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Deep Freeze: Iceland's Economic Collapse



March 03, 2011 – Comments (7)

It's rare that I move past simple book recommendations to outright urging you to read something.  This book is so good it requires urging. This the story of Iceland's economic boom and bust.  The full text has been made available for free by the authors (Phillip Bagus and David Howden) and can be read here.

In a crisp 125 page treatise that weighs in equally on theoretical and empirical analysis, Bagus and Howden uncover the root causes of Iceland's rise and catastrophic collapse.  Chapter 2, for example, analyzes the tremendous amount of maturity mismatching in the bank assets of Iceland's TBTF top 3 banks. Chapter 4 looks at the currency mismatching of these same institutions. Chapters 1 and 3 detail the theoretical analysis that lays the framework for understanding the concepts at a deeper level. However, if you are already familiar with concepts like moral hazard, malinvestment, credit expansion, or Austrian Business Cycle Theory it's probably safe to skip ahead. Chapter 5 details some of the grossest examples of malinvestment during the boom phase. From there, the crash and ensuing interventions are analyzed. Finally, ideas for reform are presented.

Maturity mismatching occurs when a bank takes on short term debt while loading up on long term assets. Short term debt must be constantly rolled over, obviously. Though it is a risky operation, it is also very profitable.  Long term rates are typically higher than short term rates and banks profit from the spread.

Borrowing short and lending long has long been known to be hazardous to a bank's health. At some point in our recent past, it became not only an accepted practice, but an encouraged one. Indeed, even as the wreckage of Iceland was laid before us, IMF economists/technocrats were advising Icelandic banks to increase the maturity mismatching!  At the height of the crisis Iceland's 3 largest banks (which accounted for roughly 80% of Iceland's banking sector assets) were short the equivalent of half of the country's GDP in liabilities due in 3 months. 

Take a moment to let that sink in.

Yes, that's right. In order to fulfill the obligations that banks had made in the next three months minus short term assets, the people of Iceland would have to be twice as productive as they normally were and hand all of that productivity over to the banks. 

Takng this evidence under consideration, I wonder about other areas of life IMF technocratic advice might be useful. If I fell down the stairs would Jack Boorman advise me, "your problem is that you didn't pick up enough speed to offset the fall. Try taking the elevator to the top floor and jump out the window."

When it comes to currency mismatching, it's all about risk, or rather, the reduction of perceived risk due to continuous and ever expanding IMF intervention in the foreign exchange markets.  Much like the situation with maturity mismatching, the Icelanding banks took the carry-trade concept and reductio'd ad absurdum.

Iceland's economic boom/bust, in fact, can be looked at as the logical outcome of taking illogical technocratic economic management ideas and implementing them to the fullest. Iceland didn't just try a little here and there. Guided by the IMF and the Central Bank of Iceland, coupled with the typical government interventions (Iceland's HFF played the Fannie/Freddie role), Iceland wholeheartedly embraced, nay, exceeded all expectations in what technocratic utopia could make possible!

It's a good thing we've stopped listening to these kinds of charlatans. Oh wait....

Enjoy the read.

David in Qatar

7 Comments – Post Your Own

#1) On March 03, 2011 at 3:37 PM, ChrisGraley (28.61) wrote:

Thank you David,

This is a topic that I'm very interested in and I'll download this to my Nook later.

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#2) On March 03, 2011 at 6:37 PM, whereaminow (< 20) wrote:


I'd be interested to get your take on it when you're through so hit me on whatever comment thread we wind up on when you finish.


David in Qatar

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#3) On March 03, 2011 at 6:57 PM, ChrisGraley (28.61) wrote:

will do!

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#4) On March 03, 2011 at 10:37 PM, Valyooo (34.94) wrote:

I will read this in the next 2 months, thanks for the tip.

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#5) On March 04, 2011 at 12:41 AM, whereaminow (< 20) wrote:


Same goes to you. When you do get to it, hit me up and let me know what you thought.

David in Qatar 

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#6) On March 04, 2011 at 1:31 AM, ChrisGraley (28.61) wrote:

I'm about halfway through and I'll give you a quick update. (yeah I know, I like to read a lot)

The first thing that struck me is that they didn't do anything different than any other country, they just did it at a larger extent.

Most of the begining was just basic economics (just like you said)

The thing that struck me early was the extent that the government was in control of the banks just excalated the crisis.

They didn't seem to police evil, they blazed new ground.

So far the Maturity mismatch thing suprised me the most though.

Most of the rest is basic economics, but you would never suspect a bank borrowing in the short term and lending in the long term and  expecting it to be sustainable. (especially given the currency and malinvestment risk that they decided to take)

The thought that a bigger nation would bail them out didn't faze me. Our big banks still expect us to bail them out.

The maturity mismatch thing reminded me most about the uneasyness that I felt when Clinton refinanced all the long term debt into short term debt. I can't fault him because he did get away with it without negative results, but I do remeber how nervous I was at the time.

Last, the biggest thing is really the fact that the government which should be limiting speculation, seemed to encourage it in this case. This should be #1 on most people's lists, but I'm too used to it. It's been going on for years. The warning signs were there.  Iceland would be better off if they didn't have a government in charge of their best interests. It's the government that killed them in my opinion so far.



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#7) On March 04, 2011 at 12:30 PM, whereaminow (< 20) wrote:


Thanks for the quick update! 

I am in total agreement.  There was another part of the book that I didn't bring up that I found interesting.  Their carry-trade was mostly short term debt denominated in Yen.  I think the number was somewhere around 75% of all short term debt was denominated in Japanese currency.  This was due to the BOJ's policy of near zero interest rates to "stimulate" their economy for years on end.

How delightful!

What other country do we know that is trying to run near-zero interest rates?  Hmmmm....

And who is loading up on short term said country's debt?

Makes me wonder about China's future....

David in Qatar 

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