|I remember that Inside Job had a brief segment near the start about Iceland, but don't remember the details except the banks were central. I suspect the alleged cause was deregulation with little or no further explanation. |
Thanks for the link to the Mises page from which I quote.
What analysts and authors commonly miss is the reason the banking sector could expand so rapidly. Indeed, as we shall see, the incentive structure of the Icelandic economy was manipulated through government guarantees, artificially low interest rates, and monetary spigots opened wide, allowing liquidity to be flushed through the economy. In addition, Iceland's homeowners were offered tantalizingly low interest rates through the "Housing Financing Fund" (HFF), a state agency that enjoyed explicit government guarantees on its debt, resulting in reduced interest charges for homeowners. The makers of Inside Job missed the government's role, too.
Thus, the banking system had to continuously roll over (renew) their short-term liabilities until their long-term assets fully matured. If an event arose whereby Icelandic banks failed to find new borrowers to continue rolling over their liabilities, they could face a liquidity crisis and, more importantly, spark the collapse of the Icelandic financial system; recent events have borne out this exact scenario.Borrow-short-invest-long has been the culprit of many crises. It was the bane of S&Ls in the U.S. in the 1970s and early 1980s. They couldn't roll over their liabilities because they couldn't compete with money market funds. It was the bane of SIVs in the recent crisis. They were holding long-term mortgages acquired mostly by borrowing in the short-term commercial paper market. In 2008 they suddenly found themselves unable to roll over commercial paper. People who got adjustable rate mortgages based on short-term teaser rates were doing it, too. They thought they could easily roll over their liability, i.e. refinance, at another low interest rate or sell the property.
(Edited by Merlin Jetton on 2/02, 3:07pm)