Iceland’s Meltdown

I’ve written about Michael Lewis’ take on the Wall Street’s meltdown in my post “The Financial Crisis Explained.”  He is one of my favorite commentators and is able to take complex issues and write about them in a way that is comprehensible to the average person.

He recently wrote an article about Iceland’s meteoric rise to prominence in the global world of finance and later its amazing crash when the bubble burst.  His article should be required reading for anyone interested in finance or the global economy.

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.

I wanted to focus on an aspect of the article that I’ve written about in my post entitled “The Business School Way of Life.”  Lewis mentions that most, if not all, of the people who were involved in Iceland’s boom and bust had degrees from prestigious American and British business schools.  They learned the Business School Way of Life in America and brought it home to Iceland.  Everyone caught the fever and it has wrecked a once stable country.  Now, the currency is worthless and debt is 850% of GDP, higher than even the highly debt burdened USA’s 350%.

As an example of a person who fell into the Business School Way of Life is Stephan Alfsson. Lewis spends some time interviewing  Alfsson, a fishing boat captain turned financier, in his article.  Here’s Alfsson’s story:

Lean and hungry-looking, wearing genuine rather than designer stubble, Alfsson still looks more like a trawler captain than a financier. He went to sea at 16, and, in the off-season, to school to study fishing. He was made captain of an Icelandic fishing trawler at the shockingly young age of 23 and was regarded, I learned from other men, as something of a fishing prodigy—which is to say he had a gift for catching his quota of cod and haddock in the least amount of time. And yet, in January 2005, at 30, he up and quit fishing to join the currency-trading department of Landsbanki. He speculated in the financial markets for nearly two years, until the great bloodbath of October 2008, when he was sacked, along with every other Icelander who called himself a “trader.

So why would an expert fisherman, who began training to go to sea at age 16, promptly give up his job to turn to finance?  Why did he think that he could work in banks and be a “trader” when he had no experience and no training?  Similarly, who do students who leave business schools believe that they can accurately project risk?  Lewis tried to get Alfsson to answer:

“You spent seven years learning every little nuance of the fishing trade before you were granted the gift of learning from this great captain?” I ask.

“Yes.”

“And even then you had to sit at the feet of this great master for many months before you felt as if you knew what you were doing?”

“Yes.”

“Then why did you think you could become a banker and speculate in financial markets, without a day of training?”

Alfsson does not have an answer and Lewis lets him off the hook, but I think that it was pure greed.  Alfsson and people like him were willing to try to get rich quick.  They saw everyone around them getting rich and decided that they wanted in on the action.  In Alfsson’s case, he saw people younger than him returning from American business schools and starting banks, seemingly making fortunes overnight.  The contrast between the hard work of a fisherman and the paper shuffling that was the Icelandic banking system cannot be any more stark, yet nobody wanted to raise a concern.  As Lewis puts it,

 At the very least, in a place where everyone knows everyone else, or his sister, you might have thought that the moment Stefan Alfsson walked into Landsbanki 10 people would have said, “Stefan, you’re a fisherman!” But they didn’t. To a shocking degree, they still don’t.

We are experiencing this same phenomenon in the US.  Why didn’t anyone try to stop the hedge funds, banks and private equity firms by saying “Hey, you just graduated from college, what do you know about CDOs and assessing risk?”  Why do many people who work in these firms still believe that they can correctly model future risk?  Why do business school students still go into finance without someone asking them questions like this?