Top Economists Recognize Iceland Did it Right

It was six months ago that I wrote about Iceland succeeding where Greece had failed. In that post I pointed out that Iceland allowed its banks to fail, protected its citizens and prosecuted bankers that had committed crime. The result was sharp contraction in GDP in 2009 followed by a normal recovery and return to about 3% growth. When I wrote that last post in February Iceland's credit rating had already recovered to BBB- by Fitch, a lower, but still investment grade rating. Today, Nobel Prize economists and even the IMF (who's prescription for ailing countries is usually more similar to the path of Greece) has recognized that Iceland is a success and has clearly done the right thing.

Via Zerohedge:

Nobel prize winning economist Joe Stiglitz notes:

What Iceland did was right. It would have been wrong to burden future generations with the mistakes of the financial system.

Nobel prize winning economist Paul Krugman writes:

What [Iceland's recovery] demonstrated was the … case for letting creditors of private banks gone wild eat the losses.

Icenews points out:

Experts continue to praise Iceland’s recovery success after the country’s bank bailouts of 2008.

Unlike the US and several countries in the eurozone, Iceland allowed its banking system to fail in the global economic downturn and put the burden on the industry’s creditors rather than taxpayers.

***

The rebound continues to wow officials, including International Monetary Fund chief Christine Lagarde, who recently referred to the Icelandic recovery as “impressive”. And experts continue to reiterate that European officials should look to Iceland for lessons regarding austerity measures and similar issues.

Barry Ritholtz noted last year:

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

Krugman also says:

A funny thing happened on the way to economic Armageddon: Iceland’s very desperation made conventional behavior impossible, freeing the nation to break the rules. Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net. Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver.

Even "more monetary stimulus Krugman" now sees that letting banks fail leads to a quicker recovery. We can see what the alternative brings by looking at Japan where "zombie banks" were preserved at the expense of economic growth resulting in two decades of economic depression.

As you can see from the chart above their growth rate has averaged between zero and one % of GDP. This in spite of the same ZIRP policies that we are now trying here in the US.

I would argue that zero percent interest rates has not been a stimulus but rather have been an impediment to the efficient allocation of capital. Clearly ZIRP has not gotten Japan out of their economic slump.

But Iceland did more than just allow their banks to fail, and this, I believe, is an important lesson for use here in the US:

Barry Ritholtz noted last year:

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

Bloomberg pointed out February 2011:

Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country’s banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.

***

“Iceland did the right thing … creditors, not the taxpayers, shouldered the losses of banks,” says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. “Ireland’s done all the wrong things, on the other hand. That’s probably the worst model.”

Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital — 46 billion euros ($64 billion) so far — to prop them up. That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.

***

Countries with larger banking systems can follow Iceland’s example, says Adriaan van der Knaap, a managing director at UBS AG.

“It wouldn’t upset the financial system,” says Van der Knaap, who has advised Iceland’s bank resolution committees.

***

Arni Pall Arnason, 44, Iceland’s minister of economic affairs, says the decision to make debt holders share the pain saved the country’s future.

“If we’d guaranteed all the banks’ liabilities, we’d be in the same situation as Ireland,” says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.

***

“In the beginning, banks and other financial institutions in Europe were telling us, ‘Never again will we lend to you,’” Einarsdottir says. “Then it was 10 years, then 5. Now they say they might soon be ready to lend again.”

And Iceland’s prosecution of white collar fraud played a big part in its recovery:

[The U.S. and Europe have thwarted white collar fraud investigations ... let alone prosecutions.] On the other hand, Iceland has prosecuted the fraudster bank heads (and here and here) and their former prime minister, and their economy is recovering nicely … because trust is being restored in the financial system.

In my previous post I wrote my conclusion which is just as accurate as ever:

Lesson for us in the US

While Iceland sent its banksters to jail, not a single one here in the US has gone to jail for the massive fraud perpetuated on the American people and the international investors who bought the mortgage derivatives thrown together with loans signed by “Linda Green”.  Even now, not a single arrest has been made resulting from the theft of over a $1 Billion after MF Global stole client money from segregated accounts. In addition, rather than bailing out their banks as the US did, they partially nationalized them. The advantage of this is that there is now an expectation that the government won’t bail them out while in the US the big banks know Bernanke and Congress will always bail them out no matter how bad their behavior. They can keep the profits in the good times and be bailed out by struggling Americans in the bad times.

 Worse, rather than the banks being nationalized, they were allowed to sell their losing mortgage derivative to the US Fed, backstopped by the US taxpayer. Then they were on the one hand allowed to switch from “mark to market” to “mark to myth”. That is, just valuating their failed loans at whatever price they deemed correct. Finally, on the other hand as the Fed embarked on its ZIRP (Zero Interest Rate Policy) policy banks were able to use an accounting trick to revalue their own debt to show phantom income as if they had refinanced their own outstanding debt at the lower rate. 

While Iceland’s banks were allowed to fail, Greece is trying to extend and pretend as they always have, following the US’ example. Iceland has endured difficulty but has recovered and is now growing again. The US and Greece however are following the Japanese who have been mired in an economic depression for two decades. We should not expect to have different results.

Iceland The Model. Greece The Failure

The contrast between Greece and Iceland are stark to say the least. Both countries had debt problems that seemed insurmountable.  Iceland’s main debt problems came from its banks that went on a lending binge very similar to that of US banks, both making consumer loans and mortgages to people who had no chance of ever repaying. Greece, on the other hand primarily is in trouble because its government spent too much since joining the EU, relying on low interest rates they thought they would last forever.

But what is so interesting is that the two countries have taken exact opposite approaches to resolve the issue which is highly instructive. While countries like Ireland force their citizens (Much like here in the US) to bail out the banks that made bad loans, Iceland twice voted to not pay to bail out their banks and default .

Not only that,

“The island’s households were helped by an agreement between the government and the banks, which are still partly controlled by the state, to forgive debt exceeding 110 percent of home values. On top of that, a Supreme Court ruling in June 2010 found loans indexed to foreign currencies were illegal, meaning households no longer need to cover krona losses.”

And how did Iceland treat their banksters?

“Iceland’s special prosecutor has said it may indict as many as 90 people, while more than 200, including the former chief executives at the three biggest banks, face criminal charges.

Larus Welding, the former CEO of Glitnir Bank hf, once Iceland’s second biggest, was indicted in December for granting illegal loans and is now waiting to stand trial. The former CEO of Landsbanki Islands hf, Sigurjon Arnason, has endured stints of solitary confinement as his criminal investigation continues.”

By contrast, Greece has negotiated one bailout after another adding more EU debt on more EU debt. The latest agreement, at best, kicks the can down the road even further. Just compare the results:

“Iceland’s $13 billion economy, which shrank 6.7 percent in 2009, grew 2.9 percent last year and will expand 2.4 percent this year and next, the Paris-based OECD estimates. The euro area will grow 0.2 percent this year and the OECD area will expand 1.6 percent, according to November estimates.”

In addition, Iceland already is back to having an investment grade rating of BBB- by Fitch.

By contrast, Greece has had a GDP decline of 7% since enacting the first round of austerity demanded by the EU. The latest “rescue” is counting on Greece to return to growth but this is looking highly unlikely.

Conclusion

Iceland recognized that its debt situation could not be resolved. They chose default and the banks were partially nationalized to preserve a functioning system. The needs of the people were put ahead of the needs of the markets and the banks. Greece, by contrast takes on ever more debt and gives up more of their sovereignty to their EU creditors. Their people are suffering under a debt they can never repay. Rather than leaving the EU and the Euro behind, defaulting on their debt, and reissuing the Drachma they are prolonging the pain without the hope of a recovery.

Lesson for us in the US

While Iceland sent its banksters to jail, not a single one here in the US has gone to jail for the massive fraud perpetuated on the American people and the international investors who bought the mortgage derivatives thrown together with loans signed by “Linda Green”.  Even now, not a single arrest has been made resulting from the theft of over a $1 Billion after MF Global stole client money from segregated accounts. In addition, rather than bailing out their banks as the US did, they partially nationalized them. The advantage of this is that there is now an expectation that the government won’t bail them out while in the US the big banks know Bernanke and Congress will always bail them out no matter how bad their behavior. They can keep the profits in the good times and be bailed out by struggling Americans in the bad times.

 Worse, rather than the banks being nationalized, they were allowed to sell their losing mortgage derivative to the US Fed, backstopped by the US taxpayer. Then they were on the one hand allowed to switch from “mark to market” to “mark to myth”. That is, just valuating their failed loans at whatever price they deemed correct. Finally, on the other hand as the Fed embarked on its ZIRP (Zero Interest Rate Policy) policy banks were able to use an accounting trick to revalue their own debt to show phantom income as if they had refinanced their own outstanding debt at the lower rate.

While Iceland’s banks were allowed to fail, Greece is trying to extend and pretend as they always have, following the US’ example. Iceland has endured difficulty but has recovered and is now growing again. The US and Greece however are following the Japanese who have been mired in an economic depression for two decades. We should not expect to have different results.

Greece or Iceland? Cyprus Must Choose

Last year I examined here and here how Iceland who took a very different approach than Greece. The result has been that Iceland, after a short period of pain and economic disruption has resumed economic growth, reduced unemployment and once again has an investment grade bond rating. What was the primary difference?

Unlike the US and several countries in the Eurozone, Iceland allowed its banking system to fail in the global economic downturn and put the burden on the industry’s creditors rather than taxpayers.

 Today, Cyprus must decide, do they want to follow Greece or follow Iceland?

Odds of Greece Leaving the Euro Just Went Up

Greece is unlikely to form a government that will meet austerity demands under the last EU bailout agreement.

“Without a functioning government, it seems highly unlikely that Greece would be in a position to present the Troika with plans for additional budget savings worth 7 percent of GDP by the end of June,” said Guillaume Menuet, an economist at Citi, in a research report on Monday.

And time is running out:

 “The Troika is likely to delay the disbursement of the next tranche of the program. Note that for the second quarter of 2012, disbursements of 31.3 billion euros ($40.7 billion) from the bailout program are scheduled,” he said. “If Greece does not make progress, in a second step, the Troika is likely to stop the program. If that happens, the Greek sovereign and its banking sector would run out of funding.”

As a result, Greece would be forced to leave the euro area, according to Menuet, who said the chances of such an outcome are now rising fast.

 More here.

 While leaving the Euro would be good for Greece, just as it was for Iceland and would likely be bullish for the Euro, it would also likely lead to a new banking crisis in Europe as it would end any question as to whether Greece has truly defaulted.

You may recall previously that Greece first did not default and then did.....sort of. The 70% "haircuts" were offered in exchanged for more Troika bailout money from the EU.

Leaving the Euro will end any and all doubt, but will almost certainly have global implications to both European and US banks that hold their debt.

Government Theft

Ever since the run on banks that started the Great Depression Western countries have always protected the depositors of banks knowing full well that if depositors do not have faith in the banking system, the banking system can't function. And without a banking system, commerce comes to a halt.

What is so remarkable about the theft of depositors money in Cyprus is that is breaks that trust. The results will range from bad to possibly catastrophic. The latest agreement between the EU and Cyprus is that they will forgo confiscation of deposits 100k Euros or less. Even if this becomes the case (And with the disappearance of all those Cyprus deposits that exited through Cypriot bank branches in London which stayed open last week it is unlikely the money is still there to confiscate.) retirees and small businesses will be effected.

Stephen Leeb at KWN:

“Cyprus is truly a disaster for the West.  It basically says to every citizen of the West, if your country runs into trouble the governments can come along and just take your money.  That’s basically what is says.”

</frame>

“What worries me is if you have an individual who is retired with let’s say 300,000 or 400,000 euros in the bank, and they suddenly find they have had some of their money or a great deal of their money stolen by governments.  Let’s say they are not retired and just run a small business and need to make a payroll.  What happens in that situation?

The funds are frozen and then part of it is stolen.  This is outrageous....

“This could happen now in Spain, Italy, or any of these other countries which are in financial trouble.  It seems like the only country in Europe which is not suffering right now is Germany.

Germany is in a power position in terms of exports because their currency is lower than what it should be because of the Eurozone construct.  So they can export like crazy.  People have to remember that what brings about chaos and extremism in countries is depressions.

People think this can’t happen here in the United States, well, I beg to differ.  What would happen if we all woke up tomorrow morning and some disaster has happened and the Suadi oil fields were out of commission?  What’s to say that the US government and the Federal Reserve can’t do the same thing that the ECB, EU, and the IMF just did to Cyprus?  They could end up freezing and seizing our deposits.

What if instead of JP Morgan making a $6 billion bad derivative bet, they make $600 billion in bad derivative bets?  Has anybody asked that question?  All of the sudden there would be no JP Morgan.  Again, what’s to say that they won’t steal our money here in the United States?

This is absolutely the worst precedent that the West could have set.  The fundamental freedom that people in the West enjoy, and that includes Cyprus, Spain, Italy, Ireland, etc, is that the government cannot without any warning confiscate their money.  Call it what it is, this is clear theft and outright confiscation.

That’s the thing to worry about.  I’m incredibly concerned when I see money being confiscated.  This tells me that we are already seeing the makings of totalitarianism in some form.  It’s getting very, very frightening at this stage.”

Leeb had this to say regarding gold:  “Gold continues to see a war going on at the $1,600 level.  It is not in the best interest of the West to see gold do any type of move that would increase its exposure as being an alternative currency.

Once gold begins its next magnificent rise and breaks to new all-time highs there will be even more demand for gold and the people in charge of the West know this.  That’s why they are battling so hard to keep the price suppressed.

This latest series of events in Cyprus just shows how desperate Western central planners have become.  They are not letting the markets trade freely because they would reveal the horror of what has just taken place.  But gold will have its day and so will silver.  Just make sure you have physical gold and silver and not paper.”

What I find really disturbing is the unelected Euro-crats are forcing this on Cypriots. Here in the US we started a revolution against the British citing taxation without representation. What we have today is confiscation without representation. The Cypriot government voted down the original "tax" the EU demanded. So now, instead, the EU is describing the theft as a "restructuring" that does not require the consent of the governed in Cyprus. Cypriots who have their deposits stolen will have no day in court, no appeal, no due process of any kind. Is this not a return to serfdom? The Cypriot people should demand to leave the Euro-zone default on their debt and return to their own currency. With this they could devalue their currency to make themselves more competitive and follow the successful example of Iceland.

Oh, and for those who have money deposited in US banks, here is a reminder that as of December 31st, 2012:

As scheduled, the unlimited insurance coverage for noninterest-bearing transaction accounts provided under the Dodd-Frank Wall Street Reform and Consumer Protection Act expired on December 31, 2012