Lesson from Iceland's 2008 Financial Crisis: Let Banks Fail

By:  Bruce Walker
11/09/2011
       
Lesson from Iceland's 2008 Financial Crisis: Let Banks Fail

The downward spiral of the Greek economy — and now likely that of Italy — has led to calls for the European Union to step in and prevent a total collapse. Portugal, Ireland, and Spain — the other three of the so-called PIIGS EU member-states — are enduring their own woes, such as downgrades of sovereign debt and corresponding jumps in the interest rates on government bonds. The cumulative effect — particularly if Italy does suffer a crisis serious enough to reduce its national credit rating to junk-bond status — will ripple throughout Europe and across the Atlantic.

Analysts have noted that continental Europeans would do well to copy the example of tiny Iceland, in how it weathered a financial crisis three years ago which stunned the placid island nation. In October 2008, its binge of bank speculation had reached a point at which the assets of the three largest Icelandic banks — Kaupthing Bank, Landsbanki, and Glitnir Bank — were 11 times greater than the entire $14 billion GDP of the nation. All three big banks defaulted on $62 billion of foreign debt, and then went belly up, not bailed out by Icelanders. Today the country's economists view that bankruptcy as a blessing in disguise. Icelandic bank analyst Jon Bjarki Bentsson put it this way:

The lesson that could be learned from Iceland's 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. 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.

The downward spiral of the Greek economy — and now likely that of Italy — has led to calls for the European Union to step in and prevent a total collapse. Portugal, Ireland, and Spain — the other three of the so-called PIIGS EU member-states — are enduring their own woes, such as downgrades of sovereign debt and corresponding jumps in the interest rates on government bonds. The cumulative effect — particularly if Italy does suffer a crisis serious enough to reduce its national credit rating to junk-bond status — will ripple throughout Europe and across the Atlantic.

Analysts have noted that continental Europeans would do well to copy the example of tiny Iceland, in how it weathered a financial crisis three years ago which stunned the placid island nation. In October 2008, its binge of bank speculation had reached a point at which the assets of the three largest Icelandic banks — Kaupthing Bank, Landsbanki (pictured), and Glitnir Bank — were 11 times greater than the entire $14 billion GDP of the nation. All three big banks defaulted on $62 billion of foreign debt, and then went belly up, not bailed out by Icelanders. Today the country's economists view that bankruptcy as a blessing in disguise. Icelandic bank analyst Jon Bjarki Bentsson put it this way:

The lesson that could be learned from Iceland's 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. 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.

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Photo: Former headquarters of Landsbanki in Reykjavik, Iceland's capital.

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