Monday, August 13, 2012

IMF says Iceland has lessons to offer on how to handle financial crisis

As reported by Bloomberg, the IMF says that Iceland has lessons to offer on how to handle a financial crisis.

Regular readers know that the first lesson is the adoption of the Swedish model for handling a bank solvency led financial crisis.  Under this model, banks are required to recognize all the losses on and off their balance sheets today.  This keeps the losses on the excess debt in the financial system in the financial system and protects the real economy.

Iceland’s commitment to its program, a decision to push losses on to bondholders instead of taxpayers and the safeguarding of a welfare system that shielded the unemployed from penury helped propel the nation from collapse toward recovery, according to the Washington-based fund. 
“Iceland has made significant achievements since the crisis,” Daria V. Zakharova, IMF mission chief to the island, said in an interview. “We have a very positive outlook on growth, especially for this year and next year because it appears to us that the growth is broad based.”...
Please note, your humble blogger doesn't think it is necessary to push losses on to bondholders.  In fact, with stress tests and other related pronouncements of solvency by the financial regulators, I think there is a moral obligation to protect the bondholders from solvency driven losses.

Regular readers know that bondholders don't have to suffer losses as a modern banking system is designed to let the banks operate and support the real economy even with negative book capital levels.  Banks can do this because of deposit insurance and access to central bank funding.

Deposit insurance makes the taxpayers the 'silent' equity partner while banks are rebuilding their book capital levels.
“The fact that Iceland managed to preserve the social welfare system in the face of a very sizeable fiscal consolidation is one of the major achievements under the program and of the Icelandic government,” Zakharova said. The program benefited from “strong implementation, reflecting ownership on the part of the authorities,” she said.
Note, the EU, UK and US chose the Japanese model for handling a bank solvency led financial crisis.  Under this model, bank book capital levels and banker bonuses are protected at all costs.

The difference in which model is used to address the financial crisis is striking.

Under the Swedish model, Iceland has put the crisis behind it and its economy is growing.

Under the Japanese model, the EU, UK, and US are still in the grip of the financial crisis and their economies are struggling despite massive amounts of fiscal and monetary support.

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