Irvine Housing Blog

Key lesson from Iceland crisis is ‘let banks fail’

By Haukur Holm | AFP – Sat, Nov 5, 2011

Three years after Iceland’s banks collapsed and the country teetered on the brink, its economy is recovering, proof that governments should let failing lenders go bust and protect taxpayers, analysts say.

The North Atlantic island saw its three biggest banks go belly-up in the October 2008 as its overstretched financial sector collapsed under the weight of the global crisis sparked by the crash of US investment giant Lehman Brothers.

The banks became insolvent within a matter of weeks and Reykjavik was forced to let them fail and seek a $2.25 billion bailout from the International Monetary Fund.

After three years of harsh austerity measures, the country’s economy is now showing signs of health despite the current global financial and economic crisis that has Greece verging on default and other eurozone states under pressure.

“The lesson that could be learned from Iceland’s way of handling its crisis is that it is important to shield taxpayers and government finances from bearing the cost of a financial crisis to the extent possible,” Islandsbanki analyst Jon Bjarki Bentsson told AFP.

“Even if our way of dealing with the crisis was not by choice but due to the inability of the government to support the banks back in 2008 due to their size relative to the economy, this has turned out relatively well for us,” Bentsson said.

Iceland’s banking sector had assets worth 11 times the country’s total gross domestic product (GDP) at their peak.

Nobel Prize-winning US economist Paul Krugman echoed Bentsson.

“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,” he wrote in a recent commentary in the New York Times.

“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,” he said.

During a visit to Reykjavik last week, Krugman also said Iceland has the krona to thank for its recovery, warning against the notion that adopting the euro can protect against economic imbalances.

“Iceland’s economic rebound shows the advantages of being outside the euro. This notion that by joining the euro you would be safe would come as news to the Spaniards,” he said, referring to one of the key eurozone states struggling to put its public finances in order.

Iceland’s example cannot be directly compared to the dramatic problems currently seen in Greece or Italy, however.

“The big difference between Greece, Italy, etc at the moment and Iceland back in 2008 is that the latter was a banking crisis caused by the collapse of an oversized banking sector while the former is the result of a sovereign debt crisis that has spilled over into the European banking sector,” Bentsson said.

“In Iceland, the government was actually in a sound position debt-wise before the crisis.”

Iceland’s former prime minister Geir Haarde, in power during the 2008 meltdown and currently facing trial over his handling of the crisis, has insisted his government did the right thing early on by letting the banks fail and making creditors carry the losses.

“We saved the country from going bankrupt,” Haarde, 68, told AFP in an interview in July.

“That is evident if you look at our situation now and you compare it to Ireland or not to mention Greece,” he said, adding that the two debt-wracked EU countries “made mistakes that we did not make ... We did not guarantee the external debts of the banking system.”

Like Ireland and Latvia, also rescued by international bailout packages and now in recovery, Iceland implemented strict austerity measures and is now reaping the fruits of its efforts.

So much so that its central bank on Wednesday raised its key interest rate by a quarter point to 4.75 percent, in sharp contrast to most other developed countries which have slashed their borrowing costs amid the current crises.

It said economic growth in the first half of 2011 was 2.5 percent and was forecast to be just over 3.0 percent for the year as a whole.

David Stefansson, a research analyst at Arion Bank, told AFP Iceland hiked its rates because it “is in a different place in the economic (cycle) than other countries.

“The central bank thinks that other central banks in similar circumstances can afford to keep interest rates low, and even lower them, because expected inflation abroad is in general quite (a bit) lower,” he said.

Sorry, but I hated every minute of the housing bubble as prices began to escalate out of my range and then ratcheted up far into the ether and away from any reasonable relationship with incomes…which didn’t begin to keep pace, and I’m still furious that prices were artificially inflated beyond the 1997 level.

I watched helplessly as condos that were substantially inferior to my rental rose so far out of parity that I would have had to pay twice as much a month to “own” a miserable studio in a 4+1 as I do to rent my beautiful rental. I had planned on buying a 2 bed 2 bath, but by 2003, at which point I expected the insane bubble to burst, 1-beds inferior to my rental were far out of my range, especially since I was seeking to lower my housing cost, not raise it.

You see, I didn’t “get it”. I could not understand what was happening. I did not get that you weren’t supposed to put, say, a 10% down payment on a reasonable place and take a 20 year or 30 year mortgage. Nah, what you were supposed to do was buy the most expensive place you could get using a pay option ARM and making the minimum payment, with the idea that you could refi as the prices continued to escalate, and then “trade up” to something more expensive and pretentious on the same terms, while extracting the equity as the prices rose to furnish the place grandly.

I just don’t think that way, never did. I was too afraid that the upward move would reverse the minute I bought, and I’d be unable to make the payments. It all felt wrong.

As for those, like my mother, who owned outright before the runup and who would seem to have gotten the most out of the bubble, what, exactly, did they really gain? I can see that my mother and other owners like her would have been better off if prices and salaries had remained in line with each other and at the prices they paid 40 yearas ago. For,really, all they’ve gained is higher house taxes- MUCH higher- and low interest rates that pay them nothing on their savings while they are inflated out of those savings. If my mother were to sell now, she’d have to pay a capital gains tax, even after figuring in the one-time senior citizen’s tax credit. Had prices stayed level, she wouldn’t have to pay that. And the place she would downsize to would have the same relationship with her place price-wise it did after the bubble runup. So what have she and other long-term owners really gained?

Now, thanks to the debt debacle of the naughties, I’m looking at steeply reduced employment opportunities and the prospect of no growth for our economy for the next two decades at least, and a poverty-stricken old age for myself. Equity investments have lost ground in the past decade while trillions of dollars in investment capital was diverted from truly productive enterprises that could give this country a diverse, productive economy with many job niches for the full array of human talent, and a future as a first world, technologically advanced nation. While we have been concentrating on building “wealth” through asset inflation and driving “economic activity” through debt creation, we have lost our scientific and technological lead and become a stagnant, backward country.

Not only was I deprived of the opportunity to buy at a reasonable price with an honest mortgage within my means to pay, but our younger generations have been deprived of a hopeful future.

The debt bubble of the past 20 years is the WORST thing that ever happened to this country, and I don’t believe we will recover from it in my lifetime, or even those of my niece and nephews.

“Part of the tight money problem in California was the nationwide housing situation.  The overbuilt situation in Atlanta, Denver, Phoenix and Florida were literally thousands of homes were sitting unsold, plus the massive increases in housing costs and interest rates had put homes out of the reach of homebuyers.”  Sound familiar?
The year is 1974, the excerpt from “Boom Builder”, a novel about the housing industry from it’s beginning at the end of WWII and centered in Orange County, by C. Robert Perryman, retired advertising and marketing executive.

Top story on OC Register on-line

http://lansner.ocregister.com/2011/11/11/realtors-blame-banks-for-slow-recovery/146883/

I’ve made counter-points repeatedly here that LTV is just one of many risk factors to consider when trying to create reasonable underwriting guidelines.  I just read this paper that suggests LTV is probably the biggest risk factor (as IR has suggested repeatedly):

http://www.law.unc.edu/journals/ncbank/volumes/volume15/citation-15-nc-banking-inst-2011/ability-to-repay-mortgage-lending-standards-after-doddfrank/

Santa Cruz County Treasurer-Tax Collector Fred Keeley announced Thursday ... he is removing New York-based JP Morgan Chase and North Carolina-based Bank of America from an approved list of banks handling bond investments for Santa Cruz County.

The decision was based on nationwide, multimillion-dollar settlements involving fraud allegations that the two companies negotiated agreements giving them a look at competitors’ bids for handling the investments.

“There seems to be no limit to the greed of some of our nation’s largest banks,” Keeley said in making the announcement.

“Whether it has been unjustifiable fees, collateralized debt obligations, betting against their own investment products through the purchase of credit default swaps, or now bid rigging.

Santa Cruz County severs ties with JP Morgan, Bank of America over municipal bonds bid-rigging

“An average Beijing apartment costs 32 times the annual salary of an average middle-class employee.”

msnbc: ‘Naked marriages’ on rise in China’s prosperous cities

Animal McMansion: Students Trade Dorm for Suburban Luxury

http://www.nytimes.com/2011/11/13/us/homework-and-jacuzzis-as-dorms-move-to-mcmansions-in-california.html?pagewanted=1&_r=1