Boomerang by Michael Lewis is divided into several different chapters that examines the role a specific country played in the global financial crisis.
The first country examined was Iceland:
Some background info on Iceland, circa 2003 the three biggest banks in Iceland had assets of only a few billion dollars, which was about 100% of their GDP. Just 3.5 years later assets had grown to 140 billion, which was too high to even calculate a sensible percentage of GDP. The increase occurred because banks typically lent money for stocks and real estate purchases, as a result prices of these investments increased dramatically from 2003-2007. During this period the stock market increased 9 times in value and the real estate market 3 times.
To show how dramatic the growth was, Lewis mentions that in 2006 the average Icelandic family was 3 times as wealthy as they had been in 2003. As a result of the seemingly fool-proof system, many men left jobs in the fishing industry (Iceland’s primary export) and flocked to the financial industry. People trusted the Icelandic people, as they culturally had a reputation for being very rational, and it’s likely that many assumed Iceland was too small to really make a difference in the grand scheme of global financial markets. So this boom went relatively undetected.
But as exemplified by the sudden and dramatic boom between 2003-2007, the exodus from fishing to finance appeared to be a smart and beneficial decision. However there were several faults which proved to be the downfall of Iceland and solidified their contribution to the global financial crisis.
The first major fault was Icelanders knew very little about the banking system. As Lewis frequently points out, they were historically a country centered around fishing exports, so they were playing in a business they knew relatively nothing about. The second major fault is the size: Iceland is a country of about 300,000 people, and it boomed way too fast. This matters because people were borrowing large sums of money from foreign banks, investing it, and reselling the investments to family and friends within their small “community”, resulting in the huge stock and real estate booms.
They did this because at the time, local interest rates were at 15.5% and the cost of the krona was rising in tandem with the increase in assets, so when Icelanders wanted to buy something they would borrow in a different currency such as yen or francs and pay a mere 3% interest, it benefited them (1) because they made tons of money on the currency exchange and (2) the increased spending added to the value of the krona.
The third major fault: Iceland operated on the assumption that they should buy as many assets as possible with cheap foreign money because asset values could only appreciate. The small population comes back into focus again because Icelanders traded within their small community, swapping assets back and forth with each other, which created perceived, yet fake, capital because they were sold at inflated values. In 2007, they owned 50 times the amount in foreign assets they did in 2002.
If the downfall were pegged to a specific event/time it would be in September 2008 with the collapse of the Lehman Brothers. People had entrusted money to the historically rational Icelanders, and they in turn invested it, but when panic set in they wanted their capital back, a classic bank run occurred. Lewis interviewed an Icelandic fisherman-turned-banker who said shortly after the collapse people could be seen around Reykjavík carrying large bags filled with any type of foreign currency they could pull out from the banks, and they would then hide them in their homes because the market for krona had disappeared.
The aftermath of this panic was devastating for Iceland, the previous loans denominated in yens or francs still had to be repaid, however the value of the krona was now less than 1/3 of its peak value. To make matters worse, Iceland imports practically everything apart from fish and heat, so the decrease in value made imports ever more pricey. By the end of the crisis, the stock market had collapsed 85% and the debt amassed to 850% of GDP. To frame the severity– as Iceland’s population is minuscule compared to the debt amassed, the 300,000 citizens of Iceland found themselves responsible for $100 billion worth of banking losses, which equates to $330,000 per man, woman and child.