Iceland gets an upgrade

[oddlots]

http://www.creditwritedowns.com/2012...palatable.html

Proof of concept?

The BBC reports:

Iceland is safe to invest in again, according to Fitch, which has upgraded its credit rating three years after its economy spectacularly collapsed.
Fitch raised Iceland’s sovereign rating by one notch, to BBB- from BB+, meaning that the country’s debt is now "investment grade".
Iceland’s economy imploded under a mountain of debt in 2008, forcing an International Monetary Fund bailout.
Since then, the debts of its neighbours have sparked a crisis in the eurozone.
Fitch said the decision "reflects the progress that has been made in restoring macroeconomic stability, pushing ahead with structural reform and rebuilding sovereign creditworthiness".
In 2008, its three banks failed under their enormous foreign debt, which at one point was larger than the Icelandic economy.
The value of the Icelandic krona plunged, which made its exports more competitive. The new government of 2009 was allowed to carry on borrowing and spending for another year before spending cuts kicked in.

[mmr]

Re: Iceland gets an upgrade

Allowing Iceland's private borrowers (banks) to default on foreign creditors was an effective strategy in this case, since the country's sovereign debt levels were relatively modest and most of the bank debt was owed to foreign creditors.

Unfortunately, that was a unique solution to a unique situation - in the troubled eurozone countries, sovereign debt (largely held by domestic investors, especially in Italy) rather than private debt is at the root of the problem.

[oddlots]

Re: Iceland gets an upgrade

Unfortunately, that was a unique solution to a unique situation - in the troubled eurozone countries, sovereign debt (largely held by domestic investors, especially in Italy) rather than private debt is at the root of the problem.

Seems relevant to at least two countries to me: a) Greece (vis-a-vis the "should I stay or should I go question") and b) Ireland vis a vis the millstone of - originally - private debt that was hung around the taxpayers necks by their government. (Ireland had the best fiscal position in Europe as far as I can recall prior to the crash.)

In fact, regardless of whether it's private or public debt, doesn't this upgrade to Iceland just clarify that the sooner one recognizes the loss and moves on, the better everyone will be. This principle is so basic it applies even if the losses are to be felt within one's own economic block surely.

What am I missing?

[mmr]

Re: Iceland gets an upgrade

You're right that, after clearing the debt, growth in those countries could potentially resume - the question is how severe the initial collapse upon sovereign default would be.

For all of its troubles, Iceland restructured its private debt in a way that preserved sovereign borrowing capacity, and had extensive international help in doing so. Keep in mind that, contrary to the idea that Iceland just defaulted on all of its debt and got away with it, the country more than quadrupled its sovereign debt to recapitalize its central bank and domestic banking system (with a loan from the IMF and a few Nordic countries). Luckily for Iceland, their sovereign debt levels were so low going into the crisis that they had some flexibility to take on more debt in trying to stabilize their domestic financial system.

Since it had its own currency, Iceland was also able to put capital controls in place (which remain in place even today, I believe). Greece and Ireland don't have that option if they want to remain in the euro.

Upon sovereign default (a very different thing from private sector debt default, as in Iceland), Greece would simultaneously face the challenges of:

(i) massive capital flight
(ii) the need to balance its budget immediately (i.e., forced austerity beyond anything currently contemplated), given that it would have no ability to borrow, and tax receipts would probably collapse
(iii) uncertainty about whether it would remain in the eurozone; an immediate return to the drachma may not be technically feasible, without a complete overhaul of the payment system first

Thanks to capital controls, international support, and having its own currency, Iceland avoided or was able to control these problems - Greece is in a far worse situation.

Since Greece certainly seems to be heading down this road, we'll find out soon enough how far the economy collapses once default occurs and how quickly it bounces back. My guess is that the outcome will be severe enough to discourage other eurozone countries from voluntarily defaulting anytime soon.

You're right that it would have been better for these countries to default earlier (or in Ireland's case, not to have socialized private debt), but unfortunately that opportunity was missed long ago.

[jk]

Re: Iceland gets an upgrade

You're right that it would have been better for these countries to default earlier (or in Ireland's case, not to have socialized private debt), but unfortunately that opportunity was missed long ago.

ireland could still renounce the private debt that it socialized, likely at the cost of leaving the eurozone. unfortunately both ireland and greece have suffered the consequences of austerity in the form of shrinking gdp. as you say, they would have been much better off to bite the bullet before indulging in austerity. there would have been austerity enough upon their defaults.

[c1ue]

Re: Iceland gets an upgrade

Thanks to capital controls, international support, and having its own currency, Iceland avoided or was able to control these problems - Greece is in a far worse situation.

It should be noted also that Iceland was offered the same type of EU support as Greece and Ireland are presently 'enjoying', but walked away - more specifically voted out that option.

[jk]

Re: Iceland gets an upgrade

It should be noted also that Iceland was offered the same type of EU support as Greece and Ireland are presently 'enjoying', but walked away - more specifically voted out that option.

i guess all kinds of crazy things happen when you let people vote.