Iceland's President explains why Swedish model works and is better for society

In a terrific interview on Business Insider, Iceland's President explained why adopting the Swedish model for handling a bank solvency led financial crisis is the appropriate policy solution.

At its core, the Swedish model is an assertion of the supremacy of the government over the banks the country hosts.  The government demonstrates this by requiring the banks to recognize their losses today and subsequently rebuild without funds from the government their book capital levels.

At its core, the Japanese model is an assertion that the government is afraid of the banks the country hosts.  The government demonstrates this by adopting policies that benefit only the banks to the detriment of its citizenry.

It’s absolutely clear in Iceland, like many other countries, the financial crisis came as a profound shock, not only to the financial institutions, but also to ordinary people, the economy... 

Somehow we were fortunate to realize early on -- that the collapse of the banks was not just an economic or financial crisis, but also developed into a very profound political, social, and even judicial crisis. 

Whereas in many other countries, until recent months, there was a tendency to read this, through 2008, 2009 into 2010, primarily as an economic and financial challenge. 

And I think one of the reasons Iceland has come out of this crisis earlier and more effectively than anyone could have expected, even ourselves, is that early on, we approached this not just with economic and financial challenge, but also attempted to deal with the profound profound social, political, and even judicial challenges, which the collapse of the bank brought about. 

And during those final months of 2008 and the early weeks of 2009, what we saw here in Iceland was a fundamental threat to the political and social stability of the nation. ... 

How the financial system could pose a fundamental threat to the political and democratic framework of Iceland illustrates the grave political and social responsibility which the market and the financial sector carries, because if a collapse in the financial sector can bring one of the most stable and secure democracies and political structures to his knees, as happened in Iceland, what could it do in countries that have less stable democratic and political history? 

So this journey in the last three years has not only been difficult for ordinary people, families, homes, many companies, but it has also been a profound learning experience for the nation, not just economically, but as I said before, politically and socially as well. 

Do you look at Greece and wonder if they should be learning from the Icelandic model?  

I think it is our obligation in Iceland to give an open and honest description of our own experience, of the lessons we have leaned, and other people can draw their own conclusions. I have already mentioned that if you want to deal with this economic crisis, you must treat it not only as an economic challenge but also as a fundamental social, political, and even a judicial challenge.

On the judicial side, we appointed a special commission headed by a Supreme Court judge that issued a report in 9 volumes, we appointed the office of special prosecutors, we have enacted various legislation and laws that relate to the judicial and legal system. 

A second lesson, interestingly enough, is in terms of our economic policies. We have, to some extent, gone against the prevailing economic orthodoxies of the American, European, and IMF model in the last 30 years. This has even been recognized by the IMF leadership....

Which recommended adopting the Japanese model and bailing out the creditors.

As you know, the IMF program finished last year, and we organized a celebratory conference in October, where we said goodbye to the IMF program, and it was attended by Paul Krugman, and other prominent economists, as well as some of the leading officials of the IMF. 

And it was very interesting to hear them acknowledge that the IMF had probably learned more from this experience with Iceland than Iceland had learned from the IMF. It has made the IMF reconsider some of their orthodox stances on what should be the proper economic and financial response to a crisis on this nature.

In fact, the IMF came out this week and said that implementing the Swedish model is the way to handle a bank solvency led financial crisis (see here and here).

Thirdly, we have, in our economic measures, tried to protect the lowest income sectors, we have to try and protect some of the elementary social and health services, and done more of that nature than has traditionally been done in dealing with such a crisis. 

By doing so Iceland avoided the problem the US is now facing of cutting back its retirement and healthcare benefits for the middle and lower income sectors (see here and here).

As everybody knows now, we did not pump public money into the failed banks. We treated them like private companies that went bankrupt, and we let them fail. 

Some people say we did it because we didn’t have any other option, there is clearly something in that argument, but it does not change the fact that it turned out to be a wise move or whatever reason. 

Whereas in many other countries, the prevailing orthodoxy is you pump public money into banks and you make taxpayers responsible for the banks in the long run, and somehow treat the banks as if they are holier institutions in the economy than manufacturing companies, commercial companies, IT companies, or whatever. 

And I have never really understood the argument: why a private bank or financial fund is somehow holier for the well being and future of the economy than the industrial sector, the IT sector, the creative sector, or the manufacturing sector.

Please re-read the highlighted text as it explains why the Swedish model handles the problems in the financial sector and the Japanese model kicks the problems permanently into the future to the detriment of everyone but the bankers.

So if you add all of this together and throw in the devaluation of the currency as well, it’s clear that what some people have called the Icelandic model includes a number of measures and approaches that have not been adopted in other countries. 

On the contrary, it includes some methods in the process that go directly against what has been adopted in other countries. But the outcome is the Icelandic economy is recovering faster and more effectively than any other economy, including the British and the American that suffered from a big financial crisis in 2008.

The Swedish versus the Japanese model.  Iceland adopted the Swedish model and the financial crisis is behind it.  The EU, UK and US adopted the Japanese model and they are still dealing with the financial crisis.

One aspect of the crisis you were personally involved in, involved you effectively using your veto over the Icesave accounts and how much money to pay back to the UK and Holland. Constitutionally, you had that right, even if it was an unusual move — was that a tough decision? 

It was absolutely very tough indeed, especially the first veto decision I took because every government in Europe was against me. Every big financial institution, both in Europe and in my own country was against me, and there were powerful forces, both in Iceland and in Europe that thought my decision was absolutely crazy. 

And to some extent, of course, it was a complicated issue. But once I had analyzed every aspect of it, it boiled to the fundamental choice of the interest of the financial market on one hand, and the democratic will of the people on the other, and rarely in history -- but it does happen -- do we come to such crossroads that we are forced to choose. 

And my answer was clearly, not only with respect to the democratic structure of Iceland, but also with respect to Europe’s contribution to the world. What is our primary legacy to countries and nations in modern times? Is the European democracy the right of the people?... Based with this choice, it was in the end, clear that I had to choose democracy.

But there were other issues at stake as well. 

What the British and the Dutch were arguing was that somehow the European banking system was such that a private bank would operate anywhere in Europe, and if it succeeded, the bankers got extraordinary benefits, the shareholders got big profits. But if it failed, the bill would simply be sent to ordinary people back home: farmers and fishermen, nurses and teachers, young people and old.

The choice between the Swedish and Japanese model is a choice between making the bankers absorb the losses for the financial excesses they created or make the real economy and the citizens of the country absorb the losses.

And that, I maintain, is a very unhealthy formula for the future of the European banking system. If you sent a signal to the bankers that you can be as irresponsible and daring as you want to be, and if you are lucky, you become very rich, but if you fail, other people will pay. 

I don’t think that is a wise journey to enter if you want to build a healthy European financial system in the future. 

In addition, the British and the Dutch government did not consult us when they decided to pay out. And as I have pointed out many times, the estate of the failed bank was sufficiently strong, as is now turning, out to pay these depositors out of the estate of the failed bank. 

There were predominantly three Icelandic banks that operated outside: Glitnir bank, Kaupthing and Landsbanki.  Glitnir and Kaupthing have paid all their depositors and everybody in Germany and the Netherlands and Scandinavia, everywhere. 

It’s only the case of Landsbanki in Britain and the Netherlands, because the British and the Dutch government were not prepared to wait to see if the estate of the failed bank was sufficiently strong to shelter the payment, as it’s now turning out to be.... 

I’m simply saying if the collective decision-making structure of the European Union can take such wrong decisions and follow a misleading course and fundamentally unwise for the healthy future of the European banking system, as I advised before, Arguing that private banks should operate in a way that the profits go to them, but the losses go to ordinary people back home is something that they need to examine.

On what has happened since the government adopted the Swedish model,

We have, however, concentrated on our recovery, and paradoxically, what we are seeing in the last two years is that many sectors in Iceland: the energy sector, the tourism sector, the IT sector, the manufacturing sector, and the fishing sector are doing better in the last two years than they did prior to the banking crisis. 

And you might also find it interesting that the collapse of the banks revealed to us a very interesting aspect of modern banking, which I think has been more or less overlooked in this discussion in Europe and in America in the last two or three years: the Icelandic banks, like all modern big banks in Europe and America and all the other parts of the world, are no longer banks in the old-fashioned way. 

They have become high-tech companies. High-ranked engineers, mathematicians, computer scientists, programmers and so on and so forth. And their success depends largely on how successful they are in hiring people with this education and capability, not necessarily those trained in business schools or finance, but in engineering, mathematics, computer science and so on. 

And when the Icelandic banks collapsed, what we saw was that a great number of companies in these creative sectors, IT, high-tech, and all of those, who had the large growth potential in the previous years, but had not been able to realize it because they couldn’t get the people, due to the fact that the banks were buying up all the best engineers and mathematicians and computer scientists, suddenly had the pool of talent available to them. And within six months, all these people who came out of the banks with these qualifications had been hired. 

So since then you have seen a great growth period in the Icelandic IT sector, the high-tech sector, the manufacturing sector, because they could suddenly get the engineers, the mathematicians, the computer scientists. 

So the lesson from this is: if you want your economy to excel in the 21st century, for the IT, information-based high-tech sectors, a big banking sector, even a very successful banking system, is bad news for your economy. 

You could even argue based on this that the bigger the banking sector is, the worse is the news for your economy, because their magnetic attraction of taking engineers and technically qualified people and computer scientists into the banking sector is due to high bonuses and higher salaries prevents these creative growth sectors from realizing their full potential. 

We were not aware of this in the years leading up to the collapse of the banks, but once it happened, what we have seen since is an extraordinary interesting demonstration in what I have just described to you. And to me, it should urge people, both in Europe and in the United States to look at the prevailing orthodoxies of a big financial sector versus other parts of the 21st century economy, at least that’s my view. 

If you want to excel in the 21st century economy, it’s more important to give high priority to your creative sectors, and IT companies and high-tech companies, and not building up big banks, because if you need money you can always get it somewhere in the world in the globalized financial system. But if you lose the most valuable manpower in your creative sector, there is nothing you can do to repair that damage.