Iceland: Coming back from the dead

Iceland: Coming back from the dead

As I was zapping a came across a film named ‘’The Margin Call’’. This movie, directed by J. C. Chandor, gave me the spark to write this week’s blog. This award-winning film takes place in the 21^st century and to be more specific a few weeks before the burst of the financial crisis of 2008.An investment bank is on the verge of ‘’pulling the plug’’. Simultaneously, a financial analyst, named Peter Sullivan (Zachary Quinto), discovers a fundamental lapse in the bank’s algorithms, which threats to tear down not only the company but the whole financial system. When the company’s executives realize the extent of the imminent hazard, they decide to take remedial action in order to find the formula to salvage the future economy. Nevertheless, the time is ticking out and the ethical dilemmas make it difficult to show diligence and prudence. 

Will they manage to redress the problem? Or will the selfish incentives predominate once again?

Well, don’t expect me to give you the answer…

‘’The Margin Call’’ is allegedly based on the collapse of the ‘’Lehman Brothers’’, which was the onset of the economic plight. The main reason for this bubble was the combination of two facts. Firstly, the Federal Reserve kept the short term interest rates to unprecedented low levels. Thus, the investors, as they were unable to find high yield, started assuming higher risks. Added to this, it was a common belief at that time that houses are a good investment as the prices had followed an upwards trend. This fact by itself can’t cause an economic recession. Nevertheless what happens if we add some human greed into the equation?

To be more specific, the banks exploited this perception, about the housing investment, by giving mortgages with low interest rate to everyone regardless their economic status .In the same time, the American regulatory systems did nothing except from giving the green light to every transaction. Moreover, the commercial banks sold these toxic liabilities to investment banks which used them to create complex financial products (CDOs, MBs).These securities were offered to investors who didn’t fully understand them. Nevertheless, in order to lure them, credit rating providers marked these products as safe in exchange for large checks with their name written on them.

Everything was going great and everyone was making profit, until the point when the home prices soared and many homeowners started struggling to make their payments.

The collapse was around the corner, everyone knew it but there was nothing that anyone could do.

What was the outcome of these greedy and toxic financial transactions?

In today’s blog we will discuss about the most –in my opinion- interesting one. The bankruptcy of Iceland. Yes, you read correctly, a country defaulted because of the hunger for abnormal profit. It all began when Iceland’s biggest banks started offering insane interest rates-up to 15%- as a return in order to lure external investors. This strategy was viable as at that moment the home currency (krona) was highly valued. Thus, these banks had gathered a huge pile cash which they invested in foreign countries-merely in United States - .Consequently, when the financial collapse came and the banks could borrow any money the bankruptcy was inevitable. To be more precise, the market value of the financial institutions was too big in order for Iceland to bail them out. This collapse dragged down the whole country. It was a matter of one week, for the Iceland’s currency to drop its value over 50% .In addition, the stock market  plunged by 90% ,as all the foreign investors were withdrawing their money from Iceland’s bonds ,causing the government to resign.

For one year unemployment never ceased to soar. Nevertheless, after the election of Johanna Sigurdardottir the country started to get back on its feet. First of all, capital controls were imposed in order to prohibit people from taking their capital away from the country. Secondly, she raised the levies imposed while not only keeping the social services funding in the same level but also providing debt-relief legislation to the mortgage holders. Last but not least, the government encouraged the citizens to invest on local businesses and their products.

Where is Iceland today?

Its people are proud to announce that they have successfully survived from this crisis. Moreover, their annual Gross Domestic Product growth has a rate of 4.9% much higher than any other healthy country. Furthermore, its GDP per capita-an index which shows how prosperous is a country in relation to its population- was $48,100 which is higher than Canada’s same index.

To conclude I strongly believe that Iceland is an example to replicate in order for other countries to successfully survive from their sovereign crisis (e.g. Greece). However, as every default takes place in a completely different environment it is obligatory to scrutiny the strategy in order to adapt it to the correlated information.

Until next time stay safe.