Iceland Voters Reject National Repayment Referendum

NY Times: Iceland Voters Reject Repayment Plan
NY Times: Iceland Blocks Bank Compensation for Foreigners
BusinessWeek: Iceland Rejects Icesave Depositors Bill in Referendum

Ninety-three percent of Icelandic voters rejected Saturday’s national referendum that proposed to repay $5.3 billion to Dutch and British governments for bailing out nearly 300,000 citizens when an Icelandic bank failed in 2008. The referendum was called when the President failed to sign a bill that required Iceland to repay the debt over 15 years at 5.5% interest. The President claims that his refusal stemmed from a petition signed by one-fifth of his country’s citizens rejecting the plan because it unfairly saddled each Icelander with $16,400 of debt created by negligent regulators and irresponsible, greedy bankers who allowed the failed banks to take on debt 10 times the size of Iceland’s economy. Icelanders’ deposits were protected by a national deposit guarantee program, but the British and Dutch citizens only recovered the first $30,000 of their lost deposits from national bailout programs.

The failed internet bank IceSave, also known as Landsbanki, was one of three Icelandic banks that failed in 2008 as a result of Iceland’s stock market crash and currency collapse that completely shut down the nation’s banking system. The money that Britain and the Netherlands paid to their citizens to recover lost deposits in the bank were really considered loans to Iceland amounting to 40% of the country’s gross domestic product. Despite the “no” vote on the referendum to repay these loans, Iceland officials made clear that country would fulfill its loan obligations, just on different terms than the referendum’s proposal. Britain and the Netherlands are eager to come to agreement because of the pressure they feel from their increasingly finicky bond investors and the Central Bank’s increased scrutiny on all EU nations’ spending and deficits.

Besides pressure from Britain and the Netherlands, Iceland is pressured by other reasons to repay its loans. Since the beginning of the country’s financial crisis, Iceland has received $2.1 billion from the IMF, funding that was conditioned on coming to an agreement with British and Dutch governments on the repayment of their bailout loans. Iceland is also under pressure to repay because it was recently invited to begin discussions to join the European Union. Failing to repay its international debts would reflect poorly upon Iceland and might cause Moody’s and Standard & Poor’s to follow Fitch’s lead in downgrading the country’s sovereign debt to below investment grade, a move that would put Iceland on the same precarious level as debt-laden Greece.

The IMF and EU nations have been careful not to push Iceland too hard because they known that an alternative to repaying its debt is filing bankruptcy. Fear of insolvency prompted Britain and the Netherlands to propose a repayment plan at a more attractive interest rate of LIBOR plus 2.75 percent (now about 3%) after two-years of interest-free payments. EU Nations, candidate EU nations, and non-candidate EU nations will all watch with great interest to see how this international drama plays out.

1. Has the dialogue shifted from financial institution systemic risk to sovereign systemic risk, or are these terms fundamentally the same thing?

2. As the old saying goes, “as goes General Motors goes the nation.” So, might the new saying be “as goes a country’s largest financial institution, so goes the world financial system?”