Iceland’s ruling families were growing increasingly dissatisfied with their economic situation. The small size of the country as well as continuing state ownership of banking and other significant business sectors placed limits on their opportunities for profit. And, as economic problems and political tensions grew, Oddsson’s leadership of the Independence Party became ever more attractive to them.
Soon after becoming prime minister, Oddsson began lowering corporate tax rates and privatizing state-owned companies. Serious change came only after 1994, when Iceland joined the European Economic Area (EEA), the free-trade bloc of the European Union. Membership gave Iceland open access to European markets and the country’s political and business leaders were quick to grasp that a privatized, deregulated, and expanded finance sector was their best vehicle for overcoming the country’s profit-constraining market size.5
Bank privatization began in the late 1990s through a highly controlled and politicized process that was completed in 2003. The first privatization was of a small investment bank. A family associated with a relatively new business group known as the Orcas gained control of that bank, and through mergers and acquisitions created Glitnir, which became one of Iceland’s three major banks. The two large state banks—Landsbanki and Buradarbanki (later to become Kaupthing)—were the main prize, and the government ensured that the bidding process would deliver majority ownership of the former to supporters of the Independence Party, which meant Octopus families, and the latter to supporters of the Progressive Party, which meant Squid families. The new owners then established private holding companies which tapped their respective banks for funds to start new businesses, and in some cases took over existing businesses owned by other elites. The new owners also funneled money back to their respective parties and party leaders.6
The resulting transformation of the Icelandic economy did produce a change in the relationship between state and ruling elites, with the latter increasing its relative power. It also led to a restructuring of elite relations, in particular a weakening of ties among leading families and the rise of new power centers. However, despite the free-market/libertarian rhetoric that accompanied it, the transformation was never designed to, nor did it, destroy close state-business ties or end monopoly dominance over the economy.
Growth and Crisis
Iceland’s economy soared, especially over the years 2003 to 2007. The annual average growth in GDP was 5.5 percent and unemployment declined from an already low 3.4 percent to 1 percent.7
The IMF estimated that Iceland was the world’s third-richest nation in per capita terms in 2005.8 As we see next, these gains were fueled by the highly leveraged expansion of the country’s three leading banks, an expansion that contained the seeds of the country’s eventual 2008 economic collapse.
The rate of growth of Iceland’s banking system from 2003 to 2007 was unprecedented.9 Total end-of-the-year assets held by the three largest banks rose from less than twice the country’s GDP in 2003 to over eight times in 2007, and to almost ten times as of June 2008.10
The banks relied heavily on foreign money for their expansion. Early funding came largely from selling bonds in the European market. When foreign rating agency warnings about the health of Icelandic banks closed off the European market in 2006, the banks turned briefly to the U.S. bond market. The following year, Landsbanki and Kaupthing turned to yet another market, foreign retail deposits, especially in the United Kingdom and the Netherlands. All three banks also used their subsidiaries in Luxemburg to engage in indirect collaterized borrowing from the Eurosystem. By the end of 2004, Iceland was the world’s most heavily indebted country measured in terms of gross external debt to GDP.11
Originally Posted by Zippyjuan
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