Hard Lessons

The 2008 crisis helped to educate us on the warning signals. These we need to watch as the global economy, businesses and households are beaten up by the economic impact of the covid-19 pandemic.

Hard Lessons
Hard Lessons

Capital Thinking • Issue #755 • View online

In his new book, Svein Harald Øygard uses the invaluable financial lessons he learned as Central Bank Governor of Iceland during the 2008 financial crisis to analyze risk in the world of finance and economics.

Iceland became an extreme example of financial ruin when the financial crisis hit. Øygard took on the role of Central Bank Governor of Iceland just as the crisis ramped up and was tasked with resurrecting the country from collapse.

Even though Iceland was one of the countries that were hit the hardest, it recovered quickly.

-Taylor Leamey

How Iceland Can Teach Us A Lesson in Risk from the 2008 Financial Crisis

Taylor Leamey | The Simple Dollar:

In The Combat Zone of Finance: An Insider’s Account of the Financial Crisis is Øygard’s experiences told through anecdotes and personal reflections.2008 may feel like a world away, but the economist reflects on past invaluable financial lessons to apply them to 2020 and beyond. We spoke with Øygard about his experiences and the warning signs of the present crisis due to the Coronavirus pandemic.

How was transitioning into your role during the financial crisis?

It felt as if I had entered a crash site, though gladly one without any fatalities. Everything had collapsed.

Ninety-five percent of the Icelandic banks had gone bankrupt, the value of the currency had been halved, two-thirds of the businesses were in distress, and one-third of the households. The unemployment soared. Diplomatic fights were raging.

Many in the Icelandic Central Bank had been traumatized by recent events. Many were exhausted by stress and long hours.

Many wondered what had happened and who was to blame. There was no plan, no structure and zero belief in the future.

What was needed was a plan, some structure, confidence and some decision making ability. And, one had to see beyond the battles over power turfs and history.In the Central Bank, I met the bank staff first. Then came the IMF team. They were all there waiting for me.

I sensed it already in the first meeting. All looked at each other. It was as if they wondered who was to pass on the sad message that we had still not reached the bottom.

But I also sensed an eagerness.They were impatient. The change of government and the fight between the government and the prior governor on whether he should resign had brought many of their efforts to a halt.

Months had been wasted. Now they wanted to get the formalities completed and move on.

What do you think are the biggest takeaways from the 2008 financial crisis?

It again confirmed that any financial crisis tends to play out in five stages.

First, a sector or sectors gain altitude through debt-financed growth. Exactly who takes on that debt varies. It could be banks; it could be companies, households or governments.

The second stage starts when markets change, and euphoria turns to mistrust. A liquidity crisis kicks in.

New money is no longer available to keep the party going. A liquidity crisis is almost always what triggers a financial crisis.

In the third stage, more sellers appear of shares, bonds and properties. But buyers can’t be found.

In a distressed market, asset values tumble. In the fourth stage, plunging asset prices and the overall fear in the markets have a cascading effect, setting off defaults, distressed situations and business closures, adding to the broader drop in consumption and investment.

In the fifth stage, the contagion spreads to state finances.Governments spend money to save the banks. The tax base shrinks. Crisis-related spending increases.

These were the learning on the causes and the rhythm of the crisis. We learned that forceful action is needed for solutions, as seen in Iceland, Ireland, Portugal and the European Central Banks.

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The 2008 crisis helped to educate us on the warning signals. These we need to watch as the global economy, businesses and households are beaten up by the economic impact of the covid-19 pandemic.

So far, the Central Banks and governments have been on the alert and responding aggressively with liquidity and support schemes.

But, we must remember that many are shaken. Balance sheets are weakened. The buffers of many have been worn down. Government debt levels have skyrocketed.

The shifts have been larger than the imbalances that created the euro crisis in 2012 and 2013.

So far, everyone focuses on the immediate challenges, but we need to ensure that government finances again are strengthened and the buffers reestablished soon.

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