continued…
The Icelandic situation has many parallels to the financial crisis in the United States. Many of the abuses in the American banking industry were caused by deregulation as well. While the U.S. banks were always private, they were regulated by the Great Depression-era Glass-Steagall Act, which was designed to limit fraud, speculation and conflicts of interest. In 1999, the last remaining provisions of the Act were repealed. Banks were allowed to combine with insurance companies and brokerages, consolidating into financial behemoths.
Many regional banks exploded in size, gobbling up smaller banks to increase their exposure to the mortgage market. They were aided by the Federal Reserve which slashed interest rates and lending standards, allowing the housing bubble to form. As mortgages could be packaged and resold, bankers had little concern about credit quality, giving large loans to unemployed or even illegal alien borrowers. Mortgage-backed securities were shopped to foreign buyers looking for a low risk investment. U.S. residents took on adjustable rate mortgages, secure in their belief that housing would always appreciate, and refinancing would always be available. Predictably, these huge institutions were not able to restrain themselves from violating their customers’ trust or securities laws if there was money to be made.
Financial institutions became a proportionally large fraction of the U.S. economy as well, dominating the S&P 500 by 2002, and peaking at 21% of the index in 2007. Even after the crash in the banking industry, the financial sector still constitutes most of the stocks in the index and 16% of the market value. Five of the 30 stocks in the Dow Jones Industrial Average are banks or have a large financial component, even after the removal of AIG last year.
Like the United States, Iceland’s economy was not solely based on bank speculation. Icelanders created real wealth in the alternative energy, biotech, and software industries.
Unfortunately, much of the value of the bank investments was illusory, created out of thin air through fraud. A small group of politically connected entrepreneurs created shell corporations to make trades amongst themselves to magnify their apparent net worth. One corporate raider, Jón Ásgeir Jóhannesson, was convicted on a charge of false accounting designed to make his corporation, Baugur, look larger, but he only received a three month suspended sentence.
Loans of hundreds of millions of kronur to insiders to purchase bank stock were forgiven when the financial collapse became inevitable. Average citizens still have repay their ballooning loans on a much reduced income, however.
The mega banks had little official oversight, so they were able to accumulate assets worth almost ten times the GDP of the entire nation of Iceland. Shockingly, few people worried that the banks could not possibly be bailed out if anything went wrong. These financial institutions lent long term and borrowed short term, and 80% of that capital was borrowed in foreign currencies. Frequent refinancing was required, but that was no problem in an era of easy credit.