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April 01, 2009

How Iceland went mad (...or not)

Michael Lewis has an amazing story in Vanity Fair about how the tiny country of Iceland essentially turned itself into a hedge fund, with disastrous results:

Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance—resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.

Highly recommended and very funny.

Update: Gregory A. Burris offers a pointed rebuttal to Lewis in Counterpunch. Thanks to commenter Hildur for recommending the piece It's a useful counterweight.

However, unlike Burris, I didn't think Lewis was scapegoating Iceland for the global financial crisis. In fact, Lewis stressed repeatedly that Iceland was just a bit player in a much larger and more nefarious economic system. Iceland is a tiny country that turned itself into a hedge fund. Compared to AIG, the entire Icelandic debacle is scarcely background noise. Iceland didn't break capitalism. Capitalism broke Iceland.

I thought Lewis was saying that Iceland the nation is an example of the devastation that unregulated global capitalism can wreak on an entire society. Big countries like the U.S. and the China are rich enough to weather the demise of many banks and hedge funds, whereas smaller countries like Iceland can be totally wiped out by much smaller failures. For me, the key point was that global capitalism is a lot more diverse than it used to be: The players aren't just the biggest companies in the richest countries in the world, and the regulatory framework must take that into account. We can't afford to let booms and busts destroy nation states.

Update 2: Jonas Moody of New York Magazine fact-checks Lewis's account and finds it wanting--nobody's hoarding food, or blowing up Range Rovers en masse. Lewis understated the number of surnames in Iceland and overstated both impact of elf mythology on daily life and the ease with which cults can obtain federal subsidies.  However, Vanity Fair stands by Lewis's source's assertion that Icelanders are hoarding foreign currency. Converting krona into foreign cash would certainly have been a smart move for those who realized that the banking system was unsound and the Icelandic currency was on the brink of collapse. (Thanks, HG.)

So far, the critiques of Lewis's article have centered on his snarkily hyperbolic Icelandic travellogue, as opposed to the financial details that are the meat of the story. The author consistently exaggerates for effect, sometimes to the deteriment of his overall credibility. But Lewis's hokey speculations about Icelanders as the risk-taking sons and daughters of fishers and smelters aside, I'd be curious to know what people think about his economic arguments.

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It's a really good article, which foreshadows the next parts of the world to experience similar crises: those that can export natural resources. People with Ph.D.s don't generally like drilling for oil or looking for diamonds any more than they like fishing or smelting aluminum. This is bad for the Middle East, but that part of the world has been on life support since the 1980s (except Dubai, which was even more of a bubble economy than Iceland).

Botswana is probably going to be the next big bubble. It's the richest country in Africa, buoyed by diamonds and an exceptionally good government. Its stable democracy has also turned it into one of the favorite countries of certain liberals, such as Amartya Sen. It's essentially a democratic Saudi Arabia before the 1970s.

The world is now pocked with cities that feel as if they are perched on top of bombs. The bombs have yet to explode, but the fuses have been lit, and there’s nothing anyone can do to extinguish them. Walk around Manhattan and you see empty stores, empty streets, and, even when it’s raining, empty taxis: people have fled before the bomb explodes.

That's not what I experience when I walk around Manhattan. That makes me doubt Lewis report about what's happening in Iceland--not so much the facts of the financial crisis, but his explanation for it that relies on some claimed general traits of Icelandic citizens. So much of his story is anecdotes--and the one anecdote I can judge based on personal experience doesn't ring true to me.

My mom, who visited me a week ago, made the same observation - she said the streets are a lot emptier than the previous times she came here. I don't notice it as much, but that's because I rarely go out of Upper Manhattan, which is an entirely different world from Midtown.

Anyway, you can ignore the explanations of citizens' traits and still take from it something useful. Aluminum smelting plants aren't the most attractive kind of job there is, nor are they enough to support a first-world economy. For some reason, which coming to think of it Lewis should have delved more into, Iceland's companies never went into high tech the way Nokia did.

Well if we are forced to stop "hoarding food and cash" at least we still have Subway, Domino's, Burger King, Sbarro, Quisnos, Pizza Hut, McDonald's and KFCs around the island ;)

That makes me doubt Lewis report about what's happening in Iceland--not so much the facts of the financial crisis, but his explanation for it that relies on some claimed general traits of Icelandic citizens.

It's plausible for me. The generic trait is a propensity for risk-taking, at least with the men. The way Icelanders first made their money was by fishing and the most successful fishermen were risk takers. They took the fishing money and combined it with their abundant non-exportable energy sources for aluminum smelting.

And then they went into investment banking. The risk taking trait was necessary but not sufficient for the bubble. You also need enablers which according to Lewis included their Milton Friedman-idolizing prime minister at the time, American business schools which (mis)educated the young Icelandic businessmen, and European regulators and banks.

As Lewis asks, why Iceland and not, say, Tonga?

The way Icelanders first made their money was by fishing and the most successful fishermen were risk takers.

Actually, that's part of Lewis' story I don't understand. It seems that guaranteeing fishermen a percentage of the catch each year would reduce the importance of being a risk taker, rather than highlight it. Taking risks might get you your quota earlier, but it wouldn't make you more financially successful.

But yes, his explanation is plausible. I just don't know if it's true.

Iceland certainly has it's share of problems these days, but Lewis' story is so badly researched and full of inaccuracies that it is hard to imagine someone actually paid him for it. No one is blowing up jeeps in downtown Reykjavík (I live there, I would have noticed) and people are not hoarding food. Life pretty much goes on as usual in spite of everything.

There is a pretty good rebuttal of Lewis' article here:
http://www.counterpunch.org/burris03272009.html

Thanks, Hildur. I added a link to the Burris piece in the original post.

With respect to why risk taking fishermen were more successful:

The key is that quotas were sellable. If you fished faster than someone else you could afford to pay more for his quota. So instead of a bunch of fishermen working part of the season you eventually wound up with a few fishermen working all of it, and catching the same amount of fish.

Actually, that's part of Lewis' story I don't understand. It seems that guaranteeing fishermen a percentage of the catch each year would reduce the importance of being a risk taker, rather than highlight it.

According ot Lewis, there was/is a system were fishermen could trade their quotas and better fishermen would trade for others' quotas and fullfill their quotas earlier and make more money.

It's funny how both CounterPunch and the libertarian Cato Institute's Reason website were so highly critical of the article, calling it racist, etc, and yet have different agendas in trashing it.

Says Counterpunch:
Lewis conveniently ignores the fact that many other countries seem to be hopelessly headed in Iceland’s footsteps—places like Hungary, Ireland, and Latvia, not to mention the United States.

They weren't as bad as Iceland, but anyone who reads the newspaper is aware of this. And everyone with an IQ above average knows that the average Icelander isn't at fault, but apparently Counterpunch would like this point spelled out repeatedly and hammer home.

The point I got from Lewis's article is that the upper class Icelanders who transformed their country into a hedge fund were more gullible and overconfident than criminally fraudulent. Is this racist? Lewis's article is a huge indictment of the global financial system which took advantage of the Icelanders - apparently an easy mark - which is why Reason did hit pieces on it also.

The New York Magazine published this article and tackles some of the inaccuracies in Lewis' article:

http://nymag.com/daily/intel/2009/03/reality_check_vanity_fairs_fis.html

Hildur, HG (and Lindsay): Thanks for posting those rebuttals to the Lewis article. VF's reply to the NY Mag's rebuttal piece was revealing. We readers — and not the author — are apparently to blame if we can't tell when Lewis is telling us real facts and when he's just kidding. It was particularly reassuring to find that Lewis relied on a single source for some of his more controversial assertions.

Lindsay, I can't quite agree with your generous evaluation of Lewis's piece. His overall writing style was mildly engaging, but for the most part he was condescending and appeared to blame the whole country for the behavior of the tiny few who facilitated Iceland's rape by international capital.

Well, Counterpunch does address the economic arguments: it complains that Lewis's article looks for explanations other than "the nature of capitalism itself." And it doesn't distinguish the haves from the have-nots, never mind that Iceland is one of the most egalitarian countries on the planet.

Hi Lindsey.
I just found a very nice Icelandic blog site.
http://icelandtalks.wordpress.com/

It might be a good source for material for you.
Best wishes
Elwiss

Keeping a fishing vessel at sea costs much more than keeping it in port (due to increased wear and tear, not to mention the cost of keeping the crew fed). Fish fast and you keep costs down for the same gross income.

Alon, could you clarify this: Botswana is probably going to be the next big bubble. ?

It's not clear to me how a country gets to be a bubble. Iceland got screwed by trying to play high finance with the big boys, only to find out that the key word was "boy" rather than "big." Botswana has a modest construction boom going right now (I was there three weeks ago), but I didn't hear anything about the kind of economic exuberance that leads to bubbles, or of the potential for such a thing.

Lindsay, I can't quite agree with your generous evaluation of Lewis's piece. His overall writing style was mildly engaging, but for the most part he was condescending and appeared to blame the whole country for the behavior of the tiny few who facilitated Iceland's rape by international capital.

I don't think he was that condescending - you must not have much of a sense of humor - and in some places he was complimentary or sympathetic. And he certaintly didn't blame the entire country.

One of the interesting bits about the economics was Lewis's assertion that

"One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem."

You don't see this discussed very much.

I don't think he was that condescending - you must not have much of a sense of humor

Given the condescension of that remark, Peter K, it's apparent you have difficulty with the concept.

Lindsay, you seemed to have inadvertently mis-posted an Iceland comment onto the Citigroup thread, which I'll respond to here.

Lewis is very clear that the tragedy of Iceland is a symptom not the main problem.

I don't think that's clear at all. Compare the ratio of "deficiencies with Icelandic culture" remarks to "problems with corporate finance instruments" remarks. Does he even mention credit default swaps?

Lewis is arguing that Iceland as a nation got caught up in a speculative craze that could have been ripped from the pages of "Extraordinary Popular Delusions and the Madness of Crowds." He claims that it wasn't just a bunch of people who happened to work for hedge funds, but a national reorientation towards global finance.

That is his claim, but there is precious little actual data to back it up. Just because the government of a presumably democratic country embraces a policy does not always equate to widespread popular support for such a policy, particularly when there is a widespread dissemination of falsehoods involved in the discussion of such policies. See Iraq, Invasion Of.

Lewis talks about how popular attitudes in Iceland shifted from skepticism to uncritical embrace of all kinds of risky deals.

Yes, he talks about it; he just doesn't back up his talk with actual data. I'll wager less than a couple hundred people had a material impact on the decisions which lead to Iceland taking the path it did, and that a vanishing few Icelanders were given accurate information by which to evaluate the level of risk their country was actually taking on.

Togolosh: Botswana is not yet at the bubble stage. But it's growing faster than a country with its level of industrial production and infrastructure should be. I heard from someone who spent some time there that they don't worry about diamonds running out, because they have enough for 200 years' demand (isn't it what the Saudis thought early on?). It's going to keep growing at 9% a year for a while, and then it's going to crash like Saudi Arabia did in 1981 and Dubai is now.

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