The Icelandic Financial Crisis

Protest in Iceland 2008

What led to the Icelandic financial crisis in 2008? What were the consequences of this troubled economy, and how did the nation manage to recover? Read on to learn more about this dark chapter in Icelandic history. 

Understand that the world of finance is shadowy and complex. Going forward, we will attempt to break the details down so as to be accessible for most readers. 

Even so, the fluctuations of a local economy – let alone a global market – is a subject one could devote their lives to without fully understanding its details. 

In fact, it is from within that misunderstanding that the foundation of this article is laid. 

So, let’s begin with the basics.

How do Icelanders view money?  

Finances in Iceland
Photo: Golli. Stacks of Icelandic krona.

For most people, money can be simplified into earning enough to pay for one’s food, shelter, and entertainment. Putting it bluntly, making money is the engine that drives societies such as ours, and oftentimes, it is from one’s occupation that people derive meaning.

Icelanders are no different in this respect, often choosing to pursue career opportunities that satiate their personal goals rather than mere financial gain. 

Ultimately, the majority of folk – Icelanders included – are content accepting that money is not the be-all and end-all in life. Instead, it is better looked at as a means of securing a comfortable and engaging life.

Shopping in Iceland
Photo: Golli. Icelanders shopping in downtown Reykjavik.

However, some people have a rather different opinion. For bankers, investors, and financial analysts, the concept of money is a constant back-and-forth that involves borrowing, interest rates, debts, and keeping a close eye on international markets. 

As is to be expected, this latter group can often have a great impact on the former, regardless of whether the results are desired or not. Such a philosophy even has a name – crony capitalism

As it so happens, Iceland is a capitalist country; one with a small population that has yet to surpass 400,000 people. Given this pairing, nepotism and corruption have long been a reality of life here. Some people continue to believe that personal gain, both for the individual and those closest to them, trumps what might be more beneficial for the nation at large. 

In that sense, Iceland is hardly different than anywhere else. But unfortunately, the consequences of such selfish thinking tend to impact a greater percentage of people on a small island than it might otherwise do in a larger, less corruptible republic.

What happens when the markets crash? 

 

 

One of the most dramatic economic events to affect life in Iceland began in 2008. The grand scale of it cannot be overemphasised, and not just for those living here. In fact, 2008 was one of the first times in history that the entire world turned its attention to this small Nordic island. 

As you might imagine, this spotlight was not cast for the best of reasons… We talk, of course, about the Icelandic financial crash. 

It was not purely Iceland’s economic woes that drew people’s notice. Rather, it was how these troubles influenced global events, particularly the markets in their own countries.

The Icelandic financial crash is often considered to be the straw that broke the camel’s back in regards to the global recession that would follow. It was, by most accounts, the first pillar to topple what had, until then, been thought of as a profitable and structurally sound pecuniary model the world over.

What led to the Icelandic financial crisis? 

Íslandsbanki headquarters in Reykjavík
Photo: Golli. Íslandsbanki headquarters in Reykjavík

The origins of the financial crash in Iceland can be traced to 2001. It was in that year that the banks were deregulated. In essence, this deregulation meant that Icelandic banks – namely, Landsbanki, Glitnir, and Kaupthing – could all operate using foreign currency. In the short term, this proved to work wonders for the Icelandic economy, as it continued to experience rapid growth right up until 2008. 

With deregulation came the need for banks to expand. This expansion could only be achieved with the adoption of increasingly aggressive lending practices aimed at both residents in Iceland, and those living beyond its shores. In particular, the real estate sector proved to be the juiciest target.    

The expansion of the banks was bolstered by taking loans from the interbank lending market. They also increased levels of external debt by taking deposits from outside of the country. 

As early as 2007, The Economist magazine ranked the Icelandic krona as the most overvalued currency in the world. For many, this should have been a clear indicator that local financial practices were not sustainable.

Waves crashing over Reykjavík lighthouse
Photo: Golli. Waves crash over lighthouse in Reykjavík winter storm

When an economic bubble bursts… 


However, little consideration was given to the fact that there was no lender of last resort. When it came to refinance the debts accumulated, it quickly became apparent that the banks had no foreign currency to pay them off.

Around this time, household debt also rose to 213% of a family’s disposable income. This imbalance soon led to inflation, which in turn, forced a hike in interest rates. In response, the Central Bank of Iceland began offering liquidity loans to other banks based solely on newly-issued bonds. 

While this might sound complicated, understand it for what it really was – the Central Bank was doing little more than printing new money. 

By September 2018, interest rates in Iceland were at 15.5%, far higher than in other European countries. For example, the United Kingdom only held interest rates at 5% at that time. This divide caused foreign investors to withhold depositing Icelandic krona, creating even higher monetary inflation, and ultimately, an economic bubble within which financiers continued to overestimate the value of Iceland’s currency.

What were the consequences of the Icelandic financial crash? 

Bjarni Benediktsson icelandic politics
Photo: Golli. Former minister of Finance, Bjarni Benediktsson

In the years leading up to the crisis, Iceland’s economy was extremely reliant on its financial sector. Following the closure of its banks, both businesses and individuals immediately felt the shockwaves. 

Having been valued far too highly for far too long, the worth of the Icelandic krona dropped considerably. As a consequence of this devaluation, many Icelanders lost their life savings, and unemployment rose considerably. It was the first sign of the recession to come, not just in Iceland, but around the world.

Overseas, it was those who held close ties to Icelandic banks that suffered the most. Beyond the tribulations these investors felt personally, the losses they accumulated through their association with Iceland would further contribute to the broader global crash.

The government’s last stand 

Alþingi parliament of Iceland
Photo: Golli. Alþingi, the Parliament of Iceland

Even amongst casual observers, the writing on the wall was obvious. And so, when the Icelandic banking system collapsed, few people were shocked by it. 

Now in the midst of a recession they had partly caused – plus no banking system to speak of – the Icelandic government quickly found themselves faced with enormous pressure to stabilise the economy. It would prove to be a challenging balance act between satisfying the demands for accountability with practical steps to prevent any further collapse from happening. 

In doing so, the government introduced sweeping changes across the financial sector. These included implementing capital controls to help steady the currency, as well as bailing out, restructuring, and nationalising the banks. Not only that; the government also chased down fiscal stimulus programs that might help boost economic recovery, as well engaged in negotiations with international creditors. 

Central Bank Ásgeir Jónsson seðlabankastjóri
Photo: Golli. Current Central Bank Governor, Ásgeir Jónsson

Still, many ministers realised they would soon be forced to resign, and mass protests – some of which became violent – continued to plague those responsible for leading the country. Iceland’s leaders realised quickly what others already knew; the road to full economic recovery would be a long and arduous journey. 

But even having come to this conclusion, there was no resting easy for government officials, nor those in charge of Iceland’s beaten down banks. As it stood, trust in the country’s financial institutions was at an all time low.

Resilient as ever, the Icelandic people demanded blood. And one way or another, they would get it. 

The Icelandic People demanded change

Photo: Golli. Pots and pans revolution protest outside of Alþingi, Iceland’s Parliament.

In true Icelandic style, the protests began with a single man – a popular songwriter by the name of Hörður Torfason. Having staged himself with a microphone outside of the parliament building on Austurvöllur, he invited others to express their frustration with the government. 

By the following week, these protests had become larger and more demonstrative. Participants organised themselves into an outfit called Raddir fólksins (Voices of the People.) They promised to vent their anger every Saturday until the government stepped down.

 

 

These protests would come to be known as the Kitchenware Revolution, or by others, the Pots and Pans Protests. As part of the growing unrest, the largest protest ever to take place in Iceland happened on 20 January 2009. 

These protests largely came to an end following the resignation of members of the Independence Party. In its place, a new left-wing government was formed, having had the support of the protesters. Iceland’s former prime minister, Geir Haarde, faced prosecution at Landsdómur, or the National Court, though ultimately, he would be found non-culpable.  

Recovery from the Icelandic Financial Crisis

Photo: Bjarki Sigursveinsson. CC. Flickr. Eyjafjallajökull erupts!

Whereas other countries opted for austerity, bank bailouts, and low inflation, Iceland decided to go in another direction. It would be a risky reaction that actually turned out to work in its favour. But aside from the changes mentioned, the tourism boom would ultimately be the saving grace in rebuilding Iceland’s economy.

Sudden interest in the country peaked during the 2010 eruption at Eyjafjallajökull. Putting that in the timeline, this event occurred a little over halfway into the financial crisis. For locals, the eruption was an uncomfortable distraction from their recently emptied wallets. But for many abroad, it was their first introduction to what would become known as the land of ice and fire.

 

 

Global news coverage broadcast compelling images of this dramatic geological event. A snow-laden mountain scorched with fire. A black column of ash and glass filling an empty blue sky. That last sentence is particularly accurate. The density of the ash pushed into the atmosphere created enormous disruptions in air travel, and many passengers found themselves stranded, waiting for the eruption to end and the air to clear. 

These pictures – and numerous flight cancellations – filled people with curiosity as to what life in Iceland was really like. It was an inquisitiveness bolstered with fascinating B-roll of Iceland’s nature; of dark pebble beaches, sweeping white glaciers, endless moss-covered lava fields. Before Icelanders had a chance to prepare themselves for the societal changes that tourism would bring, excited vacationers were booking their tickets. 

Fireworks on New Year's Eve.
Photo: Golli. Fireworks on New Year’s Eve.

Rebuilding the Icelandic Nation 


By 2012, Iceland’s miraculous recovery was being cited as a success story among other nations. Unemployment rates had dropped to 6.3%, partly on account of how Icelandic officials began to appeal to immigrants.

In April of the next year, a new government was formed, setting about a process by which many of the former bank directors were sentenced for their part in the financial meltdown of 2008.

As of today, the consequences of this dark and complex time continue to reveal themselves. For example, Iceland is still very dependent on tourism, pouring billions of krona into marketing campaigns each year to ensure it remains a bucket-list destination for prospective travellers.

túristi tourist ferðamaður tourism
Golli. Tourists in front of Esja on Sæbraut in Reykjavík

Government officials must also continue to balance the debts they incurred attempting to pull the island out from its economic woes.

Finally, much of public discourse has been shaped by these events, and stricter measures on lending, borrowing, and trading remain in place so as to avoid repeating mistakes of the past.

Going forward, we can only hope these lessons have been learned for the last time.