REYKJAVIK, Iceland — On the snowy streets of this capital city, the economic panic of 2008 has mostly faded. The trendy cafes along Laugavegur brim with customers. Restaurant menus feature $40 grilled minke whale and $60 racks of lamb, and hardly a table goes empty. Boozy youths line up to pack nightclubs that thump all night. It’s even okay now to joke about the crash, or kreppa, as it’s known: “We may not have cash, but we have ash!” reads one T-shirt with a picture of the Eyjafjallajokull volcano that erupted in 2010.
Iceland’s journey from financial ruin to fledgling recovery is a case study in roads not taken and choices not made by other countries faced with economic calamity in recent years.
By the time the United States and Europe began to wrestle with the fallout of the global financial crisis in 2008, this tiny island nation was experiencing full-fledged meltdown. Its bloated banks failed. Its currency collapsed. The prime minister invoked God’s help, and protesters filled the streets.
Iceland did what the United States chose not to do — allow its biggest banks to fail and force foreign creditors to take a hike. It did what troubled European nations saddled with massive debts and tethered by the euro cannot do — allow its currency to remain weak, causing inflation but making its exports more desirable and its prices more attractive to tourists.
Three years later, the unemployment rate has fallen. Tourism has increased. The economy is growing. The government successfully raised money from investors in the summer for the first time since the crisis.
It’s tempting to conclude that this country of 318,000 people simply handled the crisis more adeptly than others, like a pick-your-own-ending book in which Icelanders chose correctly. There is a sliver of truth in that, but the full story is more complicated. That’s partly because the circumstances in Iceland are far different than in the United States and Europe, but also because such a simple explanation ignores the anger, the angst and the struggles that remain here, hidden barely beneath the surface.
Iceland has weathered the worst of the financial crisis, but its society has yet to solve the identity crisis that followed in its wake.
In the decade leading up to the crash, Iceland transformed itself from an economy fueled by fishermen to a center for wealthy financiers. It privatized its banks, and they grew larger and larger, gobbling up assets around the globe and luring thousands of overseas depositors with promises of high interest rates.
Businessmen came and went from Reykjavik in private jets. They bought showy yachts and multimillion-dollar vacation homes. Bankers became a popular and swaggering breed; after all, they were handing out a slew of high-paying jobs and providing a fortune in tax revenue.
“You had to be crazy not to want to become a banker,” said Heimir Hannesson, a student council member at the University of Iceland. “You went to college, studied business. You became a millionaire overnight. That was the dream. And for a few years, it was the reality.”
With investments booming and the currency soaring, Icelandic business owners took on larger debts, and average citizens bought Range Rovers and swanky houses, sometimes taking out loans in other currencies to take advantage of favorable exchange rates.
An air of invincibility set in, a sense that Icelanders had mastered a powerful form of financial alchemy. “We are succeeding because we are different,” the country’s president said in a speech in London in 2005, insisting that Iceland’s “daring” entrepreneurs were risk takers who succeeded where others “either failed or dare not enter.”
When global credit markets began to freeze in 2008, suddenly investors demanded their money back. The country’s three largest banks, which had ballooned to nearly 10 times the size of the nation’s GDP, simply went broke.
“The banking system was so big, it was beyond the capacity of the state to bail it out,” said Gylfi Zoega, an Icelandic economist and university professor. “The country didn’t have the reserves to help these banks; they just defaulted. There was no choice.”
Realizing the peril — and perhaps the fallacy — of trying to rescue the banks, Iceland’s government ultimately let them collapse. “No responsible government takes risks with the future of its people, even when the banking system itself is as stake,” the prime minister said in an unprecedented address to the nation in October 2008.
The fallout came swiftly. The Icelandic krona crumbled, losing more than half its value against the euro and becoming worthless beyond Iceland’s shores. The currency collapse quickly doubled payments for many of those who had taken out loans in foreign currencies. Inflation spiked to nearly 20 percent. Companies rapidly shed jobs. Thousands of citizens protested outside Parliament — a rare sight in this tranquil society — and within months, the sitting government was swept from office.
In the wake of the catastrophe, officials guaranteed deposits of Icelandic citizens but refused to pay off many foreign investors — a controversial move that remains a sore spot here and in Europe. The government created new banks made up of the domestic operations of the failed firms. The old banks, which held foreign assets, are being dismantled and their assets sold, with proceeds going to pay off creditors.
Iceland accepted an aid package from the International Monetary Fund and loans from other Nordic countries. It put in place “capital controls” that prevent money from leaving Iceland in an effort to stabilize its currency.
Before the crash, Iceland’s government had maintained a low debt burden and a budget surplus. That vanished after it was forced to pour money into the struggling economy and freshly rebuilt banking system, and to swallow big revenue losses.
The country’s debt grew to more than 100 percent of GDP in 2011. But even as government officials made budget cuts in an effort to return to a more sustainable path, they deliberately safeguarded its already-generous social safety net, adding and expanding programs targeted to the most vulnerable groups. In part to offset those measures, the country put in place new taxes on the banking system and on wealthy individuals.
Slowly but surely, recession inched toward recovery.
The Iceland experiment, born out of circumstance, might not have translated elsewhere. The fall of its biggest banks caused pain and hardship at home and overseas. But it pales in comparison to the global wreckage that probably would have occurred had the United States allowed companies such as Citigroup to collapse.
Allowing the krona to remain weak has hastened Iceland’s return to stability. The country’s exports, which feature fish and aluminum, were running about 11 percent higher last year, and the tourism industry also showed an 11 percent increase through November. But struggling countries bound together by the euro, such as Greece and Portugal, don’t have the ability to let their currency fluctuate to more favorable levels.
Judging by economic data and by the workaday scenes of life in the capital, the economic engines are turning again. “For a country whose entire financial system collapsed, Iceland is doing remarkably well,” said Julie Kozack, the IMF’s mission chief for Iceland, adding that the country “is not out of the woods yet.”
Iceland completed its IMF program in the summer. Inflation has fallen. Consumers are spending more money. There are new investments in geothermal energy, and the fishing waters remain plentiful. Hammers and power saws have become a familiar sound again in Reykjavik. Fewer Range Rovers clog the streets, but there’s no lack of Audis and Mercedes or BMWs.
But beneath that facade, real problems and deep uncertainty remain. The unemployment rate hovers around 7 percent. Businesses and households remain mired under crushing debt, thanks in part to a mortgage system that ties loan balances to the soaring consumer price index. Widespread anger at the government and the banks persists.
People tell anecdotes of friends seeking antidepressants and families forgoing trips to the dentist. The standard of living remains high, but a recent government survey found that half of the nation’s households find it difficult to make ends meet.
In addition, Icelanders have continued to flee to places such as Norway, which promise more opportunity and a familiar culture. “There’s a significant threat of brain drain going forward,” said Brynjar Petursson Young, a business professor at Reykjavik University.
The crisis scarred Iceland’s national psyche, and citizens are wrestling with profound questions, not only about how to return to better financial footing but also about what kind of society should emerge.
“What we had before was some sort of irrational exuberance. That has left, and maybe that’s a good thing,” said Gylfi Magnusson, an Icelandic economist who served as minister of economic affairs after the crash.
Particularly among the generation of Icelanders who fill the Cafe Paris at night and scarf down fries at Hamborgara Bullan and shuffle across the frozen tundra of the university, there seems a determination to make the future brighter than the recent past.
“The smaller the country gets, the bigger the national pride, the bigger the soul. Here we are on a tiny island, with nothing but our pride,” said Hannesson, the student council member.
Driving the streets of Reykjavik on a recent evening, he proudly pointed out the landmarks of his city — the stone Parliament building, the presidential mansion, even the hot dog stand where President Bill Clinton once ate. He circled east and pointed toward the shimmering glass buildings that once housed the banks that brought down a country.
“The modern-day financial Vikings, I think we feel scarred by the reputation they gave us,” he said. “Especially among the younger population, there’s a desire to do things better and more honorably.”