Gunnlaugur Jónsson, CEO and a libertarian, explains the financial crisis in Iceland and the world in the Icelandic TV show Silfur Egils.
Part 1: http://www.youtube.com/watch?v=MBHETjZGr2Y
Part 2: http://www.youtube.com/watch?v=CDyBcKAoWs8
FULL TRANSCRIPT:
EH: With me here is Gunnlaugur Jonsson, CEO and a known libertarian. We‘re mainly going to discuss banks and financial institutions. I think you should convince me that libertarianism is not to blame for the collapse we‘ve witnessed in the world‘s financial system – that other factors are to blame, things like what you could call crony capitalism.
GJ: Yes, exactly. What‘s been happening in the world in the past years and indeed for a very long while is that a very large asset price bubble has been developing. Not only in Iceland but also for instance in the United States, Europe, the UK and Latvia. Icelanders who have bought summer houses in Spain are aware that there are similar problems there.
This bubble has been tough to deal with, it has not been as benign as it has appeared to be. People have had to highly leverage themselves in order to buy their homes and decision-making has been difficult. For example, I myself bought an apartment a few years ago. By then, real estate prices had been rising to such a degree that you had problems deciding whether to do what was sensible, which was to start saving and wait, but I decided to do what was not as sensible, which was to borrow and buy. The market price consequently went up, which meant that I did not have to leverage myself to the same degree as I would have, had I waited.
Bubbles are difficult, because they make it difficult to make the sensible decision about anything. Therefore, there are people who are generally sensible who now are in a tough position. They are so to speak not to blame, not mitigating the fact that some people have themselves to blame for a large share of their problems.
These things we call asset bubbles, which develop around the world, are formed under the protection of state guarantees on debt. The bubbles are formed by debt. People are lent money to buy things in all markets – real estate, equity shares, bonds, etc.
State guarantees are the catalyst for all this – they manufacture cheap credit. Central banks all over the world provide insurances in a direct way by operating as lenders of last resort. That’s something of which libertarians have been very critical. This insurance serves as an incentive for very irresponsible behavior – in the USA they call it the “Greenspan put”, but as we know he was Chairman of the Federal Reserve for 20 years. Investors simply said: Let’s just borrow and invest in real estate and equities – if we run into temporary problems, Greenspan will bail us out by pumping capital into…
EH: They always believe that the state will come to their aid, which means that their own responsibility is rather limited – they can behave in an irresponsible way.
GJ: Exactly. Freedom and responsibility have been separated. In Iceland we had an additional guarantee, which is actually common in other countries, in that the market sincerely believed that the Icelandic government would be willing and able to back up the Icelandic banks, if necessary.
EH: So we had an indirect state guarantee.
GJ: Yes. Under the wing of the state, a lot of loans were taken, because the responsibility was taken from the creditors who were lending the banks and it was put on the Icelandic state. The creditors didn’t care how the banks were run. In the safety of such a guarantee, a lot of very bad things can flourish. Corruption, for instance, without handing out judgments in cases that have not been thoroughly investigated.
EH: Let’s take a look at some slides you brought with you.
GJ: Yes. In this picture we see two banks. I’m going to explain how banks, enjoying state guarantees, behave in a lot riskier way than those that don’t. Here we see two banks that both enjoy state guarantees.
They decide to take part in a game of roulette and put all their money on black. One of them decides to borrow highly. They both own a single bundle of money – the green one – but one of them additionally borrows nine bundles of money. Without guarantee, no institution would be willing to lend the bank money to take part in a game of roulette, because the creditor cannot reclaim the loan if the money is lost.
On this slide, we see the result if the banks lose. Their only loss is their own bundle of money. Their losses are equal – regardless of whether they behaved in a risky way or not. The one that took a greater chance is not taking a greater chance on behalf of itself – it’s taking a greater chance on the behalf of others. Freedom and responsibility have been separated.
On the third slide, we see the potential profit. The bank which behaved in a lot riskier way made a much more profit for itself. That bank was not taking a chance at its own risk – it was taking a risk on behalf of others. This is what enabled the Icelandic banking system to grow to 12 times the gross national product of Iceland. – And enabled various other risks to be taken in the Icelandic financial system.
The Icelandic state guarantee is not the only reason for the bank growth – but also the general world-wide state guarantees, and the cheap money that flowed around the world economy. All this has been caused by the world’s governments. Libertarians have, for the last century, warned against this and opposed this system the entire time.
EH: There seems to be consent to patch up this system. Would it be better to just let it collapse entirely to the ground? Let the banks go bankrupt, and say goodbye to this system once and for all?
GJ: I think we should say goodbye to the system, and in my opinion there is a middle way in order to avoid a total collapse, but at the same time move into a new system a lot less fragile. Not rebuild the houses of cards that can easily be blown away by the smallest of breezes.
There is a way to exit this system in a way that does not require a total collapse. However, many libertarians are of the opinion that that is the only way forward.
The problem is that when bubbles were formed for the first time, their nature was not as malignant as it is now. So, the authorities decided to perpetuate the problem and convince people that the government was always there to bail them out. This escalated with time, so that the risk became increasingly high and the potential collapse became more and more severe, until the bubble burst.
EH: The bubble grows and grows, and the generation of money by the system constantly increases. In reality, the banks are the generators of the money, not the central banks.
GJ: Yes, exactly, for the most part it is the banks themselves that manufacture the money, as we see on the following two slides.
Let’s say that you have 10 bundles of money and you decide to deposit them into a bank. You are under the impression that the bank will safeguard the money, as you can see the amount you own on the account statement. In reality, what happens is that the bank loans the money out the back door to someone like Alli the Icelandic commercial Viking, seen on the picture to the right. The bank is in fact not in possession of the money. The money you believe is there for you is in reality not in the bank.
On the next slide, to the left you can see the money that appears on your statement, but to the right you can see the reality. The bank recycles the money, again and again. It lends the money out of the bank, it is deposited again, and the cycle repeats itself. Money in deposits can therefore appear to be 10 times the amount of base money behind them. This creates enormous risks, whereby let’s say if only one in 10 depositors decides to withdraw their money, the bank is bankrupt.
This is in fact why most of the world’s banks are in reality bankrupt. Everything is based on some sort of false confidence. People say that trust is important – but my point is this: It is very important to distrust banks…
EH: They should be distrusted…
GJ: Yes, they should be distrusted. If you distrust a bank, it cannot behave in this way. Take Bernie Madoff for instance, who operated a pure scam in the United States whereby he was able to pay people their money using money he was raising elsewhere. In theory, the scam could have proceeded indefinitely, as long as people put their trust in him.
You could have set up a system of a lender of last resort for Bernie Madoff, declared a state guarantee to ensure financial stability. In reality, this is the same phenomenon. The world’s banks are a kind of scam. Some want to call this embezzlement. Which may be overstating it a bit.
EH: But this is what happened when the Icelandic banks were denied credit – in part as early as 2006 and then in 2007. They had to start manufacturing money by other means.
GJ: What happened in 2006 is that until then everybody believed that a state guarantee was in place. Then, doubts emerged and economists pointed out that the Icelandic government, whether they wanted to or not, would never be able to back up the Icelandic banks should they run into trouble. So, the Icelandic banks started to put in place deposit schemes abroad – in the UK, Holland, Germany and other countries.
EH: The question is, where do we go after abandoning this system? Once upon a time we had a gold standard, so that the currency was backed by gold. That system was abandoned. Could that be a better system?
GJ: In a lot of ways, that is a much better system. The problem is really this money-printing permission, held by the banking system, which can be applied in order to blow up this enormous bubble.
EH: So you agree with the left-leaning documentary Zeitgeist?
GJ: On this issue, yes. That film is otherwise a little bit peculiar, but in it there is a really good description of this system and its volatility. How in fact it is a house of cards that can easily collapse. In order for the system to work, the world’s central bank governors have to be geniuses, able to time with precision when to pump money into the economy to protect the bubble and prolong it. That is a talent which I think no human possesses. We must change the system fundamentally, and fix the money supply, in order to put a halt to this endless issuance of debt and generation of new money.
EH: Then we have an economy not subject to the same ups and downs as we have now.
GJ: Yes. The recent economic prosperity has been an illusion. In the system I propose, freedom and responsibility go hand in hand.
EH: So, in short, you renounce the assertion that libertarianism is to blame for this economic collapse?
GJ: Yes. I do. And in my opinion that statement is highly unfair. I can well understand that people would jump to this conclusion, because on the surface it appears as if the banks enjoyed unlimited freedom, but their freedom was at our expense. That is not libertarianism.
Libertarians have, in the past century, written and warned that exactly this would happen. They have not been listened to and the result has been a sort of a mixed economy, consisting of privately owned banks enjoying state guarantees. The libertarians have opposed this all this time and in my opinion it is highly unfair to assert that the ideology of those who did warn this could happen has collapsed.
EH: Gunnlaugur, our time is unfortunately out, this is all very intriguing. Thank you very much for joining us.
