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Lesson from Iceland: let the banks fail

Posted: 16 Nov 2011 02:29 AM PST

When faced with an insolvent and bankrupt banking sector, Iceland chose to let them fail. Now while we are struggling, Iceland is recovering. We should have let our banks fail too.

Irvine Home Address ... 146 ORANGE BLOSSOM #116 Irvine, CA 92618
Resale Home Price ......  $169,000

Bleak church on a cold tundra
Black stone beach and a black death bottle
Is all me and my baby'll need
In the tropical, tropical
Tropical ice-land

The Fiery Furnaces -- Tropical Iceland

I believe we should have let our too-big-to-fail banks go bankrupt. Many have contended this would have created a global catastrophe of some sort, but I rather doubt it. In reality, a bunch of bondholders and shareholders would have lost a great deal of money, but life would have gone on. The government could have recapitalized the banking system and sold the stock for a profit when the economy recovered. In the end, we bailed out a group of people who should have lost money, and crippled our economy.

Would the recession of 2008 have been worse if we let our banks fail? Sure. It would have been very painful, but it also would have been over. It's better to take a band aid off quickly and get the pain over with quickly than endure the slow bleed we are now. I'm not the only one who believes this to be true.

Key lesson from Iceland crisis is 'let banks fail'

By Haukur Holm | AFP – Sat, Nov 5, 2011

Three years after Iceland's banks collapsed and the country teetered on the brink, its economy is recovering, proof that governments should let failing lenders go bust and protect taxpayers, analysts say.

The North Atlantic island saw its three biggest banks go belly-up in the October 2008 as its overstretched financial sector collapsed under the weight of the global crisis sparked by the crash of US investment giant Lehman Brothers.

The banks became insolvent within a matter of weeks and Reykjavik was forced to let them fail and seek a $2.25 billion bailout from the International Monetary Fund.

After three years of harsh austerity measures, the country's economy is now showing signs of health despite the current global financial and economic crisis that has Greece verging on default and other eurozone states under pressure.

"The lesson that could be learned from Iceland's way of handling its crisis is that it is important to shield taxpayers and government finances from bearing the cost of a financial crisis to the extent possible," Islandsbanki analyst Jon Bjarki Bentsson told AFP.

Iceland refused to have taxpayers absorb the private losses. They endured a brief period of severe economic contraction, but now its over. The taxpayers don't have a lingering debt, and the economy is recovering more robustly than countries which chose to bail out their banks.

"Even if our way of dealing with the crisis was not by choice but due to the inability of the government to support the banks back in 2008 due to their size relative to the economy, this has turned out relatively well for us," Bentsson said.

Iceland's banking sector had assets worth 11 times the country's total gross domestic product (GDP) at their peak.

Iceland bailing out the banks was never an option because the problem was too big. It turned out to be a blessing for them. Rather than be saddled with a generation of debt, the Icelandic taxpayers have a clean slate. What do we have? How many trillions of dollars will this cost us?

Nobel Prize-winning US economist Paul Krugman echoed Bentsson.

"Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net," he wrote in a recent commentary in the New York Times.

"Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver," he said.

That's an accurate description of what happened. Iceland bailed out Main Street while allowing their Wall Street to go belly up, and they are better off for it.

During a visit to Reykjavik last week, Krugman also said Iceland has the krona to thank for its recovery, warning against the notion that adopting the euro can protect against economic imbalances.

The problem Greece, Italy, Spain and Portugal are having is caused by their being the in Euro. If they still had their own currencies, they would print their way out of debt and inflate away the problem. The resulting decrease in the value of their currency would boost their exports and rebalance their economy. It's what we will ultimately do to correct the problem too. Notice nobody is talking about austerity here in the US.

"Iceland's economic rebound shows the advantages of being outside the euro. This notion that by joining the euro you would be safe would come as news to the Spaniards," he said, referring to one of the key eurozone states struggling to put its public finances in order.

Iceland's example cannot be directly compared to the dramatic problems currently seen in Greece or Italy, however.

"The big difference between Greece, Italy, etc at the moment and Iceland back in 2008 is that the latter was a banking crisis caused by the collapse of an oversized banking sector while the former is the result of a sovereign debt crisis that has spilled over into the European banking sector," Bentsson said.

"In Iceland, the government was actually in a sound position debt-wise before the crisis."

We were running a large deficit due to Bush's policies, so our government wasn't as healthy as it was when Clinton left office, but we could have chosen to allow the banks to fail and recapitalized the system. We didn't have a soverign debt problem until we decided to absorb the banking sector losses and run up a massive debt (thank you Obama).

Iceland's former prime minister Geir Haarde, in power during the 2008 meltdown and currently facing trial over his handling of the crisis, has insisted his government did the right thing early on by letting the banks fail and making creditors carry the losses.

"We saved the country from going bankrupt," Haarde, 68, told AFP in an interview in July.

Haarde was absolutely correct. I wish Bush would have had the courage to be a Republican back in 2008 and let the free market work. Instead, Bush chose to socialize the losses. Karl Marx would have been proud.

"That is evident if you look at our situation now and you compare it to Ireland or not to mention Greece," he said, adding that the two debt-wracked EU countries "made mistakes that we did not make ... We did not guarantee the external debts of the banking system."

Like Ireland and Latvia, also rescued by international bailout packages and now in recovery, Iceland implemented strict austerity measures and is now reaping the fruits of its efforts.

So much so that its central bank on Wednesday raised its key interest rate by a quarter point to 4.75 percent, in sharp contrast to most other developed countries which have slashed their borrowing costs amid the current crises.

Iceland devalued its currency, rebalanced its flow of funds, and now they can raise interest rates to stabilize its currency and continue with their economic recovery.

It said economic growth in the first half of 2011 was 2.5 percent and was forecast to be just over 3.0 percent for the year as a whole.

David Stefansson, a research analyst at Arion Bank, told AFP Iceland hiked its rates because it "is in a different place in the economic (cycle) than other countries.

"The central bank thinks that other central banks in similar circumstances can afford to keep interest rates low, and even lower them, because expected inflation abroad is in general quite (a bit) lower," he said.

Iceland has hit bottom and is recovering because they made a different decision than we did in 2008. We should have let the banks fail, nationalized them, recapitalized the system and endured the pain. We would be much better off now if we had.

Five years and 50% off

Back in 2007 I predicted Irvine house prices would falter by 39%. Some would fall more and some would fall less. Today's featured property is one that fell more.

The loan owners of today's featured property paid $326,000 using a $309,700 first mortgage and a $15,300 down payment. They refinanced on 2/22/2007 for $320,000 and got all but $6,000 of their down payment back.

This property is available for sale via the MLS.
Please contact Shevy Akason, #01836707 

Irvine House Address ...  146 ORANGE BLOSSOM #116 Irvine, CA 92618
Resale House Price ......  $169,000

Beds:  1
Baths:  1
Sq. Ft.:  739
Property Type: Residential, Condominium
Style: One Level, Contemporary
View: Creek/Stream
Year Built:  1976
Community:  Orangetree
County:  Orange
MLS#:  S679048
Source:  CRMLS
On Redfin:  5 days
Standard sale . Tranquality awaits you at this charming turn-key home with patio overlooking a peacful stream and lush grounds. Minute to Irvinespectrum. one bedroom condo located close to Irvine vally collage. This condo has loundry inside and installed shelves in living room. 
Proprietary IHB commentary and analysis 

Resale Home Price ......  $169,000
House Purchase Price … $326,000
House Purchase Date .... 1/12/2006

Net Gain (Loss) .......... ($167,140)
Percent Change .......... -51.3%
Annual Appreciation … -10.8%

Cost of Home Ownership
$169,000 .......... Asking Price
$5,915 .......... 3.5% Down FHA Financing
4.06% ............... Mortgage Interest Rate
$163,085 .......... 30-Year Mortgage
$55,102 .......... Income Requirement 

$784 .......... Monthly Mortgage Payment 
$146 .......... Property Tax (@1.04%)
$0 .......... Special Taxes and Levies (Mello Roos)
$35 .......... Homeowners Insurance (@ 0.25%)
$188 .......... Private Mortgage Insurance
$270 .......... Homeowners Association Fees
$1423 .......... Monthly Cash Outlays

-$70 .......... Tax Savings (% of Interest and Property Tax)
-$232 .......... Equity Hidden in Payment (Amortization)
$8 .......... Lost Income to Down Payment (net of taxes)
$41 .......... Maintenance and Replacement Reserves
$1,171 .......... Monthly Cost of Ownership 

Cash Acquisition Demands
$1,690 .......... Furnishing and Move In @1%
$1,690 .......... Closing Costs @1%
$1,631 .......... Interest Points
$5,915 .......... Down Payment
$10,926 .......... Total Cash Costs
$17,900 ............ Emergency Cash Reserves
$28,826 .......... Total Savings Needed

Short-Sale and REO Workshop

Tonight is the night.

Shevy Akason and Larry Roberts will host a short sale and REO workshop at 6:30 PM Wednesday, November 16, 2011, at the offices of Intercap Lending (9401 Jeronimo, Suite 200, Irvine, CA 92618).

real estate home sales


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