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Iceland Leads the Way

By Shlomo   Maital   

Iceland

  In the United States,  despite the fact that the global financial and economic crisis began there, and was caused by irresponsible actions by senior executives in the financial services industry, not a single banker has been sent to jail on criminal charges.  Banks have paid large fines for civil suits, but for the most part, those fines pale in comparison to recent profits. And to add to the insult – the Republicans have managed to modify the Dodd-Frank provision that keeps banks from investing in exotic derivatives (the kind that caused the problem in the first place). 

   But there is a country that has behaved differently.  Iceland,  with only 325,671 epople and 103,000 sq. km. in area.     Iceland has been independent (from Denmark) only since 1944.  Its banks were out of control in the first decade of the millennium and expanded irresponsibly.  The collapse following 2008 was massive.  Iceland had 20 percent inflation in 2008 and 8 per cent unemployment in 2010.  Its debts were huge.  But Iceland cleaned up the mess.  Bankers were sent to jail.  Iceland’s national debt was gradually reduced.  Iceland managed to maintain its social welfare system despite the enormous financial crisis. 

   According to an Icelandic economist,  “after the infamous crash of 2008, the Icelandic economy shrunk in 2009 and 2010. However, since 2011, the economy has been growing at a respectable rate, by 2.1% in 2011, 1.1% in 2012 and 3.5% in 2013. While purchasing power has yet to reach its pre-crash peak, and many families are still acutely aware of the crash when trying to make ends meet, the economy had safely exited recession.”  Lately, the economy has slowed.  And Iceland’s conservative government has practiced austerity, which in Europe has failed.   Despite this, little Iceland has emerged from a deep crisis that was worse perhaps than in any other country.  And without much help from anyone. 

 

Rearranging the Deck Chairs on the Sinking Titanic:

The Modern Version

By Shlomo Maital  

     Titanic          

 

    History will (and SHOULD rightly) judge today’s world leaders very harshly, for their incompetence in dealing with the global crisis, which really began with the bankruptcy of Lehman Brothers, Sept. 17, 2008.   To use an old metaphor:  They have been rearranging the deck chairs on the Titanic, while it sinks.

   Only, the deck chairs are the massive amounts of debt generated by the crisis.

   To summarize, and oversimplify a bit —    Greedy Wall St. types created massive amounts of new financial assets (mortgage backed securities, credit default swaps, collateralized debt), hidden from the eyes of regulators or nearly anyone, because they were named “swaps” (by US law, hence not subject to regulation).   The value of these ‘assets’ collapsed, as it inevitably would.  But the debt left in their wake remained.  Thus, nearly instantly, many banks and financial institutions were bankrupt (try cutting your assets in half, then leaving your liabilities as they were…net worth becomes negative, which is bankruptcy). 

    The desperate solution was for governments to assume the private debt, because “banks were too big too fail” (translation: the wealthy were too powerful politically to swallow their losses, caused by their own greed and misbehavior). 

   So the “deck chairs” (debt) was not changed, it was simply moved onto the shoulders of us ordinary taxpayers.  And then the crisis shifted from being one of private sector financial services institutions, to one of government, because the capital markets (those folks who got us into  hot water in the first place) placed enormous risk premiums on sovereign government bonds as governments tried to roll over their debt and pay off old bonds with new bond sales.  Why? Because governments were ‘risky’ – precisely because governments had swallowed the huge risk created by the private financial sector. 

   That’s where we stand now.  The deck chairs have been rearranged. The Titanic is still sinking. 

    In the end, that massive debt will have to be wiped out, because the assets balancing it have been wiped out.   American banks have done this most efficiently, because America is superb at creating financial crises and hence terrific at cleaning up the mess.   European banks have barely begun. Their balance sheets still haven’t ‘marked to market’ the losses they will have to swallow.  So Europe is simply deferring the real crisis, in its major banks.

    History will judge world’s political leaders, and many of the financial leaders, very harshly, for all this incompetence and bad behavior.   Meanwhile, all over the world, people suffer because political leaders lack the guts to administer the bitter medicine the world needs.  

       Clean up the mess.   And then let’s move on.   

Blog entries written by Prof. Shlomo Maital

Shlomo Maital

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