Iceland: Financial Crisis, Bankruptcy, and Economy

Iceland's Amazing Comeback Story

Icelandic volcano eruption
Eyjafjoell volcano rise in the distance above a farm on May 17, 2010. Photo: Ingoacutelfur Bjargmundsson/Getty Images

Iceland's economy successfully survived a sovereign bankruptcy and collapse. But it wasn't until June 2015, that the government released $9 billion in assets held by failed banks. In 2009, it imposed a 39% exit tax to keep foreign investors from withdrawing funds during the crisis. Without the tax, currency withdrawals would be enough to send the krona plummeting even more than it did.

The government also prohibited ordinary citizens from buying foreign currency or foreign stocks.

As a result, people invested in local businesses, including real estate and private equity.  Tourism boomed when local prices fell thanks to the low currency exchange rate. That increased after the 2011 volcano eruption. But Iceland is still an expensive country to visit since it is an island.

Iceland's economy has finally recovered. GDP growth was a robust 4.0% in 2015, and unemployment just 3.8%. But foreign investments are still at historic lows. (Source: "Nation Hit First by Economic Crisis Dismantles Last Restrictions," Global Finance, August 2015)

Iceland Financial Crisis Caused Government to Collapse

Iceland's nearly bankrupt economy caused the government to collapse in January 2009. The failure occurred because Prime Minister Geir HaardeHaarde resigned due to cancer. The minority party insisted that one of its members fill the position. Haarde asked that his party's member, Foreign Minister Ingibjorg Gialadottir, take the post.

Commerce Secretary Bjorgvin Sigurdsson resigned due to bankruptcy-related stress.

Protesters took to the streets in response to soaring unemployment and rising prices caused by the bankruptcy. (Source: AP, Iceland's government topples amid financial mess, January 26, 2009)


In October 2008, Iceland nationalized its three largest banks.

Kaupthing Bank, Landsbanki, and Glitnir Bank had defaulted on $62 billion of foreign debt. The banks' collapse sent foreign investors out of Iceland. That sent the krona down 50% in one week. The stock market fell 95%, and almost every business in Iceland went bankrupt. (Source: "How Iceland Emerged From Its Deep Freeze," WSJ, July 5, 2015)

Iceland's banks created the crisis. They used $100 billion in debt to finance foreign acquisitions. That amount dwarfed Iceland's GDP of $14 billion. Then the 2008 global financial crisis shut down bank lending. These banks' financial collapse brought down the country's economy. (Source: AP, Iceland teeters on the brink of bankruptcy, October 7, 2008)

Haarde and Gialadottir negotiated a $10 billion bailout from the IMF to insure Iceland's bank deposits. Iceland asked its neighbors Luxembourg, Belgium, and the UK to insure bank deposits of the branches in their countries. (Source: Guardian, Iceland sees IMF decision with a week, October 16, 2008)

Impact on the Global Financial Crisis

Iceland's economic collapse affected the rest of Europe. That's because Iceland's banks had expanded their retail services in Europe. They had also and invested in foreign companies.

 Iceland's Baugur was the largest private company in Great Britain. Icesave, the online arm of Landsbanki, froze withdrawals during the crisis. That affected depositors throughout Europe.

Since the government was unable to maintain the value of the krona, many suggested Iceland join the EU and adopt the euro as its currency. Iceland is already a member of the European Economic Area, a trade association that follows many EU rules. But Iceland's fishing industry is opposed. It clashed with European countries over fishing rights.

Before the crisis, both inflation and interest rates were in the double-digits. That caused many Icelanders to add second mortgages using foreign currencies. That because other countries' interest rates were lower than Iceland's. When the krona dropped, they faced mortgage costs that were double the price in krona.

At the same time, housing prices were falling. (Source: IHT, Iceland is all but officially bankrupt, October 9, 2008)

Could the United States Have a Bankruptcy Like Iceland's?

The U.S. government invested at least $5.1 trillion to stem the banking crisis. That's more than one-third of annual production and increased the U.S. debt. Although that wasn't as bad as Iceland's situation, it had similar effects on the U.S. economy. There's been less trust in U.S. financial markets, and a much slower-growing economy for decades to come. (Source: IHT, U.S. consolidates financial risk-taking in Washington, October 18, 2008)

Is it possible for the U.S. economic situation to create a collapse in government like Iceland's? It's possible, but not likely. The U.S. economy is larger and more resilient. When there is an economic crisis, investors buy U.S. debt. They believe it is the safest investment. In Iceland, the exact opposite happened.