Thursday, 31 December 2009

Iceland and the bailout merry go round

At least one country is not worried about the current difficulties facing the European Union, and more specifically the Eurozone. Iceland, according to a news release from Reuters and featured in this article in today's New York Times, will be handing over one half of the $10 billion it is borrowing from the IMF to make nice with finance ministers from two other member states - the UK and Netherlands - hoping that this may assist in their efforts to put their troubles "behind them" and look forward to future prosperity within the EU

REYKJAVIK (Reuters) — Iceland’s Parliament approved an amended bill late Wednesday to repay more than $5 billion lost by savers in Britain and the Netherlands when the country’s banks collapsed.

The passage of the legislation, by a 33-to-30 vote, bolsters Iceland’s hopes of swift entry to the European Union and of getting its shattered economy back on track.

“Approving the bill is the better option and will avoid even more economic damage,” Steingrimur Sigfusson, finance minister and leader of the Left-Green party, said during the debate. “History will show that we are doing the right thing.”

Britain had no immediate comment, but the Dutch finance minister, Wouter Bos, welcomed the bill.

“It has not been an easy process but Iceland has taken its responsibility and that deserves a compliment,” Mr. Bos said in a statement on Thursday.

The global financial crisis devastated Iceland’s economy, bringing down its top banks, sending its currency tumbling and plunging the country into recession.

The economy is expected to contract more than 8 percent this year as the effects of last year’s economic meltdown linger, with growth not predicted to return until 2011.

To cushion the worst of the fallout, Iceland has agreed to a $10 billion aid package from the International Monetary Fund and other lenders.

It is worth pondering whether the IMF was informed in disclosures made by the Icelandic government that $5 billion of its aid package would be used in such a fashion. The fact that the vote in the Icelandic parliament was so close and contentious suggests that it may not have been. Which raises some fanciful possibilities of what might happen should the Icelandic government need another round of financing and the IMF was not amused by this act of generosity.

Organizing a private sector loan for one of the riskiest sovereign borrowers in the world would be a challenge even for the slickest investment bank especially since, following the demise of AIG, there are no obviously gullible counter-parties to whom one could lay-off the risk.

Perhaps the Icelandic government really are counting on a very swift entry into the EU and then approaching Mr. Trichet for a bridging facility. Alas there are several other states already in that line up.

As a final piece of irony perhaps Gordon Brown's government, reciprocating for the unusual kindness shown by the Icelandic parliament, and using the Royal Bank of Scotland as a conduit, could be tempted into making a new £2 billion loan to Iceland (with suitably onerous interest charges) on the grounds that the credit risk as reflected in the CDS market is massively over-priced. Surprisingly this kind of reasoning would be a lot saner than Mr Brown's sale of the UK's gold reserves at the bottom of the market as referenced here.

Even more perversely, if there was a default on such a new loan to Iceland, then the UK government would, to complete the daisy chain, end up in exactly the same position as it was before the surprise announcement about the payback. Just to make things even more ironic the UK could once again expect yet another reimbursement from the Icelandic government should it have to receive any further emergency bailouts.

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