Arni Torfason/AP
Iceland's Prime Minister Geir H.

Iceland Nationalizes Third Major Bank, Halts Stock Trading

October 09, 2008 03:40 PM
by Anne Szustek
In a move to prevent its teetering economy from falling into bankruptcy, Iceland ceased all trading on its stock exchange until Monday, and took over Kaupthing, the country's largest bank.

Awash in Red

On Thursday, Kaupthing, Iceland's largest bank, became the third of the country's top three banks to be taken over by Iceland's Financial Services Authority in the past two weeks, following number two Landsbanki on Tuesday, and the third-largest Icelandic bank, Glitnir. The latter was nationalized on Sept. 29, and taken under receivership on Wednesday, granting the bank a temporary reprieve from paying its debts.

Glitnir also got 5 billion Norwegian krona ($820,000) in liquidity from the Norwegian Banks' Guarantee Fund on Thursday. The bank announced the same day that it had begun to sell off its Norwegian operations.

Iceland's stock exchange, the OMX Nordic Exchange Iceland, is being shuttered until Monday due to what officials called "unusual market conditions."

An emergency parliament measure made for the Icelandic government's creation of "New Landsbanki," a state-owned financial institution that is to hold Landsbanki's domestic deposits.

IceSave, an internet bank operated by Landsbanki, is the target of U.K. government legal action after it halted all withdrawals from its accounts on Tuesday without intending to return the funds of some 300,000 of its U.K.-based customers. According to British Finance Minister Alistair Darling, Iceland's government is required to protect up to €20,000 ($28,480) in deposits. Pledging support for the country's IceSave customers, he was quoted as saying in The Guardian, "I am prepared to stand behind ... the depositors."

As for Kaupthing, its executive chairman, Sigurdur Einarsson, noted that the bank was on steady footing, but suffered at the hands of a run on its Internet deposits similar to the one seen on IceSave. “It did not matter that the parent company had sufficient liquidity and its position was solid,” he was quoted as saying in the Financial Times. Kaupthing's British subsidiary Kaupthing Singer & Friedlander was taken under the control of the U.K. government.

Deregulation of the country’s banking sector in the mid-1990s led to Iceland becoming a magnet for trillions of dollars’ worth of foreign exchange deposits. The country went through a transformation from one of Europe’s poorest countries to one of the world’s 10 richest.

Iceland’s banking sector dwarfed the rest of the economy over the past decade. The country’s banking sector is some eight or nine times larger than its gross domestic product. High interest rates beckoned scores in foreign deposits—far exceeding locally held accounts and exposing the country to the financial ills of the world at large. Kaupthing, for one, accumulated debts stemming from funding British transactions of more than $5.2 billion within five years.

The fact that most bank accounts in Iceland are in foreign currency rather than krona is impeding the country’s central bank’s efforts to keep up Iceland's financial institutions.

Since July 2007, the Icelandic krona has dropped more than 46 percent versus the euro, prompting the country to peg its currency to the predominant EU monetary unit and seek a €4 billion (about $5.7 billion) loan from Russia to shore up its reserves and help bolster its currency.

Historical Context: Past government bankruptcies and courses of action

New York City was on the verge of bankruptcy in 1975, but stayed solvent after the teacher’s union agreed to put $150 million toward the city’s municipal bonds. The situation was so dire that the city had devised a contingency plan to determine which city services would get paid first: the top three being the police and fire departments, respectively, sanitation and public health, and food and shelter aid programs. Mayor Abraham D. Beame drafted a statement set to be released on Oct. 17, 1975, saying that the City of New York was issued a court order to protect its holdings from creditors.

Under Chapter 9 bankruptcy, developed during the Great Depression, municipalities are protected from seizure of assets by creditors and are entitled under U.S. bankruptcy law to negotiate repayment terms. In addition, the 10th Amendment effectively grants immunity to municipalities from bankruptcies, as that body of law is federal in scope, yet not part of the Constitution. As municipalities are under the authority of individual states, any law not enumerated in the 27 amendments is at the discretion of the states.

In reality, when a government goes bankrupt, until the government gets its books in order, public services are cut while taxes and fees go up. Governments often print more money to “cover” debts.

To deal with the government’s default early this decade, in January 2002, Argentina abandoned its peso’s one-to-one peg with the dollar and had all dollar-denominated bank accounts in the country changed over into local currency, exchanged into an “official” rate set at 1.4 pesos to the dollar.

The local currency rapidly devalued. That summer, Argentina stopped fulfilling its debt load.

There was a silver lining in this however: the subsequently cheaper exports resulted in an influx of hard currency, bolstering the Argentinean economy. On top of a successful debt swap in 2005 of $81 billion in defaulted Argentinean bonds in exchange for new debt instruments worth some $0.35 on the dollar, that Latin American economy has largely bounced back.

Neighbor Brazil had similar woes during the mid-1990s. Its public sector was nearly bankrupt after decades of bungling by military regimes. The administration of Brazilian President Itamar Franco implemented the Real Plan, which pegged the local currency, the real, to the U.S. dollar. This tided inflation and increased inflows of foreign currency. A public fiscal readjustment program was developed, which led to growth that helped clear some of the country’s current account deficit and assuage foreign investors’ trepidation about the emerging market economy.

American hedge fund Elliott Associates took a decidedly harsher approach in regards to $11.8 million spent on bad Peruvian public debt. Peru’s government settled in 2000 after a four-year court battle for nearly $56 million.

Less recently, German, British and Italian warships blockaded Venezuelan ports after the country defaulted on its debt in 1902. And in 1881, European countries picked away at the Ottoman Empire’s customs houses after Constantinople, by then known as “the sick man of Europe,” failed to pay up, drained by years of war against Russia.

Related Topic: Pakistan's economy nearly in default

In Pakistan, skyrocketing oil and fuel prices on top of a government allegedly rife with corruption are weighing down on the nation’s finances. Rises in prices for oil and food have pushed up Pakistan’s bills for those commodities by roughly one-third since the start of the year.

Pakistani President Asif Ali Zardari told The Wall Street Journal that the country needs some $100 billion in bailout money from other countries. Styling it in terms of bolstering counterterrorism efforts, he was quoted as saying in U.K. paper The Daily Telegraph, “The oil companies are asking me to pay $135 [per barrel] of oil and at the same time they want me to keep the world … and Pakistan peaceful.”

Pakistan’s sovereign debt credit rating from Standard & Poor’s is currently CCC+, meaning it is near default.


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