The American Interest
Analysis by Walter Russell Mead & Staff
Learning From Iceland’s Recovery

Iceland was a poster child for the kind of crazy speculative real-estate-fueled boom-and-bust that characterized the 2008 crash around the developed world. Now Reuters is reporting that Iceland is on the mend. How did it do it? Part of it was due to the blessing of being a relatively small economy not directly tethered to the euro, which allowed the government to depreciate its currency, regain competitiveness for its exports, and make itself an attractive tourist destination once again.

But profligate Greeks chomping at the bit to leave the eurozone shouldn’t get too excited. It turns out that currency depreciation is not the whole story:

Capital controls, progressive taxes and a careful phasing-in of austerity measures were also key to getting the country back on track, bringing a more than 10 percent fiscal deficit back to a near balance.

Iceland also did what other parts of Europe haven’t dared to do—let its banks go under. It took some of the cost itself but forced foreign creditors to take the biggest hit.

The article rightly points out that the heterodox Icelandic approach is not universally applicable. But that’s not the important take-away from the story, as Via Meadia sees it. Rather, it’s that sometimes it is best to rip off the band-aid rather than prolong the agony. The pain was intense, and the crisis has left deep wounds on Icelandic society that may take years to scab over. But there is life after the crash.

Sometimes it’s better to take the hit and move on — and there is no moral obligation to rescue banks or bank stockholders when loans go bad. Capitalism is about risk, and while the general good may sometimes require financial bailouts and other methods at the height of a crisis, the moral hazards created by profligate and indiscriminate bailouts in the long run can be more costly and more destructive than a short and sharp financial crash.

Published on May 1, 2012 12:00 pm
  • thibaud

    Reuters’ sentence needs to be amended:

    “Iceland also did what America hasn’t dared to do to any of its massive zombie banks – let them go under.”

    The biggest handicap to our recovery has been our pols’ and bankers’ stubborn refusal to force a write-down in Citibank’s, BoA’s etc rotten mortgage portfolios.

    Unlike the nordic countries in the early 1990s, or even the US after the savings & loan debacle during the same era, our elites today are refusing to put any pressure on the top 5 banks to accept the kinds of haircuts and financial workouts that the system desperately needs to get capital flowing and markets functioning again.

    Instead, our policy re our own rotten banking sector has been to do everything possible to help the zombie banks repair their balance sheets, avoid write-downs, prop up share prices.

    Bizarrely, we’ve seen this before, and gone through it successfully wrt S&L and the Latin Debt crises from 20 years ago. Ken Rogoff and plenty of other economists called for workouts _four YEARS ago_. Occam would call this prima facie evidence of corruption.

    As a shrewd commenter noted on one of the Europe threads, our biggest crisis is not financial but moral. Any system, blue red or in between, can be ruined by self-seeking individualists who have captured the political heights.

    In contrast to the Canadians, Danes and Swedes, we have a corrupt alliance between the US political class and our TBTF banks that should have been broken up years ago.

    Ironically, the high-growth, efficient, nations today are the blue, or maybe “purple” ones that wisely took aim at their banksters and cleaned house in ways that our elite refuses to do. Sweden and Canada are kicking our behind when it comes to growth. Sweden has done so for 15 years running.

  • thibaud

    Banking isn’t some kind of black box, or set of sacred mysteries. Boom and bust speculative cycles and financial crises happen again and again, and the lessons of how to deal with them are well known – to smart and honest people who’ve successfully managed them, anyway.

    Here’s one of the sober, smart, honest nordic bankers on the lessons that the nordic countries learned in cleaning up their own colossal banking mess in the early 1990s:

    http://www.imf.org/external/np/speeches/2002/091102.htm

    Irony of ironies, this speech was given in 2002, in the wake of the Asian Contagion meltdown, but much of what he says seems to have been forgotten by our own bank-coddling political class. Several of the factors that made the Asian crisis even worse than the nordic ones are, oddly enough, to be found in our own US system today. See #3 especially:

    “3. Ability of political systems to make decisions in the public interest

    “A very basic issue for the success of any systemic bank restructuring is the ability to get political decision makers to recognize that there is a problem, that the problem is severe, that it requires quick and resolute actions, and that the problems largely are technical rather than political in nature.

    “How lucky we were in the Nordic countries to have governments able to make tough decisions and leaving most of the implementation to a group of civil servants (statstjansteman) and technical experts.

    “In other countries, vested bank owner and borrower interests sabotage such actions through political interference, corruption and intimidation of courts and officials, etc.

    “Necessary political decisions such as loss sharing and the allocation of public support funds are hard to come by, even in cases where the governments have the financial capacity to provide the resources.

    “It is much easier to do nothing and wish the problems away. Needless to say, burden sharing decisions become exponentially more difficult when public financial resources are severely limited or nonexistent….”

    Too bad the US didn’t apply its own IMF-style medicine to its own corrupt and cratering banking sector:

    “… let me mention some of the important lessons from the Nordic countries that became part of the policies for dealing with banking crises that were adopted by the IMF. In the mid-1990s, many of them were substantially at odds with the common view of a dominant group of US RTC-inspired financial economists.

    “The principal one is that you cannot rely on the private sector or markets alone to solve systemic banking problems.

    “Similar to the need for a lender of last resort to deal with systemic liquidity shortfalls, there is need for an investor or owner of last resort when all other sources of capital have dried up—and closing down an entire banking system is not a feasible option.”

  • Paul McCaffree

    no worry . . . oppressive taxation & regulation are keeping them at bay, yet we have to find a way to pay 4 these golden parachute retirements, a 50 cent tax on NG will due, considering . . . we are sitting on a lot of it. (*note, proper training tells you to never finish a sentence with “it”. Although, that can be tough to do after a good afternoon supper & grog.

  • Jim.

    @thibaud-

    The problem is, after the GM bailout (and the rest of the heavily Politically Correct Obama stimulus) people don’t trust the Democrats to do the right thing when it comes to restructuring. The other side of the problem is that even stringent-measures Republicans like Paul Ryan, whose early works show that he at least understands th depth of our Debt/Entitlement crisis, is being forced too far to the Left by an electorate still in denial about the magnitude of the cuts we’re going to have to make.

    No one can solve this problem until the electorate comes around. The Left’s unrelenting war on the Tea Party, along with members of that group still in denial about the cuts that must be made, have blunted that most promising advance. The fact that there were not riots in the streets over Obama’s trillion-dollar deficits have allowed the problem to get enormously worse.

    America is trying to muddle through a hole that gets deeper by the hour. Maybe God will smile on us again and lift us out; but with idiots like Reich and Krugman still influential over the direction of the nation’s finances, hope continues to dim.

  • Kris

    “Learning From Iceland’s Recovery”

    You are not making it explicit that those who should do this learning are the Europeans, and not a certain 50-state country. Can this possibly be intentional?

  • thibaud

    @Jim. – it’s not a partisan issue. Neither party has acted or wanted to act.

    Ken Rogoff’s prescriptions for forced haircuts and financial workouts were made in Sept 2008, while the Bush admin was in office. Bush’s own former adviser, Columbia B-School head Glenn Hubbard, made similar recommendations.

    The TBTF lenders and their sick portfolios are the dead hand (no pun intended) on the mortgage market, which is the dead weight on the housing market, which is the dead weight on our lopsided, consumer-dependent economy that requires a widespread “wealth effect” mentality in order for US households to spend spend spend.

    So long as the housing market is in the tank, the recovery will be lame. Neither party has shown any real interest in or commitment to fixing the problem.

  • Jim.

    @thibaud-

    I’ve been saying for years that we need to break up any bank that’s “too big to fail”, and that the “wealth effect” is one of the most reckless frauds ever perpetrated by presidents on both sides of the aisle — Bush, and Clinton before him.

    And yet, for every pair of disputants from differing sides of the spectrum that can come together over issues like that, there seem to be four that come together to support the status quo of big banks and easy credit.

    Worse, for every Broccoli partisan there is an Asparagus partisan (gold standard, maybe) and a Brussels Sprout supporter (world gov’t type, maybe).

    The center is hardly unified; some call themselves “centrists” because they’re a mix of extremes… others, simply because they’ve manged to alienate both major parties. (Oops, this really goes in the new long-form for today, doesn’t it.)

    As for solutions… none have crystallized yet. Aside from Iceland, I guess. Good for them.

  • http://facingzionwards.blogspot.com/ Luke Lea

    I like what thibaud has to say.

    I also liked this: “Capital controls, progressive taxes and a careful phasing-in of austerity measures were also key to getting the country back on track …”

  • Paul McCaffree

    fog horn, leg horn, has spoken

  • Hutcher

    @thibaud #1:

    Yes the issue is essentially moral; and the deeper issue is cultural. A brief story:

    In the depths of the Depression, my grandparents, dry-land farmers in eastern New Mexico (really dry!) received loans from some New Deal agency or other to buy seed and otherwise see them through the crisis. Some years later a bureau-dandy showed up at their doorstep to to smugly inform them that they would not be required to repay the loan. They refused. “You will get all your money back from us,” they told him. His response is not known.

    How does this relate to TBTF banks? The money-for-nothing mindset, which in my grandparents day would have been viewed little better than pedophilia, now pervades our society top-to-bottom. Does America have the the collective cojones to repudiate this delusion? The future of our economy and our very way of life depends upon it.

  • Snorri Godhi

    “But profligate Greeks chomping at the bit to leave the eurozone shouldn’t get too excited. It turns out that currency depreciation is not the whole story”

    This is quite misleading. For the Greeks, profligate or not, currency depreciation is not even part of the story: their debt is denominated in euros, and would remain in that denomination even if Greeks, learning a completely wrong lesson from Iceland, decided to leave the eurozone.
    (Of course, the Greeks could unilaterally convert the debt into New Drachmas; but then, they might just as well cancel it altogether.)