The Guest Blog

By Kolfinna Baldvinsdottir, Vice-President of the Brussels Press-Club

Why should (German) taxpayers bail out Russian oligarchs who are in danger of loosing their tax-evaded money? Silly question. Of course they shouldn’t – none of their business. Where did the ECB and the IMF get the idea to rob the savings from guaranteed saving accounts from ordinary people in Cyprus? It is exactly contrary to what they are supposed to do. What a silly idea. Capitalism is supposed to be driven by the profit motive. The more you are ready to take risks, the heaftier your profit. But risk has two sides to the coin: Profit and loss. High risks, big profits, but potential loss. Just as the American airline CEO quipped, when his company went bust: Bankruptcy is to capitalism what the idea of hell is to christianity. Without hell (bankruptcy) there is no paradise (fortune).

Many commentators on the Cyprus bank crisis have drawn attention to the many similiarities between Iceland and Cyprus. The similarities are striking. Both islands wanted to become sanctuaries for the super rich. Both offered high rates of interest and lax regulation. Both islands experienced cancerous growth of the banking system. In the case of Iceland it was 10 times the GDP in 6 years; Cyprus was more modest – 8 times the GDP in 15 years. Both have connections to the Russian mafia. Having amassed handsome profits in the alcohol business in St Petersburg inthe 90s, Icelandic oligarchs bought the then recently privatised banks of Iceland. For many years the Cyprus banks have been a sanctuary for Russian oligarchs, offering both necessary secrecy and generous rates of interest. So, is there anything the Cypriots could learn from the Icelandic experience five years ago?

Well, there are differences. Iceland was and still is outside the EU and the EMU. Cyprus is in and supposed to be sheltered by that exclusive company. In both cases the crisis was started by illiquid (insomnent) banks but the reaction seems to be different. In the case of Iceland the banks simply became bankrupt. In the case of Cyprus (just as in the case of Ireland) there is a frantic scramble to shore up the banks at taxpayers expense. Why on earth? Why is there no respect for the basic principles of market economy? Those who take risks get high profits. That is why inequality is a basic feature of capitalist society. If things go wrong, those who earn the profits are supposed to take on the losses. Since when have capitalists become such eager admirers of the welfare state (now the welfare of capitalists?). Why is everything being turned upside down: you privatise the profits but nationalise the losses. This means tearing up the unwritten social contract of market societies. People accept inequality to a certain degree, as a just reward for willingness to take the risk or extraordinary contribution in terms of effort, skill, innovation etc. What people are not ready to accept is that those who reap the profits in good times, could hand out the bill or refer the losses to the general public in bad times. That is the end of democracy. This is also the end of rule of law. In the past it was the beginning of a revolution.

The nobled laureate, Paul Krugman, once again (in his column in the Herald Tribune) cited the example of Iceland as something to learn from. (Although he seems to applaud the magic of devaluations but forgetting all about the suffering of the victims). Ok, but what was the Icelandic way?

Essentially it was this: The banks were not bailed out, they went bankrupt. Partly this was courtesy of Gordon Brown who put the Icelandic banks operating in London, as well as the government and Central Bank of Iceland, on a list of terrorist organisations, along side Al Qaeda. After that, banks need not bother to open their doors again.

The Icelandic banks had by that time outgrown the real economy 10 times. All of it was on borrowed money. Who were the creditors? Mostly German bankers. (Just as in the case of the Irish and Spanish real estate bubble). Who lost money on Iceland? German bankers. (They lost approx 7x Iceland’s GDP).

What were the consequences? The German (and other foreign) banks simply wrote off their failed investments. After the Icelandic government had put the Icelandic banks into receivership, German banks sold their claims at fire sale prices in the aftermarket. Who were the buyers? Mostly American hedgefunds, which picked up the claims for perhaps 5% of nominal value. In the meantime the Icelandic government, through emergency legislations, nationalised the failed banks.They took all “Icelandic” assets out of the bankrupted banks (saving deposits and outstanding loans). When the banks were privatised again they came into the ownership of those American hedge funds. The hedge funds wanted to make windfall gains through the privatised banks’ profits.

But now they are up against another war. Iceland still maintains its own national currency. Admittedly it was devalued to the tune of 70%+. For the Icelandic people that meant high inflation, doubling of debt, exorbitant interest rates, dispossession of a generation, higher taxes, cuts in social services and a drastic fall in purchasing power. This by the way seems to have passed by the notice of Mr Krugman. For export industries it meant short term bonanza. Society is polarised as never before for between those who benefitted from the crash and the others who pay the bills and bear the burden.

But Iceland itself went into IMF receivership and to prevent another devaluation, the IMF imposed capital controls. They were meant to be temporary, but they are still there, getting more and more stringently implemented. What does that mean for the hedgefund managers who want to present their full claims (even if they were bought at fire sale prices). It means that they have to accept negotiating with the government. Under capital controls they can not convert their assets in the local currency (which is worthless) into euros or dollars. Either they have to reinvest their local currency money in Iceland or seek exemption from capital controls, which means accepting drastic haircuts.

What is the moral of the story? Nation states – even small micro states – are not without power when it comes to dealing with the owners of capital. They are usually depicted as helpless victims of superior forces, almighty bond markets or speculative investors. But it ain’t necessarily so. But it requires political leadership to take on the international predators. The way to do it is to let them go bankrupt and to (at least temporarily) abolish or limit the freedom of movement of capital. That is the Icelandic lesson. Can the Cypriots learn anything from this story?

Perhaps they should invite the Icelandic Central Bank governor to Nicosia rather than Mr Draghi?

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  1. Indeed this is European taxpayers’ money.

    Now watch the money move to Spitzbergen! See if the Norwegians are able to sort that one out. This is the best location in to World to bank far better than Cyprus or Bulgaria or Romania or the Channel Islands or Gibraltar.

    Anonymity secured and not many residents. Plenty of coal though.

  2. I would have to say a bankruptcy proceeding would probably be a better way to go. It seems bailouts have a tendency to correct the financials on a temporary basis only to have said company or institution coming back to seek a bk later down the road.

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