Clash of the Pygmies 2: Iceland Balks at Paying UK

Here we have two past poster children for neoliberalism going at it again. When we last mentioned Iceland and the UK in the same breath, the latter extracted guarantees from the former that it would compensate depositors in the now-extinct Icesave online banking service. Having privatized its mammoth failed banking institutions, Iceland too acquired a lot of liabilities of dubious merit. Lo and behold, a year or after hostilities broke out, we now have additional skirmishes. Apparently, the casus belli this time around is of a popular petition movement in Iceland not to pay back Icesave depositors given the cost that will be inflicted on the populace. From Bloomberg:

Iceland’s President Olafur R. Grimsson is delaying his decision on a U.K. and Dutch depositor accord that lawmakers passed last week as he weighs voter opposition to the bill against the prospect of souring international relations. “There hasn’t been any decision as to when the president will announce his decision,” Arni Sigurjonsson, Grimsson’s deputy chief of staff, said in a telephone interview yesterday. “There’s nothing to say about this issue at the moment, the cards are being looked at.”

More than 60,000 of Iceland’s 320,000 inhabitants signed a petition handed to Grimsson on Jan. 2 urging him to veto the legislation. A presidential rejection of the so-called Icesave accord would mean lawmakers must either drop the bill or put the matter to a referendum.

The legislation, which polls show about 70 percent of the population opposes, obliges Iceland to use borrowed funds from the U.K. and Netherlands to cover depositor claims from the two countries after the failure of Landsbanki Islands more than a year ago. The absence of clear cross-border regulatory rules on depositor insurance has allowed settlement of the claims to drag on and left Icelandic taxpayers disgruntled over having to pay for the failure of a private bank.

“We need the matter to be resolved before the markets open again,” Bjorn Valur Gislason, deputy chairman of the budget committee and a lawmaker in the ruling Left Green Party, said in a telephone interview yesterday...

Non-ratification of this bill will likely mean yet another collapsed government. It's all very Argentina circa 2001-like, mayhaps:

The government, which has been working for the past year to rebuild the island’s financial system, said last month it completed a bank recapitalization plan after creditors accepted settlements. Iceland’s three biggest lenders collapsed in October 2008, leaving about $80 billion in outstanding claims.

“If the president doesn’t ratify the bill it will mean the end of this government,” Gislason said. The parliament voted 33 to 30 to allow the Social Democrat and Left Green government of Prime Minister Johanna Sigurdardottir to provide a state guarantee for the U.K. and Dutch loans to cover the Icesave claims.

Thousands of British and Dutch depositors risked losing their savings when Landsbanki collapsed along with the rest of Iceland’s over-leveraged banking system. By passing the bill, lawmakers hoped to pave the way for unlocking further disbursements from a $4.6 billion bailout from the International Monetary Fund and Nordic countries. The bill would allow Iceland’s government to guarantee repayments of as much as 2.35 billion pounds ($3.8 billion) borrowed from the U.K. and 1.2 billion euros ($1.7 billion) borrowed from the Netherlands to repay Icesave depositors...

Standard & Poor’s on Dec. 31 raised its outlook on Iceland’s BBB- rating to stable from negative and said parliament’s ratification of the depositor bill is a step “that will contribute significantly to securing crucial external financing throughout 2010.” Fitch Ratings, which also ranks Iceland’s debt one level above junk, said on Dec. 23 that a resolution of Icesave represents an “essential component” in determining whether its negative outlook on the rating will end in a downgrade.

In this clash of the pygmies at least, I do believe the UK has the upper hand. First, the credit rating agencies prioritizing payment as evidence of financial stabilization in Iceland is quite great short-term pressure. Second, there will be related pressure from Iceland and other Nordic countries that want to put this sordid business behind them and not make things worse even if the fiscal burden on Iceland will be sizeable. Third--and this is the most important one, I believe--Iceland's pending application to join the EU means it must seek unanimous approval from existing EU members. That, of course, includes the Netherlands and the UK. It becomes a matter of what's preferable: short-term gain in refusing to pay off Icesave, or long-term gain in joining the EU.

I'd just go for joining the EU and leave the histrionics behind. Screwed either way, I'd take the forward-looking option.

PS: Also see this BBC News clip.