Cablegate: Icelandic Economic Crisis: Goi Officials Cautiously

DE RUEHRK #0252/01 3021608
O 281608Z OCT 08




E.O. 12958: DECL: 10/26/2018

Classified By: Economic Section Chief Fiona Evans for reasons 1.4 (b)
and (d).

1.(C) Summary: During the October 24 visit of U.S. Treasury
Department Acting DAS Eric Meyer and Iceland desk officer Larry
Norton, the visiting International Monetary Fund team in Reykjavik
announced it had reached an agreement with Icelandic officials on a
2.1 billion USD loan deal. With this agreement on the table, the GOI
focused its conversations with Treasury on plans to move forward,
including discussing the obstacles to floating the krona, and finding
the additional cash loans to supplement the IMF funds. The Prime
Minister and Finance Minister traveled to Helsinki on October 26 to
meet with their counterparts to ask for additional funding. No
Icelandic official asked for USG funding support. However, DAS Meyer
indicated that USG would support the IMF deal within the IMF.
Several officials took the opportunity to complain about British
actions at the outset of the crisis (including freezing the banks'
U.K. assets under an anti-terrorist law), with Central Bank Head
David Oddsson going to the extreme of comparing Gordon Brown to
Mussolini. The Russian loan still seems to be a possibility, but the
IMF deal has pushed this prospect to the back burner. Everyone
acknowledged that the road ahead would be painful, but maintained a
sense of cautious optimism. End Summary.

2. (C) Central Bank Governor of the Board David Oddsson opened his
meeting with the Treasury visitors by asserting that the Financial
Times had misquoted him in saying he blamed the Fed and other Central
Banks for the Icelandic collapse; he had said only that he was
"disappointed in them." He emphasized the need for a show of
strength and predicted that the IMF loan would be small and would be
disbursed incrementally. Oddsson and Director of International
Markets Sturla Palsson warned of investors hedging "against us" and
the need to show strong reserves so that "we can stand a speculative
run against the Icelandic krona." Palsson said they were prepared to
use a tight monetary policy and the priorities were to 1) create the
new banks, 2) get the payment systems in order, and 3) get the bond
market up and running. They were cautiously optimistic on the
economic outlook, and Palsson asserted, "the time to normalcy will be
shorter than the textbooks tell us." He was confident the krona
could be floated sooner than the IMF estimate of six months to a

3. (C) Oddsson was clearly bitter about the UK's freezing of
Icelandic assets and compared Gordon Brown's actions to Mussolini's
Ethiopian venture in 1935 in which a large country brought about the
ruin of a defenseless small one. Oddsson said they were doing their
utmost to respond to creditors in a "fair and open way" and cited the
hiring of known specialists to ensure there is no favoritism. He
said that the government's new emergency law prioritizes depositors
over other creditors and that the law lumps all depositors together
(retail and wholesale). Oddsson said that the EU Directive on
banking establishes a bank fund to serve as a guarantor of the
deposits. This works well in a system in which hundreds of banks
contribute, but obviously is not a good system when there are only
three banks. The Icelandic bank fund isn't sufficient to guarantee
the losses that have been incurred by the bankruptcy of the three
Icelandic banks. The legal question now is whether the state is the
back-up institution when the bank fund is exhausted. The UK argues
yes, but Iceland sees it completely differently. This is a question
that must be settled in court. Regarding the bond holders, Oddsson
said that creditors will be surprised when they receive much more
than what is currently being traded. Both Oddsson and Palsson
reiterated how important it is to restore trust in the system.

4. (C) At the Financial Supervisory Authority (FME), Head of Foreign
Operations Hlynur Jonsson gave a technical description of recent
events. He said that the three new banks (New Glitnir, New Kaupthing
and New Landsbanki) had been formed from the Icelandic deposits and
internal business of the old banks; the old banks would receive a
bond, which would be evaluated by an international evaluator within
90 days, for the new banks. The state will have to capitalize the
new banks with bonds issued by the old bank to cover the difference.
Jonsson said they needed to liquidate the old banks without ruining
Iceland's international reputation. Jonsson said the foreign
operations were left in the old banks and are limited because of the
authorities in various jurisdictions. He said the situation is most
complex in the UK and in Luxembourg, "where huge repos with the
European Central Bank and the mother company owing subsidiaries might
make it possible to save the subsidiaries." Jonsson said that they
are talking with their counterparts in other countries and that
everything is going well except with the U.K. When asked about the
long term impact of what has happened, Jonsson and Gudrun Jonsdottir,
Head of the Securities Market, said they were still putting out fires
and were not able to answer just yet.

5. (C) Finance Minister Arni Mathiesen said the IMF deal was not
complicated; its focus was on banking structures, monetary policy
(key to restoring some confidence in the currency) and fiscal policy
(how the government manages the very high debt it will incur as a

REYKJAVIK 00000252 002 OF 002

result of the crisis.) Mathiesen said in his mind, there were no
areas of disagreement. He said he would travel with the Prime
Minister on October 26 to Helsinki for two days of meetings with
their Nordic counterparts where they anticipate raising further
funds. When asked whether Iceland had approached the EU, Mathiesen
said he had talked to French Finance Minister Lagarde and that it
seems the EU does not have a structure to tackle these kinds of
financial problems and that the assistance would likely be in
post-program. He said Foreign Minister Kouchner and Lagarde may be
coming to Iceland at some point. He expected the krona to plunge
when it is floated but hoped it would stabilize at more or less the
current level (115 ISK to 1 USD).

6. (C) The Permanent Secretary of the Prime Minister's Office, Bolli
Bollason, said the formal decision to seek IMF assistance had been
approved in a Cabinet meeting earlier in the day (Oct. 24.) Bollason
understood the size of the IMF package was unusual relative to
Iceland's size (as a percentage of Iceland's IMF quota, the program
will be bigger than most in IMF history) and said that it was
fundamental to restore stability in Iceland. He said that the main
concern is passing the hurdle of floating the ISK. He said that the
Prime Minister was preparing for the Nordic Prime Ministerial meeting
in Helsinki on Monday with his Nordic counterparts, to request funds
or swap lines or both. Asked about how Iceland would fill the 4
billion USD gap between the IMF funding and the purported 6 billion
USD necessary, Bollason said they asked Central Bank Governor Oddsson
to call his counterparts in the Nordics and ask how far they are
willing to go. Bollason said in his personal opinion, he didn't
expect the Russians to contribute money, that Iceland had not been in
contact with the Russians since the Icelandic team left Moscow, but
said "let's see how things develop."

7. (C) Director of the Institute of Economic Studies at the
University of Iceland Gunnar Haraldsson told Meyer and Norton that
the repercussions of the crisis would be painful. He predicted
inflation, mass layoffs, business bankruptcies, and a brain drain.
He described the hardships that many Icelanders now face with their
payments on foreign currency loans (on their houses and cars)
resetting with the krona's depreciation. He saw the IMF as the only
way out, and even with their help, it would be a rough 6 to 12 months

8. (U) This cable has been cleared by Treasury.


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