How Iceland Can Train Us A Lesson in Danger from the 2008 Monetary Disaster
In his new book, Svein Harald Øygard uses the invaluable financial lessons he learned as Governor of the Central Bank of Iceland during the 2008 financial crisis to analyze risks in the financial and economic world.
Iceland became an extreme example of financial ruin when the financial crisis hit. Øygard took over the role of governor of the Central Bank of Iceland when the crisis deepened and was supposed to revive the country after the collapse. Although Iceland was one of the hardest hit countries, it recovered quickly.
In the financial battle zone: An inside report on the financial crisis is Øygard’s experience, told through anecdotes and personal reflection. 2008 may feel like a world away, but the economist is reflecting on the invaluable financial lessons of the past to apply to 2020 and beyond. We spoke to Øygard about his experience and the warning signs of the current crisis due to the coronavirus pandemic.
How was the transition to your role during the financial crisis?
It felt like I had stepped into a crash site, albeit without a fatality. Everything collapsed. Ninety-five percent of Iceland’s banks had gone bankrupt, the value of the currency had halved, two-thirds of businesses were in distress and a third of households. Unemployment rose. Diplomatic battles raged.
Many in Iceland’s central bank had been traumatized by recent events. Many were exhausted from stress and long hours. Many wondered what had happened and who was to blame. There was no plan, no structure, and no belief in the future.
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What was needed was a plan, a certain structure, trust and a certain ability to make decisions. And you had to look beyond the battles for turf and history. At the central bank, I first met the bank staff. Then came the IMF team. They were all waiting for me there. I felt it at the first meeting. Everyone looked at each other. It was as if they were wondering who was going to convey the sad news that we still hadn’t reached the bottom.
But I also felt an eagerness. You were impatient. The change of government and the battle between the government and the former governor to resign had stalled many of their efforts. Months had been wasted. Now they wanted to finish the paperwork and move on.
In your opinion, what are the main lessons learned from the 2008 financial crisis?
It has been re-confirmed that every financial crisis unfolds in five phases. First, a sector or sectors gain height through debt-financed growth. Who exactly takes on this debt varies. It could be banks; It can be companies, households, or governments.
The The second phase begins when the markets change and euphoria turns into suspicion. A liquidity crisis sets in. There is no more money left to keep the party going. A liquidity crisis almost always triggers a financial crisis.
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In the third phase, more sellers of stocks, bonds and real estate appear. But buyers cannot be found. In a distressed market, assets fall. In the fourth phase, falling asset prices and general fear in the markets cascade, creating defaults, emergencies and business closures, contributing to a wider decline in consumption and investment.
In the fifth phase, the contagion spreads to public finances. Governments spend money to bail out the banks. The tax base is shrinking. Crisis-related expenses increase. This was learning about the causes and rhythm of the crisis. We have learned that solutions like those in Iceland, Ireland, Portugal and the European Central Banks require firm action.
Do you think other countries could have reacted and recovered as quickly as Iceland?
Simply put, a broad financial or economic crisis can be compared to a situation where you go to a restaurant with a large group and come up with a big bill. If you split the bill evenly, everyone can pay their fair share and move on. Or there are some who have to wash the dishes. But paying is better than arguing, or worse, getting into a fist fight and damaging the bill.
Unfortunately, the latter often happens when countries get into a financial crisis. They end up arguing about who should pay the cost instead of finding a way to share it fairly.
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Iceland was different as all of the major banks went bust and the bank creditors took a large chunk of the bill. The lenders had given banks money that was not proving profitable. Private parties lending to private banks were affected. Smaller local banks were established. A systemic crisis was thus avoided.
Iceland was hit harder than any other country and therefore had more draconian measures than any other country. However, it is difficult to say that Iceland was hit hardest. This is an excuse for most other countries, almost all of which have taken longer to recover.
What lessons can be applied to 2021?
The 2008 crisis helped educate us about the red flags. We need to watch them as the global economy, businesses and households are hit by the economic impact of the Covid-19 pandemic. So far, central banks and governments have been on the alert and responded aggressively with liquidity and support programs.
But we have to remember that many are shaken. Balance sheets are weakened. Many have worn out their buffers. National debt has skyrocketed. The shifts were larger than the imbalances that caused the euro crisis in 2012 and 2013.
So far, everyone has focused on the immediate challenges, but we must ensure that public finances are strengthened again and that buffers are restored soon. The soundness of banks needs to be carefully monitored. Finally, we also need to see investment and growth. Fortunately, there is no shortage of opportunities to invest in the energy transition in order to mitigate the climate crisis, the technology and the growth of the emerging markets.
About the author
Svein Harald Øygard
Svein Harald Øygard was appointed provisional governor of the Central Bank of Iceland amid the deepest crisis in the country. He was the first foreigner to run an independent central bank. He was previously Deputy Minister of Finance for Norway and has been a corporate strategist at McKinsey & Company for 22 years.