How to Deal with a National Crisis

It may be interesting to others how Iceland resolved her national crisis in 2008...

Hopefully the coronavirus pandemic will soon be over. It came as a complete surprise. In my lifetime, I have witnessed three such unexpected large-scale events, major crises, game changers: before the pandemic the collapse of communism in 1989–1991 and the international financial crisis of 2007–2009. But some crises are on a national rather than an international level. How can they be resolved? The American geographer and popular science writer Jared Diamond has devoted many books to national crises. He has the ability to think outside the box, although he tends occasionally to overstate his case, putting too much emphasis on geographical and psychological factors.

In his most recent book, Upheaval, Diamond discusses how some societies have successfully coped with national crises. I have already commented critically on his analysis of Finland, Chile and Germany. Although Diamond only mentions my own country, Iceland, in passing, it seems to me however that his scheme fits her well during the international financial crisis of 2007–2009. Iceland was the first great casualty of the crisis, with her whole banking sector collapsing in October 2008 after the Central Bank of Iceland, CBI, was denied the same liquidity assistance from the European Central Bank and the U. S. Federal Reserve Board as the other Nordic countries received. The British Labour government, led by Prime Minister Gordon Brown and Chancellor Alistair Darling, even imposed an anti-terrorist law on Iceland, freezing Icelandic assets for eight months. Incredibly, the CBI was listed on the British Treasury’s website as a terrorist organisation, alongside Al-Qaeda, the Talibans and the governments of North Korea and Sudan. In the midst of the bank collapse it certainly looked like Iceland was facing her gravest challenge since the 1780s when a series of volcanic eruptions and earthquakes nearly destroyed her fragile economy. Few would in the autumn of 2008 have anticipated Iceland’s swift recovery which took place over the next few years.

Diamond identifies twelve factors related to the outcomes of national crises:

1. National consensus that there is a national crisis.

2. Acceptance of national responsibility to do something.

3. Building a fence, defining and containing the problem.

4. Getting help from other nations.

5. Using other nations as models of how to solve the problem.

6. National identity.

7. Honest national self-appraisal.

8. Historical experience of previous national crises.

9. Dealing with national failure.

10. Situation-specific national flexibility.

11. National core values.

12. Freedom from geopolitical constraints.

I think the third factor identified by Diamond, building a fence, was crucial for Iceland’s recovery. When the CBI (where I served at the time on the Board of Overseers) discovered, early in the international credit crunch, that it would not get the same liquidity assistance as the other Nordic central banks, its governors decided to build a fence around the country. The most important task was to prevent the default of the Sovereign. The second line of defence applied to the depositors, both to stave off panic and to ensure that the intricate web of production and trade, domestic and foreign, was not torn apart. The interests of other bank creditors came third and the interests of bank shareholders came fourth and last (they lost everything). The CBI therefore advised the government not to try and rescue the embattled banks or to issue any government guarantees of their liabilities, but rather to pass an Emergency Law giving priority to depositors over other claimants on the banks. This had the intended effect of staving off panic. The government put the fallen banks into resolution and established new banks which took over domestic deposits and sufficient assets against them.

The brutal response of the British Labour government, to impose an anti-terrorist law on Iceland and to freeze Icelandic assets, seems to have been based on a misunderstanding. One of the Icelandic banks, Landsbanki, had been collecting deposits through a branch in the United Kingdom, and somehow Brown and Darling thought that it might illegally transfer assets to Iceland although this had been made impossible in a Supervisory Notice by the British Financial Services Authority already issued to Landsbanki. Brown and Darling also believed, wrongly, that Iceland’s Emergency Law discriminated against foreign depositors. In fact, the Law discriminated between all depositors, domestic and foreign, on the one hand and all other bank creditors on the other hand (such as foreign banks and financial institutions). In a report I wrote in 2018 for the Icelandic government I suggested that perhaps Brown and Darling were partly motivated by their desire to demonstrate to their Scottish constituencies that independence might be perilous.

The fourth and the fifth factors identified by Diamond, getting help from other nations and learning from their example, certainly did not apply to Iceland. On the contrary, the British government not only aggravated the crisis by its actions, but the governments of three Nordic countries (Norway, Finland, and Denmark) also connived with local businessmen to snatch up assets of the fallen Icelandic banks at rock-bottom prices, as I describe in detail in my report. For the Icelanders, it was amazing to see our Nordic cousins transforming into scavengers. It should be mentioned, though, that in the crisis two friendly countries offered unconditional assistance to Iceland, the tiny Faroe Islands and Poland.

The various factors connected to national self-consciousness identified by Diamond clearly applied to the Icelanders: they have a strong sense of identity, although after the bank collapse some demagogues tried with temporary effect to play the blame game. The tenth factor mentioned by Diamond, flexibility, was also relevant. The Icelanders, as a nation of fishermen dealing for centuries with changeable weather and volatile markets, are used to unexpected events and adversity. In Iceland it is considered less important that you have fallen down than that you have the ability to stand up again.

The twelfth and last factor listed by Diamond, freedom from geopolitical constraints, also played a role in the Icelandic debacle, for worse and better. The disadvantage for Iceland was that her powerful protector in the past, the United States, had completely lost interest in her, as she was no longer thought to have any strategic importance. It is noteworthy that both Sweden and Switzerland—which unlike Iceland have never been political or military allies of the United States—received the liquidity assistance from the U. S. Federal Reserve denied to Iceland. The geopolitical advantage for Iceland on the other hand was that she was not a member of the European Union which would never have allowed her not to rescue her banks and instead to transfer risks from depositors to other creditors of troubled banks. Witness Ireland, Greece, and Cyprus. There was indeed pressure from the EU on the Icelandic government to guarantee the liabilities of the banks.

My conclusion is that Diamond’s analysis of factors related to outcomes of national crises is quite relevant to Iceland in and after the 2008 bank collapse. But the general lesson from this Icelandic saga is that if depositors are given priority claims over other bank creditors, then government guarantees of banks would be unnecessary. Such guarantees make liquidity crises toxic. But banks should not be allowed to use hapless depositors as human shields. The principle is unacceptable that during upturns bankers should enjoy their profits while in downswings they can pass on the losses to taxpayers.