08 October 2010

Too big to fail? Ireland v Iceland

Yes I’ve neglected my blog for a while.

No I don’t have a decent excuse.

However, on the up side, the passage of time has allowed the greatest social experiment of the GFC to develop. Iceland and Ireland have generously lent their entire economies to answering the question: Can a bank be too big to fail?

You will recall when we left the story back in March the two countries had shattered banking systems, crushed economies and severe downturns in their property markets. Both had massive private sector banks either on the verge of falling over or already collapsed. The issue was whether the governments of those nations would step in to guarantee the banks' liabilities?

The Irish chose to nationalise their banks and all the toxic assets that they contained, while the Icers rejected paying for the excesses of Icesave and others despite threats from creditors.

When the British and Dutch investors demanded the Iceland government guarantee the banks’ debts, the Iceland government put the question to the people. Asked whether the government should pay €3.8 billion to cover British and Dutch investor losses following the collapse of their Icesave accounts, 93% of Iceland said “just as soon as Satan rides to work in a snow plow” and the debt remained stubbornly private (at least in Iceland, in the UK and the Netherlands their own governments covered the losses).

The world is finally getting to see a side by side comparison of the two strategies. Would the pain of saving the banks be worth the price to the citizens of Ireland, or would it have been better to let them fail and pick up the pieces Iceland style?

The cost of the Irish bailout was staggering. In 2009 the Irish government injected €54 billion into its largest banks to protect them from collapse. The only way to pay for this was to smashed its local population.

Public sector wages were slashed by 1 billion euros and welfare reduced by €760 million (about 20% and 4% respectively in real terms).

The removal of that much public spending increased the contraction pressue in the economy and helped send unemployment to its current 13.7%.

This month, the other shoe dropped: Anglo Irish Bank just hit the wall with massive unserviceable debts.

The Irish government has agreed to save the bank at a cost of up to an additional €35 billion (if you’re doing the maths, that’s about 20 times the savings from wage restraint and welfare cuts).

Even after this, the bank's bonds are rated as junk.

Once again, the Irish taxpayers have been advised that they will be paying the bill to protect investor confidence and save the Irish economy.

The net effect? Ireland’s current account deficit is projected to increase from 14% to 32% of GDP as a direct result of swallowing all that toxic debt. That will put government debt up from the current 77% to 115% of GDP in the next years.

The only way to pay for this will be further cuts to services and wages from a people already on their knees. If you’re of a keynesian school, you know this will lead to further contractions in the economy, more unemployment and still further reductions in public services.

On the other side of the experiment, the Iceland government is still talking with the Brits and the Dutch about someday looking at the real possibility of considering kicking the can for some of the bad loans. So far they haven’t paid a single euro towards those debts.

While they are at it, the Icers declared a moratorium on house repossession to give households a bit of breathing space without forgiving debt.

They also defiantly refused to strip what has become the hallmark of Nordic countries, a strong social safety net.

People predicted it was the end of Iceland, it would be frozen out of the world economy, their children would starve, the country would come to resemble an arctic version of Mad Max II.

So how are the Icers doing beyond Thunderdome? Well, not good, to be sure, but not Irish bad.

Contrary to threats made, the IMF has continued to provide a “Stand by Arrangement” to provide $2.1 billion in loans. The third tranche was paid on 29 September.

While their public debt is currently 115% of GDP, Iceland's 2010 budget will actually produce a surplus. The IMF itself believes Iceland will get back to a national debt of 80% GDP by 2015. This is more or less the exact reverse of the Irish trajectory.

Unemployment is at 7.3% which sucks if you’re in that group, but better than the 13.7% in Ireland.

Real wages, which were put to the sword in 2008, remain depressed but have been growing in the last three months.

It’s a tough long road for the Icers, but they seem to be climbing back.

On the flipside, the Irish are crushed and look like getting more crushed as their deficit continues to spiral, their economy shrinks and those that can leave, get on a plane out of there.

Its still too early to decide if the Irish were fools to listen to the "too big to fail" mantra; this experiment still has quite a way to run. Iceland has not resolved its dispute over the Icesave accounts, nor does a projection of reigning in nation debt by 2015 automatically mean that it will happen.

However at this stage it looks like Iceland has its nose in front.


  1. Thanks Toad. For reasons not entirely clear to me, I really prefer the tough love approach and am hoping for some justification that it really is better in the long term. I think I want people who take risks (ie investments that return greater than cpi) to be shown that the word "risk" means that you can lose all your money.

    Have you read "The Black Swan" by Nassim Taleb (http://amzn.com/081297381X)? Very interesting analysis of risk and the usefulness (or lack thereof) of the Gaussian/normal distribution.


  2. in the end it shows how important it is not to let banks deal with other people's money without independent and diligent regulation- ric

  3. Ric and Vic, thanks for reading.

    Ric you raise an interesting question: How to prevent bankers taking stupid risks in the first place?

    In my view leaders with a bit of skin in the game are less likely to let the system run out of control.

    I think here Iceland might also have a good idea. They have charged their former Prime Minister with criminal negligence over this whole matter. He could do two years if convicted.

    That might give the next leader pause for thought when risking taxpayer funds.


  4. Thanks Toad for a well written & interesting analysis. I'd be keen to see a breakdown of "Bad financial sector debt (private) that was offloaded to the taxpayer (public)" per capita -- across countries like Ireland, USA, Iceland, Spain.

    As a % of average annual income this would offer a tidy "Shafted Index" against populaces around the globe -- and seed a comparison re: the public's response v.s. the degree to which they were shafted by their particular Kleptocracy.

    There is a bargain being made here: Because our banks are "too big to fail", each of you will carry a (Shafted Ratio times your annual income worth of) debt because the private bets our bankers made didn't come in.

    At what Shafted Ratio does a populace go all Iceland and say "Oh a GFC ? How about you GFY ?"

  5. Hi Dave,

    thanks for your comments.

    Conceptually, I like the Shafted Index but it does presume that bail outs serve no purpose other than to save banks. I'm still not 100% convinced they don't have social value. Its an argument that's there to be won.

  6. Toad

    You've got me thinking. In theory, a country should be able to make a rational decision about whether to (a) all go bankrupt now and have everyone start saving again for retirement and living with the private austerity which that involves or (b) prop up the nation's investments now with public debt and start living with paying higher taxes and lower government handouts. But whilst investors can make that sort of decision, in Iceland's case, it was voters who decided (which includes many people who just dont care (yet) about retirement) and I think you could accept it as a rule that voters in any country don't want to pay any more tax than they already do. So in that way I see the plebiscite as no more than a predictable confirmation of that preference, and a very understandable, and overdue, get fucked to fat cat bankers.

    In terms of the numbers, I just can't see that there could be any real difference between Iceland and Ireland by reason of this issue as opposed to where they started from. I can see the figures might look like they point one way, but would that really be the case once Icelandic private austerity is factored in, which will be required if Icelanders are to fight their way out of this (ie the reduction in domestic consumption needed to fund the forced private savings). And isn't the Icelandic situation already a little better for the UK and Netherland stepping in to guarantee part of their banking debts? Has anyone done that for Ireland?

    But, for mine, the thing that is vexing me is this. Do they really want to fight their way out of this? Dont they really just want to get bailed out. I’m thinking it cant be anything but the latter, and frankly I'd do the same. I’ve read that local newspapers are running some line that Norway should step in pay off the debt. You were outraged by the Greeks in a previous post. Isn’t it inevitable that Icelanders will accept international funds (backed by taxpayers in those countries)?? Someone has to pay for the Icelandic debt and turning their back on it won't change anything for them. All that oil in the Gulf of Mexico didn't just disappeared either; its gone somewhere but right now no one with any power in the US wants to think about it. Of course getting someone else to pay for your debts is a great idea if you can get away with it but I don’t see it as heroic.

    Finally, can I say I’m glad to see you are continuing your blog.