Financial Crisis

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Posted by r2d2 03/10/2009 @ 12:24

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2008 Icelandic financial crisis

Former headquarters of Landsbanki in Reykjavik and current headquarters of NBI, founded by FME from the ruins of Landsbanki.

The 2008–2009 Icelandic financial crisis is a major ongoing economic crisis in Iceland that involves the collapse of all three of the country's major banks following their difficulties in refinancing their short-term debt and a run on deposits in the United Kingdom. Relative to the size of its economy, Iceland’s banking collapse is the largest suffered by any country in economic history. A number of economists have linked Iceland's woes to the nation's adoption of neo-liberal and laissez-faire economic policies starting in the 1990s.

The financial crisis has had serious consequences for the Icelandic economy; the national currency has fallen sharply in value, foreign currency transactions were virtually suspended for weeks, the market capitalisation of the Icelandic stock exchange has dropped by more than 90%, and a severe economic recession is expected.

In late September, it was announced that the Glitnir bank would be nationalised. The following week, control of Landsbanki and Glitnir was handed over to receivers appointed by the Financial Supervisory Authority (FME). Soon after that, the same organisation placed Iceland's largest bank, Kaupthing, into receivership as well. Commenting on the need for emergency measures, Prime Minister Geir Haarde said on 6 October "There a very real danger … that the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool and the result could be national bankruptcy." He also stated that the actions taken by the government had ensured that the Icelandic state would not actually go bankrupt. At the end of the second quarter 2008, Iceland's external debt was 9,553 billion Icelandic krónur (50 billion euros), more than 80 percent of which was held by the banking sector. This value compares with Iceland's 2007 gross domestic product of 1,293 billion krónur (8.5 billion euros). The assets of the three banks taken under the control of the FME totaled 14,437 billion krónur at the end of the second quarter 2008.

The full cost of the crisis cannot yet be determined, but already it exceeds 75 percent of the country's 2007 GDP. Outside Iceland, more than half a million depositors (far more than the entire population of Iceland) found their bank accounts frozen amid a diplomatic argument over deposit insurance. German bank BayernLB faces losses of up to €1.5 billion, and has had to seek help from the German federal government. The government of the Isle of Man will pay out half of its reserves, equivalent to 7.5 percent of the island's GDP, in deposit insurance.

The Icelandic króna had declined more than 35 percent against the euro from January to September 2008. Inflation of consumer prices was running at 14 percent, and Iceland's interest rates had been raised to 15.5 percent to deal with the high inflation.

On the Wednesday night, 8 October, the Central Bank of Iceland abandoned its attempt to peg the Icelandic króna at 131 krónur to the euro after trying to set this peg on 6 October. By 9 October, the Icelandic króna was trading at 340 to the euro when trading in the currency collapsed due to the FME's takeover of the last major Icelandic bank, and thus the loss of all króna trade 'clearing houses'. The next day, the central bank introduced restrictions on the purchase of foreign currency within Iceland. From 9 October to 5 November, the European Central Bank quoted a reference rate of 305 krónur to the euro.

The Central Bank of Iceland set up a temporary system of daily currency auctions on 15 October to facilitate international trade. The value of the króna is determined by supply and demand in these auctions. The first auction sold €25 million at a rate of 150 krónur to the euro. Commercial króna trading outside Iceland restarted on 28 October, at an exchange rate of 240 krónur to the euro, after Icelandic interest rates had been raised to 18 percent. The foreign exchange reserves of the Central Bank of Iceland fell by US$289 million during October 2008.

During November, the real exchange rate (discounting inflation) of the Icelandic króna, as quoted by the Central Bank of Iceland, was roughly one-third lower than the average rate from 1980–2008, and 20 percent lower than the historical lows during the same period. The external rate as quoted by the European Central Bank was lower still. On the last trading day of the month, 28 November, the Central Bank of Iceland was quoting 182.5 krónur to the euro, while the European Central Bank was quoting 280 krónur to the euro.

On 28 November, the Central Bank of Iceland and the Minister for Business Affairs agreed a new set of currency regulations, replacing the central bank's restrictions imposed early on in the crisis. Movements of capital to and from Iceland were banned without a license from central bank. It is estimated that foreign investors hold some €2 billion in króna-denominated securities, popularly known as "glacier bonds".

The foreign exchange rules also oblige Icelandic residents to deposit any new foreign currency they receive with an Icelandic bank. There is anecdotal evidence that some Icelandic exporters had been operating an informal offshore foreign exchange market, trading pounds and euros for krónur outside the control of any regulator and starving the onshore market of foreign currency. Hence the central bank had to sell €124 million of currency reserves in November 2008 to make up the difference, compared with an estimated trade surplus of €13.9 million.

The last currency auction was held on 3 December. The domestic interbank foreign exchange market reopened the following day with three market makers, all of them government-owned. On the first two days of domestic trading, the króna climbed to 153.3 to the euro, up 22 percent against the last currency auction rate.

In January 2009, the exchange rate of Icelandic króna (ISK) against Euro seemed to be more stabilized compared with the situation in October 2008, with the lowest rate at 177.5 ISK per EUR on January 1, January 3, and January 4, 2009, and the highest at 146.8 on January 30, 2009. In the meantime, however, Iceland's 12-month inflation in January 2009 climbed to a record high of 18.6 percent.

On 29 September 2008, a plan was announced for the bank Glitnir to be nationalised by the Icelandic government with the purchase of a 75 percent stake for €600 million. The government stated that it did not intend to hold ownership of the bank for a long period, and that the bank was expected to carry on operating as normal. According to the government, the bank "would have ceased to exist" within a few weeks if there had not been intervention. It later turned out that Glitnir had US$750 million of debt due to mature on 15 October. However, the nationalization of Glitnir never went through, as it was placed in receivership by the Icelandic Financial Supervisory Authority (FME) before the initial plan of the Icelandic government to purchase a 75 percent stake had been approved by shareholders.

The announced nationalisation of Glitnir came just as the United Kingdom government was forced to nationalise Bradford & Bingley and to sell its retail operations and branch network to Grupo Santander. Over the weekend of 4–5 October, British newspapers carried many articles detailing the nationalisation of Glitnir and the high leverage of Iceland's other banks. Influential BBC business editor Robert Peston published an opinion piece on the banks, stating that debt insurance for Kaupthing, the largest bank in Iceland, required a premium of £625,000 to guarantee the return of £1 million: "the worst case of financial BO I've encountered in some time" was his graphic description. The Guardian said "Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall". These articles spooked investors discussing Icesave (the brand name of Landsbanki in the UK and the Netherlands) in online forums and many started moving their savings out of the Internet bank. Problems with access to the site hinted at a run on savings.

On 6 October, a number of private interbank credit facilities to Icelandic banks were shut down. Prime Minister Geir Haarde addressed the nation, and announced a package of new regulatory measures which were to be put to the Althing, Iceland's parliament, immediately, with the cooperation of the opposition parties. These included the power of the FME to take over the running of Icelandic banks without actually nationalising them, and preferential treatment for depositors in the event that a bank had to be liquidated. In a separate measure, retail deposits in Icelandic branches of Icelandic banks were guaranteed in full. The emergency measures had been deemed unnecessary by the Icelandic government less than 24 hours earlier.

The FME placed Landsbanki in receivership early on 7 October. A press release from the FME stated that all of Landsbanki's domestic branches, call centres, ATMs and internet operations will be open for business as usual, and that all "domestic deposits" were fully guaranteed. The UK government used the Banking (Special Provisions) Act 2008 first to transfer retail deposits from Heritable Bank to a Treasury holding company, then to sell them to Dutch bank ING Direct for £1 million.

The UK Prime Minister, Gordon Brown, announced that the UK government would launch legal action against Iceland over concerns with compensation for the estimated 300,000 UK savers. Geir Haarde said at a press conference on the following day that the Icelandic government was outraged that the UK government applied provisions of anti-terrorism legislation to it in a move they dubbed an "unfriendly act". The Chancellor of the Exchequer also said that the UK government would foot the entire bill to compensate UK retail depositors, estimated at £4 billion. It is reported that more than £4 billion in Icelandic assets in the UK have been frozen by the UK government. The UK Financial Services Authority (FSA) also declared Kaupthing Singer & Friedlander, the UK subsidiary of Kaupthing Bank, in default on its obligations, sold Kaupthing Edge, its Internet bank, to ING Direct, and put Kaupthing Singer & Friedlander into administration. Over £2.5 billion of deposits for 160,000 customers were sold to ING Direct. The scale of the run on Kaupthing Edge deposits had been such that many transactions were not completed until 17 October. Although Geir Haarde has described the UK government's actions over Kaupthing Singer & Friedlander as an "abuse of power" and "unprecedented", they were the third such actions taken under the Banking (Special Provisions) Act 2008 in less than ten days, after interventions in Bradford & Bingley and Heritable Bank.

On the same day, the Sveriges Riksbank, Sweden's central bank, made a credit facility of 5 billion Swedish krona (€520 million) available to Kaupthing Bank Sverige AB, the Swedish subsidiary of Kaupthing. The loan was to pay "depositors and other creditors".

On 9 October, Kaupthing was placed into receivership by the FME, following the resignation of the entire board of directors. The bank said that it was in technical default on its loan agreements after its UK subsidiary had been placed into administration. Kaupthing's Luxembourg subsidiary asked for, and obtained, a suspension of payments (similar to chapter 11 protection) in the Luxembourg District Court. Kaupthing's Geneva office, which was a branch of its Luxembourg subsidiary, was prevented from making any payments of more than 5000 Swiss francs by the Swiss Federal Banking Commission. The directors of Kaupthing's subsidiary on the Isle of Man decided to wind up the company after consultation with the Manx authorities, and the Finnish Financial Supervision Authority (Rahoitustarkastus) took control of the Helsinki branch to prevent money from being sent back to Iceland.

On 21 October, the Central Bank of Iceland asked the remaining independent financial institutions for new collateral against their loans. This was to replace the shares in Glitnir, Landsbanki and Kaupthing which had been pledged as collateral previously and which were now of much lower value, if not worthless. The value of the collateral was estimated at 300 billion krónur (€2 billion). One of the banks, Sparisjóðabanki (SPB, also known as Icebank), stated the next day that it could not provide new collateral for its 68 billion krónur (€451 million) loan, and would have to turn to the government for help. "This problem won’t be solved in any other way," said CEO Agnar Hansson.

On 24 October, it emerged that Norway's semi-public export credit agency Eksportfinans had made a complaint to Norwegian police concerning the alleged embezzlement of 415 million Norwegian kroner (€47 million) by Glitnir since 2006. The Icelandic bank had acted as an agent for Eksportfinans, administering loans to several companies: however Eksportfinans alleges that, when the loans were paid off early by borrowers, Glitnir kept the cash and merely continued with the regular payments to Eksportfinans, effectively taking an unauthorized loan itself.

Trading in shares of six financial companies on the OMX Nordic Iceland Exchange was suspended on 6 October by order of the FME. On Thursday 9 October, all trading on the exchange was frozen for two days by the government "in an attempt to prevent further panic spreading throughout the country's financial markets". The decision was made to do so due to "unusual market conditions", with share prices having fallen 30 percent since the start of the month. The closure was extended through Monday 13 October due to continuing "unusual market conditions".

The market reopened on 14 October with the main index, the OMX Iceland 15, at 678.4, compared with 3,004.6 before the closure. This reflects the fact that the value of the three big banks, which form 73.2 percent of the value of the OMX Iceland 15, had been set to zero. The values of other equities varied from +8% to –15%. Trading in shares of Exista, SPRON and Straumur-Burðarás (13.66% of the OMX Iceland 15) remains suspended. After a week of very thin trading, the OMX Iceland 15 closed on 17 October at 643.1, down 93% in króna terms and 96% in euro terms from its historic high of 9016 (18 July 2007).

Trading in the shares of two financial services companies, Straumur–Burðarás and Exista, resumed on 9 December: together the companies account for 12.04% of the OMX Iceland 15. The values of the shares in both companies dropped sharply, and the index closed at 394.88, down by 40.17% on the day. Trading in shares in SPRON and Kaupthing remains suspended, at prices of ISK 1.90 and ISK 694.00 respectively.

The four credit rating agencies which monitor Iceland's sovereign debt all lowered their ratings during the crisis, and their outlook for future ratings changes is negative. The Icelandic government has a relatively healthy balance, with sovereign debt of 28.3 percent of GDP and a budget surplus of 5.5 percent of GDP (2007).

In addition, the value of foreign currency bonds which mature in the remainder of 2008 is only $600 million, and foreign currency debt service in 2009 is only $215 million, well within the government's ability to pay. However the agencies believe that the government will have to issue more foreign currency bonds, both to cover losses as the banks' overseas operations are liquidated and also to stimulate demand in the domestic economy as Iceland goes into recession.

A team of experts from the International Monetary Fund (IMF) arrived in Iceland at the start of October 2008 for talks with the government. Industry Minister Össur Skarphéðinsson was said to be "favourable" to help from the IMF to stabilise the króna and to allow interest rates to be lowered.

A team of Icelandic negotiators arrived in Moscow on 14 October to discuss the possible loan. Russian deputy finance minister Dmitri Pankin said that "The meeting took place in a friendly atmosphere … We are working thoroughly on the issue to take a final decision". On the same day, the Central Bank of Iceland drew on its swap facilities with the central banks of Denmark and Norway for €200 million each. Iceland has swap facilities with the other Nordic countries for a total of €1.5 billion. Iceland is also seeking assistance from the European Central Bank (ECB): there is some precedent for the move, as the ECB already has currency swap arrangements with Switzerland, another non-member of the European Union.

On 24 October, the IMF tentatively agreed to loan €1.58 billion. However the loan had still not been approved by the Executive Board of the IMF on 13 November Apparently, UK and Holland had halted IMF's aid to Iceland as the Icesave dispute had not been resolved. Due to the delay Iceland found itself caught in a classic catch-22 situation, loans from other countries could not be formally secured until the IMF program had been approved. The Icelandic government spoke of a $500M (€376M) gap in the funding plans. Dutch finance minister Wouter Bos stated that the Netherlands would oppose the loan unless agreement was reached over deposit insurance for Landsbanki customers in the Netherlands.

The IMF-led package of $4.6bn was finally agreed on 19 November, with the IMF loaning $2.1bn and another $2.5bn of loans and currency swaps from Norway, Sweden, Finland and Denmark. In addition, Poland has offered to lend $200M and the Faroe Islands have offered 300M Danish kroner ($50M, about 3% of Faroese GDP). The Icelandic government also reported that Russia has offered $300M. The next day, Germany, the Netherlands and the United Kingdom announced a joint loan of $6.3bn (€5bn), related to the deposit insurance dispute.

In 2001, banks were deregulated in Iceland. This set the stage for banks to upload debts when foreign companies were accumulated. The crisis unfolded when banks became unable to refinance their debts. It is estimated that the three major banks hold foreign debt in excess of €50 billion, or about €160,000 per Icelandic resident, compared with Iceland's gross domestic product of €8.5 billion. As early as March 2008, the cost of private deposit insurance for deposits in Landsbanki and Kaupthing was already far higher (6–8½ percent of the sum deposited) than for other European banks. The króna, which was ranked by The Economist in early 2007 as the most overvalued currency in the world (based on the Big Mac Index), has further suffered from the effects of carry trading.

Coming from a small domestic market, Iceland's banks have financed their expansion with loans on the interbank lending market and, more recently, by deposits from outside Iceland (which are also a form of external debt). Households also took on a large amount of debt, equivalent to 213 percent of disposable income, which led to inflation. This inflation was exacerbated by the practice of the Central Bank of Iceland issuing liquidity loans to banks on the basis of newly-issued, uncovered bonds — effectively, printing money on demand.

In response to the rise in prices — 14 percent in the twelve months to September 2008, compared with a target of 2.5 percent — the Central Bank of Iceland has held interest rates high (15.5 percent). Such high interest rates, compared with 5.5 percent in the United Kingdom or 4 percent in the eurozone for example, have encouraged overseas investors to hold deposits in Icelandic krónur, leading to monetary inflation: the Icelandic money supply (M3) grew 56.5 percent in the twelve months to September 2008, compared with 5.0 percent GDP growth. The situation was effectively an economic bubble, with investors overestimating the true value of the króna.

As with many banks around the world, the Icelandic banks found it increasingly difficult or impossible to roll over their loans in the interbank market, their creditors insisting on repayment while no other banks were willing to make fresh loans. In such a situation, a bank would normally have to ask for a loan from the central bank as the lender of last resort. However in Iceland the banks were so much larger than the national economy that the Central Bank of Iceland and the Icelandic government could not guarantee the repayment of the banks' debts, leading to the collapse of the banks. The official reserves of the Central Bank of Iceland stood at 374.8 billion krónur at the end of September 2008, compared with 350.3 billion krónur of short-term international debt in the Icelandic banking sector, and at least £6.5 billion (1,250 billion krónur) of retail deposits in the UK.

The situation was made worse by the fact that Icesave was operating as a branch of Landsbanki, rather than as a legally independent subsidiary. As such, it was completely dependent on the Central Bank of Iceland for emergency loans of liquidity, and could not turn to the Bank of England for help. The UK Financial Services Authority (FSA) was aware of the risk, and was considering imposing special liquidity requirements on Icelandic deposit-taking banks in the weeks before the crisis. However the plan—which was never implemented—would have forced the Icelandic banks to cut interest rates or stop taking new deposits, and might even have sparked the sort of bank run it was designed to prevent. The Guernsey authorities were also planning on bringing in restrictions on foreign banks operating as branches and on transfers of funds between Guernsey subsidiaries and parent banks ("parental upstreaming"). Landsbanki operated in Guernsey through a legally independent subsidiary.

The existence of a bank run on Landsbanki accounts in the UK in the period up to 7 October seems confirmed by a statement from the bank on 10 October, which said "Landsbanki Íslands hf. transferred substantial funds to its UK branch during this time to fulfil its Icesave commitments." The transfer of funds from Landsbanki Guernsey to Heritable Bank, a Landsbanki subsidiary in the UK, also suggests a bank run in the UK. A transfer of "substantial funds" from Iceland to the UK would have been a significant downward push on the value of the króna, even before the effects of any speculation.

The Financial Supervisory Authority (FME) has acted to "ring-fence" the Icelandic operations of Landsbanki and Glitnir, stating its aim of "continued banking operations for Icelandic families and businesses." NBI (originally known as Nýi Landsbanki) was set up on 9 October with 200 billion krónur in equity and 2,300 billion krónur of assets. Nýi Glitnir was set up on 15 October with 110 billion krónur in equity and 1,200 billion krónur of assets.

Talks with Icelandic pension funds to sell Kaupthing as a going concern broke down on 17 October, and Nýja Kaupþing was set up on 22 October with 75 billion krónur in equity and 700 billion krónur of assets.

The equity in all three new banks was supplied by the Icelandic government, and amounts to 30 percent of Iceland's GDP. The new banks will also have to reimburse their predecessors for the net value of the transferred assets, as determined by "recognised appraisers". As of 14 November 2008, these net values were estimated as: NBI ISK558.1bn (€3.87bn), Nýi Glitnir ISK442.4bn (€2.95bn); Nýja Kaupþing ISK172.3bn (€1.14bn). The total debt of 1173 billion krónur is more than 90 percent of Iceland's 2007 gross domestic product.

Glitnir and Kaupthing, shorn of their Icelandic operations, obtained moratoriums on payments to creditors (similar to Chapter 11 protection) from the District Court of Reykjavík on 24 November.

The current economic climate in the country has affected many Icelandic businesses and citizens. With the creation of Nýi Landsbanki, the new organisation which replaces the old Landsbanki, around 300 employees will lose their jobs due to a radical restructuring of the organisation which is intended to minimise the bank's international operations. Similar job losses are expected at Glitnir and Kaupthing The job losses can be compared with the 2,136 registered unemployed and 495 advertised vacancies in Iceland at the end of August 2008.

Other companies have also been affected. For example, the private Sterling Airlines declared bankruptcy on 29 October 2008. The national airline Icelandair has noticed a significant slump in domestic demand for flights. However, the airline states that year-on-year international demand is up from last year. Guðjón Arngrímsson, a spokesman for the airline, said "we're getting decent traffic from other markets... we are trying to let the weak help us." He has also stated that it is impossible to predict whether the company will be profitable this year. Morgunblaðið, an Icelandic newspaper, is cutting some jobs and merging parts of its operations with the media corporation 365. The newspaper 24 stundir has ceased publication due to the crisis, resulting in the loss of 20 jobs.

Importers are particularly hard hit, with the government restricting foreign currency to essential products such as food, medicines and oil. The €400 million loan from the central banks of Denmark and Norway is sufficient to pay for a month's imports, although on 15 October there was still a "temporary delay" which affected "all payments to and from the country".

The assets of Icelandic pension funds are, according to one expert, expected to shrink by 15–25 percent. The Icelandic Pension Funds Association has announced that benefits will in all likelihood have to be cut in 2009. Iceland's GDP is expected by economists to shrink by as much as 10 percent as a result of the crisis, putting Iceland by some measures in an economic depression. Inflation may climb as high as 75 percent by the end of the year.

Unemployment had more than tripled by late November 2008, with over 7000 registered jobseekers (about 4% of the workforce) compared to just 2136 at the end of August 2008. As 80% of household debt is indexed and another 13 percent denominated in foreign currencies, debt repayment is going to be more costly. Since October 2008, 14% of the workforce have experienced reductions in pay, and around 7% have had their working hours reduced. According to the president of the Icelandic Federation of Labour (ASÍ), Gylfi Arnbjörnsson, these figures are lower than expected. 85% of those currently registered as unemployed in Iceland stated that they lost their job in October, after the economic collapse.

Over £840 million in cash from more than 100 UK local authorities was invested in Icelandic banks. Representatives from each council are meeting to try to persuade the Treasury to secure the money in the same way that customers' money in Icesave was fully guaranteed. Of all the local authorities, Kent County Council has the most money invested in Icelandic banks, currently £50 million. Transport for London, the organisation that operates and coordinates transport services within London, also has a large investment at £40 million. Local authorities were working under government advice to invest their money across many national and international banks as a way of spreading risk. Other UK organisations said to have invested heavily include police services and fire authorities, and even the Audit Commission. It is hoped that about one-third of the deposited money will be available fairly rapidly, corresponding to the liquid assets of the UK subsidiaries: liquidation of other assets, such as loans and offices, will take longer.

In an emergency sitting of the Tynwald on 9 October, the Isle of Man government raised compensation from 75 percent of the first £15,000 per depositor to 100 percent of £50,000 per depositor. The Chief Minister of the Isle of Man, Tony Brown, confirmed that Kaupthing had guaranteed the operations and liabilities of its Manx subsidiary in September 2007, and that the Manx government was pressing Iceland to honour this guarantee. Depositors with Landsbanki on Guernsey found themselves without any depositor protection.

On 11 October, an agreement was reached between the Icelandic and Dutch governments on the savings of about 120,000 Dutch citizens. The Icelandic government will cover the first €20,887 on savings accounts of Dutch citizens held by Landsbanki subsidiary Icesave, using money lent by the Dutch government. The total value of Icesave deposits in the Netherlands is €1.7 billion. At the same time Iceland and Britain reached an agreement on the general contours of a solution: Icesave deposits in the UK total £4 billion (€5 billion) in 300,000 accounts. The figure of €20,887 is the amount covered by the Icelandic Depositors' and Investors' Guarantee Fund (DIGF; Tryggingarsjóður in Icelandic): however, the DIGF had equity of only 8.3 billion krónur at the end of 2007, €90 million at the exchange rates of the time and far from sufficient to cover the Dutch and British claims.

The cost of deposit insurance in the UK is not completely clear as of November 2008. The Financial Services Compensation Scheme (FSCS) paid around £3 billion to transfer deposits from Heritable Bank and Kaupthing Singer & Friedlander to ING Direct, while the UK Treasury paid an additional £600 million to guarantee retail deposits that were higher than the FSCS limit. The Treasury also paid out £800 million to guarantee Icesave deposits that were higher than the limit. A loan of £2.2 billion to the Icelandic government is expected to cover the claims against the Icelandic DIGF relating to Icesave, while the exposure of the UK FSCS is expected to be £1–2 billion.

The crisis also prompted the Ministry of Foreign Affairs to reduce its foreign aid to developing nations, from 0.31% percent to 0.27% of GNP. The effect of the aid cut was greatly amplified by the falling value of the krona, leading the Icelandic International Development Agency (ICEIDA) to see its budget fall from $22 million to $13 million. Since Iceland's foreign aid is targeted in sectors for which the country has particular expertise (e.g. fisheries, geothermal power), the cutbacks will have a substantial impact in countries which receive Icelandic aid - most noticeably in Sri Lanka, where ICEIDA is pulling out altogether.

One February 27, 2009, the Wall Street Journal reported that Iceland's new government is trying to raise $25 million by selling its ambassadorial residences in Washington, New York, London and Oslo.

Parts of the Icelandic public have arranged protests against the Central Bank, the Parliament and the government's alleged lack of responsibility before and after the crisis, attracting between 3000 and 6000 people (1–2% of Iceland's population) on Saturdays.

In early November, the President of Iceland, Ólafur Ragnar Grímsson, at an informal lunch with foreign diplomats, criticized Iceland's traditional friends (particularly Britain, Sweden and Denmark) as well as the International Monetary Fund. According to a memo from the Norwegian embassy, he suggested that the Russians might want to use the Keflavík Air Base, the Russian ambassador replied that they had no need for it. The President is quoted to have said that Iceland would soon recover, even if they had to fight alone. The President does not necessarily agree with the government on these issues.

In October 2008, the UK PM Gordon Brown used powers dating from the Second World War to freeze Landsbanki holdings in the United Kingdom. Iceland's prime minister Geir Haarde protested against what he described "a terrorist law being applied against us", calling it "a completely unfriendly act".

The diplomatic row with Britain has threatened to spill over into the traditional defence links between the two countries. Iceland has no standing army of its own, and relies on NATO (and geography) for its defence: the UK Royal Air Force was due to take its turn in patrolling Icelandic airspace from December 2008, but this was cancelled.

According to a poll from late November 2008, 64% were in favour of early elections, with only 29.3% opposed. A poll from 22 November 2008 saw the Social Democratic Alliance lead with 33.6%, followed by the Left-Green Alliance at 27.8% and the Independence Party at 24.8%; the Progressive Party and the Liberal Party were far behind, with only 6.3% and 4.3%, respectively.

As the Althing met again on 20 January 2009, there were protests with reinvigorated force and escalation of conflict between protesters and the police. On 22 January, police used tear gas to disperse people on Austurvöllur (the square in front of the Althingi), the first such use since the 1949 anti-NATO protest.

Prime Minister Geir H. Haarde announced on 23 January 2009 that he would be stepping down as leader of the Independence Party for health reasons: he has been diagnosed as having a malignant oesophageal tumour. He said he would travel to the Netherlands around the end of January for treatment. Education Minister and Independence Party Vice-Chairman Þorgerður Katrín Gunnarsdóttir was to serve as Prime Minister in his absence. The leader of the Social Democratic Alliance, Foreign Minister Ingibjörg Sólrún Gísladóttir, is also unwell, undergoing treatment for a benign brain tumour since September 2008. The government recommended that elections be held on 9 May 2009.

Björgvin G. Sigurðsson, Iceland's Commerce Minister, resigned on 25 January, citing the pressures of the nation's economic collapse, as the country's political leaders failed to agree on how to lead country out of its financial crisis. One of his last acts as minister was to dismiss the director of the Financial Supervisory Authority (FSA). Björgvin acknowledged that Icelanders have lost faith in their government and political system. "I want to shoulder my part of the responsibility for that," he said.

Negotiations on continuing the coalition broke down the next day, apparently over demands from the Social Democratic Alliance to take over the leadership of the government, and Geir Haarde tendered the government's resignation to the President of Iceland, Ólafur Ragnar Grímsson. The President asked the present government to continue until a new government can be formed, and held talks with the five political parties represented in the Althing.

After these discussions, Ingibjörg Sólrún Gísladóttir of the Social Democratic Alliance and Steingrímur J. Sigfússon of the Left-Green Movement asked by the President to negotiate the formation of a new coalition government. Such a coalition would be five seats short of an overall majority in the Althing, but the Progressive Party (seven seats) is expected to support the coalition without actually joining the government. Neither party leader is expected to become Prime Minister: instead, the position would go to Jóhanna Sigurðardóttir of the Social Democratic Alliance, the current Minister of Social Affairs and Social Security.

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Global financial crisis of 2008–2009

Financial crisis

The global financial crisis of 2008–2009 emerged in September 2008 with the failure, merger, or conservatorship of several large United States-based financial firms and spread with the insolvency of additional companies, governments in Europe, recession, and declining stock market prices around the globe.

The underlying causes leading to the crisis had been reported in business journals for many months before September of 2008, with commentary about the financial stability of leading U.S. and European investment banks, insurance firms and mortgage banks consequent to the subprime mortgage crisis.

Beginning with failures caused by bad debts and debt insurance investment trading (derivatives) large financial institutions in the United States and Europe faced a credit crisis, deflation and sharp reductions in shipping. The impacts rapidly evolved and spread into a global shock resulting in a number of European bank failures and declines in various stock indexes, and large reductions in the market value of equities (stock) and commodities worldwide. The credit crisis was exacerbated by Section 128 of the Emergency Economic Stabilization Act of 2008 which allowed the Federal Reserve System (Fed) to pay interest on excess reserve requirement balances held on deposit from banks, removing the longstanding incentive for banks to extend credit instead of hoard cash on deposit with the Fed. The crisis led to a liquidity problem and the de-leveraging of financial institutions especially in the United States and Europe, which further accelerated the liquidity crisis, and a decrease in international shipping and commerce. World political leaders and national ministers of finance and central bank directors have coordinated their efforts to reduce fears but the crisis is ongoing and continues to change, evolving at the close of October into a currency crisis with investors transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc, leading many emergent economies to seek aid from the International Monetary Fund. The crisis was triggered by the subprime mortgage crisis and is an acute phase of the financial crisis of 2007–2009.

The subprime mortgage crisis reached a critical stage during the first week of September 2008, characterized by severely contracted liquidity in the global credit markets and insolvency threats to investment banks and other institutions.

Reserve balances from banks in the Federal Reserve System began increasing over required levels of about $10 billion at the beginning of September 2008, just after the Democratic and Republican national conventions, and just before the stock market crash and presidential debates. Beginning October 6, Section 128 of the Emergency Economic Stabilization Act of 2008 allowed the Federal Reserve System to pay interest on the excess balances, producing further pressure on international credit markets. Excess on reserve balances topped $870 billion by the end of the second week of January 2009. In comparison, the increase in reserve balances reached only $65 billion after September 11, 2001 before falling back to normal levels within a month.

House Representative Paul E. Kanjorski stated in a January 27, 2009 interview with CSPAN that there was an "electronic run on the banks" commencing at 11AM on September 11, 2008. According to Rep. Kanjorski, the Federal Reserve noted a tremendous withdrawal of $550 billion dollars from money market accounts in the U.S. within a two hour time-span. The Federal Reserve responded by releasing $105 billion dollars into the financial system to stem the tide and announced that FDIC would guarantee up to $250,000 in money market deposits. Representative Kanjorski claims that if these steps had not been taken, the U.S. would have lost all its wealth within twenty-four hours . This timeline of events was told to policymakers by Secretary of the Treasury Paulson on September 15, 2008.

On Sunday, September 14, it was announced that Lehman Brothers would file for bankruptcy after the Federal Reserve Bank declined to participate in creating a financial support facility for Lehman Brothers. The significance of the Lehman Brothers bankruptcy is disputed with some assigning it a pivotal role in the unfolding of subsequent events. The principals involved, Ben Bernanke and Henry Paulson, dispute this view, citing a volume of toxic assets at Lehman which made a rescue impossible. Immediately following the bankruptcy, JPMorgan Chase provided the broker dealer unit of Lehman Brothers with $138 billion to "settle securities transactions with customers of Lehman and its clearance parties" according to a statement made in a New York City Bankruptcy court filing.

The same day, the sale of Merrill Lynch to Bank of America was announced. The beginning of the week was marked by extreme instability in global stock markets, with dramatic drops in market values on Monday, September 15, and Wednesday, September 17. On September 16, the large insurer American International Group (AIG), a significant participant in the credit default swaps markets suffered a liquidity crisis following the downgrade of its credit rating. The Federal Reserve, at AIG's request, and after AIG has shown that it could not find lenders willing to save it from insolvency, created a credit facility for up to US$85 billion in exchange for a 79.9% equity interest, and the right to suspend dividends to previously issued common and preferred stock.

Speculation that the Emergency Economic Stabilization Act of 2008 would accelerate the effective date of the Financial Services Regulatory Relief Act of 2006 from October 1, 2011 to October 1, 2008 may have precipitated this fall. By September 17th, dramatic increases began in deposits with the Fed. Section 128 was signed into law on October 3rd effectively ending the commercial paper market.

On September 19, 2008 a plan intended to ameliorate the difficulties caused by the subprime mortgage crisis was proposed by the Secretary of the Treasury, Henry Paulson. He proposed a Troubled Assets Relief Program (TARP), later incorporated into the Emergency Economic Stabilization Act, which would permit the United States government to purchase illiquid assets, informally termed toxic assets, from financial institutions. The value of the securities is extremely difficult to determine.

Consultations between the Secretary of the Treasury, the Chairman of the Federal Reserve, and the Chairman of the U.S. Securities and Exchange Commission, Congressional leaders and the President of the United States moved forward plans to advance a comprehensive solution to the problems created by illiquid mortgage-backed securities. At the close of the week the Secretary of the Treasury and President Bush announced a proposal for the federal government to buy up to US$700 billion of illiquid mortgage backed securities with the intent to increase the liquidity of the secondary mortgage markets and reduce potential losses encountered by financial institutions owning the securities. The draft proposal of the plan was received favorably by investors in the stock market. Details of the bailout remained to be acted upon by Congress.

On Sunday, September 21, the two remaining investment banks, Goldman Sachs and Morgan Stanley, with the approval of the Federal Reserve, converted to bank holding companies, a status subject to more regulation, but with readier access to capital. On September 21, Treasury Secretary Henry Paulson announced that the original proposal, which would have excluded foreign banks, had been widened to include foreign financial institutions with a presence in the US. The US administration was pressuring other countries to set up similar bailout plans.

On Monday and Tuesday during the week of September 22, appearances were made by the Secretary of the Treasury and the Chairman of the Board of Governors of the Federal Reserve before Congressional committees and on Wednesday a prime-time presidential address was delivered by the President of the United States on television. Behind the scenes, negotiations were held refining the proposal which had grown to 42 pages from its original 3 and was reported to include both an oversight structure and limitations on executive salaries, with other provisions under consideration.

On September 25, agreement was reported by congressional leaders on the basics of the package; however, general and vocal opposition to the proposal was voiced by the public. On Thursday afternoon at a White House meeting attended by congressional leaders and the presidential candidates, John McCain and Barack Obama, it became clear that there was no congressional consensus, with Republican representatives and the ranking member of the Senate Banking Committee, Richard C. Shelby, strongly opposing the proposal. The alternative advanced by conservative House Republicans was to create a system of mortgage insurance funded by fees on those holding mortgages; as the working week ended, negotiations continued on the plan, which had grown to 102 pages and included mortgage insurance as an option. On Thursday evening Washington Mutual, the nation's largest savings and loan, was seized by the Federal Deposit Insurance Corporation and most of its assets transferred to JPMorgan Chase. Wachovia, one of the largest US banks, was reported to be in negotiations with Citigroup and other financial institutions.

Early into Sunday morning an announcement was made by the United States Secretary of the Treasury and congressional leaders that agreement had been reached on all major issues: the total amount of $700 billion remained with provision for the option of creating a scheme of mortgage insurance.

It was reported on Sunday, September 28, that a rescue plan had been crafted for the British mortgage lender Bradford & Bingley. Grupo Santander, the largest bank in Spain, was slated to take over the offices and savings accounts while the mortgage and loans business would be nationalized.

Fortis, a huge Benelux banking and finance company was partially nationalized on September 28, 2008, with Belgium, the Netherlands and Luxembourg investing a total of €11.2 billion (US$16.3 billion) in the bank. Belgium will purchase 49% of Fortis's Belgian division, with the Netherlands doing the same for the Dutch division. Luxembourg has agreed to a loan convertible into a 49% share of Fortis's Luxembourg division.

It was reported on Monday morning, September 29, that Wachovia, the 4th largest bank in the United States, would be acquired by Citigroup.

On Monday the German finance minister announced a rescue of Hypo Real Estate, a Munich-based holding company comprising a number of real estate financing banks, but the deal collapsed on Saturday, October 4.

The same day the government of Iceland nationalized Glitnir, Iceland’s third largest lender.

Stocks fell dramatically Monday in Europe and the US despite infusion of funds into the market for short term credit. In the US the Dow dropped 777 points (6.98%), the largest one-day point-drop in history (but only the 17th largest percentage drop).

The U.S. bailout plan, now named the Emergency Economic Stabilization Act of 2008 and expanded to 110 pages was slated for consideration in the House of Representatives on Monday, September 29 as HR 3997 and in the Senate later in the week. The plan failed after the vote being held open for 40 minutes in the House of Representatives, 205 for the plan, 228 against. Meanwhile US stock markets suffered steep declines, the Dow losing 300 points in a matter of minutes, ending down 777.68, the Nasdaq losing 199.61, falling below the 2000 point mark, and the S.&P. 500 off 8.77% for the day. By the end of the day, the Dow suffered the largest drop in the history of the index. The S&P 500 Banking Index fell 14% on September 29 with drops in the stock value of a number of US banks generally considered sound, including Bank of New York Mellon, State Street and Northern Trust; three Ohio banks, National City, Fifth Third, and KeyBank were down dramatically.

On Tuesday, September 30, stocks rebounded but credit markets remained tight with the London Interbank Offered Rate (overnight dollar Libor) rising 4.7% to 6.88%. 9 billion USD was made available by the French, Belgian and Luxembourg governments to the French-Belgian bank Dexia.

After Irish banks came under pressure on Monday, September 29, the Irish government undertook a two year "guarantee arrangement to safeguard all deposits (retail, commercial, institutional and inter-bank), covered bonds, senior debt and dated subordinated debt (lower tier II)" of 6 Irish banks: Allied Irish Banks, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide and the EBS Building Society; the potential liability involved is about 400 billion dollars.

Key risk indicators became highly volatile during September 2008, a factor leading the U.S. government to pass the Emergency Economic Stabilization Act of 2008. The “TED spread” is a measure of credit risk for inter-bank lending. It is the difference between: 1) the risk-free three-month U.S. treasury bill rate; and 2) the three-month London InterBank Offered Rate (LIBOR), which represents the rate at which banks typically lend to each other. A higher spread indicates banks perceive each other as riskier counterparties. The t-bill is considered "risk-free" because the full faith and credit of the U.S. government is behind it; theoretically, the government could just print money so that the principal is fully repaid at maturity. The TED spread reached record levels in late September 2008. The diagram indicates that the Treasury yield movement was a more significant driver than the changes in LIBOR. A three month t-bill yield so close to zero means that people are willing to forgo interest just to keep their money (principal) safe for three months – a very high level of risk aversion and indicative of tight lending conditions. Driving this change were investors shifting funds from money market funds (generally considered nearly risk free but paying a slightly higher rate of return than t-bills) and other investment types to t-bills. These issues are consistent with the September 2008 aspects of the subprime mortgage crisis which prompted the Emergency Economic Stabilization Act of 2008 signed into law by the U.S. President on October 2, 2008.

In addition, an increase in LIBOR means that financial instruments with variable interest terms are increasingly expensive. For example, car loans and credit card interest rates are often tied to LIBOR; some estimate as much as $150 trillion in loans and derivatives are tied to LIBOR. Furthermore, the basis swap between one-month LIBOR and three-month LIBOR increased from 30 basis points in the beginning of September to a high of over 100 basis points. Financial institutions with liability exposure to 1 month LIBOR but funding from 3 month LIBOR faced increased funding costs. "Durvexity" spiked as markets rapidly deteriorated. Overall, higher interest rates place additional downward pressure on consumption, increasing the risk of recession.

The Labor Department said that the US lost 533,000 jobs in November 2008, the biggest monthly loss since 1974. This raised the unemployment rate from 6.5% to 6.7%.

On December 11, the FBI announces the arrest of Bernard Madoff in a Ponzi scheme which totals $50 billion by Madoff's own estimate, and which is soon found to affect banks, individuals, and charities in the U.S. and Europe.

On December 22, US industry leaders asked the Federal Reserve for assistance un-freezing the commercial real estate market, which has not securitized any loans in the last six months of 2008.

The two month period from January 1-February 27 represented the worst start to a year in the history of the S&P 500 with a drop in value of 18.62%. By March 2, the Dow Jones Industrial Average Index had dropped more than 50% from its summer 2008 peak. The decline has been compared to that of the 1929 Great Depression, which was 53% between September 1929 and March 1931.

On March 6, the Bank of England announced up to 150 billion pounds of quantitative easing, increasing the risk of inflation.

On September 15, 2008 China cut its interest rate for the first time since 2002. Indonesia reduced its overnight repo rate, at which commercial banks can borrow overnight funds from the central bank, by two percentage points to 10.25 percent. The Reserve Bank of Australia injected nearly $1.5 billion into the banking system, nearly three times as much as the market's estimated requirement. The Reserve Bank of India added almost $1.32 billion, through a refinance operation, its biggest in at least a month. On November 9, 2008 the 2008 Chinese economic stimulus plan is a RMB¥ 4 trillion ($586 billion) stimulus package announced by the central government of the People's Republic of China in its biggest move to stop the global financial crisis from hitting the world's fourth largest economy. A statement on the government's website said the State Council had approved a plan to invest 4 trillion yuan ($586 billion) in infrastructure and social welfare by the end of 2010. The stimulus package will be invested in key areas such as housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income-building, tax cuts, and finance.

China's export driven economy is starting to feel the impact of the economic slowdown in the United States and Europe, and the government has already cut key interest rates three times in less than two months in a bid to spur economic expansion. On the 28th of November, China Ministry of Finance and the State Administration of Taxation jointly announced a rise in export tax rebate rates on some labor-intensive goods. These additional tax rebates will take place on December, 1st 2008.

The stimulus package was welcomed by world leaders and analysts as larger than expected and a sign that by boosting its own economy, China is helping to stabilize the global economy. News of the announcement of the stimulus package sent markets up across the world. However, Marc Faber January 16 said that China according to him was in recession.

In Taiwan, the central bank on September 16, 2008 said it would cut its required reserve ratios for the first time in eight years. The central bank added $3.59 billion into the foreign-currency interbank market the same day. Bank of Japan pumped $29.3 billion into the financial system on September 17, 2008 and the Reserve Bank of Australia added $3.45 billion the same day.

The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps on September 19 to intervene in the crisis. To stop the potential run on money market mutual funds, the Treasury also announced on September 19 a new $50 billion program to insure the investments, similar to the Federal Deposit Insurance Corporation (FDIC) program. Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups to more easily share funds within their group. The exceptions would expire on January 30, 2009, unless extended by the Federal Reserve Board. The Securities and Exchange Commission announced termination of short-selling of 799 financial stocks, as well as action against naked short selling, as part of its reaction to the mortgage crisis.

The Pension Protection Act of 2006 included a provision which changed the definition of Qualified Default Investments (QDI) for retirement plans from stable value investments, money market funds, and cash investments to investments which expose an individual to appropriate levels of stock and bond risk based on the years left to retirement. The Act required that Plan Sponsors move the assets of individuals who had never actively elected their investments and had their contributions in the default investment option. This meant that individuals who had defaulted into a cash fund with little fluctuation or growth would soon have their account balances moved to much more aggressive investments.

Starting in early 2008, most employer sponsored plans sent notices to their employees informing them that the Plan default investment was changing from a cash/stable option to something new, like a Retirement Date fund which had significant market exposure. Most participants ignored these notices until September and October, when the market crash was on every news station and media outlet. It was then that participants called their 401(k) and retirement plan providers and discovered losses in excess of 30% in some cases. Call centers for 401(k) providers experienced record call volume and wait times, as millions of inexperienced investors struggled to understand how their investments had been changed so fundamentally without their explicit consent, and reacted in a panic by liquidating everything with any stock or bond exposure, locking in huge losses in their accounts.

Due to the speculation and uncertainty in the market, discussion forums filled with questions about whether or not to liquidate assets and financial gurus were swamped with questions about the right steps to take to protect what remained of their retirement accounts. During the third quarter of 2008, over $72 billion left mutual fund investments that invested in stocks or bonds and rushed into Stable Value investments in the month of October. Against the advice of financial experts, and ignoring historical data illustrating that long-term balanced investing has produced positive returns in all types of markets, investors with decades to retirement instead sold their holdings during one of the largest drops in stock market history.

During the week ending September 19, 2008, money market mutual funds had begun to experience significant withdrawals of funds by investors. This created a significant risk because money market funds are integral to the ongoing financing of corporations of all types. Individual investors lend money to money market funds, which then provide the funds to corporations in exchange for corporate short-term securities called asset-backed commercial paper (ABCP). However, a potential bank run had begun on certain money market funds. If this situation had worsened, the ability of major corporations to secure needed short-term financing through ABCP issuance would have been significantly affected. To assist with liquidity throughout the system, the Treasury and Federal Reserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Window using ABCP as collateral.

The Secretary of the United States Treasury, Henry Paulson and President George W. Bush proposed legislation for the government to purchase up to US$700 billion of "troubled mortgage-related assets" from financial firms in hopes of improving confidence in the mortgage-backed securities markets and the financial firms participating in it. Discussion, hearings and meetings among legislative leaders and the administration later made clear that the proposal would undergo significant change before it could be approved by Congress. On October 1, a revised compromise version was approved by the Senate with a 74-25 vote. The bill, HR1424 was passed by the House on October 3, 2008 and signed into law. The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets.

In an effort to increase available funds for commercial banks and lower the fed funds rate, on September 29 the U.S. Federal Reserve announced plans to double its Term Auction Facility to $300 billion. Because there appeared to be a shortage of U.S. dollars in Europe at that time, the Federal Reserve also announced it would increase its swap facilities with foreign central banks from $290 billion to $620 billion.

As of December 24, 2008, the Federal Reserve had used its independent authority to spend $1.2 trillion on purchasing various financial assets and making emergency loans to address the financial crisis, above and beyond the $700 billion authorized by Congress from the federal budget. This includes emergency loans to banks, credit card companies, and general businesses, temporary swaps of treasury bills for mortgage-backed securities, the sale of Bear Stearns, and the bailouts of American International Group (AIG), Fannie Mae and Freddie Mac, and Citigroup.

The European Central Bank injected $99.8 billion in a one-day money-market auction. The Bank of England pumped in $36 billion. Altogether, central banks throughout the world added more than $200 billion from the beginning of the week to September 17.

On September 29, 2008 the Belgian, Luxembourg and Dutch authorities partially nationalized Fortis. The German government bailed out Hypo Real Estate.

On 8 October 2008 the British Government announced a bank rescue package of around £500 billion ($850 billion at the time). The plan comprises three parts. First, £200 billion will be made available to the banks in the Bank of England's Special Liquidity scheme. Second, the Government will increase the banks' market capitalisation, through the Bank Recapitalisation Fund, with an initial £25 billion and another £25 billion to be provided if needed. Third, the Government will temporarily underwrite any eligible lending between British banks up to around £250 billion. In February 2009 Sir David Walker was appointed to lead a government enquiry into the corporate governance of banks.

In early December German Finance Minister Peer Steinbrück indicated that he does not believe in a "Great Rescue Plan" and indicated reluctance to spend more money addressing the crisis.

In January 2009 the government leaders of Iceland were forced to call elections two years early after the people of Iceland staged mass protests and clashed with the police due to the government's handling of the economy. Hundreds of thousands protested in France against President Sarkozy's economic policies. Prompted by the financial crisis in Latvia, the opposition and trade unions there organized a rally against the cabinet of premier Ivars Godmanis. The rally gathered some 10-20 thousand people. In the evening the rally turned into a Riot. The crowd moved to the building of the parliament and attempted to force their way into it, but were repelled by the state's police. In late February many Greeks took part in a massive general strike because of the economic situation and they shut down schools, airports, and many other services in Greece. Police and protesters clashed in Lithuania where people protesting the economic conditions were shot by rubber bullets. In addition to various levels of unrest in Europe, Asian countries have also seen various degrees of protest. Communists and others rallied in Moscow to protest the Russian government's economic plans. Protests have also occurred in China as demands from the west for exports have been dramatically reduced and unemployment has increased.

Beginning February 26, 2009 an Economic Intelligence Briefing was added to the daily intelligence briefings prepared for the President of the United States. This addition reflects the assessment of United States intelligence agencies that the global financial crisis presents a serious threat to international stability.

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Russian financial crisis of 2008–2009

Sergei Ignatiev (Chairman of the Central Bank of Russia), German Gref (Chairman and CEO of Sberbank) and Andrey Kostin (Chairman and CEO of Vneshtorgbank) at a meeting convened by President of Russia Dmitry Medvedev dealing with economic issues in Russia on 18 September 2008.

The 2008–2009 Russian financial crisis, part of the world Economic crisis of 2008, is an ongoing crisis in the Russian financial markets that has been compounded by political fears after the war with Georgia, as well as renewed concern about state intervention in corporations of strategic interest and by the plummeting price of Urals heavy crude oil, which has lost more than 70% of its value since its record peak of $147 on 4 July 2008. While according to the World Bank Russia’s strong short-term macroeconomic fundamentals make it better prepared than many emerging economies to deal with the crisis, its underlying structural weaknesses and high dependence on the price of a single commodity make its impact more pronounced than would otherwise be the case. Swift fiscal management and substantial financial reserves may have protected Russia from deeper consequences of this shock.

In November 2008, there were reports that trade in Russian shares had increasingly shifted to London traded Global Depositary Receipts during frequent suspensions in Moscow, dictated by rules imposed by the regulator to reduce volatility on Moscow's increasingly illiquid stock market. Reuters reported more than $1 trillion has been wiped off the value of Russia's shares during the crisis.

As the crisis progressed, it became clear the Kremlin would play the dominant role in deciding which Russian oligarchs -- many of whom were highly leveraged -- would survive the crisis. Reuters and the Financial Times speculated that the crisis would be used to increase the Kremlin's control over key strategic assets in a reverse of the "loans for shares" sales of the 1990s, when the state sold off major assets to the oligarchs in return for loans. State VEB bank was used to refinance the debt of Oleg Deripaska, once ranked by Forbes as Russia's richest man, but demanded a 25 percent stake in Norilsk Nickel as collateral for the $4.5 billion loan. The Financial Times called it another "sale of the century", a reference to the book about the Russian asset sales of the 1990s by Chrystia Freeland.

In February 2009, Fitch Ratings downgraded Russia's Long-term foreign and local currency Issuer Default ratings (IDR) to 'BBB' from 'BBB+', the Short-term foreign currency IDR to 'F3' from 'F2' and the Country Ceiling to 'BBB+' from 'A-' (A minus). "The downgrade reflects the negative impact on Russia from the fall in commodity prices and the dislocation to global capital markets that has left Russian banks and companies struggling to refinance external debt, and the difficulties Russia faces in managing the necessary macroeconomic policy adjustments," said Edward Parker, Head of Emerging Europe in Fitch's Sovereigns team. "The scale of capital outflows and the pace of decline in Russia's foreign exchange reserves have materially weakened the sovereign balance sheet," said Mr Parker. Russia's foreign exchange reserves (FXR) have fallen by USD210bn, from their peak at end-July 2008 to USD386.5bn as at 23 January 2009, albeit around USD58bn of which was due to valuation effects. The euro fell to session lows versus the dollar below $1.29 after ratings agency Fitch downgrade.

Russia is a major exporter of commodities such as oil and metals, so its equity market has been hit hard by the decline in the price of many commodities. In addition, investors have pulled billions of dollars out of Russia on concerns over escalating geopolitical tensions with the West following the military conflict between Georgia and Russia, as well as concerns about state interference in the economy. Those concerns were underscored in July by Prime Minister Vladimir Putin's criticism of steel company Mechel which wiped out billions of dollars of its market capitalization. By September 2008, the RTS stock index plunged almost 54%, making it one of the worst performing markets in the world. Compounding the volatile situation in Russia's financial system has been also involvement in the US subprime mortgage crisis with the Russian Central Bank owning US$100 Billion of mortgage-backed securities in the two American mortgage giants Fannie Mae and Freddie Mac that were taken over by the US government that most likely will have to be written off.

Members of the government of Russia, including President Dmitry Medvedev, Prime Minister Vladimir Putin and Finance Minister Alexey Kudrin, fully attribute the decline in the Russian stock market to the impact of the liquidity crisis in the United States and contend that the crisis in Russia has little if anything to do with internal problems in its economy and the government policies. However, many analysts, including Andrei Illarionov, former economic policy adviser to then-President Vladimir Putin, claim that in Russia the crisis in the stock market was deepened dramatically by internal factors, including concerns over state interference in the economy fueled in June by Putin's criticism of Mechel and the conflict over TNK-BP, lack of transparency in banking and political risks associated with escalating geopolitical tensions following the 2008 South Ossetia war in August. Swedish Foreign minister Carl Bildt said on 17 September that the current Russian financial crisis is "obviously more worrying" than the ongoing subprime mortgage crisis in view of the political development in Russia.

According to the Wall Street Journal and Gazeta.ru, as the Russian market declined in September, conspiracy theories circulated in Russia among the leadership that the U.S. government allegedly incited American investors to withdraw their capitals from Russia, punishing Moscow for the recent war in Georgia.

July 24, 2008, Mechel's stock plunged by almost 38 percent after Russia's Prime Minister Vladimir Putin criticized its CEO Igor Zyuzin, and accused the company of selling resources to Russia at higher prices than those charged to foreign countries. The comments, which raised fears of another attack similar to that made on Yukos in 2004, contrasted sharply with previous efforts by President Dmitry Medvedev to improve Russia's reputation as an investor-friendly country. On the following day, Mechel issued a contrite statement promising full cooperation with federal authorities, while share values rebounded by nearly 15 percent. July 28 presidential aide Arkady Dvorkovich then sought to restore calm, declaring that all parties would "act in a civilized way," and confirming that Mechel was cooperating with antitrust authorities. Just hours later, however, Putin announced that Mechel had been avoiding taxes, by using foreign subsidiaries to sell its products internationally. His renewed attack caused share prices to tumble once more—this time by almost 33 percent.

On September 16 Russia's most liquid stock exchange MICEX and the dollar-denominated RTS were suspended trade for one hour after the worst one-day fall in 10 years as Finance Minister Alexei Kudrin reassured markets there was no "systemic" crisis. Next day, trading was suspended for the second day in succession on Russia's two main stock exchanges (MICEX and RTS) after shares fell dramatically, forcing the Federal Financial Markets Service to intervene. The simultaneous collapse of money markets prompted reaction from the government and the Central Bank, while Finance Minister Alexey Kudrin sought assurances from U.S. Treasury Secretary Henry Paulson that the U.S. didn't play politics with Russia in the crisis.

The crisis continued on September 18, as trading was suspended for the third day in succession on Russia's two main stock exchanges amidst fear of financial collapse. News agencies are quoting Russia's finance minister Alexei Kudrin as saying trading on Russian exchanges won't resume until 19 September 2008. Officials at MICEX stock exchange describe conditions in the Russian markets as "extraordinary" Deputy Finance Minister Pyotr Kazakevich asserted that "Russia is facing its worst stock market decline in a decade mainly because of a confidence crisis rather than liquidity problems".

October 6 the MICEX and RTS crashed by 18.6% and 19.1% respectively. The losses forced the Federal Financial Markets Service to suspend the stocks three times. The decreases in other world markets on that day were considerable, but less dramatic than in Russia. Trading on both exchanges was suspended on the next day; Russian companies have augmented in price at London LSE. On October 8 the MICEX and RTS plunged 14.4% and 11.3% respectively, trading on the markets was halted until 10 October, respectively. However, on October 9 MICEX trading resumed ahead of schedule, and the stock market rose 14.7%. On the next day the regulator, wary of crises in American and Asian markets, decided not to open trading at all.

The crisis in money markets was imminent since spring, when Central Bank of Russia warned the public of a gradual contraction in bank lending due to unfolding world liquidity crisis. However, the regulator preferred to combat inflation, raising the refinancing rate and bank reserve contributions. September 1 hike in reserve rate alone withdrew nearly 100 billion roubles from the money market. The raise coincided with a seasonal peak in tax payments and left the banking system in a worse state of liquidity than that of August 1998. A subsequent drop in rouble-to-dollar exchange rate and dollar-denominated prices of Russian corporate securities forced investors to crowd out, worsening the positive feedback loop. The interbank money market that traditionally relied on Russian corporate stock as a colllateral for the repurchase agreements, immediately imploded in what was called "a crisis of trust" or even "elimination of trust": when the borrowers defaulted on loans, leaving lenders with impaired collateral, other banks stopped lending as a precaution.

Money market crunch passed its first lowest mark September 15–17. September 17 the government lent the country's three biggest banks, Sberbank, VTB Bank and Gazprombank, 1.13 trillion rubles ($44 billion) for at least three months to boost liquidity; the Central Bank lowered the reserve requirement. This was followed September 24 by Central Bank loans to keep the current accounts afloat and prevent a bank run. The regulators also raised the cap for deposit insurance from 400 to 700 thousand roubles (equivalent to 25 thousand dollars). These actions served their short-term purpose but failed to revitalize the money market: no bank was willing to lend for longer than overnight.

November 17 MosPrime interbank interest rate on rouble loans reached a record high of 22.67%, indicating another shortage of liquid funds as the bank clients transferred funds overseas or paid taxes due. Rates on six-month US dollar forward contracts fluctuated at 40–60%, short-term currency swaps averaged around 80% as the banks anticipated further drop in exchange rates.

On September 15 the KIT Finance brokerage failed to pay off its debt, signalling problems in Russia's financial sector. On 8 October the Russian Railways and Alrosa agreed to acquire a 90% stake in KIT Finance.

In the beginning of October Sergey Ignatyev, chairman of the Central Bank, announced imminent bankruptcy of 50 to 70 banks. Actually, in late August - late November the regulator has shut down only nine banks. More smaller banks showing signs of distress are allowed to operate, like the Moscow Mortgage Bank that defaulted on returning individual deposits in November. Regional banks, heavily dependent on individual deposits, were in particular hit. A bank run registered in Bashkortostan in November caused a local crises. Three of the four worst affected banks were promised rescue by their shareholders or third-party buyers; fate of the fourth one is yet to be decided.

On 18 September Russian President Dmitry Medvedev ordered ministers to inject 500 billion roubles of funds from the state budget into the markets and pledges that the financial system would receive "all necessary support". October 7, Medvedev announces an additional $36 billion for banks on top of the $150 billion approved in September.

On 29 September Vladimir Putin announced a government policy aimed at refinancing Russian corporations that previously relied on foreign loans. Government authorized Vnesheconombank as its principal agent in distributing state loans to these corporations, amounting initially up to 50 billion US dollars, or 8% of Russia's foreign currency assets. At the same time Putin recommended the Central Bank to extend unsecured stabilization loans to Russian banks, which was duely implemented. The policy was immediately dubbed "soft re-nationalisation" and criticized for selective picking of "eligible" borrowers. The 50 billion installment covers only the current portion of 477 billion US dollars owed by Russian corporations to foreign lenders; total assets of the government and the Central Bank combined are estimated at 550 billion US dollars.

On 23 October Standard & Poor's changes the long-term outlook on the sovereign credit ratings of Russia from stable to negative, warning of the costs of bailing out troubled banks and a rising risk of a budget deficit in 2009. It also lowered Russia's Transfer and Convertibility (T&C) assessment to BBB+ from A-. At the same time, the 'BBB+' long-term foreign currency, the 'A-' long-term local currency ratings and the short-term ratings of A-2 were affirmed.

By 13 November, Russian government spending to quench the recession reached 222 billions US Dollars, or 13.9% of its GDP; in November the state was spending its reserves at an average 22 billion dollars a week.

On 8 December 2008 Standard & Poor's additionally lowered Russia's foreign currency credit ratings to BBB (long term) and A-3. It also lowered Russia's Transfer and Convertibility (T&C) assessment to BBB and the long-term local currency assessment to BBB+. On the other hand the short term credit rating in local currency is left intact as A-2. The lowering of credit ratings was caused by the sharp decline of reserves and investment flow. Standard & Poor's also launched a downward revision of Russian municipal and corporate bond ratings.

November 20 Vladimir Putin announced government package of tax reforms. Corporate profit tax rate (24% in 2008) is to be reduced to 20%. Profit tax base will decrease for companies investing in capital assets as the immediately-recoverable depreciation allowance is raised from 10% to 30% of the asset cost. There will be no change in value added tax rates (maximum 18%) in 2009, but the government considered changing VAT accrual rules in favor of the taxpayers. Minister of finance Alexey Kudrin, who resisted tax breaks until September, concurred with Putin's proposal, estimating that they will save the businesses around 500 billion roubles annually.

Earlier in November, Kudrin announced that the state has accepted the fact of a long-term drop in oil prices and that the existing state budget plans will hold unchanged if the oil prices stabilize on 50 dollars per barrel mark. Even with tax breaks effective, Kudrin estimated that the 2009 state budget will break even or, in worst case, bear no more than 1% deficit. The deficit will be covered by Stabilisation Fund, without resorting to borrowing.

In December the government lifted import tariffs on industrial equipment imported by metallurgy, construction, forestry and textile industry, at the same time enforcing increased tariffs on imported cars.

Federal Financial Monitoring Service of Russia, the agency in charge of domestic stock markets and corporate governance, pressed the corporations to reveal their true owners and signed an agreement with the government of Cyprus (November 20) that may enable inter-government dislosure of ownership records. Cyprus is, nominally, the number one investor in Russia; 99% of RTS stock trades are arranged between foreign shareholders.

Russia has agreed to co-finance International Monetary Fund emergency loans to other states, initially contributing one billion US dollar. Earlier, in October, Russian ambassador to Iceland announces that Iceland will receive a €4 billion loan from Russia to mitigate the 2008 Icelandic financial crisis. The loan will be given across three or four years, and the interest rates will be 30 to 50 points above LIBOR. Prime minister Geir Haarde had been investigating the possibility of a loan provided by Russia since the mid-summer. Iceland's Central bank Governor Davíð Oddsson later clarified that the loan was still being negotiated.

At the end of November 2008, The Russian economy as a whole was not in a state of recession. The government forecast for 2009 stood a 6.7% annual growth; World Bank conservatively expects a 3% growth.

In the middle of of December 2008 Russian officials confirmed that possibilty of a recession was inevitable. "Russia is headed for a recession", the country's deputy economy minister, Andrei Klepach, has said. Asked whether Russia would have a recession, he said: "It's started already. I'm afraid it will not be over in the next two quarters. ... A major drop began in October and there will also be drops in November-December," he said, according to official reports. Recessions are normally declared after two quarters of negative growth. He also said that full-year economic growth for 2008 would be lower than the 6.8% previously forecast.

Russian steel industry is dependent on foreign markets and domestic construction and automobile industries. Crisis in the industry was first publicly reported in the end of September - early October. Magnitogorsk Iron and Steel Works laid off 3,000 workers (10% of its Urals staff) and reduced output by 15% on October 7, another layoff of 1,300 was announced in early November. Severstal reduced domestic production by 25%; its US and Italian production dropped by 30%. Evraz Group, employer of 40 thousands workers in Kemerovo Oblast, was reported negotiating layoffs with the unions and regional government since October 30. The company, specializing in construction-grade rolled steel, was inherently in worse position than other Russian steel mills. November 13 Evraz announced that, instead of layoffs, it will decrease workers' wages by a third. Some of Evraz facilities were converted to a four-day working week; the company reduced output to an estimated 50-60% of its capacity.

On November 18 Goskomstat insider reported an unprecedented drop in industrial prices - minus 6.6% monthly, following a 0.8% drop in September (the agency itself delayed its regular monthly report). Most of the losses concentrate in raw material industries; automobile and tool-making industries dropped only 0.4%. In two months, gasoline and diesel oil wholesale prices dropped by 12.8% and 16.5%. The worst price fall hit the steel industry: pig iron an ferric alloys dropped 21.7% in October after a 8.9% drop in September. Prices on aluminum and nickel are down to break-even point. The decline is sufficient to indicate a recession.

In November the industry relied on government funds distributed through Vneshtorgbank loans. VTB issued a 10 billion roubles emergency loan to Evraz to finance its current tax payments; a similar 5 billion loan was issued to OAO TMK. Magnitka was reported "in the line" for VTB financing. The industry continued to implode, and on November 14 and 18 Novolipetsk Steel shut down two of its five blast furnaces, reducing its pig iron capacity by 2.5 million metric tons, or 27%. On the same day Novolipetsk Steel denied steel shipments to GAZ due to automobile maker's default on payments.

In June 2008 The Economist described "Russia's booming car market" as a place where "you just need someone to count the money". In November the market slowed to its lowest since January 2007. AC Nielsen linked the market drop to a collapse in auto loan programs and general uncertainty among consumers, and predicted that unless auto loans recover, the market will slide back into 1990s. The government supported domestic auto makers by an increase in tariffs on imports, leading to an expected 7.5–8% price increase for imported cars.

GAZ and KAMAZ were the first auto makers to declare production cuts in September-October 2008. GAZ truck production has decreased by 23.4% in September 2008; in October the company announced week-long shutdowns of the main assembly line to meet decrease in demand for its most successful line, the GAZelle truck. KAMAZ, the target of acquisition by Daimler AG since July, has been reporting financial difficulties since September. In October KAMAZ reduced working hours by a third, from six-day to four-day working week. KAMAZ requested a 15 billion rouble state-backed loan and took a private loan from Citigroup at 9% over prime rate; in December Daimler AG acquired the first 10% in KAMAZ stock, citing "perfect storm" as a good time acquisition.

AvtoVAZ disclosed emergency measures on October 16, when Igor Sechin held an industry-wide anti-crisis brainstorming session in Togliatti. AvtoVAZ reported a stockpile of 100 thousands unsold cars (two months' output). The company requested government assistance of 1 billion US Dollars arranged through a Vneshtorgbank loan. Unlike other major borrowers who used VTB loans to substitute foreign capital, AvtoVAZ loan was intended solely to pay current expenses.

AvtoFramos, Moscow-based manufacturer of Renault Logan, has confirmed that instead of a planned weekly New Year holiday, the plant will stop for a month, December 12, 2008 to January 12, 2009. Trade unions asserted that AvroFramos has practiced short-time stoppages in November; plant administration refuted these statements. According to the unions, unsold stock reached 8 thousand cars, a month's output of the plant.

Amtel-Vredestein has closed two of its tire plants due to cash flow problems. On December 2 media announced closure of Bor Glass Works, the principal supplier of auto glass, but the news was soon refuted as false by the plant administration.

October 27 Vladimir Putin urged the government agencies to increase state purchases of road and housing construction services, arguing that the state must capitalize on the decrease in prices of raw materials. The state allocated 50 billion roubles to buy ready-to-occupy urban housing from cash-strapped developers. Putin emphasized that the new contracts must be struck on new, decreased, price terms - estimated to be 20–30% cheaper than in spring. Strabag executive estimated that in 2009 construction costs will decrease a further 30%. In November Moscow city government has been successfully pressing local developers for a 25% discount against October auction prices; the only developer who attempted to sue the city for a breach of contract withdrew their lawsuit and accepted the government terms. City government also pulled out of the 118-floor Russia Tower project, which was immediately suspended by its developer, citing "credit crunch".

In November, the volume of Russian paper exports to China decreased by 30–40%, coupled with a 30% drop in prices. Exports to Western Europe fare marginally better, with an estimated 25–40% drop in production volumes. Russia's largest producer of industrial paper bags, Segezh Paper Mill (controlled by the Bank of Moscow and the City of Moscow), declared a ten day shutdown on November 24. UPM-Kymmene Oyj anticipates at least a 30–40% decrease in output compared to 2008.

In June-August 2008 the fleet of KrasAir, a Krasnoyarsk-based airline with a controlling state interest, was grounded by the fuel suppliers' refusal to extend credit to the company that defaulted on payments. Other members of AiRUnion consortium, notably Dalavia, also folded in August. Thousands of passengers were stranded in airports; flight delays and cancellations became a national agenda. Government action focused on setting the cap on jet fuel prices and restructuring its assets into a new company managed by Rostechhologii, a newly-formed state conglomerate. Ministry of Transportation distributed the licenses to fly former KrasAir routes to other companies. KrasAir also defaulted on payments to its staff, and on October 27 a strike action, coupled with fuel suppliers' denial of service, finally ruined the airline. Dalavia lost its license earlier in October. The collapse of KrasAir also threatened Sky Express, Russia's first low cost carrier co-owned by the EBRD and former manager of KrasAir. October 22 the assets of bankrupt companies were consolidated in a new company, Rosavia, co-financed by the City of Moscow and Rostekhnologii.

Russia had a high grain harvest in 2008, but so it was elsewhere in the world, bringing the prices down. Russian grain, even if sold at breakeven prices, cannot compete with cheaper Ukrainian product. To support the trade, Dmitry Medvedev authorized a state export subsidy of 40 US dollars per metric ton. This, according to the minister of agriculture, is sufficient to maintain exports at 20–25 million metric tons. The food industry is, however, locked between high costs of farm produce and tight price and credit terms dictated by retail chains. Food industry executives anticipate that the chains will eventually lose part of their clients to street markets, as the suppliers are forced to develop this independent sales channel.

Domestic retail chains, heavily leveraged, were experiencing liquidity crisis at least since April 2008. The first chain to go bankrupt in May 2008, Grossmart (190 stores in Moscow region), had a particularly high debt-to-EBITDA ratio of 6 to 1. Arbat Prestige, subject to government attacks since 2007, defaulted on its bonds in June. In November 2008 nine leading food retail chains (out of nearly 300) received access to government-backed financing. Nevertheless, retailers are pressing food suppliers for longer credit terms or bigger cash discounts, demanding up to 50% price cut for cash payment. Suppliers, in a mirror move, raised "regular" credit prices by 20–60%. Rather than submit to the chains' demands, they simply refuse to sell; visible depletion of stocks has affected only a few affected chains.

A proprietary Ernst & Young survey of 113 clients that leaked into Russian press in November summarized their losses at 8% of managerial and 6% of low-level jobs by end of October. All companies in the survey practiced some sort of reducing labor costs. One company in four practiced unpaid "vacations"; 8% of clients settled for reduced working hours. Federal Migratory Service announced in November that 1123 Russian companies reported upcoming layoffs of 45 thousand.

Most layoffs were reported in metallurgy and financial services: 20% in Uralsib, 1000 in Vneshtorgbank's VTB24 retail division. December 1 Vedomosti reported upcoming 40% cuts in MDM Bank and 80% in IFD Kapital. Sberbank endorsed a long-term program to reduce headcount by 25% in 2014. In telecommunications, Sitronics laid off up to 10% in all business units; in audit services, Deloitte Touche Tohmatsu reduced number of partners in its Russian division by 17 out of 180. Vedomosti has set up a private "layoff newsreel" syndicating independent reports of job cuts, yet as at December 7, 2008, there are no reliable nation-wide statistics on white-collar unemployment, which usually escapes official unemployment record.

By late November, Kremlin First Deputy Chief of Staff, Vladislav Surkov, was warning that the middle classes should be defended from poverty during the crisis. He called for swift measures to protect the middle class from layoffs and to support consumption. "If the 1980s were the times of the intellectuals and the 1990s were the times of the oligarchs then the 00s can be seen as the epoch of the middle classes,' Surkov said in a speech published on the Web site of the ruling United Russia party ... The main task of the state during the slump must become the preservation of the middle class, the defence of the middle class from the waves of poverty and confusion that are coming from the West," he said.

According to official statements released December 9, rate of unemployment growth peaked in the middle of November and slowed down in subsequent weeks. In the week ending December 3 overall unemployment grew by 1.6% to 1.315 million people, following a 2.3% increase in the preceding week. The state also reported an increase in unpaid vacations and reduced working week employees to 149.3 thousands. The number increased by 84% in a single week ending December 3. The trade unions anticipate that official unemployment will peak at around 2 million people in 2009, when hidden forms of unemployment become visible to statisticians. Yet on December 12 Putin announced completely different unemployment numbers - 4.6 million in October.

In early 2009 unemployment continued to rise, but at a slower pace. In January the unemployment rate rose by 0.4% to 8.1%, the highest in four years. The total number of unemployed rose by 300,000.

Official consumer price inflation in January–August reached 14.8%. By the end of November, food price inflation for 11-month period reached 15.3%. Overall price inflation, taking into account consumer and industrial prices, reached 12.5% compared to 10.6% for the same period of 2007. Decline in short-term inflation was credited to a reduction in monetary supply.

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