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Iceland: You win some, you learn some

Iceland: You win some, you learn some

The Greek crisis has provided a lesson for governments around the world in what not to do. Greece’s years of covering up fiscal irresponsibility finally caught up with them, and the European Central Bank (ECB) had little mercy in its austerity measures and demands on the Greek government. This arguably hurt the Greeks more than it helped, especially those worst off; the only thing worse than a bad economy is no economy at all.

Greek crisis has provided a lesson for governments around the world in what not to do. Greece’s years of covering up fiscal irresponsibility finally caught up with it, and the European Central Bank (ECB) had little mercy in its austerity measures and demands on the Greek government. This arguably hurt the Greeks more than it helped, especially those worst off; the only thing worse than a bad economy is no economy at all.

Many economists, and the government itself, pointed to its euro membership as a source of Greece’s burden. The ECB maintains full control of the European Union’s finances and currency, which prevented the Greeks from doing more on their own in terms of devaluing the currency or making adjustments to interest rates.

The ECB has been cautious since the financial crisis in 2008 and 2009, as have most global financial institutions. However, this inaction has perhaps done more harm than good. Although banks were issued fines, the bankers themselves suffered very little personally.

Iceland approached things completely differently after it racked up debts worth around 10 times the country’s annual income. The country’s projected national debt is shown in Graph 1.

Instead of focusing solely on the institutions behind the poor procedures, Icelandic authorities also jailed individuals at the root of the cause. Instead of shutting banks and prompting panic among consumers, all the struggling banks stayed open. And instead of suffering with a currency that was not appropriate for its economy, Iceland took action and devalued the krone.

Globalisation has meant that financial institutions and sovereign economies are more intertwined now than ever before. When one goes down, others are likely to follow. Iceland’s three major banks – Landsbanki, Kaupthing, and Glitnir – all failed within a week of each other in October 2008.

Chris Iggo, fixed income chief investment officer at AXA Investment Managers, says, “It quickly became apparent in the wake of Lehman Brothers’ collapse in 2008 that the financial system had become a complex, tangled web of financial connections as a result of the massive growth in leverage, the proliferation of off-balance sheet financing vehicles and the myth of risk reduction through scrutiny.

“Everything was linked, from Northern Rock to Icelandic banks to sub-prime defaults and government fiscal balances, and we are still dealing with the consequences of disentangling all those connections and making sure that the system never becomes so susceptible to shocks again.”

They all went down together, but Icelandic authorities broke free in their reactions to these events. Although its economy is not directly comparable to many others – the country only has around 300,000 inhabitants – others could stand to learn a few lessons.

Caught red-handed

If common sense prevailed, those behind the financial crisis would all be sitting in prison, but while many of the major banks were handed heavy fines, few of the individuals suffered directly. Some may have had a bonus withheld, but none ended up behind bars. Even the fines issued to the banks have been criticised for being based on the banks’ ability to pay rather than the extent of the misdemeanour.