Iceland’s Financial Crisis & Lessons
The collapse of Iceland’s three largest commercial banks between 2008 and 2012 was the single largest economic crisis for a country in history. Since the banking sector accounted for such a large part of its economy, the failure of these banks led to a 90%+ drop in the country’s stock market and a steep rise in unemployment. In this article, we’ll take a look at how the government handled the crisis and what lessons it may hold for future crises.
Iceland’s problems began when the country decided to diversify into the offshore banking industry. With this new growth potential, the krona began to appreciate in value against the euro and pound. The currency’s appreciation led the central bank to raise interest rates to curb its rise, which led to more favorable rates for offshore depositors in its banks.
The party ended with the U.S. subprime mortgage crisis and Lehman Brothers bankruptcy, which caused a ripple effect throughout the international banking sector. Without the ability to borrow money, Iceland’s banks became unable to pay the high interest rates that they offered depositors and many of them quickly decided to close their accounts.
The bigger problem, however, was that these banks were larger than Iceland’s national economy, which made them impossible to bailout in the case of emergency. In fact, the total debt owed by Iceland’s banks topped 1.17 trillion krona or roughly 90% of its pre-crisis 2007 gross domestic product (“GDP”), practically guaranteeing their demise.
Iceland began by implementing capital controls in order to prevent currency traders from placing large bets against the krona. The IMF and a coalition of nordic countries also assembled a $5.1 billion bailout package that called for some austerity measures and “minimum deposit guarantee loans” to reimburse foreign account holders that lost their savings.
Unlike Greece, Iceland politicians brought their concerns to the public and let them vote on how to handle the matter. This resulted in better terms for their bailout deal which spared cuts to many social programs and included a longer-term repayment plan to foreign depositors. Private debt forgiveness programs were also introduced along with tax cuts for the poor.
The debt relief helped boost consumption and ultimately spur the economy to more than 4% growth during the first quarter of 2013. Meanwhile, the government has been able to sell some of the stakes that it acquired in the banks at favorable prices to offset its losses.
Iceland’s economy bounced back to growth just two years and voters seem to approve of the way the government handed the crisis, which comes in stark contrast to the ongoing recession and riots occurring in countries like Greece. Many economists point to Iceland as an example of how austerity may not always be the best policy when it comes to dealing with a crisis.
In addition to the economic benefits, Iceland’s citizens weren’t afflicted with the health impact of austerity seen in other countries. There was very little change in healthiness reported throughout the crisis, compared to countries like Greece that saw much worse outcomes. While the country still grapples with low investment and somewhat high unemployment, the way the government handled the crisis could become a new model for how things should be done.
Causes of the Crisis
Iceland’s problems began when the country decided to diversify into the offshore banking industry. With this new growth potential, the krona began to appreciate in value against the euro and pound. The currency’s appreciation led the central bank to raise interest rates to curb its rise, which led to more favorable rates for offshore depositors in its banks.
The party ended with the U.S. subprime mortgage crisis and Lehman Brothers bankruptcy, which caused a ripple effect throughout the international banking sector. Without the ability to borrow money, Iceland’s banks became unable to pay the high interest rates that they offered depositors and many of them quickly decided to close their accounts.
The bigger problem, however, was that these banks were larger than Iceland’s national economy, which made them impossible to bailout in the case of emergency. In fact, the total debt owed by Iceland’s banks topped 1.17 trillion krona or roughly 90% of its pre-crisis 2007 gross domestic product (“GDP”), practically guaranteeing their demise.
Solutions to the Crisis
Iceland began by implementing capital controls in order to prevent currency traders from placing large bets against the krona. The IMF and a coalition of nordic countries also assembled a $5.1 billion bailout package that called for some austerity measures and “minimum deposit guarantee loans” to reimburse foreign account holders that lost their savings.
Unlike Greece, Iceland politicians brought their concerns to the public and let them vote on how to handle the matter. This resulted in better terms for their bailout deal which spared cuts to many social programs and included a longer-term repayment plan to foreign depositors. Private debt forgiveness programs were also introduced along with tax cuts for the poor.
The debt relief helped boost consumption and ultimately spur the economy to more than 4% growth during the first quarter of 2013. Meanwhile, the government has been able to sell some of the stakes that it acquired in the banks at favorable prices to offset its losses.
Crisis Aftermath & Lessons
Iceland’s economy bounced back to growth just two years and voters seem to approve of the way the government handed the crisis, which comes in stark contrast to the ongoing recession and riots occurring in countries like Greece. Many economists point to Iceland as an example of how austerity may not always be the best policy when it comes to dealing with a crisis.
In addition to the economic benefits, Iceland’s citizens weren’t afflicted with the health impact of austerity seen in other countries. There was very little change in healthiness reported throughout the crisis, compared to countries like Greece that saw much worse outcomes. While the country still grapples with low investment and somewhat high unemployment, the way the government handled the crisis could become a new model for how things should be done.
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