Economasochism: Iceland Vetoes Paying UK

There I was watching TV while doing bicycle crunches--identified as the best exercise for abdominals since they work upper and lower abs as well as obliques--when our friendly BBC news correspondent aired a live segment featuring Iceland's President Olafur Grimsson firing a shot across the United Kingdom's bows. Just two posts ago, we had the second coming of the Clash of the Pygmies series [1, 2] in which Iceland and the UK were contesting the compensation of British and Dutch depositors in the now-defunct Icelandic online bank Icesave. On the air, Grimsson vetoed legislation that would pave the way for paying these foreign depositors and subjected it to a referendum. I almost kneed my head in surprise.

To make a long story short, Icesave went under when its parent company Landsbanki collapsed. At the same time, Iceland was dithering on whether they would make commitments to compensate UK depositors. This event set into motion HM Treasury freezing Landsbanki assets in the UK together with those of Iceland's central bank and the Icelandic government's assets related to Landsbanki. Meanwhile, Iceland decided to nationalize Landsbanki in the belief that doing so would mitigate a mounting crisis. Diplomatic mayhem ensued, with UK authorities suggesting the use anti-terrorist legislation to help recoup the funds of British savers. In the end, the Dutch and British agreed to lift objections to an IMF-organized bailout of Iceland if it agreed to compensate those holding accounts in Icelandic financial institutions. HM Treasury guaranteed Icesave accounts in the meantime in expectation that Iceland would compensate it in due time.

While a bill to pay off Dutch and British depositors was working its way through Icelandic parliament, there arose popular opposition to this quite onerous burden equivalent to over five percent of Iceland's GDP. Approved on 31 December, all the Icelandic president had to do was sign it for it to take effect. While the Dutch and British have some objections to its stipulations, the bill was generally seen as a step forward in repairing Iceland's international relations.

All this brings us to today's bout of economasochism. In true Pontius Pilate wash-my-hands-of-the-matter fashion, Grimsson has declined to sign the document, saying it would be subject to referendum. With a reported 70% of the population opposed to what's now called the Icesave bill, things are not looking up for Iceland in the How to Win Friends and Influence People department. From Bloomberg:

Iceland’s President Olafur R. Grimsson blocked a depositor accord with the U.K. and Netherlands that lawmakers passed last week, threatening to undermine the island’s efforts to repair international relations.

“The cornerstone of Iceland’s constitution is that the nation is the highest judge for the validity of law,” Grimsson told reporters at his residence outside the capital Reykjavik today. He vetoed the so-called Icesave accord after more than 60,000 of Iceland’s 320,000 inhabitants signed a petition handed to Grimsson on Jan. 2 urging him to reject the legislation. His decision means lawmakers must either drop the bill or put the matter to a referendum.

The bill, which polls show about 70 percent of the population opposes, had obliged 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...

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...

Lawmakers on Dec. 31 voted 33 to 30 to allow the government to provide a state guarantee for the U.K. and Dutch loans to cover the so-called Icesave depositor 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 in October 2008. 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 have allowed 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...

The failure of Landsbanki, Glitnir Bank and Kaupthing Bank hf led to the collapse of the currency and forced Iceland to go to the IMF to get a $2.1 billion loan, with a further $2.5 billion pledged by Nordic nations.

It's an interesting but very foolhardy decision IMHO. IceNews lists some of the possible consequences:

It was widely thought that Grimsson would accept the law and political commentators remain split on what the actual consequences will be now that he has decided the opposite. An end to IMF cooperation with Iceland, an end to the EFTA agreement, the break up of the government and even trade sanctions are among possible consequences; but there could equally be no serious consequences.

The worst one isn't even listed here of probably saying goodbye to all chances of Euro adoption if the referendum results in a "no" vote--something clearly of benefit to a small, very open economy like Iceland. I hope there are no serious consequences here but I cannot help but think it's a daft political ploy which we haven't fully understood yet. As always, stay tuned. All I can say for now is, wow.

UPDATE: The WSJ suggests Iceland Should Have Stuck to Fishing. Meanwhile, the Huffington Post brings us populist fare with a dose of scaremongering via People of Iceland Versus Global Economic Policymakers.