Iceland Citizens and Icelandic Private Banks Repudiate Debt Financial Bailout
Should Iceland Refuse to Pay?
In March of 2010, something rather remarkable happened. Icelanders voted not to accept a proposal called "Icesave" which would have provided for repayment of funds which England and the Netherlands had paid to its citizens who had lost savings in Icelandic private banks.
When Icelandic banks went bankrupt in 2008 and 2009 due to the worldwide lack of liquidity, or put another way, money to carry on investment activities (the same reason the stock market crashed in the U.S.), the banks went belly up. To give you an idea of the severity of the problem, the Central Bank of Iceland had a total of 378.4 billion kronur while the Icelandic private bank debt totaled 356.8 billion kronur.The central bank could not finance such repayments without incurring catastrophic damage to the Icelandic economy, an economy it was required to support by law. Hence, there was the birth of an idea for a graduated payment schedule based on gross domestic product (GDP). Iceland's total debt to outsiders is 9.553 trillion kronur. This is equivalent to 50 billion Euros, or 65.91 billion USD at today's conversion.
Osvor Fishing Museum
A Proposal and What Happened
The proposal called for a kind of moratorium on debt payment. The government at the time felt it necessary to agree to the proposal for fear of being denied future loans, European Union membership, and a host of things viewed by politicians as intolerable. Negotiated with the participation of the Icelandic government, it required as much as 4% of Iceland's gross domestic product (GDP) to be paid to the United Kingdom (in British currency) from 2017 through 2023. The Netherlands would receive up to 2% of Icelandic GDP (calculated in Euros) over the same time frame. These loans were required to pay back the English and Dutch governments who had bailed out their country's citizens who had put their money in Icelandic banks. The private Icelandic banks had offered high interest rates which was a lure to savers. But as anyone knows from economics 101, with higher return comes higher risk.
As mentioned earlier, in 2010, Icelanders voted down (90%) the proposal (viewed by some as repudiating its debt) claiming that they were not responsible for liabilities of a private bank. Some estimates of the time to repay this debt are more like 30 years.
After a campaign to bring the population on board with the agreement, a second vote was taken. On 10 April 2010, Iceland voted again to reject the proposed government treaty by a margin of 60% to 40%. Spokespeople for the government have said that the people have spoken; no need for a third vote.
Capitalism and Lingering Questions
The interesting feature of this whole thing is that the response of this small island people brings into question some of the perceived principles of capitalism, and as a result, the way democratic capitalist governments around the world have been dealing with private debt bailouts.
What is one such question? The first one will come shortly.
Free market capitalists are fond of supporting a hands off approach to conducting business. Just about any interference by government is opposed. But in the case of Iceland, the people voted for a hands off approach, namely that the public had no responsibility to England or the Netherlands for risks taken by its citizens. In other words, no bailout of private banks. Iceland’s banks are now under government boards who are basically locating assets, determining how much creditors will receive through bankruptcy laws, and closing down business until such time as new private banks are chartered. And incidentally, Iceland banks paid for adequate deposit insurance under European law.
Question 1: This issue is going to wind up in International Court, but if the Icelanders decide to continue to repudiate the “debt”, what will happen? They aren’t currently getting loans from anyone and limitations have been placed on investment overseas which results in keeping money at home in Iceland. So far so good compared to predictions.
Question 2: Will Britain or the Netherlands invade militarily and hold the people under marshal law while these two forcefully implement a skimming of Iceland’s gross domestic production? Invasion (explosives) will hardly do anything for gross domestic production, and occupation certainly will do nothing to help the GDP. British and Dutch governments would be directly overseeing private business in Iceland in order to exact payment of the lost depositors’ money. That’s a formula for failure.
Most capitalists love to quote Adam Smith, usually accepted as the father of modern economics. Smith was of the opinion that by dividing labor, stuff could be manufactured more cheaply. Through greater and greater divisions of labor, more and more products could be made. This would result in more and more money being earned, which would result in satisfying the needs of labor (including owners), with profit being turned back into industry for improvements in production. He saw this as a moral process and a pattern that was cyclical; a pattern that should provide the best life for the masses.
Question 3: How does accepting the terms of the proposed agreement help the cycle of production in Iceland for children and grandchildren? It puts a burden on those generations that Iceland feels, under law, they should not place on them.
Question 4: Even though the Brits and Dutch feel they “loaned” their people money that Iceland should repay, this all brings into question whether a sovereign nation has an obligation to repudiate debt when it becomes a tool to subjugate its people for generations? The two largest industries in Iceland are fishing and geothermal heat. Iceland is already in recession and has been since 2008.
Question 5: If there is a point at which it is the obligation of a people to reject a proposal to pay off a “debt”, does this apply to less wealthy nations who have revolving loans, loans to pay off prior loans with ever increasing interest rates and conditions? In Europe, for instance, Portugal, Greece, Spain, and Italy are at the point where any further loans will probably be conditioned on public property being used as collateral. So there would be the prospect of public lands being divided among banks, buildings being sold, lottery proceeds being promised to banks, access fees being promised to banks, etc. In essence, the banks would become the government. One could say that the people did not enter into the agreements, but the government did (I know, the people are the government because they vote, but we know how that goes). Under the current situation, a lot of economists think no matter what these countries do, they will never be able to pay off the debt. Is their a point when a debt becomes impossible to repay, and therefore whether or not a government should or shouldn’t have acted more prudently, the debt should be repudiated? Would these nations be better off to repudiate than to continue what has been going on with growing debt service and huge loans? Can what has been going on even continue before the loaner nations and/or debtor nations break?
I don’t have answers to these questions, but Iceland’s refusal to pay for loans to English and Dutch depositors charges the imagination. The commonly held thinking about the consequences of repudiation come into question.
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© 2011 John R Wilsdon