Iceland's mistake

Willem Buiter and Anne Sibert publish this brief but insightful article summarizing their findings when Icelanders asked them to look at their banking sector in early 2008:

Briefly, they state that Iceland's problem was being (1) a small country, with (2) a large, internationally exposed banking sector, having (3) their own currency, and (4) limited ability to provide their banks with backup financing in difficult times, relative to their banks' obligations.

Even if their banks were solvent and profitable, which they very well might have been, they were prone to collapse during a liquidity crisis, because they did not have a large enough economy to back them.

Buiter and Sibert suggest that Switzerland, Denmark, Sweden, and even perhaps the UK may be in a similar predicament.


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