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Iceland's Pyrrhic Victory

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As expected, Iceland's voters overwhelming rejected legislation to settle their country's dispute with the United Kingdom and the Netherlands regarding the government's liability for losses suffered by the depositors of the IceSave accounts when its parent--Landsbanki--collapsed in 2008.

The voters are rightfully angry about the matter. The Icelandic financial regulators failed to assert any meaningful control over Landsbanki's rapid ascension in the 2000s. When the house of cards began to fall after Lehman Brothers default, Landsbanki offered high interest saving accounts over the internet for depositors in a last-ditch effort to maintain liquidity. The Icelandic government at least implicitly guaranteed the deposits, as required under European Economic Area (EEA) rules, but failed to properly evaluate the level of risk or to charge the bank an appropriate premium. As a result, the deposit insurance fund was incapable of meeting the 20,887 euro guarantee, or about 3.7 billion euros for the non-Icelandic accounts. The British and Dutch governments seized Landbanki assets within their countries, immediately paid their domestic depositors to avoid a run on their banks, then asked how Iceland intended to repay them.

There is little doubt that the initial IceSave settlement agreed was unrealistic. It called for a high (5.5%) rate of interest. It did not spread responsibility for the lack of regulation to the British and Dutch regulators. The Icelandic negotiators did not effectively point out that the sum being sought would impoverish their country for a generation.

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"The Icelandic Economic Wonder." Courtesy of Halldór Baldursson, www.mbl.is

The voters also feel that holding the entire nation liable for the actions of a few incompetent and/or corrupt bankers is deeply unjust. Any repayment, it appears, would let them off scot-free. Not one banker has been sent to jail or forced to regurgitate any ill-gotten gains. Not one regulator has been fired. The politicians who oversaw (and profited from) the bank deregulation remain in power and, if anything, they and their buddies are in a better position than ever.

The British, in particular, have been demonized for their actions in this matter. Their invocation of anti-terrorist legislation to freeze all Icelandic bank accounts after Glitnir collapsed is seen by some to be the cause of the collapse of Landsbanki and Kaupthing. The fact that Iceland has been a NATO ally for decades was seen as meaning nothing, and this was seen as a personal insult to the Icelandic people.

It is widely rumored that the seized assets will be sufficient to cover nearly the entire IceSave debt. As a consequence, the British and the Dutch are seen as bullies, kicking a weaker neighbor while it's down, for no reason.

So the voters were right on nearly every front. The UK and Holland should accept some responsibility for the debt. The agreement was unconscionable. The Icelandic nation should not be left destitute to cover debts that amount to very small fractions of those countries GDP. The wrongdoers should be forced to pay for their wrongdoings.

In the end, however, I am reminded of King Pyrrhus's response to congratulatory messages he received after suffering heavy losses while defeating the Roman army at Asculum in 279 BC: "Another such victory and I am undone."

It is almost certain that Iceland's access to desperately-needed capital will be cut off. It is unlikely that the IMF (or anyone else) will provide any additional funds until the matter is resolved. Iceland's already low sovereign rating will be downgraded even further, requiring the government to pay even higher interest rates. Iceland will never get into the European Union without support from the United Kingdom and Holland.

Of equal importance is the fact that the ruling coalition has been gravely damaged. The petition for a referendum was spearheaded by the opposition parties. It is a very distinct possibility that the parties that got us into this mess will be returned to power in short order.

The IceSave matter has taken the country attention away from many other pressing matters. While we have been endlessly debating IceSave, our unemployment rate has continued to climb, the number of insolvencies has continued to increase, and the number of public services has continued to decrease. Other scandals of comparable magnitude and abuse of taxpayer money--but involving only Icelanders--are being ignored by the Icelandic media.

We scored some points by rejecting the IceSave agreement, and we'll probably get a marginally better deal from the Brits and the Dutch. Unfortunately, though, we're probably worse-off overall financially, and we've lost valuable time, energy, and focus as a result. Any more "victories" like this, and we'll be next to King Pyrrhus in history's waste bin.