In 2019 Iceland is in the news for erecting a memorial plaque to its glacier, known as Okjökull, or Ok, which shrank so much due to the raised temperatures associated with climate breakdown that it lost its status as a glacier. It was the first to do so, but the country expects all its glaciers to be lost to the same process. Not long ago, however, the country was in the grip of a different crisis, and its response showed how rapid changes of government policy can turn a crisis around.

Iceland was at the heart of the global financial crisis in late 2008 and was nearly destroyed by it; as much as 97 percent of their banking sector collapsed in a matter of three days. The three largest banks in Iceland — Glitnir, Kaupthing and Landsbankinn — had accumulated a debt of $85 billion, equivalent to 10 times the country’s national income (GDP) or 20 times the national budget. A bailout was unthinkable, given losses of about $330,000 for every man, woman and child on the island. The Icelandic stock market then collapsed – 80 percent wiped out overnight – and huge numbers of businesses went bankrupt. The country was forced to approach the International Monetary Fund (IMF) for emergency financial aid – the first western country to do so since 1976 – and a loan of $2.1bn (£1.4bn) was approved to help Iceland through the crisis.

Iceland’s economy had thrived on speculative finance but, after the meltdown, rather than making the public pay for the crisis, as the Nobel economist Paul Krugman points out, Iceland ‘let the banks go bust and actually expanded its social safety net’ and instead of placating financial markets, ‘imposed temporary controls on the movement of capital to give itself room to manoeuvre.’ Following this, a ‘pots and pans’ revolution kick-started a process to draft a new citizen-drafted constitution, which succeeded in engaging half the electorate. The constitutional exercise proposed a new approach to the ownership of natural resources for the public good, which has had a lasting effect on the country’s choices: all its electricity and heat today comes from renewable sources, and transparency has become a central part of Icelandic public life.

Wider relevance

The iceland example is interesting because it shows that there is an alternative path to shoring up a speculative financial system. Most other nations at the heart of the financial crash did almost the very opposite: they bailed out the banks, forgave the bankers and paid for the collapse by cutting social security and other social safety nets. Iceland instead protected savers’ deposits and forgave debts for a quarter of the population. As Bloomberg News reported in 2012, “Iceland’s approach to dealing with the meltdown has put the needs of its population ahead of the markets at every turn.”

Controls on the movement of capital, whether they were temporary or permanent measures, were widely expected to lead to a collapse in the nation’s debt rating and possibly, later, a run on the currency. But in February 2009, when voters elected Jóhanna Sigurðardóttir and her coalition, she barred capital from leaving the country and raised taxes. The use of such capital controls, while perhaps a seemingly obvious measure in the situation, had for decades been an economic policy tool not just ignored, but frowned upon in most Western economies.

But Sigurðardóttir also kept social services and provided debt relief to mortgage holders. She prohibited citizens from buying foreign currency or foreign stocks. As a result, people invested instead in local businesses, including real estate and private equity, providing real support for local enterprises. Tourism boomed as local prices fell thanks to the low currency exchange rate.

Politicians in most other countries played down the long-term damage and tried to restore the status quo. Iceland managed to go a different way by making the most of the upheaval to forge a new path. This started immediately after the crash, as disgruntled people took to the street and weekly demonstrations involved thousands of people – in a country with a population of just 330,000. And after five months of escalation, the protesters’ demands were met: the government, the head of the Central Bank and the director of the Financial Supervisory Authority all resigned. The protests gave the incoming left-leaning coalition government the political space in which to set up an investigations office with the power to prosecute bankers and government officials.

The upheaval also allowed for some radical thinking and new processes: in 2010 the parliament initiated a process whereby ordinary citizens could take part in writing a new constitution for the country, starting with a peoples’ assembly of 950 citizens chosen at random to formulate some guiding principles. Next, a handful of experts on constitutional law wrote a 700-page guidance document. The constitution was then drafted over four months by an elected group of 25 citizens who decided to use consensus decision-making. The committee’s work was transparently communicated via the internet, with comments and contributions from the wider public taken on board as the writing unfolded. Afterwards, 67 percent of people in a national referendum voted for the document to act as the basis of a new constitution for the country. Parliament then put the process on hold, citing existing constitutional problems, and after extremely complicated machinations within parliament the Bill to introduce the new constitution never actually came to a vote, even though there appeared to be a parliamentary majority in its favour. A subsequent general election then changed the character of parliament and the debate moved on. However, most agreed that the process at the very least had a powerful impact on public awareness in Iceland regarding the significance of the constitution and its core principles.

Context and background

Iceland’s banks had created the crisis by luring deposits from the Netherlands and the United Kingdom by offering irresistible interest rates – often as high as 15 percent. They could offer these rates because the value of Iceland’s currency, the krona, was high. It had become a major trading currency, which drove its value up an extraordinary 900 percent between 1994 and 2008. This also created inflation, pushing up house  prices and falsely inflating the stock market. By 2006, the average Icelander was 300 percent wealthier than in 2003, which encouraged many to take on second mortgages in cheap foreign currencies.

The banks used $100 billion in deposits to invest in foreign companies, real estate, and even soccer teams – an amount that dwarfed Iceland’s 2008 GDP of $14 billion. The system was later revealed to be a web of interlocking entities, often lending to each other against assets that were based only on debt, with no underlying value.

Iceland’s banks had also expanded their retail services into Europe and invested in foreign companies. Iceland’s Baugur was the largest private company in Great Britain. IceSave, the online arm of Landsbanki, froze withdrawals during the crisis, which affected depositors throughout Europe and became the subject of two referendums, in which the Icelandic people were asked if they should pay compensation to these savers.

Enabling factors

There were several key factors that enabled such rapid and fundamental change: the extent to which the economic system was irreparably damaged; the decision by the government to respond to the people’s demands and not to those of the banks; and the decision to punish those at fault and start anew. It is possible that the Icelandic way of governing also played a part, because they have a longstanding history of deeply embedded democracy and a culture that discourages hierarchy. Was their natural reflex to protect the many, rather than the few?

Once the extent of the financial collapse was clear, people were very angry and took to the streets. Large crowds gathered in front of parliament demanding answers. Parliament had to respond swiftly and with serious action to the outcry; it set up a Special Investigation Commission, equipped with extraordinary data privileges that meant it could reveal the truth behind the collapse. The result of this effort was made public, in a 3000-page report (in Icelandic) in 2010. Meanwhile, the government demanded the banks reduce the levels of debt for households owing more than the value of their home so that people were not forced into bankruptcy. It also set up a special agency for people with insurmountable debts to apply for them to be forgiven. These steps dealt quickly with the real issues facing people, rather than focusing on the banks and their survival.

The Icelandic authorities treated the situation – unlike the UK, for example – as criminal activity. The top executives of Iceland’s banks were eventually prosecuted for their role. Unlike in the UK or US, Iceland sentenced 29 bankers to prison for their role in the crash. The prime minister at the time, Geir Haarde, was also sentenced, though he was acquitted in 2012. It seems likely that this more hardline attitude emerged, not as a result of any specific decision, but because of the chaos of the moment, when the banks were taken over by financial regulators who were told to seek reasons for the collapse in the books of the banks. They identified criminality (as opposed to simply reckless but nevertheless legal banking practice) according to whether procedures had been followed. A number of gaol sentences were imposed as a result.

Scope and evidence

  • The first step was to allow a default on the $85 billion in debt accumulated by the nation’s banks.
  • The three largest banks in Iceland — Glitnir, Kaupthing and Landsbankinn — had accumulated liabilities that amounted to almost 10 times the country’s gross domestic product.
  • It was simply unimaginable that any bailout could have been possible, given losses of about $330,000 for every man, woman and child on the island.
    Iceland applied to the International Monetary Fund (IMF) for emergency financial aid – the first western country to do so since 1976 and a loan of $2.1bn (£1.4bn) was approved.
  • The crowd-sourced constitution ultimately fell foul of legal technicalities and the Supreme Court, but that didn’t stop the new mood creating lasting conditions for change and the desire for new economic approaches.
  • Where other countries largely let banks off the hook; in 2015, Iceland’s Supreme Court upheld convictions against bankers at the heart of the crisis. Iceland charged its bankers (and some government officials) with breaking the law, bringing more than 28 cases and 60 prosecutions.
  • Finance is now so sensitive that when the Prime Minister was caught up in revelations from the release of the so-called Panama Papers, he was forced from office.
  • The debts are now largely paid off, but most multinational businesses have left Iceland, for fear of the capital controls.
  • A huge expansion in tourism has rescued the nation’s economy, but at the cost of much lower average wages.
  • The country protected the accounts of Icelanders’ deposits in banks and forgave debts for a quarter of the population. As Bloomberg News reported in 2012, “Iceland’s approach to dealing with the meltdown has put the needs of its population ahead of the markets at every turn.”

Lessons for a rapid transition

  1. Contrary to the conventional wisdom that individual countries cannot independently follow radically different economic policy and control capital flows, Iceland shows they can, and quickly.
  2. Radical change can become a habit – once you have started, new opportunities may open for yet more change.
  3. It is possible to put people before the demands of financial markets and still run a successful economy. Citizen engagement and economic reform can go hand in hand.



2000s, 2010s, 2020s

Areas of change

Enough money