Skip to comments.Key Lesson From Iceland Crisis: “Let Banks Fail” (Why Iceland is recovering and others aren't)
Posted on 11/10/2011 7:05:50 AM PST by SeekAndFind
Agence France-Presse notes:
Three years after Icelands banks collapsed and the country teetered on the brink, its economy is recovering, proof that governments should let failing lenders go bust and protect taxpayers, analysts say.
The lesson that could be learned from Icelands way of handling its crisis is that it is important to shield taxpayers and government finances from bearing the cost of a financial crisis to the extent possible, Islandsbanki analyst Jon Bjarki Bentsson told AFP.
Even if our way of dealing with the crisis was not by choice but due to the inability of the government to support the banks back in 2008 due to their size relative to the economy, this has turned out relatively well for us, Bentsson said.
Nobel Prize-winning US economist Paul Krugman echoed Bentsson.
Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net, he wrote in a recent commentary in the New York Times.
Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver, he said.
During a visit to Reykjavik last week, Krugman also said Iceland has the krona to thank for its recovery, warning against the notion that adopting the euro can protect against economic imbalances.
Icelands former prime minister Geir Haarde, in power during the 2008 meltdown and currently facing trial over his handling of the crisis, has insisted his government did the right thing early on by letting the banks fail and making creditors carry the losses.
We saved the country from going bankrupt, Haarde, 68, told AFP in an interview in July.
As I noted last week:
Iceland told the banks to pound sand. And Icelands economy is doing much better than virtually all of the countries which have let the banks push them around.
Barry Ritholtz noted in May:
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.
Bloomberg pointed out in February:
Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the countrys banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.
Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks, says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. Irelands done all the wrong things, on the other hand. Thats probably the worst model.
Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital 46 billion euros ($64 billion) so far to prop them up. That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.
Countries with larger banking systems can follow Icelands example, says Adriaan van der Knaap, a managing director at UBS AG.
It wouldnt upset the financial system, says Van der Knaap, who has advised Icelands bank resolution committees.
Arni Pall Arnason, 44, Icelands minister of economic affairs, says the decision to make debt holders share the pain saved the countrys future.
If wed guaranteed all the banks liabilities, wed be in the same situation as Ireland, says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.
In the beginning, banks and other financial institutions in Europe were telling us, Never again will we lend to you, Einarsdottir says. Then it was 10 years, then 5. Now they say they might soon be ready to lend again.
Even the IMF praises Icelands strategy:
As the first country to experience the full force of the global economic crisis, Iceland is now held up as an example by some of how to overcome deep economic dislocation without undoing the social fabric.
While the conditions in Iceland are in many ways different from the conditions in the U.S., Icelands lesson applies to America, as well.
Specifically, a study of 124 banking crises by the International Monetary Fund found that propping banks which are only pretending to be solvent hurts the economy:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the governments fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
Indeed, numerous Nobel prize winning and otherwise highly-regarded American economists say that our economy cannot recover until the big banks are broken up.
If the politicians are too corrupt to break up the big banks (because the banks have literally bought the politicians), lets break them up ourselves.
Many people are doing just that.
Wait. That's sane and rational. Did Krugman smash his head stepping out of the airplane and start making sense?
The banks in Iceland relied primarily on depositors in Europe. The Icelandic economy was not hurt when those depositors lost their deposits.
It would be quite different if, for example, General Electric’s cash account at Bank of America were wiped out. They would not be able to pay employees or vendors, and would have to go bankrupt immediately.
Been sayin’ it from the git-go: NOBODY is “too big to fail”. Shame on Congress and two presidents.
The scary part is that the only reason Iceland did this is that a big leftist OWS style protest movement broke out and stopped the government from accepting an EU bailout deal.
Krugman was the biggest chearleader for the bailouts from day one. He still justifies them in the all too familiar “it had to be done” format. He still calls for more ‘stimulus’ which are nothing more than back door bailouts.
They guy is a total fake.
I believe there was a referendum and the people of Iceland convincingly told their government — NO. No BANK BAILOUTS.
That was my first thought also. How can I be on the same side as Krugman?
Do I need to re-think this?
Spot on. "Too big to fail" is a delusion of industrial policy types, if not actual socialists, at least moderately anti-capitalist dirigistes. Schumpeter's notion of "creative destruction" should be brought up loudly any time anyone asserts some enterprise is "too big to fail".
Nah, don’t second guess yourself: Krugman’s actually smart; he just believes one of those ideas that Orwell characterized as “so stupid only an intellectual could believe them” — Keynsianism. When he’s doing economic analyses in which the delusional idea that government can “prime the pump” during a recession with deficit spending is irrelevant, he often gets things right (as for example his work on trade and business siting that got him the Nobel).
All his worries over structure disappeared though, when Obama bailed out the auto industry. That had to be done. They were too big to fail, especially on a Democrat's watch.
Basically, his fealty to the idea of big government is secondary to his party hack inner core. It has to be his big government, or he's not interested.
Iceland was essentially a big fishing village. One day, they decided that they would be good bankers. They offered high return on investments in go-go times and suckers in Europe poured their money in with dreams of riches.
The go-go times ended, the money disappeared, the eurinals got pissed on, and Iceland went back to fishing.
Just imagine if the congress would have backed the voting public on TARP and dismantled the TBTF fraudulent banks and investment houses in 2008. We would have already been through the worse of it without going trillions of dollars more in debt to maintain the broken ponzi financing system that will still collapse in the future. Not only did Iceland put it’s country and people first, but they actually rounded up the crony capitalists and prosecuted them for their crimes. Accountability, not rewarding bad behavior, protecting the nation over the oligarchs, what radical thinking. Everyone said Iceland was doomed for not playing ball, looks like it is working out for them by taking their medicine.