Icelandic freeze and Greek saga show risks of snapping

Iceland is balking at crushing terms demanded as part of its making whole overseas depositors in its ruined banking system, while Greece is involved in a game of chicken with the Eurozone authorities over how, when and with whose assistance it heals its fiscal difficulties.

Like so many of us paying bills in January we ran up last year, they face a depressing prospect and no easy way out.

First, Iceland, whose president vetoed an agreement with Britain and the Netherlands to pay about $5bn towards the costs of reimbursing depositors in its failed Icesave bank, saying he would put the bill to a referendum. While British and Dutch officials have mustered up a good show of outrage, President Grimsson’s move should not surprise; he was petitioned by a fifth of the population, each of whom can look forward to helping to pay back their individual $17,000 share of the costs.

Iceland is not refusing to repay the debt, which it acknowledges, but wants repayments tied to gross domestic product through 2024 with the possibility of a renegotiation if the full amount is not repaid by then. It is a brave move, and maybe a foolhardy one, given that the rejection puts in doubt an aid package from the IMF and Scandinavia, as well as potentially hurting its bid to join the European Union. Iceland’s debt has already been downgraded to junk status by Fitch Ratings, with similar moves likely.

No one looks good in this saga, certainly not Iceland, which was effectively a hedge fund with a small fishing fleet attached and, you have to say, vastly better controls on overfishing then overlending. The Netherlands and Britain also look silly and incompetent; neither took effective steps to protect their citizens from the menace of Vikings offering higher rates of interest. Last but not least is the credulousness and cupidity of the British and Dutch depositors, including some local governments which not only chased the highest rates of interest but sometimes concentrated the vast majority of their funds with one bank.

A pox on everyone’s house then, but someone has got to pay. The point here is that public opinion in Iceland does not necessarily subscribe to the rules of the game as played in Washington and Frankfurt. If a sensible compromise is not reached, it is not inconceivable that Iceland’s negotiating position hardens. It is far from clear, for example, that Argentina is worse off for having thumbed its nose at the IMF and global financial community in 2001, nor is it apparent that Turkey, for example, has done well out of compliance.

Financial Balkanisation
The central case is a compromise, but the disagreement itself is instructive. Iceland, like Ireland but suffering from not being inside the European and euro zone tent, shows in an extreme way that governments pledging to make good debts is entirely different from them in the end making them good. The US borrows on equal terms from the bond market and Iceland as a supplicant from the international community, but the principal is the same. Sovereign risk and brinkmanship go hand in hand.

An Icelandic blowup would also give impetus to moves by countries to contain the risks they face in their banking system to more easily controlled onshore players and activity. There has been good work on the international level to avert this, but it is also clear that politicians and regulators have reasons to make local rather than international lending a priority, both to control risks and to benefit their own banking systems. This, which could amount to financial Balkanisation, would retard growth and cause international friction. Just wait until the effects of the stimulus begin to ebb in the second half for this to gain traction.

ECB Executive Board member Juergen Stark delivered a sharp rebuke to Greece in Italy’s Il Sole 24 Ore newspaper, saying in essence that Greek competitive and fiscal problems are homemade and that investors expecting a euro zone bailout are “deluded.”

Given that the ECB is not the authority which would effect a bailout, if one were needed, this is probably best viewed as jawboning. If markets treat Greece like it is in receipt of a bailout it – like, say, Citigroup – will be less inclined to take painful steps.

Like Iceland however, the common themes are sovereign credit risk and situations where it is partly unclear who must pay and doubly unclear who will do best out of paying or balking.

There is lots of paying up by governments yet to be done, and doubtless there will be lots of balking too.