Iceland regaining investment grade rating confirms Swedish Model is solution to financial crisis

The Guardian reports that Fitch has upgraded Iceland's debt so that it is now investment grade.

Why is this important?

Two reasons.

First, note the direction of travel of Iceland's credit rating is from junk to investment grade.  A clear sign that Iceland's economy is improving.  Compare and contrast this with Greece and Spain where full fledge depressions are setting in.

Second, the debt rating upgrade confirms that the Swedish Model adopted by Iceland for handling a bank solvency led financial crisis works and the Japanese Model which Greece and Spain adopted does not.

This result was to be expected (or at least is should have been expected by the readers of this blog as your humble blogger has championed the Swedish Model and documented that even when not perfectly executed it has worked every place it has been used).

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  This protects the real economy and the social safety net.

Under the Japanese Model, bank book capital levels and banker bonuses are protected at all cost.  This puts the burden of the excess debt on the real economy and capital needed for growth and reinvestment is diverted to debt service.  The result is at best a prolonged Japan-style economic slump and at worse adoption of austerity measures that lead to a depression.

Iceland's rehabilitation after several years as a pariah in the global financial markets gathered pace last night after ratings agency Fitch said the island nation's debts had regained investment grade status. 

Fitch said Iceland's debts had been upgraded to BBB from junk after a strong recovery from the financial crisis. 

Reykjavik's meteoric recovery comes after its 300,000 residents were told they would be locked out of the world's financial markets for decades after they refused to rescue a group of bankrupt banks in 2008. 

Unlike Ireland, Portugal and Spain, the Icelandic government let the country's banks become insolvent rather than spend tens of billions of pounds on bailout funds.

Ireland, which spent more than €40bn rescuing its banks, recently re-negotiated a series of loans with the EU that will mean its debt payments stretch beyond 2050. 

Spain could still be forced to accept an EU bailout after a further deterioration in the financial stability of its major banks, which have only recently revealed the full extent of they bad loans they made in the run up to the banking crisis. 

Paul Rawkins, senior director in Fitch's Sovereign Rating Group, said: "The restoration of Iceland's long-term foreign currency rating to investment grade reflects the progress that has been made in restoring macroeconomic stability, pushing ahead with structural reform and rebuilding sovereign creditworthiness since the 2008 banking and currency crisis. 

"Iceland has successfully exited its IMF programme and gained renewed access to international capital markets. A promising economic recovery is under way, financial sector restructuring is well-advanced, while public debt/GDP appears to be close to peaking on the back of a robust fiscal consolidation programme."