I have long been in the Swedish camp when it comes to food (meatballs with lingonberries) women (tall blondes) and financial crises (prepackaged bankruptcy, no bailouts for banks).

While the Japanese have lots to offer (Sushi, Anime, and reliable cars), their approach to financial panics was to nationalize all of the debt, prop up insolvent corporations, and continually kick the can down the road. Ever since their 1989 RE/Bank collapse, their economy has been paying the price for bad policy decisions.

Its been two and a half years since our credit crisis, and we now have enough distance to see the results of various policy choices different nations have made. The Irish made a horrific decision to completely transfer the losses from their reckless bankers to the taxpayer, and are suffering under the weight of about €25,000 for every man woman and child in the Ireland. Similarly, the U.S. assumed much of the responsibility for irresponsible bankers and their reckless leveraged bets. Our economy has muddled along with subpar growth, weak job creation, and a nagging suspicion that another crisis is likely sometime in the future.

And then there is tiny Iceland.

Bankrupted by the global collapse, Reykjavik made the more painful, but ultimately better, Swedish choice of putting their insolvent banks through bankruptcy.

There is a hefty story in the NYT Magazine this weekend — Iceland’s Big Thaw — that explains what happened during the collapse, and since, in the tiny European island:

“During the boom years, Iceland became a nation obsessed with banking. “Everyone was working for the banks — from the physicists to the philosophers,” one Icelander told me. I met two women in their mid-20s who said that when they graduated from college, virtually all of their classmates were jockeying to get into finance, and for a brief spell, they both became bankers. I asked one of the women, who trained to be an engineer, if she ever paused to consider whether she really wanted to be a banker. “It was just the coolest,” she recalled giddily. “Everybody was like, Yeah, give me a high-five!”

The success of the nation’s banks, however, was deceptive to say the least. The assets of Icelandic banks were equal to 174 percent of the nation’s gross domestic product in 2003, and rose to 744 percent in 2007, while the G.D.P. itself rose by an average of 5.5 percent per year. The economy was fueled almost entirely by foreign money. Then, as the global financial infrastructure teetered on the verge of collapse, the bonds came due, and Iceland’s banks couldn’t repay them. Depositors in other countries raced to pull their money out of Icelandic banks. The government didn’t have the resources for a bailout; the banks failed. The government did guarantee that Icelanders would not lose the money in their savings accounts, but other financial assets — including the many investment funds that the banks offered — plummeted in value, and many ordinary Icelanders lost large sums that they believed were safely invested.”

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

>

Source:
Iceland’s Big Thaw
JAKE HALPERN
NYT, May 13, 2011  
http://www.nytimes.com/2011/05/15/magazine/icelands-big-economic-thaw.html

Category: Bailouts, Credit, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

32 Responses to “How to Handle a Financial Crisis Like Iceland”

  1. super_trooper says:

    Take a straight flights from JFK to KEF. It’s never been this cheap in Reykjavik. The island is beautiful. Take your wife to a uniquie trip over an extended weekend, it’s beautiful. I probably wouldn’t stay there for more than 3 nights.

  2. BusSchDean says:

    Well it isn’t as if we didn’t know. Here is a 2008 NYT article that made that option very clear.

    http://nyti.ms/iY0Dgl

    What we have here..is NOT failure to communicate. What we have is the flip side of the invisible hand — the visible hand of self-interest that made damn sure the gov’t wouldn’t let capitalism work.

  3. Petey Wheatstraw says:

    Iceland is the oldest continuous democracy in the world. They’re not ideologically prone, nor large enough, to allow corporatism to take root, much less take over.

  4. philipat says:

    But seriously for a moment?

    Iceland, like Sweden, allowed insolvent Banks to fail, rather than using taxpayer funds to bail them out. Temporary Nationalisation is employed. In this model, Managements and Boards are fired, Equity and Bond Holders are wiped out to the extent necessary as the bad assets are written-down and the Good assets are credited when the Banks are re-floated.

    You know, I don’t really have too many issues with that approach??!!

  5. louiswi says:

    So, is it time to invest in Iceland and if so, how?

    Super_trooper is right. Iceland is a great country to visit and fully affordable. The people are wonderful!

  6. barbacoa666 says:

    Interesting that the Swedes, supposed socialists, held closer to the tenets of capitalism than the supposed practitioners of unfettered capitalism here in the US.

  7. Bruman says:

    I think some kind of controlled bankruptcy process is called for. At the time of the crisis in the US, I believed that some bailout and propping up was needed just because it looked like the collapse would happen in a matter of 48 hours or so and we needed some time to think about options, which I eventually felt would be some kind of controlled bankruptcy. Unfortunately, we got the formula of:

    1) Give the banks a bunch of money

    2) Get it from the taxpayers

    3) Tell taxpayers that they’ve been too frivolous and can’t have things like food stamps anymore.

    I find Iceland’s approach brave, but it sounds like they didn’t really have an option to go the bailout route. Could it be that the lesson here is “if you’re going to have a financial crisis, make sure it’s so big that you can’t possibly bail out anyone.”

    Perhaps that’s what we’ll get next time?

  8. BusSchDean says:

    philipat

    It isn’t “In this model,…” but rather “In THE model of free markets…” Real markets require losers. Actually, real markets create losers. So, yes, management is gone, the boards are fired (they were clearly useless in any case), and equity and bondholders are wiped out (did they think the were getting FDIC protection when they laid down their bet?). To your final point about the bank being re-floated. If it happens it happens, as you say, without that Management, and without that Board. All equity and bond holders have lost. The only remaining decision is to determine if the near dead bird in the road can fly again, and if so at what price.

    All of which is why banks and investment banks need to be separate.

  9. MayorQuimby says:

    Oh but we can’t let our precious STOCK market tank (even for a couple of years).

    Must save the STOCK market.

    All hail the STOCK market!

    Just keep saying STOCK market until all fundamental supports (ethical, moral, financial, etc.) are completely washed away. Then you will see what happens to 3rd world STOCK markets. They collapse and STAY collapsed.

  10. deaner66 says:

    Seriously, what were you expecting when a former Goldman CEO is the Secretary of the Treasury? We get the government we deserve, and boy are we richly rewarded for it. When you do the research on all of this, the most painful thing of all is that the answers are clear and real, but what really happens is muddled and surreal.

    But none of this is new. Our government and the Fed has been guaranteeing bad decisions by the large banks for many, many years. There is no such thing as the free market. Bankers are the biggest socialists of all.

    Again, we get the government we deserve.

  11. NeutralObserver says:

    Yes, capitalism not only requires an invisible hand, but also an obvious foot.

  12. lalaland says:

    “The government did guarantee that Icelanders would not lose the money in their savings accounts, but other financial assets — including the many investment funds that the banks offered — plummeted in value, and many ordinary Icelanders lost large sums that they believed were safely invested.”

    many ordinary Icelanders lost large sums that they believed were safely invested

    Something tells me that last line will probably get overlooked a lot, and shouldn’t be. I suspect if we let those funds get wiped out in the US there would have been hell to pay, and it would have resulted in much poorer seniors, etc. Isn’t it possible the government wasn’t willing to let that happen? Perhaps Iceland has a strong enough social safety net to do that to people without severe consequence; I’m sure ours is far weaker. Maybe the US would have been far more susceptible to the collapse of social order as a result since we are less homogenous, and a less stab;e society than Iceland, of all places.

  13. JimRino says:

    Barry, How Do You Get This Much Reading Done!

  14. MacroEconomist says:

    I partially dispute the last sentence with respect to the USA: “They are now much much better for it than the countries like the US and Ireland who did not.”

    The U.S. is a large economy. The banking sector as a % of GDP is much smaller here than Ireland or Iceland.

    Bank failures are going on every week as we speak and the bankruptcy process is working. The government pursued a time old policy of capital raises and short-term loans to assuage market confidence. There is nothing wrong with this.

    What I do find offensive is the continued desire for lack of regulation and the intense lobbying dollars spent to that end by the Too Big To Fails.

  15. Winston Munn says:

    (many ordinary Icelanders lost large sums that they believed were safely invested)

    There was a time when people understood the wisdom of Will Rogers when he said, “I’m not concerned with the return ON my money but the return OF my money.”

    Of course, that was during pre-inflation days when saving money meant getting ahead and actually staying ahead.

  16. Jojo says:

    Its been two and a half years since our credit crisis, and we now have enough distance to see the results of various policy choices different nations have made…. Similarly, the U.S. assumed much of the responsibility for irresponsible bankers and their reckless leveraged bets. Our economy has muddled along with subpar growth, weak job creation, and a nagging suspicion that another crisis is likely sometime in the future.
    —————
    Imagine how high the markets would be if we had actually fixed the problems!

  17. socaljoe says:

    There is no reason why every failed bank, regardless of size, could not have been handled the way that Washington Mutual and hundreds of smaller banks were handled… except for the fact that much of congress is bought and paid for and the rest are cowards.

    The issues leading up to the crisis still exist… many are worse. Too big to fail is even bigger now. Bank deposits are still used to fund speculation. The moral hazard is greater. Government is tapped out. All we have accomplished is to postponed the solution. I fear it will take an even bigger crisis before the right actions will be taken.

  18. clawback says:

    BR, a few months back you were on Ratigan with Steve Rattner. He basically pooh-pooh’d your Swedish solution. Did have an argument to back it up other than “Financial companies are complicated, and it would have been really hard to do…blah blah blah”?

  19. clawback says:

    Sorry, did RATTNER have an argument to back up his dismissal of the Swedish solution?

  20. CitizenWhy says:

    As usual, excellent points, succinct. But you leave out the role of Tim Geithner in regard to Ireland and Europe. He’s pressured Europe to rescue big banks at all costs, his model being more China than Japan.

    Merkel, the IMF and the EU would like to give a fair deal to Ireland, but the ECB and Sarkozy, siding with Geithner, veto any such move.

    The Geithner Doctrine: “Big Banks first, citizens move to the rear of the line.”

    To be a bit fair, Geithner expected the US Congress to enact better financial reform than it did, and that would help the US banks eventually emerge as responsible as well as sound institutions. Naive. He listens to and obeys Goldman Sachs. Why did he think the Congress would not?

  21. Unless the stakeholders get their fingers nipped and they feel a little pain they will have no incentive to change their ways or control the actions of their representatives. It is also bad form to punish taxpayers for something stakeholders did. That is like smacking little brother even though big brother broke the window

  22. DeDude says:

    One great advantage of the icelandic solution is the down-sizing of a bloated financial sector. We still have money pushers sucking up 1/3 of the real economy, and absurd incentives that makes it a lot more profitable to be part of the destructive economy rather than create something useful in the productive economy.

  23. PORG says:

    Iceland will recover but the PIGS are getting slaughtered by the ECB.

  24. afr114 says:

    Sometimes I really wonder if letting the banks fail is actually entirely feasible in the US considering how messy it would have been.

    a1) The FDIC guaranteed up to 100,000 dollars in savings at that time (now I think it’s 250,000), and just about every big bank and regional bank was on the verge of failure. When Indy Mac went under, that ate up about 10-15% of the FDIC’s reserves that were saved towards this process, and, in all likelihood, would have probably had to come and “borrowed” money from the treasury to foot the entire bill for the bank failures. It cost up to 160 billion to bail out the Federal Savings and Loan Insurance Corporation during the savings and loans crisis and that was miniscule in scale compared to the current financial crisis.

    a2) What to do about foreign banks in the US and the US depositers? What to do about foreign depositers in the US banks?

    b) The investment losses that people would have suffered in their 401ks and pension funds would have been enormous…a lot of wealth would have literally been wiped out, much more so than it has been with the bail-outs. Remember just about every investment bank including Goldman Sachs was on the verge of failure due to the CDS contracts and the massive losses that they would have had to take on their bond losses.

    C) With the foreclosure mess currently going and the issues regarding who actually owns the note to the property, I see massive amounts of confusion once the banks fail regarding who owns the property and what to do with the underwater homeowners.

    It just seems to me that the bank-bail outs, although terrible as it is and as massive the cost, has kept stability and some sense of order.

    Your thoughts?

  25. AHodge says:

    All true
    and now Iceland knows where their losses were.
    they have passsed them on (bondholders) to Europe and other places
    where no one will know where they are, but UK and denmark are a good guess

  26. DeDude says:

    afr114; the Swedish solution saved the banks, not the banksters. The loses are there and will have to be taken by someone at some point in time (when mark to fantasy, meet up with reality). Currently the conservative small savers are paying these loses by a negative real interest on their savings, while banksters keep partying. Remember that one or the reasons that we never got real financial reform and that the Banksters sock puppets in congress can block even the watered down regulations implemented is that the 401K and pension funds were saved. If everybody at this point were down 30-40% in their 401K then those bastards would be hung out to dry. The slow and steady robbing is a lot easier to sell as a normal force of nature.

  27. afr114 says:

    The Icelandic example sounds terrible on the average person there: massive losses of investments and pensions, huge personal debts, increase unemployment close to 9% with high underemployment and self-imposed austerity measures.

  28. DeDude says:

    afri114; just like our RE gains their gains were all fake and had to be taken out one way or another. You can either say that those who got all the fake gains should take the loses on those fake gains or you can say we will pass those loses on to the next generation. Some would call it immoral to let people keep those gains and then pass the bill to future generations, others would (like our banksters) would call it part of the plan. Their 9% unemployment doesn’t sound worse than our 9% considering that they have not swept anything under the rug that will come back and bite them later.

  29. batmando says:

    afri114 –
    the icelanders recognized and accepted their economic reality and are now living and growing in it.
    for us, it is extend and pretend.., until it’s not and economic reality forces itself upon us.

  30. afr114 says:

    DeDude and batmando,

    I understand that argument, but isn’t that essentially what Andrew Mellon advocated to Hoover : “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

    So much absolute value would have been lost and so many lives ruined, and for what? I feel like you gentleman are assuming that the country would have been able to get back on its feet as quickly as we did with the government bailing out the banks and others, but I just don’t think that would be the case.

    The Lehman Bankruptcy has been going on for three years now (?) and the foreclosure mess is still being sorted out, and this is with the government propping things up. I can’t imagine how much of a mess we would have been if the entire system went down.

  31. batmando says:

    afr114 -

    “I can’t imagine how much of a mess we would have been if the entire system went down.”

    we hear variations on that on many sides, the paulson threat, tanks in the street, yet where is the case made that it would have been so? “(you) just don’t think that would be the case.” why?

    why would a swedish solution not have been as quick as, and more stabilizing than, bail-outs and leading to something better grounded than this recoveryless recovery? extend and pretend may well result in even more absolute value lost and lives ruined.

    the bad debt must be realized on someone’s balance sheet. why not on those who actually incurred it, be they homeowners or reits, or invested in it, be they investment bankers or 401k holders.
    socializing the losses by “government propping things up” only increases the eventual total price paid.

  32. PDS says:

    BR…thanks for pointing this out…I appeared on CNBC back in March of 08 with EB, before it hit the fan for Icelanders, warning that Iceland was the proverbial canary in the coal mine…it was….

    Now I find it ironic, as the article points out, that they are still seriously considering joining the Euro zone…odd because it is because of their fiscal and monetary independence that they have been able to come back from the dead by devalueing the heck out of the krona allowing exports to surge and economy grow….

    The Club Med countries and Ireland, as they suffer through IMF and EU austerity, I’m sure are wishing they had Icelands monetary policy freedom so they can devalue their own currencies to regaint their competitiveness..
    Unfortunately for them they have outsourced it those escargot munching, DP swilling out of touch Eurocrats in Brussels….