic operations of Iceland's private banks.

Government officials, including the then Prime Minister, Geir Haarde and Central Bank Governor David Oddsson, announced that the state did not intend taking over the banks' foreign debts or assets. Quoting from Sweden's E24 News, Geir Haarde addressed the nation saying: "No responsible government takes risks with the future of its people, even when the banking system itself is at stake. The Icelandic nation and its future takes precedence over all other interests."

If this address comforted Icelanders and the setting up of new banks averted a domestic catastrophe, what of the foreign savers, an estimated £8bn worth for UK accounts alone and the combined balance sheets of the Icelandic banks amounting to some ten times Iceland's GDP?

The British Government was as furious with the Icelandic Government as with the offending banks and Prime Minister Gordon Brown branded Iceland's failure to guarantee British savers, over 220,000 of them, as "totally unacceptable and illegal". Using the Anti-terrorism, Crime and Security Act 2001, Part 2 (Freezing Orders) Chancellor of the Exchequer Alistair Darling, whilst stating that all £4bn invested in Landsbanki Icesave accounts would be met by the UK Government, a freezing order was being put into effect - 08 October 2008 - against all Landsbanki assets in the UK.

An HM Treasury Press Notice on the same day affirmed that the retail depositors in Kaupthing Singer & Friedlander would be given similar protection and that KSF's Kaupthing Edge deposit business had been transferred to the Dutch bank ING Direct.

It very soon became clear that the British Government was not simply protecting innocent "rate tarts". About a hundred local authorities, charities, police authorities and such like, had serious amounts of money at risk in Icelandic accounts. According to The Guardian on 10 October 2008 these local authorities had the following deposits:

Kent £50m

Nottingham City Council £41.6m

Transport for London £40m

Haringey £37m

Norfolk County Council £32.5m

Metropolitan Police £30m

Dorset County Council £28.1m

Barnet £27.4m

Somerset County Council £25m

Northumberland £23m

Hillingdon £20m

Neath Port Talbot £20m

Westminster £17m

North Ayrshire £15m

Brent £15m

These top 15 include the worst case in Wales and the worst in Scotland and the total for local authorities by this list was some £800m, a little surprising when many of the finance officers will remember the BCCI fallout in 1990/91 when the tiny Western Isles Council was told they should have known better and to take the hit of around £25m. Heads rolled and jobs were lost.

Although the Icelandic Government refused to take responsibility for the actions and failures of private banks, should not the banks' balance sheets have been raising alarms with the financial regulatory authorities? It is not simply the (very) light supervision of the banks that the UK Government can reasonably point a finger of blame at their Icelandic counterparts but the fact that Iceland's depositor guarantee scheme was empty and the guarantees given in the banks' advertisements implied the same protection as offered in and by the UK.

Gordon Brown's use of the word "criminal" in his condemnation, no doubt more rhetorical than strictly legal, has therefore some justification. Forget Salomon v Salomon (1897) A. C. Held - that the company was a separate and distinct person. Forget proving just cause why the corporate veil should be lifted and that the very swift action taken by the UK authorities may not have treated Kaupthing in as fair a manner as could be expected in less anxious circumstances. It could and should have been put more diplomatically, but it's hard not to say that the Icelandic finance authorities were not grossly negligent.

The outcome is clear. Very soon after 08 October 2008, the liabilities of the Icelandic Banks in so far as they affected British subjects had become the liabilities of Iceland, full stop. Iceland's corporate bank debt for all practical purposes had become Iceland's sovereign debt.

In early 2009 the coalition government lost power and a new Prime Minister, Johanna Sigurdardottir took office and a new Finance Minister, Steingrimur Sigfusson appointed. During the past two years the country has gone through really hard times with the currency falling some 50 percent (and many individuals and businesses had borrowed in foreign currencies during the boom) unemployment rising from one percent to seven at present, price and tax rises and real wage cuts.

Iceland wants to move on and it’s in everybody's interest that the country does. Whether it joins the EU in one year or five years probably isn't so important as getting access to international loans and finance to develop her geothermal and hydro power capacity and stem cell and HDTV technology. For what it's worth, I'd bite a bullet for the minimum guaranteed depositor pay out, some £2.2bn.