Iceland was a pioneer in recklessness during the credit boom. And now the small nation in the north Atlantic is a pioneer in political accountability during the credit bust. Geir Haarde, the Icelandic prime minister between 2006 and 2009, appeared in a special constitutional court in Reykjavik yesterday on charges of "failures of ministerial responsibility" during the 2008 financial meltdown. But there is an irony here. For the economy that Mr Haarde helped to wreck has fared surprisingly well since the bust.
Iceland experienced one of the most severe recessions in the world when the markets crashed in 2008. Economic output fell by about 12 per cent over two years. But the latest report on Iceland by the International Monetary Fund shows that growth is resuming. GDP is expected to increase by a relatively healthy 2.5 per cent in 2011. The Icelandic public finances are on a sustainable path too with government debt projected to fall to 80 per cent of GDP in 2016.
The turnaround should not be exaggerated. Iceland is still more than 10 per cent below pre-crisis output levels. Unemployment remains at about 6.7 per cent, considerably higher than before 2007. The standard of living of most Icelanders is well down. Access to foreign currency is tightly controlled. And risks to recovery remain. Central bank interest rates are going up in order to curb inflation. This could stifle growth. Yet the fact remains that the outlook for the Icelandic economy is looking rather healthier than other distressed economies in Europe such as Greece, Portugal and Ireland.
So how did Iceland manage it? There were four pillars to Icelandic policy in the aftermath of the bust: external assistance, debt repudiation, currency depreciation and capital controls. The assistance was considerable. Reykjavik called in the IMF in November 2008. So far Iceland has received €1.56 billion (£1.38bn) in assistance from the fund (in the context of a GDP of €8.4bn). It has had help from friendly governments, too. Iceland received $3bn (£2bn) from Nordic nations to bolster the foreign exchange reserves of its central bank.
Iceland's debt repudiation was considerable too. The three largest banks – Landsbanki, Kaupthing and Glitnir – collapsed in autumn 2008. Rather than nationalising them, the government allowed the banks to go into administration. Foreign bondholders lost some of their money and saw the rest of their loans converted to equity. A hard line was also taken with other creditors. Icesave, an online subsidiary of Landsbanki, took deposits from some 400,000 people in the UK and the Netherlands. When it went bust, these depositors were rescued by the Dutch government as well as our own. Iceland refused to guarantee reimbursement. That saga might, however, have a relatively happy ending. Last week the administrators of Landsbanki said that the estate of the banks should yield more than enough to pay the UK and Dutch governments what they are owed.
Depreciation has helped too. The value of the krona fell by 50 per cent against the euro from peak to trough. This has delivered a boost to Iceland's two main exports, aluminium and fish. Finally, capital controls were imposed to prevent investors withdrawing funds from the country in a panic. The overseas owners of high-yielding "glacier bonds" were prevented from selling them. This helped to prevent a total collapse of the currency. All this has helped Iceland to absorb the pain of a fiscal consolidation, under IMF supervision, of 10 per cent of GDP over the past two years.
Reykjavik was warned that it would never borrow again if it failed to honour the debts of its financial sector. But the country already seems to have been forgiven by the markets. The Icelandic government issued $1bn in sovereign debt in June at an interest rate of around 6 per cent. This was twice oversubscribed by investors. The contrast with Ireland, which assumed responsibility for all the liabilities of its bust banking sector, is stark. Thanks to Dublin's blanket bailout, total government debt is now more than 100 per cent of GDP, four times pre-crisis levels. And Ireland's reward from the markets has been a rise in the cost of insuring its sovereign bonds. Iceland's currency depreciation also looks good by international comparisons. Latvia doggedly kept its peg with euro after the 2008 crash and has experienced a catastrophic 25 per cent decline in GDP and seen unemployment reach 22 per cent.
The economic policy orthodoxy through this crisis – pushed by ratings agencies and European politicians alike – has demanded that national governments honour the debts of their banking sectors, protect their exchange rates, eschew capital movement restrictions, and impose massive austerity to earn back the confidence of bond markets. Much of that wisdom was ignored by Reykjavik. And the early signs are that Iceland is doing quite well as a result.
Haarde on their heels
Geir Haarde heads a cast of hundreds who could face prosecution for their part in Iceland's financial implosion.
Iceland's special prosecutor, Olaf Hauksson, has named more than 200 suspects in his criminal investigation into the country's financial crisis.
So far, those convicted in connection with the country's big banks – Landsbanki, Kaupthing and Glitnir – include former Kaupthing brokers who got six months in jail for manipulating bond deals and Baldur Gudlaugsson, a former permanent secretary at the finance ministry, who received two years for insider trading of Landsbanki shares. Haukur Thor Haraldsson, a former managing director with Landsbanki, was sentenced to two years in July for embezzlement.
With the full criminal investigation set to run until 2014, there may well be bigger fish to fry. Hreidar Mar Sigurdsson, the former boss of Kaupthing, and Landsbanki's ex-chief executive, Sigurjon Arnason, were both arrested in the last two years.
Mr Hauksson has also linked up with Britain's Serious Fraud Office. In March they swooped on properties in London and Reykjavik, in connection with the collapse of Kaupthing. The British tycoons Robert and Vincent Tchenguiz were arrested but were released the same day; they have not been charged and have denied wrongdoing.
Later in March the SFO, Luxembourg authorities and Mr Hauksson's team raided premises including Banque Havilland, owned by David Rowland, the former Conservative Party treasurer. Mr Rowland's son Jonathan said the investigation covered events before Mr Rowland bought the bank.
The former chief executive of Kaupthing Luxembourg, Magnus Gudmundsson, was also co-chief of Banque Havilland until he was arrested as part of the investigation in May last year. Sean Farrell