Iceland’s Crash and Stunning Recovery: Lessons for Greece?

"Iceland’s leaders defied the austerity orthodoxy, and to good effect....[but] alas, the Icelandic remedy won’t revive Greece."

In Independent People, the best-known work of Iceland’s Nobel Prize-winning writer Halldór Laxness, the protagonist, Bjartur of Summerhouses, a hardscrabble sheep farmer, embodies self-reliance, thrift, and attachment to the land and to nature. Bjartur’s disdain for the wealthy and powerful doubtless reflects Laxness’s own antipathy toward the materialism and power hierarchies produced by capitalism.

In reality, during the inflation-marked years following Iceland’s independence in 1944 (the island had been ruled by Norway and then Denmark), Icelanders spent money in the moment, fearing that to defer spending to later would be to pay more. Still, until the late 1990s, Iceland  was a socialist economy; the state’s role was extensive, and the commitment to social welfare through publicly financed programs was robust.

The economy’s mainstays were sheep farming (family-run farms still dot this bucolic island of 360,000 people, and free-roaming sheep are ubiquitous in the countryside), fishing, tourism, and the American military base at Keflavik, which at its height employed several thousand Icelanders. Apart from aluminum smelting, a bauxite-based energy-intensive process made economical by Iceland’s abundant thermal power, there was no industry to speak of. So it was not until the 1990s when an economic revolution got underway. The catalyst was Davíð Oddsson, leader of the rightist Independence Party, who became prime minister in 1991 and served until 2004, longer than anyone had before, or has since. Oddsson imbibed the free-market theories of Friedrich Hayek and Milton Friedman, whose 1984 lecture at the University of Iceland he attended, and was a devotee of Margaret Thatcher’s and Ronald Reagan’s economic policies.

Oddsson believed that bold privatization and deregulation would liberate Icelanders’ creative spirit, which the state’s extravagant economic role, myriad regulations and steep taxes had suppressed. Once its economy was unshackled and entrenched socialistic policies jettisoned, Iceland would become a private enterprise dynamo propelled by high finance, hi-tech, and a state-of-the-art service sector. Iceland would be remade into a globalized 21st-century economy on par with Europe’s best. The leveler-like nostrums of Laxness and his ilk would become relics.

Such was the dream. Reality proved rather different, and the privatization of banking, begun in 1998, had particularly disastrous consequences. It culminated in the rise of three private banking giants, Kaupthing, Landsbanki, and Glitnir, each of which also established foreign branches and affiliates: brick-and-mortar and online. The triad effectively comprised Iceland’s entire banking sector. Operating alongside it was a Byzantine network of interlocking holding companies created expressly for purchasing shares in companies, with the aim of taking them over.  

The holding companies’ owners also tended to control the largest shares in the banking triumvirate, or to sit on its boards. They were also its principal borrowers. This arrangement guaranteed Iceland’s tycoons the lavish bank loans that they relied on to amass real estate, retail chains, banks, telecommunications companies, and newspapers, television networks, and radio stations. This unrestrained leveraged buying was not limited to Iceland. The moguls bought assets in Europe (Britain was a favored venue) and, albeit to a much smaller extent, the United States.

The largest of the holding companies was the Baugur Group, owned by the swashbuckling, hard-partying, free-spending Jón Ásgeir Jóhannesson, who typified the big-risk, borrow-and-buy ethos of the times. Icelandic financial barons like him were smart, brash, and self-confident in the extreme, akin to the cardboard characters in Ayn Rand novels. That proved to be big a part of the problem: those same qualities blinded them to their hubris. They were convinced that they had the savvy to play indefinitely what was essentially a ponzi game—albeit a complicated one that in the aftermath of the crisis would confuse the best investigators—and that their economic empires and wealth would keep expanding.

The more assets these magnates acquired, the more they coveted, never mind that each new acquisition inflated further their already-huge debts. Why worry? Iceland’s banks provided a steady stream of credit; and what they could not provide, foreign banks and bond-purchasers would.

Iceland’s oligarchs were not the only ones caught up in this credit-fueled excess; so was Icelandic society more generally. The boom years swelled the ranks of young, inexperienced, bankers. Newly rich, they wanted to drive swanky cars, to live in plush apartments, and to dine in fine restaurants. When their earnings—padded by big bonuses—could not finance their tastes, they turned, as befitted the times, to loans. Their lifestyles, in turn, shaped other Icelanders’ conception of success, which in essence amounted to a shopping spree funded by borrowed money.