At year's end

The year 2008 will long be carved into Iceland’s history as the year of the great bank crash that took place last autumn. The year will also be remembered for the economic turbulence that the nations of the world have suffered. Following a period of a pronounced expansion, the world economy has come into turbulent waters and the gains of recent years have evaporated. In the case of Iceland, where the expansion was most pronounced, the fall has also been the greatest.

In the face of such a crash, it is easy to become despondent and give up. But we Icelanders are like no others and we will stand firm. It is in our nature to accept calamities with equanimity and overcome difficulties with optimism and perseverance. We all know that the bank crash has caused great harm to Icelandic families and businesses. The size of the banks’ operations relative to the overall economy was such that their crash unleashed a shock wave that currently is shaking our economy down to its very roots. We Icelanders must be prepared for the fact that the worst is yet to come before we can again advance with the same determination as before. Next year is going to be difficult and will test our mettle and solidarity as never before.

Sacrifices, accord and unity

Those who now must shoulder heavy burdens in the wake of the bank crash – Icelandic taxpayers and their families, our children and generations unborn – have the unconditional right to learn the truth about why the banks crashed. A special investigative committee of the Althingi, staffed with the best available experts, will in the coming weeks and months investigate the events leading up to the crash, what actually happened and why. This will highlight the issues of contention and aim to answer the many questions that have arisen. We should all welcome the results of such an investigation that is intended to expose the truth without exception. Until the conclusions of the committee are at hand, we can not render judgment upon individuals, companies or institutions on their role in the affair.

A special prosecutor with wide-ranging investigative authority will inquire whether laws have been violated before the bank crash or in their operations. This is the only way to prosecute culpable individuals, absolve others of guilt, who have done their duty with conscience and diligence, and implement measures to avoid such events in the future.

How could this happen?

In recent weeks, we have all asked how it could happen that the robust Icelandic banks could collapse in a matter of a few weeks. There is, of course, no simple answer to that question. With a bit of simplification, it may be said that the banks were not strong enough to stand on their own two feet when international financial markets dried up but still too large for the Treasury and the Central Bank to protect them from collapse. The size of the banking system relative to the gross domestic product had no comparison. Under normal circumstances, the size of the banks would be an element in their strength, but once the world recession came on in full force, their size turned out to be their nemesis.

Regrettably, the Icelandic banks, as well as many large Icelandic companies, expanded far too fast in their foray abroad. The banks took advantage of the liberal regulatory environment of the European Economic Area on capital movements as well as of the ample supply of funds in the international financial markets for many years and at favourable terms. When this situation was reversed and the supply of funds dwindled, originally due to events in the US housing market in late summer of 2007 the banks were not prepared. One could say that the fate of the banks was decided with the bankruptcy of the giant US investment bank, Lehman Brothers, on September 15th, when the US authorities refrained from coming to the bank’s rescue. Following its collapse, the traditional sources of loanable funds in the international markets dried up. Banks that could not rely on help from governments and public funds had scant prospect of saving themselves.

On Monday October 6th, I addressed the nation on television to report on the serious condition of our financial system. The reason for the dismal state of events was twofold. The first was that the international financial shortage hit with its full force and caused the collapse of many companies, banks and financial institutions both in the US and Europe. The other reason was that the banks themselves had taken undue risks in their operations and investments in recent years and were insufficiently prepared for the changed circumstances in financial markets. It should be remembered that the mid-year statements of the banks that were released last summer – and were confirmed by their auditors – did not give reason to believe anything but that they were robust. The banks were believed to be well financed throughout 2009 and their assets appeared sound. Last May, the Central Bank stated that the banks’ position was largely sound, and the oft-repeated stress tests of the Financial Supervisory Authority pointed to the same conclusion.

Nevertheless, by the end of September it had become inevitable that the government would have to intervene. The banks were vital for the normal course of business in the country. If banking services would be interrupted, the entire economy could come to a standstill and create a serious disturbance in the economy, since the public could not withdraw its funds from the banks. It was therefore of prime importance to ensure that basic banking services would continue and that the interests of Icelandic taxpayers and families would be protected. With the passage of the so-called Emergency Act on the eve of October 6th, the Financial Supervisory Authority was trusted with the task of taking over the operation of the banks and establish new banks on the foundation of the old ones.

In the end, the authorities were compelled to take over all the three large banks and establish new ones in order to continue normal domestic banking services. For a while it appeared that the Kaupthing Bank could survive the difficulties, but the measures taken by the Financial Supervisory Authority of the UK caused the collapse of the Kaupthing subsidiary in London, Singer & Friedlander, a bank that was more than a hundred years old. This caused Kaupthing, the mother bank in Iceland, to collapse too. All indications are that the legality of the measures taken by the British authorities will be tested in British courts. The strong measures taken by the British authorities in this case, by invoking the Terrorism Act against Landsbanki and other Icelandic interests, is an ugly stain on the reputation of the British authorities and much to their discredit. The authorities thereby abused their power against a peaceful and friendly ally by resorting to measures that they would never have invoked against a larger and more powerful country. In the long term, it is evident that these measures will be seen as shameful, both at home and amongst other nations. Towards the end of its autumn session, the Althingi passed a bill, sponsored by members from all parties, to provide funds for litigation against the British authorities in this matter. The new Act underlines the broad determination of the nation in this case.

A worldwide financial turmoil

In the discussion of banking affairs here at home, there are many who seem unaware that we Icelanders are not the only ones in difficulties. The international financial breakdown is precisely that: international. It has wreaked a great deal of havoc around the world. Two of the member nations of the European Union have followed our lead to seek the assistance of the IMF. The number of nations requiring such assistance continues to increase. The member countries of the EU have allocated scores of billions of public funds to support their banking systems, and the same is to be said of the United States. A number of well-established giant corporations on both sides of the Atlantic are teetering on the brink of bankruptcy, and countless companies have gone out of business, not to mention the large number of people who have lost their jobs.

Unfortunately, there is every possibility that the recession will deepen further and affect the Icelandic economy. There are signs that prices of our export products, such as fish and aluminium have declined and that foreign financing is virtually unavailable. It must be assumed that the growth in world tourism will be marginal next year. It will thus be important to cultivate the niche markets for tourism in which we have some experience. The adverse effects of the world recession are to some extent mitigated by declining prices for oil and some raw materials.

Difficult year ahead

The collapse of the banks will have a profound and adverse effect on our economy in 2009. The Government decided, in consultation with the Central Bank, to seek the cooperation of the International Monetary Fund in Washington, where Iceland has been a member since 1945, to restore the economy. The cooperation with the Fund’s experts was smooth and swift, and a recovery plan was drafted on which the assistance of the Fund and several friendly nations was based.

Our cooperation with the Fund has begun well, although it has proved necessary to resort to harsh measures, both by restricting capital movements to and from the country and in our fiscal affairs with the passage of the 2009 fiscal budget. With its passage, the expected fiscal deficit was cut from 215 billion krónur to 153 billion. This achievement was very important, although it is clear that we must continue on this course for the next several years. The restrictions on capital movements to and from the country will be lifted as soon as possible.
If the recovery plan drawn up by the Government and the IMF proves successful, we may expect that inflation will subside rapidly in 2009, followed by a decline in interest rates. The situation will look different at the end of next year. We must all work together to achieve this end.

From the beginning, the Government has been determined to respond to these problems, both in the short as well as the long run. A number of measures have already been announced to ease the impact of the crisis on individuals and businesses in the country. Information on the measures, as well as our work with the IMF, may be accessed on the websites www.island.is and www.iceland.org.

I especially wish to mention measures to ease the payment burden of individuals who owe indexed debt by applying a repayment equalisation index and the possibility for freezing repayments of foreign currency-denominated debt. The Government has also asked public debt collectors to apply mild measures against individuals. The regulation has been abolished whereby the Treasury could apply child benefits against tax liabilities and mortgage interest credits could be offset against mortgage repayments to the Housing Finance Fund.

The Government intends to establish a Recovery Fund, a robust business investment fund with the participation of the pension funds, banks and other investors, including foreign investors, The boards of the new banks will be required to set clear guidelines regarding the supply of credit to businesses with the aim of protecting jobs and help the continued operation of viable companies. The Government has also emphasised that agreement will be reached with creditors of the old banks, since it is important to find a solution that proves agreeable to such important creditors. To offer them a share ownership in the new banks could prove an option worth exploring.

For the first time in a long while, we Icelanders must face deteriorating living standards, increasing unemployment and declining purchasing power. The contraction in the economy basically means that the growth of the past two to three years has evaporated. Let us however remember that these past few years have been very good to us and our standard of living has improved incredibly fast. Although it is painful and difficult to have to turn back, our state as a nation and community is quite strong and enviable by most measures.

Iceland in a changed world

In the wake of the economic calamities that Iceland has suffered, we, the Government, that holds office under a democratic mandate of the people, must look for answers to the question of Iceland’s position with respect to its cooperation with other nations and what kind of a national community we wish to build up for the future. These questions are closely related, because for a small nation such as Iceland they are of profound importance, both for our economy and our security.

At the turn of this year, fifteen years have passed since the entry into force of the EEA Agreement. There are few who dispute that this agreement has served us well. There are some who wish to go further in our European cooperation, others would like to step back. Opinion has been divided within the Independence Party on these issues, but the majority opinion in recent years has been that our interests are better served outside the European Union. This means that the party bases its decision upon the interests of the Icelandic people, not on political beliefs or theories.

In the turbulence of the past year, circumstances have changed rapidly. This applies not only to the Icelandic economy but also to the cooperation of nations in the international arena. The world has changed and we must reconsider our position accordingly. It is for this reason that I proposed to the central council of the Independence Party that a special Europe committee would be established to review Iceland’s position towards the European Union, the countries of Europe and Iceland’s options in international cooperation. The Europe committee will present its proposals to the general meeting of the Independence Party at the end of January in the new year. The final decision rests with the general meeting, over which neither I nor anyone else has a say.

I am very pleased with the extensive and profound debate on European issues that is currently going on within the Independence Party and I expect good results from the work of the Europe committee. It is important that both the opponents and the supporters of membership in the European Union contribute their assessment of the pros and cons for such membership. In my mind, it is most important that we continue to control our natural resources on land and sea. So far, the European Union has not granted permanent exceptions to its fisheries policy. Should it amend its stance, a major obstacle to Iceland’s accession to the Union would be overcome.
The conclusions of possible membership negotiations will of course be put to a public referendum. But, due to the serious nature and importance of this issue, I see it as possible that the Government may ask for a clear mandate in a public referendum to proceed towards membership negotiations with the European Union. It would be reasonable to pass special legislation to this effect next February and proceed towards a referendum several weeks later, following a presentation of the issue. Should the conclusion be to move towards membership negotiations, it would require preparation with the participation of all political parties.

A strong nation is richer for the experience

The present difficulties facing us Icelanders also provide us with a number of new opportunities. Such difficulties often become a rich source for new ideas. Once we are compelled to respond to changed circumstances, opportunities for new ventures present themselves. It is important that we use all such opportunities to our advantage.

We have often before suffered serious setbacks. Our close proximity to the natural elements has taught us better than most how to move against headwinds and surmount difficulties. It has brought us closer together, and I am convinced that this will also be the case in this instance. Next year, we will face greater adversity than we have had to face for many years. Still, our standard of living will be amongst the best in the world.

We are a young and powerful nation. As is the case with many young people, we have tended to take too many risks. We have been tempered by our experience, following a fateful year. We should make use of this experience and not let it shackle us into isolation. Reverting back to increased government interference and restrictions on free trade, as many advocate, is a path of fear and despair. That is not the path forward.

In the next several years, opportunities for a new economic offensive will emerge, based on growth in our basic industries along with new ventures in all sectors, the use of our natural resources on shore and in the oceans, our high degree of specialisation and level of education and, last but not least, on the special Icelandic characteristic of energy and optimism that have enabled us to progress from poverty to a high standard of living in the space of several decades.

I wish everyone in our country a happy new year.