Iceland's Economy Recovery Post-2008 Crisis and Lessons Learned

When the 2008 global financial crisis hit, Iceland faced a devastating collapse of its banking sector. This article explores how the country has recovered since then and the crucial lessons from this unique economic experience.

In 2008, Kaupthing Bank, Landsbanki, and Glitnir Bank defaulted on 62 billion of foreign debt. This event sent foreign investors running, causing the krona to fall by 50% in just one week. The stock market plummeted by 95%, and almost every business in Iceland felt the impact as banks were the root cause of the crisis. These banks had used 100 billion in debt for foreign acquisitions, an amount that dwarfs Iceland's GDP of 14 billion at the time. The collapse of the banks brought down the country's economy.

However, today, Iceland's economy shows signs of a remarkable recovery. GDP levels have returned to pre-bubble trends, unemployment stands at a low 4%, and inflation rates have fallen back to pre-crisis levels. Recent plans to lift capital controls imposed during the crisis further underscore the country's progress.

Recovery and Resilience in a Small Economy

Iceland, despite its small size, has endured a major economic reconstruction. This rapid recovery fuels arguments that allowing banks to fail was a prudent strategy. The argument hinges on the cost to moral hazard - the act of banks taking risks, knowing that they will not bear the full cost of failure. However, there are three key points to consider before embracing this approach:

The Cost to Taxpayers

Fixing the banking crisis came at a significant cost. Icelanders spent more as a percentage of GDP on the crisis than any other country except Ireland. Estimates suggest that the cost ranged from 20-25% of GDP. Furthermore, when the banks failed, they left the government with substantial debts that were never recovered. This level of financial strain underscores the significant impact on taxpayers.

International Holdings and Impact on Foreigners

The three failed banks had extensive international holdings, a necessity given Iceland's small population of about 300,000. Rapid expansion across borders and regions led to foreign nationals often bearing the full brunt of the crisis. This phenomenon is less prevalent in other countries, especially those without banks making up 1 GDP in debt.

Currency Stability and Long-Term Effects

The krona has not fully recovered from this period. Even against the euro, the Icelandic Krone remains significantly lower than pre-crisis levels. This situation highlights the long-term economic impacts of such a crisis, posing questions about the effectiveness of financial recovery strategies.

Despite the challenges, it's argued that Iceland’s economy has recovered more quickly than those countries that bailed out their banks. Some believe that hitting rock bottom is essential for economic recovery. Embracing this reality allows clarity in assessing the value and efficiency of different economic sectors.

While not against bailouts, this experience highlights the need for simplicity and transparency in rescue packages. Financial instruments should be understandable by an ordinary 10-year-old. Direct loans or payments should be avoided when they are not supported by the electorate, as they are not taxpayers' money.

Further, the general principle that when a bank sector or country faces trouble, an acute response might be preferable to chronic avoidance is crucial. Iceland's case is a stark reminder of the consequences of such avoidance strategies.

In conclusion, Iceland's journey post-2008 offers valuable lessons in economic resilience and the importance of fiscal transparency and straightforward financial strategies.