Setting the Record Straight

Politics - January 17, 2022

Some misinterpretations, half-truths and falsehoods about David Oddsson’s role in Iceland’s 2008 bank collapse have to be corrected…

David Oddsson dominated Icelandic politics as Prime Minister from the spring of 1991 to the autumn of 2004 and then as Foreign Minister for a year. Inevitably he made many enemies during this period, not least among the left-wing intellectuals whose unsolicited advice he mostly ignored. In the autumn of 2005 David (as he is always called in his own country: instead of family names, Icelandic has patronymics, Oddsson only signifying that David is the son of Oddur) became one of the three governors of the Central Bank of Iceland, CBI, and it was therefore on his watch that the whole Icelandic banking sector collapsed in October 2008. Recalling that one should never let a good crisis go to waste, David’s enemies immediately started a campaign blaming him for the bank collapse. Abroad, they have been surprisingly successful, perhaps because there has been little effort to correct their misinterpretations, half-truths and sometimes plain falsehoods. Here I shall try to set the record straight on the most important points.

Time Magazine Blames David

Perhaps the most influential denunciation of David was when Time Magazine put him on a list of twenty-five people to blame for the 2008 financial crisis, with the following explanation:

In his two decades as Iceland’s Prime Minister and then as central-bank governor, Oddsson made his tiny country an experiment in free-market economics by privatizing three main banks, floating the currency and fostering a golden age of entrepreneurship. When the market turned … whoops! Iceland’s economy is now a textbook case of macroeconomic meltdown. The three banks, which were massively leveraged, are in receivership, GDP could drop 10% this year, and the IMF has stepped in after the currency lost more than half its value. Nice experiment.

There are some minor inaccuracies in this short statement. David was Prime Minister for thirteen and a half years and one of the three governors of the Central Bank for three years. Sixteen and a half years do not amount to two decades. Also, one of the three major banks had already been privatised in 1990, indeed by a left-wing government, before David became Prime Minister.

It is however the overall narrative which is wrong. David did not conduct a free-market experiment during his tenure as Prime Minister: he simply brought Iceland into line with other Western European countries. According to the Fraser Institute’s Index of Economic Freedom, the Icelandic economy was ranked 25th in 1990 and 10th in 2005, which means that then nine economies were freer than the Icelandic one. If the bank collapse was caused by David’s liberalisation of the economy, why did these nine economies escape Iceland’s fate? It should also be noted that since 1994 Iceland has been a member of the European Economic Area and that her financial market operated under the same rules as other such markets in the EEA.

Icelandic Banks Were Refused Liquidity Assistance

It is true that the Icelandic banks were massively leveraged. But so were banks elsewhere. The difference was that in the international credit crunch of 2007–9 the Icelandic banks were refused the liquidity assistance other banks received. The banking sectors of Scotland and Switzerland were in fact larger proportionally than the Icelandic banking sector. RBS in Scotland and UBS in Switzerland would both have failed if they had not been assisted, by the Bank of England and by the U.S. Federal Reserve System, respectively. The three Scandinavian central banks could make dollar swap deals with the U.S. Fed which enabled the Central Bank of Denmark, for example, to save Danske Bank which would otherwise have gone under. The Fed however refused to make such deals with the Central Bank of Iceland. (I discuss the possible reasons in a report I wrote in 2018 for the Icelandic Ministry of Finance.)

In the United Kingdom, government bailed out all banks except the two banks owned by Icelanders (which seems to be in breach of the EEA rules about non-discrimination). It is interesting that those two banks (Heritable and KSF) eventually turned out to be solvent: their creditors got almost all their money back despite costly resolution processes. It is also the conclusion in a meticulous study of the bank collapse by two Icelandic scholars, Asgeir Jonsson and Hersir Sigurgeirsson, that the assets of the Icelandic banks were probably no worse than the assets of other banks on average.

The rapid recovery of the Icelandic economy after the bank collapse is a testimony to the soundness of David’s liberalisation of the economy in 1991–2004. It was also crucial that on his advice, indeed insistence, as CBI Governor the Icelandic Treasury did not assume responsibility for the debts of the banks.

The Negligence Charges

There is no denying that the Icelandic banks were reckless, above all in their rapid expansion in 2003–2005, far beyond the capacity of the Central Bank of Iceland and the Icelandic Treasury to rescue them in a possible credit crunch. It is however ironical to blame David Oddsson for their recklessness because both as Prime Minister and as CBI Governor he was quite critical of the bankers, and in 2007–2008 he repeatedly warned his former colleagues in government that the banks might fail. They took his warnings seriously but there was very little that either the Central Bank or government could do. The Central Bank could print kronur, but not dollars or euros, and as already noted it was refused the same dollar swap deals that the Scandinavian central banks made with the U.S. Fed. The government could not force the banks to downsize, and it was hardly feasible anyway after the international credit crunch had started, in mid-2007. It is easier said than done to sell assets during a financial crisis. You are damned if you do; you are damned if you don’t.

A Special Investigation Commission which was appointed after the bank collapse showed scant understanding of this dilemma. Instead it engaged in bureaucratic pedantry. A vocal left-wing intellectual, Professor Stefan Olafsson, writes:

It was one of the main conclusions of the report of the Althingi’s Special Investigating Committee into the fall of the banks (SIC) that regulators (the Central Bank of Iceland and the Financial Supervisory Authority) had grossly failed to carry out their duties. In fact, the governors of these institutions (including David Oddsson, the most influential neoliberal politician) were found guilty of gross negligence by the Committee.

This is highly misleading. First, the Central Bank was not the regulator of the banks, only the Financial Supervisory Authority. In the second place, in the English version of its report, the SIC spoke about negligence, but not about gross negligence. Thirdly, it should be noted that this was negligence in the sense of a law passed about the SIC at the end of 2008, after the bank collapse. This was in other words an instance of a retroactive rule. Moreover, the three members of the SIC received special immunity from lawsuits which meant that individuals dissatisfied by their treatment by the SIC were deprived of their constitutional right to a fair and public hearing by an independent and impartial tribunal. Both the retroactive stipulation and the legal immunity of the SIC went against the rule of law, as generally understood in the West.

Reasonable Decisions, but Without Much Paperwork

It is worth while however to take a closer look at the particular charges of negligence against the three governors of the Central Bank. In fact, since there were three of them, the two other governors—both trained economists with much experience—could have overruled David Oddsson if they disagreed with him, which they did not. The SIC concluded that the governors had been negligent in two cases. First, when they refused a request by Landsbanki in August 2008 for a special credit facility in foreign currency, they should have called for more information about the bank’s real liabilities. In the second place, when they refused a request by Glitnir in September 2008 for an emergency loan, advising the government instead to buy a controlling share in the bank for the same amount of money, they should also have called for more information about the bank’s real liabilities. Crucially, however, the SIC did not think that the two decisions were unreasonable, only that they should have been supported by more paperwork. But these two charges were so pedantic as to be risible. At the same time finance ministers and central bankers all over the world were making decisions over the phone, often in the course of a few minutes, about buying and selling bank assets and creating credit facilities. Sometimes pricing seemed to be quite arbitrary. For example, the U.S. government organised the takeover by JP Morgan Chase of Bear Sterns for 2 dollars a share, but upon hearing complaints, the buyer swiftly changed the price to 10 dollars a share.

The SIC obviously tried hard to find something blameworthy about David Oddsson, and by implication about his two colleagues. After digging for sixteen months, with a generous budget and access to all the relevant documents, the only two cases with which they could come up against the CBI governors were complaints about the lack of paperwork supporting decisions which were deemed in themselves to be reasonable. This was really an example of the mountains in labour and a silly little mouse being born.

David Deserves Praise, Not Blame

David deserves praise rather than blame for his role in the bank collapse. It is well documented in the SIC report how he and his colleagues repeatedly warned privately against possible bank failures. It is also documented there that they suggested to the bankers that the largest bank, Kaupthing, should move its headquarters abroad, that Glitnir should sell its large Norwegian subsidiary, and that Landsbanki should transfer its Icesave accounts in the United Kingdom and the Netherlands from a branch to a subsidiary. This would probably have halved the total liabilities of the Icelandic banking sector. It also facilitated an adequate response to the bank collapse that during David’s tenure as Prime Minister public debt had been almost eliminated. Surprisingly (or perhaps unsurprisingly) the SIC gave David little or no credit for any of this. But most importantly, in 2008 the Central Bank quietly prepared an emergency plan according to which Iceland would be ring-fenced: panic would be avoided by giving depositors priority over other bank creditors; the banks would be put into resolution, and their domestic operations would be taken over by new banks; the Treasury would take no financial responsibility for the banks. This was the plan David presented to the government at a historic meeting on 30 September 2008. It took the government ministers about a week to realise how serious the situation was. Indeed, when some ministers wavered the Central Bank rented a private jet to bring experts from JP Morgan to Iceland, and they managed in the wee hours of 6 October to convince the last sceptics in government about the necessity to adopt David’s plan which ultimately turned out to be quite successful.