The problems that have beset Cyprus this year have an all too familiar ring to them, but the post-crisis reaction to its economic problems by Iceland show how a full investigation into the causes of a financial crisis are essential to enable a new system that is fit for purpose to be established.

A friend of mine was once granted a job interview at one of the most prominent central banks in the world. At one stage of the interview, he was asked to put himself in the place of the governor of the central bank in a hypothetical meeting with the chief executive of the country's largest bank. In the meeting, the chief executive reveals: “There is no easy way to say this, but we cannot close the books this evening.” What should the response be? The 'correct' answer was something akin to: “Thank you for bringing this up with us so soon. It is worrisome, but go home and relax. I will bring the matter up with your successor in the morning.”

In October 2008, 97% of Iceland’s banking sector collapsed within three days. Needless to say, Icelanders have a long list of lessons learned from this calamity. One of the first was that we were too slow to clean up our house. The country's leading bankers and the top financial watchdog staff were fired, in line with the logic in the story above, but it took months for the cabinet to resign, and even longer to oust the central bank governor who had run the central bank into the ground. Some management-level staff in the banks also remained in their jobs long enough to cover their tracks. To this day there has been remarkably little turnover among Iceland's civil servants.

Iceland's population is small and its people are genuinely friendly to one another. In fact, it is hard to misbehave in Iceland – the chances are that you will run into someone you transgressed against in an extended family get-together the following weekend.

It is therefore with much solidarity and sadness that I view the current situation in Cyprus. Just as Icelanders did, Cypriots probably find themselves feeling uncertain and suddenly mistrusting of one another – the bankers, the government, and their neighbouring countries – as they ask themselves “what on earth just happened?”.

Good moves

In spite of the problems that beset the country in the wake of the global financial crisis, Icelanders can be proud of having done many things right. The jury is still out on the impact of capital controls, but splitting up the failed banks and establishing new ones with ample equity to take on the uncertainties ahead has proved to be the correct move. 

It was also correct to maintain that the ownership of Iceland's banks would remain at arm's length from politicians and hedge fund managers via 'industrial foundations'. Keeping the banks under the control of independent boards of directors, many of whom are foreigners, has proved worthwhile. Recruiting bank employees who are motivated and have a reputation to protect from their good work elsewhere has also been very important. They have been rewarded and rewarded well, but not led into temptation through incentive pay. Instituting elevated financial oversight – including an independent committee reporting to parliament on the equal treatment of bank customers – has laid the ground for restoring the reputation and credibility of Iceland's financial system.

Last but not least, the enactment of law 142 in 2008 – which established the Icelandic parliament's Special Investigation Commission to seek the true causes of the collapse of the three banks – was essential. No other country may ever again provide as extensive investigative powers to a truth commission as the Icelandic parliament did. But such investigations can lay the foundation for essential reforms, as the 1913 Pujo Investigation did in the US, leading to creation of the Federal Reserve System.

The truth hurts

When Iceland's Special Investigation Commission published its extensive report in 2010, it surprised the bankers, the political establishment and the public. The report meticulously laid out the facts, revealing the painful truth about the former prodigies of the Icelandic economy who had once been described – by Iceland's president, Olafur Ragnar Grimsson, in explaining their entrepreneurial superiority to a meeting of London business leaders – as “poets of enterprise”.

Writing about the Pujo Investigation in Other People’s Money and How The Bankers Use It (1914), Louis Brandeis provided the message that should serve as a lesson for the people of Cyprus: “How shall emancipation be wrought? On what lines shall we proceed? The facts, when fully understood, shall teach us.”

Gudrun Johnsen is vice-chair of the board of directors of Arion Bank, former senior investigator for the Icelandic parliament's Special Investigation Commission, and author of the forthcoming book Bringing Down the Banking System: Lessons From Iceland.


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