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Viewing cable 08REYKJAVIK252, ICELANDIC ECONOMIC CRISIS: GOI OFFICIALS CAUTIOUSLY

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Reference ID Created Released Classification Origin
08REYKJAVIK252 2008-10-28 16:04 2011-01-13 05:05 CONFIDENTIAL Embassy Reykjavik
VZCZCXRO6873
OO RUEHFL RUEHKW RUEHLA RUEHROV RUEHSR
DE RUEHRK #0252/01 3021608
ZNY CCCCC ZZH
O 281608Z OCT 08
FM AMEMBASSY REYKJAVIK
TO RUEHC/SECSTATE WASHDC IMMEDIATE 3865
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
C O N F I D E N T I A L SECTION 01 OF 02 REYKJAVIK 000252 
 
SIPDIS 
 
STATE FOR EUR/FO A/S Dan Fried 
 
E.O. 12958: DECL: 10/26/2018 
TAGS: EFIN ECON PGOV IC
SUBJECT: ICELANDIC ECONOMIC CRISIS: GOI OFFICIALS CAUTIOUSLY 
OPTIMISTIC IN MEETINGS WITH USG 
 
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 
year. 
 
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 
ahead. 
 
8. (U) This cable has been cleared by Treasury. 
 
 
VAN VOORST