Cracks in the Ice

To restore investor confidence, Icelandic banks and government officials have emphasized their economy's unflagging strengths in a charm offensive directed at ratings agencies and investors. Iceland is the fifth richest country in the oecd; the prices of its largest exports, aluminum and fish, are at record highs. "The Icelanders are richer than us," says British economist Portes. "They're not exactly going to starve." (Iceland's gross national income per capita is $39,400, compared to the U.K.'s $35,300.) What's more, the banks remain fundamentally sound: they have strong deposit ratios and are more profitable than their Nordic peers. First-quarter results suggest the financial climate has started to warm: the three largest banks all reported strong core earnings, with Landsbanki's rising by 27% compared to the same period last year. On May 16, in a show of support, the central banks of Denmark, Norway and Sweden offered to loan Iceland $2.4 billion in emergency credit, doubling the nation's reserves; the krona immediately gained 5% against the euro. Iceland's central bank asked parliament on May 28 to let it borrow up to $6.9 billion so it can better protect the country's currency and banking system.

Edda Rós Karlsdóttir, a senior director at Landsbanki, says Iceland's peculiar macroeconomic conditions pose the biggest challenge to maintaining investor confidence. With so few potential depositors at home, the nation's banks have little choice but to raise capital abroad. Furthermore, the size of Iceland's economy — the U.S. economy is roughly a thousand times larger — has always made it volatile, partially explaining its much-discussed $2.7 billion current-account deficit. "If my father decides to build a garage onto his house, it will almost show up in national accounts," she quips. So imagine the impact of constructing two large aluminum smelters from 2005 to 2007. Those projects required the import of generators and other materials, and amounted to 35% of the nation's GDP. With aluminum prices higher than ever before, those smelters will soon turn profits — and boost national income.

The banks flatly dismiss the notion that the central bank will need to bail out the system. "That's just unthinkable," says Ásgeir Jónsson, chief economist at Kaupthing, Iceland's largest bank. Following the 2006 crisis, banks greatly strengthened their liquidity positions and shifted their liabilities further into the future: on average, newly issued bonds now mature in 2010 or after, rather than within a year. Although Iceland's major banks had hoped to grow quite quickly this year, they will use their liquidity conservatively as a buffer instead. Meanwhile, to their relief, Iceland's banks have negligible subprime exposure. Whether through luck or foresight, Glitnir and Landsbanki didn't buy any of the bad paper.

Despite these strong fundamentals, Iceland has undoubtedly lost some steam — and importers feel it the worst. Úlfar Steindórsson, CEO of Toyota Iceland, says that the depreciated krona raised the price of imported cars by 25% in just a matter of weeks, bringing his booming sales to a standstill. He now predicts year-on-year revenues will end 30% lower. But Steindórsson doesn't blame the government or Iceland's banks. "The crisis didn't start in Iceland — it started in the U.S.," he says. As he sees it, the international dimension of the credit crunch means that Iceland's hands are essentially tied. "We can't move the prices on Wall Street, and we can't buy all the empty houses in the States," Steindórsson says. "Those are problems that someone else has to solve, and we just have to wait." On this isolated island that has endured extreme temperatures and fierce glacial winds for centuries, this bout of economic turmoil is simply another nasty storm that the locals expect to weather.