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.
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.
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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.
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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.
Do you believe that other countries could have reacted and recovered as quickly as Iceland?
Simply put, a broad financial or economic crisis can be compared to a situation where you go to a restaurant with a big group and rack up a big bill. If you split the bill equally, everyone can pay their fair share and move on. Or there may be a few who have to wash dishes. But, paying up is better than quarreling or, even worse, getting into a fistfight and adding damages to the bill.
Sadly, the latter is often what happens as countries end up in a financial crisis. They end up quarreling as to who should take the costs instead of finding a way to split them fairly.
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Iceland was different as they had to let all the largest banks go bust, with the bank creditors taking a large part of the bill. The lenders had provided money to banks that proved themselves not to be viable, private parties lending to private banks took a hit. Smaller, local banks were established. Hence, a systemic crisis was avoided.
Iceland was harder hit than any, thus ended up with more draconian measures than any other country. However, it’s hard to argue that Iceland was the hardest hit is an excuse for most other countries that almost all took longer to recover.
What lessons can be applied to 2021?
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. The solidity of the banks needs to be monitored carefully. Lastly, we also need to see investments and growth. Luckily there is no lack of opportunities we can pursue to invest in the energy transition to mitigate the climate crisis, technology and emerging market growth.
About the author
Svein Harald Øygard
Svein Harald Øygard was appointed interim Central Bank Governor of Iceland in the midst of the country’s deepest crisis. He became the first non-national to head an independent Central Bank. Previously, he was Deputy Minister of Finance for Norway and he has worked at McKinsey & Company as a corporate strategist for 22 years.
