21st Century Economic Reporter Zheng Qingting from Beijing
On the one hand, growth is economic power, and on the other hand, hidden risks. "Looking back at the 2008 financial crisis, the first foreign governor in the history of the Icelandic Central Bank, Svan Harald Igad, said in an exclusive interview with 21st Century Business Herald reporters.
The global financial tsunami triggered by the US subprime crisis in 2008 made Iceland, a small country thousands of miles away, the first country to be on the brink of bankruptcy. Before the crisis, Iceland was one of the wealthiest countries in Europe, with a per capita GDP ranking sixth in Europe. After the crisis broke out, Iceland's three major systemic banks collapsed one after another, the stock and real estate markets collapsed, and the unemployment rate tripled within six months, leaving almost no one unscathed.
At the height of the global financial crisis in 2009, Igad, who had previously served as Norway's Deputy Minister of Finance, parachuted into Iceland and took over the important role of Governor of the Icelandic Central Bank. Under his leadership, although Iceland was the hardest hit, it recovered the fastest, with a stable financial system and debt levels much lower than before the crisis, becoming the first country to withdraw from the International Monetary Fund rescue plan.
By 2023, the global financial crisis that broke out in 2008 seemed to have moved away from people's lives. But whenever people evaluate various financial risks, it is still inevitable to use the crisis 15 years ago as a reference frame.
In his book "At the Center of the Storm", Igad reviewed the precursors, outbreaks, response measures, and the process of economic recovery from both a hands-on and macro perspective. He believes that in a sense, Iceland's experience is also a microcosm of what has happened in other countries. Iceland's experience can help people understand the advantages, vulnerabilities, and policy choices that can be utilized when encountering new shocks.
He pointed out that among all cases of over borrowing, Iceland in 2008 was the most extreme foam economy. Behind the surface of economic prosperity, Iceland's debt leverage and risk taking have experienced an astonishing expansion, with its three-year cumulative credit growth rate reaching a peak of 97% in 2006. The severe financial imbalance has made the arrival of the crisis inevitable.
In Igarde's view, the development of financial crises usually has five stages: the first stage is a sharp expansion of debt, the second stage is the emergence of a liquidity crisis, and the third stage is a market downturn, with asset values plummeting; The fourth stage is the spread of panic, causing a setback in investment and consumer confidence; The fifth stage is when the crisis spreads to the national finances.
He pointed out in the book that in the first stage, few people would notice signs of excessive borrowing, and few would notice that the red warning light of economic overheating was already flashing, while those who really started doing something were even rarer. But the real situation is that due to excessive debt and high debt repayment costs, the root cause of the financial crisis has been planted
This cycle repeats itself in one country after another, crisis after crisis, "he said." Sometimes it takes an economy several years to complete all five stages, and sometimes it only takes a few months
He believes that from the Silicon Valley banking incident at the beginning of this year, it can be seen that developed countries have learned a lot from the global financial crisis of that year, placing greater emphasis on coordinating policy actions and becoming more vigilant against risks. But at the same time, the lessons they have learned are not enough, and debt levels are still allowed to significantly increase, especially in the private sector (the debt levels of the US government are also soaring), and there is still a lack of good mechanisms to solve the banking crisis.
Every financial crisis has five stages
21st Century: It has been more than a decade since the outbreak of the financial crisis from 2008 to 2009. Looking back, how do you see the impact of this crisis on the global economy?
Igarde: The financial crisis that broke out in 2008 had a huge impact on the global economy, especially bringing deep scars to some OECD countries. To this day, it remains the reference standard for people when measuring the impact of risk events. The financial crisis of that year was triggered by the US subprime mortgage crisis, which was further exacerbated by the collapse of Lehman Brothers, and ultimately had a profound impact on the global economy.
As I wrote in the book, each crisis has five stages: first, debt growth; second, liquidity scarcity; third, market distress; fourth, a collapse of confidence; and finally, a national budget crisis. So, in many ways, the global financial crisis has also triggered the euro crisis, debt problems, and so on. Nowadays, some countries are still affected by the 2008 financial crisis, such as Greece and Italy.
21st Century: Has the unity of the European Union been consolidated or weakened based on the response of member states to the euro crisis?
IGAD: In a sense, although the euro crisis cannot be said to have been completely resolved, it has at least eased the tension in the capital market. Therefore, I believe that today the EU is actually more united. When there was turmoil in the US banking industry in early 2023, the central banks of the relevant countries immediately gathered together and expressed the need to find a solution to the problem, as if not resolved, everyone knew it would have an impact on the broader system. Therefore, compared to 2008, there has been a more coordinated and coordinated response from all parties today. In my opinion, if we had not experienced the 2008 global financial crisis, such a situation would not have occurred.
21st Century: Before the outbreak of the epidemic, had the global economy emerged from the impact of the global financial crisis? Do you agree with Larry Summers' view that developed economies are stuck in long-term stagnation?
Igad: I agree with this direction, but it's not because of the global financial crisis. The global economy has almost different factors at play simultaneously, one of which is the sharp rise in debt levels, the mortgage crisis, the subsequent economic collapse, and the euro crisis. But the main factor behind the euro crisis is that these countries borrowed too much money in a zero interest rate environment and were not aware of the potential danger. I believe that stagnation is indeed happening, but it is mainly due to insufficient innovation, weak productivity growth, and insufficient investment in public infrastructure.
As a foreign governor, there is no ideological burden
21st Century: Let's talk about your role as the governor of the Icelandic Central Bank in responding to the crisis. From the perspective of insiders, how did small Iceland unexpectedly become the center of the 2008 financial crisis, and how did the country better respond to the crisis than most people expected?
Igad: Iceland is a small country, but it has a large banking sector. At that time, two of the top ten global defaults occurred in Iceland. Three of the top ten financial institutions that collapsed during the 2008 crisis are located in Iceland. These all indicate that there is no necessary connection between the size of the banking system and the national land area. Just like Switzerland, although the country is small, it has a huge banking system.
At that time, there were a large number of players in Iceland's capital market. Over time, the internal problems in Iceland have become increasingly serious. After the collapse of Lehman Brothers, Iceland's banks were among the first to fail. But at the same time, Iceland is also the only country that allows its systemic banks to fail, which makes everything simple. In fact, this country has also suffered serious losses and made things easier. It has achieved recovery at a very fast pace.
21st Century: As the first foreign governor in the history of the Icelandic Central Bank, how would you describe your experience at that time?
Igad: As an economist, my memories have both good and bad. On the negative side, I almost parachuted from Norway to Iceland, which was in crisis, where there was devastation and problems everywhere. But the good thing is that I don't have any historical baggage, and I don't have any responsibility for the problems that have occurred in Iceland. Therefore, as the president, I can spend all my time dealing with problems without having to explain what has already happened.
In fact, this is a very important experience in crisis management, applicable to a wider range of fields. Once any institution collapses, the staff will be exhausted, thinking repeatedly about what happened and how it happened, and half of their mental abilities are almost blocked. And I was fortunate not to be exhausted as a result and could spend all my time on the upcoming events. I have stated that I will not spend a minute commenting to the media on what happened during my tenure, so it is only now that I have written a book that truly tells the story of what happened at that time.
Propose 25 action points on one page
21st Century: What was the biggest challenge you faced when you first took office? How did you decide on the priorities for dealing with the crisis?
Igad: I have proposed 25 action points on one page to restore balance in the real economy through these measures. We start from the core areas: macroeconomic adjustment, monetary policy, fiscal policy, and national debt management. Then, two additional matters were added: revitalizing the banking sector and resolving the debt crisis for businesses and households.
At the macroeconomic and monetary policy levels, we must reduce the inflationary pressure caused by the weakness of the Icelandic krona. Due to the lack of further capital inflows, we need to develop a plan that can increase exports and reduce imports.
In a sense, implementing 25 initiatives in a short period of time is a huge challenge, but I believe it is also truly achievable learning. Every time someone tells me that there's too much of this, I say, 'We can do it as long as we can achieve efficient management and mobilization.'.
The most direct challenge we face is that even if I come after everything collapses, the worst consequences may not have arrived yet, and things are getting worse day by day - the currency is still weak, and the number of bankrupt banks is constantly increasing. Pressure was the biggest challenge at the time.
21st Century: What unconventional measures did you take during the crisis?
Igad: We took many innovative measures at that time, and I wrote them down in the book. One of them is that bank restructuring goes through two stages: the first stage is the way banks split, and I did not participate in it; In the second stage, what the restructuring committee did was quickly give creditors bank ownership and convert debt into equity, which made the bank very strong overnight.
In addition, we have taken some measures that are contrary to the IMF's plan, and I have fully utilized my experience in the private sector. For example, we thoroughly investigate the cash flow and debt of each bank to determine their operational status. As the central bank, we also bought back a large number of Icelandic krona treasury bond bonds in the secondary market, which shocked the IMF at that time.
China should strive to improve capital productivity
21st Century: China has successfully withstood the most severe impacts of the Asian financial crisis (1997-1998) and the global financial crisis (2008-2009). How would you evaluate China's response during the financial crisis?
IGAD: In a sense, the countries that were most severely injured were those that had the deepest integration into the global economy in terms of capital markets and trade flows, and at that time, China's degree of integration was still very limited. In addition, China has been less affected due to the strong fiscal capacity of the government, a robust banking system, and robust economic performance, all of which are the lines of defense against the global financial crisis.
21st Century: Currently, the Chinese economy is also facing some downward risks, especially in the real estate industry. Do you think there is a systemic risk in China?
Igad: This is not what I saw. Many elements of the Chinese economy are still very strong, and the level of inflation is very low, allowing for greater room for adjusting interest rate policies. The government's fiscal revenue and expenditure are also relatively stable, and there is still a surplus in the current account.
I believe that low capital productivity poses a challenge to China's long-term growth because a large amount of investment is inefficient under the leadership of local governments. China has noticed this and is striving to establish better capital discipline by raising interest rates, as this will bring pressure to some industries, especially the real estate industry. In a sense, this is a necessary process in order to maintain a high growth trajectory.
But China's advantage is that if it goes too far, it has the ability to reverse this process and can make timely adjustments through loose policies. China has sufficient policy space.
21st Century: After the global financial crisis, developed countries led by the United States have made many changes, passed multiple relevant laws, and made many commitments. In your opinion, have developed countries learned enough lessons from the 2008 financial crisis?
Igad: Not enough, I want to say they have learned a lot because they place more emphasis on the coordination of policy actions I mentioned earlier and are more vigilant about risks. All central banks are now more clear about what to do and have a much higher understanding of systemic financial risks, as reflected in the Silicon Valley banking incident earlier this year. But at the same time, the lessons they have learned are not enough, and debt levels are still allowed to significantly increase, especially in the private sector (the debt levels of the US government are also soaring), and there is still a lack of good mechanisms to solve the banking crisis.
We should fully understand the dual responsibilities of bank supervision
21st Century: Do you have any ideas on how to improve banking system regulation?
Igad: I think what is particularly important is the duality of bank regulation. On the one hand, you can conduct micro reviews with financial regulatory agencies, audit accounting books, and ensure the integrity of supporting business. On the other hand, you also need to have macro prudence, reflect on potential changes in the macro environment, and promptly signal the economy and measure blood pressure. The second part has already improved, but I believe there is still room for improvement, and we need to have a better grasp of the economic cycle.
For banks, this involves the issue of the size of capital buffer zones. Banks not only shoulder the task of lending to enterprises to support the development of the real economy, but also need to ensure sufficient capital to ensure financial stability. Therefore, we must promptly understand the economic situation and be able to take prompt action.
21st Century: How to evaluate the performance of the Federal Reserve in responding to the banking turmoil in Silicon Valley? Will the Federal Reserve's forceful backtracking create moral hazard?
Igad: My overall impression is that if a bank owner earns a lot of money by taking risks when the situation is good, and does not take on the burden when the situation is bad, it is moral hazard. But from the perspective of bank governance, if a bank falls into the risk of the Silicon Valley banking incident, the value of ownership and equity will be reduced. Therefore, in my opinion, authorities such as the United States and Switzerland have taken very decisive actions to avoid the spread of risks, and everything they have done is appropriate.
In my opinion, the private sector should truly be questioned. How did Silicon Valley Bank claim to have applied advanced technology and data analysis to the field of financial services, but this financial risk arose? In fact, true moral hazard exists in the asset management industry, especially in private equity funds.
The IMF may underestimate the risk of global financial instability
21st Century: The IMF warns in its latest Global Financial Stability Report that if central bank interest rates remain high for a long time, about 5% of global banks will face pressure, and if the global economy enters a period of stagflation, another 30% of banks (including some of the world's largest banks) will face pressure. What is your comment on this?
Igad: In some ways, I think the picture they depict is a bit too optimistic, which is the significance of predicting the macroeconomic outlook. On the one hand, an increase in interest rates may exacerbate the fragility of the financial system, but on the other hand, it may also bring about consequences of vicious cycles, such as problems for banks as their customers fall into economic difficulties. During the banking crisis in Norway in the early 1990s, I was serving as Norway's Deputy Minister of Finance. At that time, half of the bank loans were provided for households and the other half for businesses. Banks did not have a significant impact on household business, but suffered a 12% loss on corporate lending, resulting in a 6% loss on the total investment portfolio, causing all major Norwegian banks to default.
As I mentioned earlier, many large departments have too much debt, including real estate, acquisition funds, private equity funds, and special asset management institutions. Although not all banks face these risks, I expect some banks to face significant risks, and as the interest rate hike process continues, these banks will face challenges.
Therefore, the challenge faced by monetary policy institutions is that the conventional approach is to first raise interest rates to combat inflation, then reduce unemployment and stimulate growth, and finally ensure the integrity of the entire financial system. As monetary policy continues to tighten, risk events will occur. When these events occur, the government and central bank must be prepared to deal with the chaos.