The Iceland and Ireland banking crisis: lessons for the future

A working paper for the Mercatus Centre:

Abstract

The economic collapses of Iceland and Ireland after 2008 are the most severe in the developed world in recent history. This paper assesses five key differences in the causes of and responses to each country’s crisis. On the causal side, we look at (1) the role that deposit insurance served in artificially increasing risk-adjusted returns and (2) the subsequent increase in loanable funds that bred large and unsustainable financial sectors. On the response side we look at (1) the speed, transparency, and effectiveness of the nationalization of each country’s financial sector; (2) the decision whether to bail out key financial institutions or to allow them to fail; and (3) the differences in exchange-rate structures that created different recovery paths. We conclude by drawing policy conclusions for countries with large, unstable banking sectors, notably the United States.

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1 Comment

  • Paul Marks says:

    The “bottom line” here is that NEITHER government has followed sensible policies.

    That the Irish bailoutism (effectively making the country a colony of the E.U.) was an error is obvious, but the Icelandic policy has also been terrible.

    The “one off” payments to create new banks is an absurd policy – especially as the new banks do not differ IN PRINCIPLE from the old banks (they are still not really honest money lenders whose business is lending out real savings – rather than building credit bubbles).

    Also the utter failure to understand that Iceland is a country based on fishing and farming and can not afford a vast welfare state (which the “new economy” of credit bubble banking was supposed to finance) is depressing.

    The increase in Icelandic government debt to more than 100% of GDP (from about 25% of GDP) is a clear demonstration of political bankruptcy (bankruptcy of ideas) – which will, eventually, lead to economic bankruptcy.

    It must be clearly understood that Iceland has a budget defict (even in present circumstances of the “Obama boomlet” – the last gasp of credit-money expansion produced by the Federal Reserve to aid Barack Obama’s reelection campaign) – when the world tips back into recession in 2013, the Icelandic fiscal deficit will widen.

    There is no defence budget to cut, and the ideological atmosphere of Iceland holds the Welfare State to be a de facto RELIGIOUS DOCTRINE (as it is most Western countries – the worship of the Welfare State has repaced, or subverted, the worship of God in most Western countries) – so serious reform is unlikely.

    Especially as the parties of the right in Iceland have been partly discredited by their association with the credit bubble banks (there has even been a political show trial of the former Independence Party Prime Minister).

    A glance at the emerging Icelandic Constitution will conferm that the ideological assumptions of this polity are nonrational.

    As for Ireland….

    Ireland must reject the zombie banks (i.e. finally allow them to go bankrupt) and the Irish must reject rule by the European Union.

    Sadly neither of these developments is likely at the present time.

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