Is Iceland the Canary in the U.S. Coal Mine?

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Includes: DIA, SPY
by: Ed Zimmer

The collapse in late January 2009 of the Icelandic Government is being blamed directly on the collapse in 2008 of the country's banks after they were overleveraged to such an extent that the world-wide financial crisis caused investment values to implode. During a period of rapid growth, the banks amassed huge debts in financial implements that turned out to be based on little more than promises that the good times would last forever.

Turns out forever had an expiration date. As a result of the banks' implosion, the currency has plummeted, unemployment is rising and inflation is growing as the value of the currency falls.

Iceland was unable to prevent the banks' collapse - it was simply too much, too quick. Elsewhere in the world, governments have been creating money hand over fist and pumping that money into banks by any means possible to avoid what happened in Iceland. Results are hard to quantify so far because the extent of losses seems to grow with each passing month.

In the UK, the government there is talking of nationalizing banks, yet no one is talking about how much is still at risk in these banks. The general feeling is that if the true extent of the losses were made public, the pound would literally ‘take a pounding’ in the currency exchange markets.

Here in the US, the same problem is showing up. Predictions less than six months ago that the total losses of bad investments would be around a trillion dollars have now been surpassed, with new estimates putting the total losses over 2.2 trillion dollars. 350 billion dollars of government bailout has not righted the economic ship and proposals now include spending the rest of the 700 billion dollar stimulus, plus another 850 billion dollars in new spending and buying up the “bad” assets by the US government.

However, just as in Iceland, no one is willing to admit just how much “bad” assets will need to be purchased or guaranteed by the government to stem the crisis. No one is even willing to admit to just how much needs to be written off, although research by NYU economist Nouriel Roubini is now placing US banking losses at some 3.6 trillion dollars. If that is accurate, it is 16% more than the entire US budget for this fiscal year.

The US continues to literally throw money at a problem that we are clueless about. The banks refuse to divulge any information that would make them look bad or create a “crisis in confidence” among their depositors, but it's okay to take government funds, paid as taxes by those same depositors.

Still, the problem for the government remains how to save the banks, which could be completely insolvent due to bad assets on their books, without further shooting the economy which is in a recession. Both appear to be drowning, and with Iceland as the most recent model of what follows a banking collapse, the US government may not be willing to lose banks that could trigger a political coup. For the average person in the US, the question may be one of getting the bad medicine over quickly, or a lingering illness that produces a long term Japanese Pseudo Recovery.

For US politicians, it must appear as a no-win situation, and not a single politician wants to be accused of doing nothing while the crisis grows. But ignoring the consequences of their actions as an excuse for throwing money at a problem is not the answer. 350 billion dollars already spent would have given every man, woman and child in the US about $1000 each. That would have allowed some people to postpone the repossession of their homes, allowed others to pay bills or buy Christmas presents or even save for a rainy day. Instead the money went into a banking black hole and for all visible purposes, vanished from sight. Banks won’t even say how they have used the funds.

We may not be able to resuscitate this canary. The question may be, is there a better solution available or is it going to die anyway?