“Regrettably, the current focus on the causes of the crisis continually misidentifies its true source, resulting in prescribed cures that fall short of the necessary actions. Peter Gumbel writing for the December 4th, 2008, edition of Fortune reckons previous Prime Minister Oddsson’s free-market reforms during his 1991-2004 years in office are what ultimately gave rise to the bust. Likewise, the IMF’s mission chief sent to Iceland to survey the nature of the problem, Poul Thomsen, recently commented in an interview that the root problem in Iceland was an unregulated environment that allowed an oversized banking system to develop. Indeed, the post-privatization banking experienced in Iceland resulted in a banking sector that saw assets increase to over 1,400% of GDP!
What analysts and authors commonly miss is the reason the banking sector could expand so rapidly. Indeed, as we shall see, the incentive structure of the Icelandic economy was manipulated through government guarantees, artificially low interest rates, and monetary spigots opened wide, allowing liquidity to be flushed through the economy. In addition, Iceland’s homeowners were offered tantalizingly low interest rates through the ‘Housing Financing Fund’ (HFF), a state agency that enjoyed explicit government guarantees on its debt, resulting in reduced interest charges for homeowners. Interestingly, while the Fund’s merely implicitly guaranteed American counterparts – Freddie Mac and Fannie Mae – have been the center of much controversy, the HFF has remained relatively unscathed.
The policy prescriptions in the wake of the crisis have called for more interventions, which will prove to exacerbate the situation if put into effect. Only by gaining a true understanding of the unsustainable and artificial nature of the boom of the past decade may we arrive at effective solutions to navigate the bust that engulfs the country.” (Read more from mises.org)