Reykjavík Grapevine - 20.05.2011, Page 14

David Howden is Assistant Professor of Economics at St. Louis University—
Madrid Campus. He recently published the book ‘Deep Freeze: Iceland’s
Economic Collapse’ along with his colleague Philipp Bagus.
Icelanders are upset.
That may be an un-
derstatement, and
it’s also unfortunate.
The real unfortunate part is
that they’re a little unsure
about what they’re upset
about.
Domestic bankers made some bad
loans. Icelandic consumers took on
more leverage than might otherwise
be sensible. Politicians (corrupt or
otherwise) made some promises that
they couldn’t keep. In a common story,
bankers and politicians became unusu-
ally friendly during the boom years. In
an unusual twist, central bankers and
politicians made for strange bedfel-
lows.
Whom should we blame? There are
the usual suspects—the ones that made
out so well during the boom that no one
could object to penalising them today.
And while some of this group—those
bankers that made money both by both
hook and crook—seem to be all-too-
easy targets, others were just trying to
make an honest króna.
It’s the same thing on the political
side of the fence. Although we can eas-
ily point to some less than level-headed
representatives during the boom, there
were also plenty of honest politicians.
After all, after the elections of 2009 only
26 Alþingi seats had a new bottom to
fill them—far less than half.
CBI’S LOOSE-MONEY POLICY
I would like to draw attention to an-
other usual suspect, but with a twist.
The Davíð Oddsson led Central Bank
of Iceland (CBI)—that venerable, if re-
cent creation of Alþingi—controls two
important facets of banking: regulation
and monetary policy. The CBI’s loose-
money policy throughout the 2000s
ushered in low interest rates (at least
when adjusted for inflation), and en-
ticed investors and consumers to take
on more debt than was prudent. Few
would argue today that Icelanders have
not become aware of the risks of bur-
geoning debt levels.
More latent, if salient, are the types
of guarantees that the CBI had com-
mitted itself to through its regula-
tory role. Contained in the new Central
Bank Act of 2001 (passed, incidentally,
while Davíð Oddsson served as Prime
Minister), was a promise by the CBI to
insure all bank accounts held with any
Icelandic bank. This pledge extended
regardless of the currency the account
was denominated in (whether krónur,
euro, dollar, yen, or even, presumably,
Congolese francs), and regardless of
the geographic location where the de-
posit was held (whether in Reykjavík,
Amsterdam, New York, Tokyo or, again
presumably, the Congolese capital of
Kinshasa). The new Act on the Central
Bank of Iceland is brief—700 words ex-
actly, including the title—but the ramifi-
cations were drastic.
By explicitly committing itself to act
as a “lender of last resort”, the CBI ef-
fectively gave investors a carte blanche
to not worry about their banks’ activi-
ties. No longer would a depositor be
concerned with whether her bank
prudently managed her hard-earned
wages, or whether the bank’s man-
agement was being transparent and
sensible. Bankers didn’t have to worry
much about these things either. The
CBI, backstopped by Alþingi, was there
to provide the necessary funds when
profits turned to losses. Heck, even the
IMF gave the green light to Icelanders
to continue their reckless spending
during the boom and to not fret over
and potential problems that could de-
velop. And problems did develop. So
many problems that no one was able to
deliver on their promises when the time
came.
WHERE WERE ICELAND’S FRIENDS?
It’s nice to have people say that they
will support you in your time of need.
The unfortunate part about this “sup-
port” is the behavioural change that
comes with it. Caution gets thrown to
the wind. A whole nation got swept up
in a euphoric sense of success, guaran-
teed by multiple layers of guarantees.
If you think that these guarantees are
being used as a scapegoat to absolve
some individuals from acting sensibly,
read what none other than Kaupthing’s
ex-CEO Ármann Þorvaldsson had to
say about his own decisions: “I always
believed that if Iceland ran into trouble
it would be easy to get assistance from
friendly nations.” These types of quotes
only beg the wrong type of questions:
Where were Iceland’s friends? Why
didn’t they come through? We can
speculate on why the guarantees and
promises never materialised, but it’s
mostly bygones by now.
Lest I be misunderstood, I am not
absolving Þorvaldsson (or any other
banker, lender or borrower) of re-
sponsibility. Nor do I pick him out for
any other reason than the fact that his
concise quote encapsulates the whole
point I wish to make. He was and is only
human; so were all the other Icelandic
bankers. If one wants to start finger
pointing, one needs to find the reasons
why that finger is directed at someone.
Lots of bankers (and individuals, busi-
nesses, and even politicians) acted
completely rationally given the incen-
tive structures they faced—however
perverse they were.
If you make someone an offer he
can’t refuse, he won’t. If you offer
someone an investment that she can’t
lose money on, she’ll invest. If you make
the deal sweet enough, she won’t even
ask questions about it. Depositors,
lenders and borrowers were given just
such a sweet deal in 2001 via the CBI’s
guarantee to insure their deposits—re-
gardless of the money’s physical loca-
tion or denomination.
THE RISK OF A FUTURE NOT UN-
LIKE THE PAST
I don’t write this as anyone who had
to live through the last three years of
Icelandic recession (or, unfortunately,
the boom). There are, in all honesty,
at least a milljónir ranghala that I don’t
understand about the beautiful country
and its people. I write as a person that
knows a crisis when he sees one. Finger
wagging at some guilty suspects might
provide some closure, but it doesn’t
do anything to improve an already bad
situation. The losses have been earned,
and the profits have been lost—finding
the guilty parties isn’t going to reverse
history. Identifying the true root causes
of the turmoil will enable Icelanders to
make sure that the same mistakes don’t
repeat.
Looking at how laws, particularly
banking laws, affect the incentives we
face will go far in reducing (or even
eliminating) the risk of these unfor-
tunate events from happening again.
Guaranteeing people’s deposits is just
one such way that the Central Bank of
Iceland created an atmosphere of risk-
taking from an otherwise reasonable
country. And as my co-author Philipp
Bagus and I outline in our new book
‘Deep Freeze: Iceland’s Economic Col-
lapse’, these guarantees came from all
layers of government, and covered all
sorts of investments. The guarantees
on Icelandic bank accounts that I have
discussed herein still remain on the
CBI’s statutes. Until they are changed,
the country faces the risk of a future
not unlike its recent past.
14
The Reykjavík Grapevine
Issue 6 — 2011
Opinion | Economics
Whom To Blame?
DAVID HOWDEN
GúNDI
“The losses have been earned, and the profits have
been lost—finding the guilty parties isn’t going to
reverse history. Identifying the true root causes of the
turmoil will enable Icelanders to make sure that the
same mistakes don’t repeat.”