It's October 2008. Northern Rock has already suffered the largest run on a UK bank in more than a century. Icelandic banks Landsbanki and Kaupthing are close to the edge. Both are feeling extra pressure from the UK treasury thanks to their respective savings accounts Icesave and Kaupthing Edge, which hold billions in UK deposits. Alistair Darling and his opposite number, Icelandic trade secretary Arni Matthiesen, have just concluded a phone conversation about the fate of Landsbanki. What was to follow sparked a diplomatic row to rival the Cod Wars of the 1970s.
When Alistair Darling was interviewed on BBC Radio on the morning of October 8, he stated: "The Icelandic government, believe it or not, has told me yesterday they have no intention of honouring their obligations here . . . Because this is a branch of a foreign bank the first call would be on the Icelandic compensation scheme which, as far as I can see, hasn't got any money in it . . . But I have decided in these exceptional circumstances that we will stand behind those depositors so they get their money back."
Gordon Brown held a press conference at 9:15 that same morning, and unveiled his new plan for saving the British banking system with a £500 billion rescue package. There was more to report than a bailout at home, however. Brown used the opportunity to announce that he was "taking legal action against the Icelandic authorities to recover the money lost to people who deposited in UK branches of its banks."
Indeed, he was. Barely one hour later, the British government enacted an antiterrorism law (Landsbanki Freezing Order 2008) that authorized them to seize all assets of Landsbanki in Britain. The freezing order was issued under the 2001 Anti-Terrorism, Crime and Security Act, which was passed after the 9/11 attacks. The application of this law to a peaceful nation or bank that was truly not involved in terrorist activities was unprecedented. Later that day, Landsbanki, the Central Bank of Iceland (CBI), and the Icelandic finance ministry were listed with other "financially sanctioned regimes" such as Al Qaeda, the Taliban, North Korea, and Burma. (The CBI and Icelandic ministry of finance were later removed, leaving Landsbanki as the lone Icelandic bedfellow of terrorist states.)
This action probably did more to revive Brown's popularity than any other. A typical response, recorded by the BBC later that day after the statement from Darling, came from Mike Davis, age 62, who had £75,000 in retirement savings locked up in an Icesave account. Claiming that he had not slept in days, Davis said he was "highly relieved and thankful" after hearing the chancellor's pledge. "It has restored my faith in Britain and the British government." Both Brown and the Labour Party watched their approval ratings jump in next few days.
But they had more in store for Iceland than this. As a result of the negative publicity, the outflow from Kaupthing Edge had turned into a flood. On the morning of October 8, the British FSA asked Kaupthing for an additional £300 million infusion to address the deteriorating liquidity situation. Sensing that his position in Britain was now untenable, [Kaupthing chairman] Sigurdur Einarsson asked Deutsche Bank if it would be possible to sell Kaupthing Singer & Friedlander (KSF). The Deutsche advisors thought it was quite possible, but noted that a sale would take 24 to 48 hours to complete. At 9:30 a.m., while discussing KSF sales options, Einarsson watched a headline run across his TV screen: "ING Buys 3 Billion Pounds of Deposits From Icelandic Banks." Without his knowledge, the British FSA had seized the Kaupthing Edge deposits (about $4.5 billion), sold them off to ING, and sent KSF into bankruptcy proceedings. Landsbanki's holding, Heritable Bank, was condemned to the same fate.
Singer & Friedlander was an independent UK bank, and its bankruptcy did not automatically take down its mother company in Iceland. But it did breach Kaupthing loan covenants and open up the possibility of an early redemption for bondholders. The rest of that day was filled with frantic attempts to persuade bondholders not to request early redemption. Some agreed to waive their rights, but others, who had hedged themselves out by shorting Kaupthing in the CDS market, actually stood to gain from the default that would result.
Management gave up the ghost at midnight. Control of Kaupthing was given over to the Icelandic FSA. In three days, all of the Icelandic banking giants and 85 percent of the financial system had collapsed. Seventy-five percent of the stock market value was wiped out.
The government was in a state of shock. Apart from Darling's call to Matthiesen on Tuesday morning, there had been no discussion, and no warning of Britain's intentions. Nevertheless, Britain's treasury spokesman stated that "the UK government has made it clear repeatedly that this decision to protect UK depositors in Icelandic banks was made after extensive conversations with the Icelandic government."
Prime Minister Geir Haarde held a press conference at 4 p.m, October 9, to express his personal upset and shock at the use of "hostile" antiterrorism legislation as a means to freeze the assets of Icelandic banks. Beyond that, he refused to discuss the matter publicly. Iceland's official statement toed a friendly line:
The Icelandic government appreciates that the British authorities are willing to step in and respond to the immediate concerns of depositors of Landsbanki's IceSave accounts. The governments of the two countries will immediately review the matter in detail through official channels with a view to finding a mutually satisfactory solution... The government of Iceland is determined not to let the current financial crisis overshadow the long standing friendship between Iceland and the United Kingdom.
For his part, Gordon Brown had no objection to taking this matter public. He did not take Haarde's call on October 9. Haarde was able to speak with Darling, who assured him that transactions between their countries would return to normal. Meanwhile, Brown told BBC political editor Nick Robinson, "I've spoken to the Icelandic prime minister, I have told him this is effectively an illegal action that they have taken. We are freezing the assets of Icelandic companies in the UK where we can. We will take further action against the Icelandic authorities where necessary to recover the money."
This sounded like some kind of corporate ethnic cleansing. Brown seemed intent on confiscating the firms and assets of Icelanders who had done nothing wrong beyond standing under the same flag as the accursed banks. Later that day, Brown declared on Sky News that Iceland was bankrupt.
The gaming between Brown and Haarde turned into a contest of cat and mouse. However, Iceland's government, without an effective spokesperson or a well-placed public relations channel inside Britain, looked amateurish. At home and abroad, Icelanders experienced their country's "terrorist entity" label as the final tremor that brought down the house. The nation's international payment system collapsed.
Funds sent to other countries were held up at some banks, or simply disappeared. Money could not be sent outside the island. Most banks simply refused either to send or to receive Icelandic payments. Icelanders throughout the world often found to their horror that their credit cards no longer worked and that they could not transfer funds from home. Foreign trade became next to impossible, since payments could not be cleared.
All at once, everything Icelandic had become toxic, untouchable, banished to a place outside the world of business. The situation in Britain was the worst; accounts of all Icelandic businesses were effectively frozen until the British authorities at last made it clear that the freezing order pertained only to Landsbanki. Despite this single mercy, Gordon Brown had brought the Icelandic economy to its knees with a single swipe.
The cultural and personal ramifications of the invocation of the Terrorist Act were terrible. The Icelanders had looked up to the British and emulated many of their ways. "We thought they were our friends" was a typical, plaintive response at the outset. But public anger soon began to grow over the perceived injustice. Kicking a tiny, friendless island carried no cost for the British authorities, since such tactics are still admired in many quarters. While UK tabloids shouted for Icelanders to "Give us our money back," most Brits conveniently ignored that the Terrorist Act had made it harder than ever for the banks to pay.
Icelanders in Britain were targeted by customs officials at airports, thrown out of rental apartments, laid off at work, and verbally abused as thieves in the pubs. They were ridiculed in other countries as well, and subjected to cheap shots. A Danish paper held a mock charity drive in Copenhagen's main square to support penniless Icelanders. There was also some magnanimity, especially in the form of financial aid to students who were stranded by the collapse of the payment system. Perhaps the nation's risk-seeking and self-assuredness (or arrogance) warranted this comeuppance; even if this was so, the experience of a friendless world was a bitter one.
Why Iceland? by Asgeir Jonsson is published on 15 September 2009. Publisher: McGraw-Hill. ISBN: 978-0-07-163284-3, £16.99, 240 pages, hardcover.
Ásgeir Jónsson is head of research and chief economist of Kaupthing Bank
Posted 20 August 2009 : Director.co.uk
