The financial liberalization of the Icelandic banking system took place in few steps from 1998 to 2003. A government memo from June 1998 described a vision of attracting foreign investors and experience to provide financial services in Iceland. However, the process of privatization didn't go as planned. The new owners of the three major banks in Iceland grew their banks at an alarming rate and less than a decade later, the Icelandic banking system collapsed.
How could tiny Iceland build a banking system in less than a decade that proportionally exceeded Switzerland's? Why did the bankers decide to grow the system so fast? How did businesses tunnel money out of the banking system? And why didn't anybody stop them before it was too late?
Bringing Down the Banking System: Lessons from Iceland, is an in-depth look at the total collapse of the Icelandic banking system in 2008 in an attempt to answer these questions and provide lessons that can help us avoid such a calamity in the future.
The combined bankruptcy of the three largest banks in Iceland in October 2008 is the 3rd largest bankruptcy in world history, behind Lehman Brothers and Washington Mutual.
Although bankruptcies occur every single day, events of this magnitude have an enormous impact on our society. They tear apart families and disrupt our lives. Economically, they have a dramatic effect on aggregate demand and due to their systemic nature, they hurt those who otherwise have no association with them. It is therefore imperative that we study their causes.
In December 2008, the Icelandic Parliament passed a historic law, setting up a Special Investigation Commission (SIC) to investigate the causes and events leading up to the collapse of Kaupthing, Glitnir, and Landsbankinn in October 2008, the three main banks in Iceland, or 97% of the Icelandic banking system.
“I have always had considerable respect for those who pursue their entrepreneurial vision, risking their money and foregoing consumption during the first few years of their business with the hope of future gains. This is what I used to think of as the fundamental element of capitalism.”
The SIC investigation revealed in great detail how far from the fundamental idea of capitalism we have strayed. For one, it revealed a complex ownership structure, a cobweb of holding companies which eventually contributed significantly to Iceland's financial instability and ultimate crash.
“It shouldn’t surprise us that if we don’t require investors to put their own skin in the game, there is no limit to the amount of risk they are willing to take.”