Missing the Story on Iceland: Can the Bankers Steal Your Kids' Money

The NYT's piece on Iceland's referendum on using public money to pay debts to foreign bank depositors failed to explain the real issues involved. During the boom, several Icelandic banks courted deposits outside the country, mostly in the UK and the Netherlands, by offering higher interest rates. The banks then used these deposits to finance a range of highly speculative investments.

As long the bubbles kept expanding, this model was hugely successful. However, when the bubbles burst, the value of the banks' assets collapsed and they had no ability to repay their depositors. This would have all been a private matter, except that the government insures bank deposits up to a certain level (like the FDIC in the United States). Iceland, as a matter of its treaty obligations with the European Union, is obligated to maintain a system of public deposit insurance which applies to both domestic and foreign depositors.

The issue here is whether private banks can effectively create enormous obligations (the money at stake would be equivalent to $6 trillion in the United States) for taxpayers. There was obviously an enormous regulatory failure on the part of the Icelandic bank regulators. International agencies like the IMF also played a role in failing to call attention to what were obviously very speculative investments. (Frederick Mishkin, a former Federal Reserve Board governor, did his part to promote the Iceland catastrophe, touting the great strength of its economy in a 2006 report. He does not appear to have faced any consequences as a result.)

It is also likely that some of the banks' actions involved fraudulent accounting practices if they concealed the extent of their true liabilities. The question then is whether the taxpayers or the depositors should bear the risk from fraudulent actions by banks. Arguments could be made in both directions, but this issue is never mentioned in the article.

It should also point out how the Iceland makes a mockery of anyone who claims to support leaving financial activities to the market. In almost all cases, actors in financial markets assume that governments will stand behind banks at the end of the day. Therefore when they say want the government to leave things to the market they are lying. They just want to be able to take risks with taxpayers money, without being fettered by regulations limiting the extent of these risks. In short, the finance boys want a free lunch, not a free market.

--Dean Baker

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