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Iceland Was Right on Bondholders, Gudmundsson Says

Iceland was right not to bail out bondholders in the country’s banks and wasn’t ever in a position to support creditors because of the size of the debt, central bank Governor Mar Gudmundsson said.

“Bondholders should not rely on the government stepping in and bailing them out,” Gudmundsson said after delivering a speech at the Goethe University of Frankfurt’s House of Finance yesterday evening. “They should do their due diligence.”

Creditors are still trying to recoup $85 billion after Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf failed more than two years ago. Iceland’s decision to push the cost of its banking failure onto bondholders instead of taxpayers is in contrast to Ireland’s agreement to protect senior bondholders from losses as part of its 85 billion-euro ($111 billion) rescue package.

“I think the Irish are accepting that they were probably too fast in guaranteeing the whole liabilities of banks,” Gudmundsson said. “Now this is turning out to be a big burden because the assets of these banks turned out to be much worse than they thought.”

Kaupthing’s so-called winding-up committee said Nov. 26 that it’s dealing with 28,167 claims totaling $63 billion filed by creditors across 119 countries.

Budget Position

Iceland’s budget will be in surplus by 2012, compared with Ireland’s deficit of 9.1 percent of gross domestic product, the European Commission estimates. Unemployment in the euro member will stay at 13.6 percent this year and next, compared with a 2011 peak of 8.1 percent in Iceland, according to a Nov. 18 report published by the Organization for Economic Cooperation and Development.

“I haven’t made up my mind whether it is the right decision for everybody, but Iceland didn’t have any other option,” Gudmundsson said. “It will be very interesting to assess this issue after a few years in terms of whether it was maybe the right thing to do.”

Countries in the European Economic Area, including Iceland, were competing to build their own financial centers, which led domestic banks to expand in other European countries even though no cross-border regulatory framework existed, Gudmundsson said.

Banking Licenses

One way to reduce risks may be to require banks to get two banking licenses, with one for lenders operating only nationally that would be supervised locally and have domestic deposit insurance programs. A second license would be required for cross-border banks, of which there’d probably be 30 to 50, he said.

On monetary policy, Gudmundsson, who previously worked at the Bank for International Settlements in Basel, said “inflation tackling” is not enough and called for “inflation tackling plus,” saying the plus stands for additional measures such as strict fiscal policy, active foreign exchange intervention as well as possibly selective capital controls.

When asked whether Iceland was right to let its banks fail, he said while it’s too early to say, the country couldn’t have afforded to take over all the lenders’ liabilities. “In some sense I think yes, it was. We stumbled down the right thing,” he said.

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