Iceland’s Meltdown


With all of the focus in the United States on the collapse of Bear Stearns, AIG, Lehman Brothers, and Merril Lynch, we may be a bit myopic in not noticing other issues around the world. Iceland stands out as a country that has really run into trouble. As Michael Lewis wrote in Wall Street on the Tundra: “Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’”

The collapse has been so big that Iceland is abandoning its own currency to join the European Union. Until the collapse, Iceland had little interest in joining the EU. They do want the bureaucrats in Brussels messing with their fishing. Iceland put some excellent regulatory controls on fishing that have lead to stable fish populations and rich fishermen.

They failed to do the same with their financial system. They ended up having fisherman quitting the sea to engage in currency trading.

There are lots of lessons to be learned from a compliance and risk management perspective.

Legend has it that Joe Kennedy cashed out of the stock market when his shoeshine boy gave him stock tips. Maybe a warning sign should be fishermen engaging in currency trading. We saw similar events in the U.S. as people quit their jobs to be real estate entrepreneurs. I heard a success story from an acquaintance who told of buying a house for 100, putting in 10 and selling it for 120. I didn’t have the heart to tell him that house prices has risen by 15% during that same time frame. A rising market makes everyone look like a genius.

As Michael Lewis points out “One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem.” You saw that with Iceland’s collapse and you saw that with the collapse in the United States. The most publicity shined on Goldman Sachs for its profits in September 2007 made from shorting mortgage positions. I am sure that there were quite a few mortgage originators who knew they were peddling garbage. But they had no incentive to stop the income coming from origination fees.

The three biggest banks in Iceland, a country of only 310,000, made loans totaling over 850% of Iceland’s Gross Domestic Product.  Only 1/5 of the loans were in Iceland’s currency. They instead borrowed from their banks in cheaper currencies such as yen and Swiss francs. To compare, the balance sheet of Britain’s banking system was at 450% of GDP and the US at 350%. Clearly, carrying too much debt is a problem. Especially when their are few alternative sources of capital besides more debt.

Iceland’s debt load increased from 200% of GDP in 2003 to almost 1000% in 2008. That is an enormous growth curve. Even steeper than the rise of housing prices in the United States.

Economic cycles are part of human nature. We overbuy into good times and oversell in bad times. It easy enough to look back a few years to the Dot-Com bubble focusing on market share and eyeballs at the expense of the bottom line.