Reykjavík Grapevine - 15.07.2011, Blaðsíða 12

Reykjavík Grapevine - 15.07.2011, Blaðsíða 12
12 The Reykjavík Grapevine Issue 10 — 2011 Magnús Sveinn Helgason is a historian. He most recently authored addendum five to the SIC Report, and is currently working on a book about 'financial bubbles'. It is curious, when one considers how obvious it now seems that the Icelandic financial miracle was a giant bubble, that this idea has re- ally not received any attention from academic economists. In fact there are no academic studies that ad- dress the question whether or not the Icelandic financial miracle was a bubble—or if it was, when it be- came one. This is all the stranger because of the centrality of finance in the Icelandic economy during the past decade—one would have assumed that Icelandic economists would have taken up this question. After all, it is one of the reoccurring themes of financial economics and financial history. Perhaps all the economists were too busy engineering derivatives or work- ing at complex deals for the banks to spend time on idle research? Perhaps the question didn‘t seem important? Perhaps the answer was too obvi- ous and the existence of a bubble too glaring to warrant any research? Why spend time studying something and proving the existence of something that is apparent to any casual observer? Or, perhaps, the question was too controversial. After all, it might have caused a bit of alarm had an Icelandic economist—as opposed to some for- eigner “who doesn’t understand Ice- land and the Icelandic economy”—had pointed out the obvious: That the ‘fi- nancial miracle’ was nothing more than a bubble. Whatever the reason, this is a strange omission in Icelandic econom- ics scholarship. An omission that prob- ably tells us something about the state of the economics profession in Iceland. A BUBBLE OF HISTORICAL PRO- PORTIONS One measurement of bubbles is the size of the price increases while the bubble is inflating, and then the size of the fall as it comes crashing down. If we employ these measures the Icelan- dic financial bubble does, in fact, seem rather enormous. During the great bull market of the 1920s, between 1921 and September of ’29, the Dow Jones index rose by 490%. In the internet bubble of the ‘90s, NASDAQ gained an impres- sive 570% between 1995 and March 2000. The Icelandic Financial Miracle, however, outdid both, as the Icelandic market grew by a staggering 680% be- tween 2002 and July 2007, when the market peaked. The Icelandic crash was similarly spectacu- lar. When the internet bubble burst, NASDAQ dropped by 78% in two and a half years, be- tween March 2000 and October 2002. In the ‘Great Crash’ of ’29— which actually lasted for nearly three years, be- tween September 1929 and July 1932—the Dow Jones lost 91% of its value. During the Icelandic crash, which lasted a little over a year, the Ice- landic market lost 95% of its value. This is actually a world record for a stock market crash! So, it was no ordinary bubble. It was a bubble of historical proportions. The only viable alternative is that ‘some- thing remarkable’ happened in Ice- land around the turn of the century, something so amazing that it suddenly made Icelandic assets far more valu- able than they had been, triggering a 680% ‘price correction,’ only to be fol- lowed by another equally drastic 95% ‘price correction,’ caused by a sudden unforeseeable change in the underly- ing fundamentals. HOW TO DENY A BUBBLE This latter scenario would be the basic model of any paper that followed the ‘efficient market hypothesis,’ the idea that market participants are rational and that stock markets are efficient— that they always incorporate all avail- able information, making prices a cor- rect reflection of underlying economic realities. The rise could not have been caused by the madness of crowds, an irrational exuberance of investors who were picking and choosing what infor- mation to act on, over-hyping positive news and ignoring warning signs. No, if prices rise spectacularly, it must be because the underlying fundamentals warrant such a rise. When they fall, it is because the underlying fundamen- tals have changed. And if the fall is very sudden, it must be because the change was unforeseeable and the information about these changing underlying fun- damentals arrived very suddenly. How would one go about making this argument? Well, one simply goes back to the boosters of the bubble and assumes their arguments were cor- rect—or rather, that there was no way to know, at the time, that they were any- thing but rock solid. Financial econo- mists can also use all kinds of statisti- cal tools to show that market indicators were all ‘normal,’ that even the most advanced statistical tools could not have predicted the collapse and so on and so forth. But since we don’t have such statistical tools at hand, and since such statistical exercises are dreadfully boring anyway, I suggest we explore the former route, assuming that people were right when they observed the bubble inflating, proclaiming to them- selves, “this time it’s different.” HOW WAS IT DIFFERENT? Just as in all other cases of irrational exuberance, those who claimed things were somehow different could, at the time, point to some pretty compelling arguments to bolster their case. All epi- sodes financial historians have identi- fied as bubbles begin as reasonable price increases, a strong bull market, based on some sound fundamentals, a price correction triggered by some dramatic economic change which justi- fies increased optimism. At some point, however, prices simply lose their moor- ings to these underlying fundamentals and start heading toward the strato- sphere. The Icelandic economy had under- gone a dramatic transformation in the 1990s, due in part to massive free mar- ket reforms. At the same time all cur- rency controls had been lifted, opening the financial system up to global mar- kets. All of this seemed to have un- leashed tremendous energy—pundits and politicians were particularly fond of pointing to the foreign investments of the banks and allied Icelandic busi- ness Vikings as proof of this explosive energy. During the earliest phases of the Icelandic asset bubble, rising prices were explained with increased effi- ciency due to mergers and restructuring of existing firms made pos- sible by the creation of a stock market and the transformation of the banking system. When the opportunities for mergers and takeovers in Iceland had dwindled and the banks and busi- ness Vikings had turned their eyes outward, the rising stock prices were explained by the potential and profitability of foreign expansion. At first glance this reasoning seemed, and still seems, pretty con- vincing. CIRCULAR LOGIC The rule of thumb measures used to judge stock prices similarly appeared to justify higher prices. The price-earn- ings ratios of the Icelandic market were relatively low in international compari- son, leading Kaup!ing to suggest in April 2007 that market valuations were relatively low in international compari- son (a price-earnings ratio, or a P/E ratio, is the number of years of current profits it would take a company to jus- tify its market price). The P/E ratios of the investment companies which domi- nated the Icelandic stock market and which led the ballooning asset bubble appeared especially reasonable. In July 2007, the price-earning ratio of FL- Group was 9,4—which is not at all that outrageous—the historical average P/E ratio of firms in the S&P 500, a broad measure of the US stock market, was around 15. Since the P in the P/E ratio was as- tronomically high (the market value of FL Group was over 400 billion ISK in July 2007, or some 6,7 billion dollars. To put that in perspective—Twitter was recently valued at 7 billion dollars), the P/E ratio could only be reasonable if the E of the equation was equally high. And of course it was—all these firms were making record profits. The profit of FL Group during the first six months of 2007 was 23 billion ISK. But since as- sets were booked at their current mar- ket price, rising asset prices showed up as profits on the books, meaning the massive profits of these compa- nies were largely the result of a rising market, which in turn generated even larger profits. This circular logic was constantly used to justify ever higher prices, and surprisingly few people pointed out how absurd this really was. A edito- rial in the business section of Morgun- bla"i" made a note of this in July 2004, remarking that this logic was made worse by the cross-ownership of finan- cial firms and that it could work both ways: a drop in stock prices would lead to a chain reaction of losses and falling prices. But the market apparently shrugged off these concerns. And, strangely enough, nobody made any attempt to explain why exactly it was reasonable to expect FL Group or any of these companies to maintain astronomical profits for a decade. Especially since such profits could only be maintained if asset prices continued their upward march unstopped, it seems odd to as- sume that they would continue to grow at the same rate as they had. How on Earth was this supposed to work? The absurdity of these ex- pectations is especially glaring when we consider the banks. Their stock prices rose by 444% (Glitnir), 536% (Landsbankinn) and 661% (Kaup!ing) between January 2004 and July 2007, thanks to handsome profits caused by profitable investment banking op- erations at home and abroad. But their high stock prices could only be justi- fied if they continued to grow. And who could seriously expect the banks to continue to expand their balance sheets? Between 2004 and 2007 the banks grew their books sevenfold—at the end of 2007, their assets were 870% of Iceland’s GDP. The FDIC, which reg- ulates deposit institutions in the US, considers annual growth that exceeds 25% a red flag—indicating that the in- stitution in question has taken on too much risk. The Icelandic banks would have raised a whole lot of red flags at the FDIC. Finance | Bubbles Playing The Game Of ‘This Time It’s Different’ How Iceland almost became ‘a global finance centre’—ha ha ha “When the internet bubble burst, NASDAQ dropped by 78% in two and a half years, between March 2000 and October 2002. In the ‘Great Crash’ of ’29—which actually lasted for nearly three years, between September 1929 and July 1932—the Dow Jones lost 91% of its value. During the Icelandic crash, which lasted a little over a year, the Icelandic market lost 95% of its value. That is actually a world record for a stock market crash!” Continues on page 44 Words Magnús Sveinn Helgason
Blaðsíða 1
Blaðsíða 2
Blaðsíða 3
Blaðsíða 4
Blaðsíða 5
Blaðsíða 6
Blaðsíða 7
Blaðsíða 8
Blaðsíða 9
Blaðsíða 10
Blaðsíða 11
Blaðsíða 12
Blaðsíða 13
Blaðsíða 14
Blaðsíða 15
Blaðsíða 16
Blaðsíða 17
Blaðsíða 18
Blaðsíða 19
Blaðsíða 20
Blaðsíða 21
Blaðsíða 22
Blaðsíða 23
Blaðsíða 24
Blaðsíða 25
Blaðsíða 26
Blaðsíða 27
Blaðsíða 28
Blaðsíða 29
Blaðsíða 30
Blaðsíða 31
Blaðsíða 32
Blaðsíða 33
Blaðsíða 34
Blaðsíða 35
Blaðsíða 36
Blaðsíða 37
Blaðsíða 38
Blaðsíða 39
Blaðsíða 40
Blaðsíða 41
Blaðsíða 42
Blaðsíða 43
Blaðsíða 44
Blaðsíða 45
Blaðsíða 46
Blaðsíða 47
Blaðsíða 48
Blaðsíða 49
Blaðsíða 50
Blaðsíða 51
Blaðsíða 52
Blaðsíða 53
Blaðsíða 54
Blaðsíða 55
Blaðsíða 56
Blaðsíða 57
Blaðsíða 58
Blaðsíða 59
Blaðsíða 60
Blaðsíða 61
Blaðsíða 62
Blaðsíða 63
Blaðsíða 64

x

Reykjavík Grapevine

Beinir tenglar

Ef þú vilt tengja á þennan titil, vinsamlegast notaðu þessa tengla:

Tengja á þennan titil: Reykjavík Grapevine
https://timarit.is/publication/943

Tengja á þetta tölublað:

Tengja á þessa síðu:

Tengja á þessa grein:

Vinsamlegast ekki tengja beint á myndir eða PDF skjöl á Tímarit.is þar sem slíkar slóðir geta breyst án fyrirvara. Notið slóðirnar hér fyrir ofan til að tengja á vefinn.