The latest euro rescue plan lurched into crisis this week after the Greek prime minister decided to put the package to a popular vote. This unexpected gesture of independence "sent tremors through Europe's financial markets," according to The New York Times, and "hammered" U.S. markets, "showing once again how the domestic politics of even the smallest members of the European Union can create troubles" beyond all proportion.
The panic over Greece, of course, is panic over the euro. Another European country, Iceland, took a far more radical path than did Greece, yet it went largely unnoticed. Iceland, in 2009, did what Greece would like to do now: it let its banks fail, and told their creditors to take a hike.
Two years on, Iceland's economy is recovering, while Greece and Ireland and other euro-zone members struggle with huge taxpayer-funded bank bailouts and austerity measures that will probably fail to create jobs. "Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks," Joseph Stiglitz, the Nobel Prize-winning economist, told Bloomberg. "Ireland's done all the wrong things, on the other hand. That's probably the worst model."
Private bankers in Iceland piled up mountains of risky debt in the heady days of cheap money after 2001 — like bankers did around the world. But the crisis in Iceland quickly became so grave that a government bailout was impossible (although the sitting government tried). David Oddsson, head of Iceland's central bank, now says there was a conscious decision to reject piling up a bailout fund for bankers, even in the years before the crisis. "They were collecting debt in such a fast pace, it would be stupid for us to build a mountain they could lean on if they failed," Oddsson told Bloomberg. "The creditors that were lending to the banks recklessly had to face the losses."
Iceland is not a member of the euro or the EU, and independence became its main asset when the banks began to crash. Greece, Ireland, and Portugal haven't been so nimble precisely because they belong to the common currency. If a euro-zone member lets its banks fail, the whole zone may suffer damaged credit (which helps explain the ongoing circus in Brussels.) But an independent Iceland could afford to devalue its currency and watch its credit be slashed — temporarily — to junk.
Lessons from Iceland won't translate directly to the EU unless Greece returns to the drachma. But it would be nice to see Angela Merkel and other European leaders show more Icelandic spine toward Greek creditors -often German banks - as well as international credit-rating agencies. The new euro-rescue plan does involve haircuts for Greece's creditors, but it may be too late for Greek voters.
In any case, Iceland's president, Olafur Grimsson, has pointed out that credit raters like Moody's and Fitch failed to predict the trouble in Iceland's banks and also failed to predict the island's recent recovery. It's refreshing to hear him talk. "The financial institutions including the ratings agencies have an abysmal record of being utterly wrong in their conclusions ... over the previous three or four or five years," he told the BBC in July. "I have often said my mistake in 2006 was to respect what the rating agencies were saying" when they reported that Iceland's banks were doing just fine.
Binar Einarsdottir, who runs one of Iceland's restructured banks, says Iceland's reputation on capital markets has recovered more quickly than expected. "In the beginning, banks and other financial institutions in Europe were telling us, 'Never again will we lend to you,'" she said to Bloomberg. "Then it was 10 years, then five. Now they say they might soon be ready to lend again."
But maybe the main lesson from Iceland is that brave behavior by political leaders can start from below. After the bank collapse in 2008, thousands took to the streets of Reykjavik to protest a deal by the sitting government, led by former Prime Minister Geir Haarde, to save foreign creditors and impose austerity measures. By January 2009, Haarde was gone. President Grimsson now sees those Facebook-organized protests as forerunners of Occupy Wall Street and the Arab Spring.
"Iceland, in a nutshell, has become a case of what you're now seeing in the United States," Grimsson said recently to CNN. "I have even concluded that this so-called social media has now transformed our democracies in such a way ... that I can't see any chance for the traditional, formal institutions of our democratic systems to keep up."