Iceland Econ Thriving After Nixing Bail Out of banks and investors
Proving that the the US-Irish model of bailing out the banks with taxpayer money was harmful unless you were a wealthy bank investor.
Feb 1, 2011

On his second day as head of Iceland's third-largest bank, Arni Tomasson faced a crisis: The bank was out of cash. "Everybody was panicked -- depositors, creditors, banks around the world."

Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country's banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.With the economy projected to grow 3 percent this year, Iceland's decision to let the banks fail is looking smart -- and may prove to be a model for others.

three banks had become the largest companies in Iceland, creating thousands of well-paid positions and controlling the top trade associations, says Oddsson, who oversaw the privatization of Iceland's state-owned lenders as prime minister. Their headquarters were the largest buildings in Reykjavik, dwarfing the parliament.

"Nobody wanted to listen when the party was on," says Oddsson, 63, now editor of Morgunbladid, one of the largest dailies in the country, with a circulation of about 50,000.

It was Oddsson's decision not to build up the central bank's foreign currency reserves from 2005 to 2008 that made a bailout impossible.

"They were collecting debt in such a fast pace, it would be stupid for us to build a mountain they could lean on if they failed," Oddsson says. "The creditors that were lending to the banks recklessly had to face the losses."

"Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks," says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York.

Van der Knaap, who has advised Iceland's bank resolution committees:. "Even Irish banks aren't too big to fail."

Today, Iceland is recovering. The three new banks had combined profit of $309 million in the first nine months of 2010. GDP grew for the first time in two years in the third quarter, by 1.2 percent, inflation is down to 1.8 percent and the cost of insuring government debt has tumbled 80 percent. Stores in Reykjavik were filled with Christmas shoppers in early December, and bank branches were crowded with customers.