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Icelandic Prime Minister Sigmundur Davíð Gunnlaugsson resigned on Tuesday, after documents leaked from a Panama-based law firm revealed that his wife possesses a secret offshore account worth millions of dollars.

The money is housed in a shell corporation called Wintris, which had bought bonds in Icelandic banks. So when Iceland's financial sector collapsed in 2008, Wintris became a creditor to those banks. In 2013, Gunnlaugsson became the prime minister, having run partly on a promise to get tougher with Iceland's remaining foreign creditors.

So what Icelandic voters didn't know when they elected him in 2013, but have learned with this week's "Panama Papers" revelations, is that Gunnlaugsson's own wife was secretly one of the creditors he'd promised to crack down on — an enormous and undisclosed conflict of interest.
When the truth came out this week, it led to mass protests on Monday calling for Gunnlaugsson's resignation. He stepped down the next day.

What happened in Iceland shows the political power of the Panama Papers, but it also shows the degree to which the political turmoil from the 2008 financial crisis is, in some ways, still ongoing in that country.

What's more, if Gunnlaugsson's resignation leads Iceland to schedule new elections soon, that vote could end up empowering a radical political party called the Pirate Party, a left-libertarian amalgam that's obsessed with transparency and direct democracy.

Here's what you need to understand the Iceland situation: what happened, why it matters, and what could happen next.
How the financial crisis changed Iceland's politics
 Handful of Icelandic bills
Pall Stefansson/Getty Images
No country was hit as hard by the global financial crisis as Iceland, where all three major banks collapsed.
From the mid-'90s until the 2008 financial crisis, Iceland engaged in a grand experiment. It slashed the size of government and downgraded financial regulations, hoping to grow Iceland's economy and make it into a hub for global finance really quickly.

At first, it seemed to work — Iceland's GDP per capita skyrocketed from $27,000 to about $69,000 in 2008. Inequality also surged, and the financial system seemed riven by corrupt backroom dealings, but it seemed to many like a reasonable price to pay.

Icelandic banks promised depositors high interest rates while they spent heavily on purchasing new assets. Bankers took out loans from abroad, lent the money to each other, and used it to buy assets whose prices became more and more inflated. This gave the appearance of rapidly ballooning wealth, but built on little more than paper.

Michael Lewis, the great financial journalist, explains it like this:

You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets.

This was a bubble set to pop, and so it did in 2008 when the global financial system on which it depended began falling apart. The banks began failing, and Iceland faced a difficult choice about how to respond.

The effect on Iceland was dramatic. As the Washington Post's Matt O'Brien explains, the government itself took on enormous debt to cover its citizens' deposits:

Iceland's government couldn't afford to bail out its banks that had gotten so much bigger than its economy. The only choice was to let them go under. In other words, Iceland's banks were too-big-not-to-fail. That was a lot easier, though, when letting the banks fail meant letting foreigners lose their money. Iceland's government, you see, guaranteed its own people's deposits, but no one else's. But now it was Iceland's government that needed a bailout.

This got really bad. The stock market lost 95 percent of its value; unemployment shot up from under 2 percent to over 8 percent. GDP per capita fell by nearly $30,000.

"No other developed country endured a systemic collapse in its banking sector on the scale that occurred in Iceland," Icelandic scholars Throstur Olaf Sigurjonsson and Mar Wolfgang Mixa write. In fact, they write, a collapse of this scale had occurred "rarely in the history of finance."

The political fallout was immediate and dramatic. Iceland's center-right party, which had masterminded the country's financial liberalization, lost power to a left-wing coalition in February 2009. The new left-wing government began rebuilding Iceland's regulatory and welfare state and securing an international bailout.

It was that last point that enabled Gunnlaugsson's later rise. For much of his career, he had been a kind of pop journalist, placing third in the 2004 "sexiest man in Iceland" competition. During the financial crisis, Gunnlaugsson had moved into activism — leading a right-wing group called InDefence, short for In Defense of Iceland, which opposed the bailouts.

Gunnlaugsson and InDefence argued that Iceland should stand up to its international creditors to limit the amount of money Iceland would have to pay them.

A key moment in their campaign came in 2008. At the time, as the International Consortium of Investigative Journalists (ICIJ) explains, the UK was demanding money from Iceland — a lot of Brits had had money in collapsing Icelandic banks, and the UK wanted to make sure its citizens got their deposits back. Iceland refused, and the UK invoked a counterterrorism law to try to seize the money from them.

Gunnlaugsson's group rallied against this, using the slogan "Icelanders are NOT terrorists." When Iceland received its international bailout, the group opposed taking any British money — and won, forcing Iceland's government to accept bailout funds only from and other Scandinavian countries and the IMF.

Gunnlaugsson was tapping into a sentiment of Icelandic nationalism. Many Icelanders believe the financial crisis had already punished their country enough, and that the people shouldn't have to pay back foreign creditors. He rode this wave to political power, winning a seat in parliament in 2009 and ultimately the premiership in 2013 election as the leader of the right-wing Progressive Party.

Standing up to the creditors was the core of Gunnlaugsson's political appeal; if he hadn't had that, then he might not have ever won power. And that's why the Panama Papers release was so damaging to him.

The Panama Papers revealed Gunnlaugsson's wife had a shell company
  
ICIJ
A stock certificate from the leaked documents.
In Iceland, the biggest revelations in this week's Panama Papers focused on Wintris, the shell company Gunnlaugsson's wife, Anna Sigurlaug Pálsdóttir, used to hide millions of dollars in offshore account.

Wintris was created in 2007 in the British Virgin Islands, as a dual investment by Pálsdóttir and Gunnlaugsson. (While shell companies are often used for activities such as avoiding taxes, they are not necessarily illegal.)

In 2009, when he was elected to parliament, Gunnlaugsson was legally required to either disclose or sell his interest in Wintris. He chose the latter, selling it to his wife for $1, a single day before Icelandic law would have required him to disclose its existence.

A lot of this was known in Iceland before the rest of the world found out. On March 15, after Gunnlaugsson started getting questions about whether he'd ever had an offshore account, Pálsdóttir wrote a Facebook post disclosing the existence of Wintris and thus her offshore investments.

Then the ICIJ, which first reported the papers, found that Wintris was claiming about $4.2 million in bonds from Iceland's three main commercial banks — Landsbanki, Kaupthing, and Glitnir.

So Gunnlaugsson's wife has money in a shell company, which was initially started as a joint investment with her husband, that claims to be owed money from the very Icelandic banks over which her husband's government has some legal authority — and that are among the foreign creditors he'd promised to get tough on.

The people of Iceland reacted by throwing yogurt at parliament
 Protesters holding signs
Spencer Platt/Getty Images
Iceland saw some of the largest protests in its history before Gunnlaugsson resigned.
Gunnlaugsson's government, a center-right coalition of his libertarian Progressive Party and the more conservative Independence Party, was already in trouble before the new information about Wintris.

Some of its recent political problems:

Iceland saw widespread union strikes over wages in 2014 and 2015, including among nurses. Parliament eventually passed legislation to stop the nurses' strike and force the nurses to return to work after more than two months.
Iceland dropped its European Union membership bid in 2013, and recently announced that the country was officially no longer a candidate. This wasn't a surprise — skepticism of Europe was cited as a major reason for its victory in the first place — but opponents argued the matter should have been put to a referendum or a parliamentary vote.
The government proposed putting power lines, dams, and power plants in the untouched Icelandic highlands. Environmentalists protested, and Björk made a public appeal to stop the development.
A slow leak of shell company revelations, all from the Panama Papers, built on these problems. The Icelandic broadcaster RUV, in a story published March 29, said that three ministers in the Icelandic government were involved with offshore accounts (and could have tipped off the rest of the world that similar disclosures were coming, if anyone had been paying attention).

The minister of the interior, Ólöf Nordal, had an offshore company founded for her husband but never used, according to Süddeutsche Zeitung. And the minister of finance, Bjarni Benediktsson, held 33 percent of a shell company in the Seychelles, which he said was founded to purchase real estate in Dubai.

So many in Iceland saw the final revelations as part of a trend of malfeasance. In the wake of the leaks, at least 10,000 people — in a country of only 330,000 — turned out to protest in front of parliament, throwing yogurt and blowing whistles in one of the largest protests in the country's history.

Gunnlaugsson initially vowed to stay on. But on Tuesday he bowed to the pressure, resigning his job.

An opportunity for Iceland's Pirate Party?
 Pirate flag from Pirate Party event
Adam Berry/Getty Images
The Pirate Party is an international organization, but it's most successful in Iceland.
Gunnlaugsson's coalition is vowing to remain in power, which would require choosing a new prime minister. But opposition parties are calling for Iceland's president to dissolve parliament, which would mean new elections.

Currently, the highest-polling party in Iceland is the Pirate Party, with 37.8 percent. It's part of an international protest group that emphasizes transparency and copyright reform. Its somewhat opaque agenda embraces left and libertarian ideas such as:

Reducing the role of Iceland's parliament and replacing it with a direct democracy, where all citizens can vote on legislation
Decriminalizing or maybe even legalizing drugs (it's hard to tell from their platform)
A universal basic income
True to its direct democracy principles, the party has no actual leader. While there are other Pirate Party branches elsewhere in Europe, only Iceland's is so popular.

The "rise of the Icelandic Pirate Party has no direct parallel in any other Western country," Vidar Thorsteinsson, a PhD student at Ohio State, writes in Jacobin.

It's not clear if Iceland's government will call for parliamentary elections, or if it hopes that Gunnlaugsson's resignation will put an end to the crisis. But it's possible that the Panama Papers could, ironically enough, help empower an Icelandic party that supports, among other things, radical transparency of exactly the sort that led to the leak in the first place.
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