Lecture Notes on the Financial Crisis and Deregulation

Overview of Iceland

• Stable democracy with high standard of living
• Low unemployment and government debt until 2000
• Strong infrastructure: clean energy, food production, fisheries
• Good healthcare, education, low crime
• Nearly reached an "end-of-history" status

Deregulation Policies (2000 Onwards)

• Initiated by Iceland’s government
• Allowed multinational corporations to exploit natural resources (e.g., aluminum smelting plants)
• Environmental and economic consequences of deregulation
• Privatization of Iceland's three largest banks leading to financial deregulation experiment

Financial Deregulation Consequences

• Banks borrowed $120 billion (10x Iceland's economy)
• Rapid increase in stock and house prices, massive bubble
• Major players emerged, e.g., Jan Asger Johannesson, who acquired assets with borrowed money
• Banks advised clients to withdraw funds into money market accounts

Regulatory Failures and Collapsing Banks

• Regulatory bodies failed to protect citizens
• Conflicts of interest, with regulators becoming bank employees
• US accounting firms and credit rating agencies failed to identify issues

Collapse of Iceland's Banks (2008)

• Resulted in tripling unemployment in six months
• Widespread loss of savings

Broader Context of Financial Crisis (2008)

• Global financial crisis triggered by Lehman Brothers' bankruptcy
• Resulted in recessions and massive job losses globally
• Major financial institutions had made reckless investments and deregulation led to destructive practices

Historical Perspective on Financial Regulation

• Financial regulations post-Great Depression led to 40 years of stability
• 1980s deregulation allowed increased risk-taking and created conditions for future crises
  • Example: deregulation of savings and loan institutions leading to previous crisis
  • Key players: Donald Regan (Treasury Secretary), Alan Greenspan (Federal Reserve)
• 1999 Graham-Leach-Bliley Act repealed Glass-Steagall Act, enabling riskier financial practices

Role of Rating Agencies and Financial Products

• Rating agencies like Moody's and S&P played a significant role in the crisis
• Creation of unregulated derivatives market (e.g., credit default swaps)
• Increased speculative practices led to market vulnerabilities

Key Events Leading to 2008 Crisis

• Rapid expansion of subprime lending and CDOs
• Major financial firms betting against the very securities they sold to clients
• Lack of meaningful oversight and accountability

Regulatory Responses Post-Crisis

• Government bailout of major banks and financial institutions
• Slow response from regulators and lack of criminal prosecutions for top executives
• Aftermath: growing inequality, layoffs, and foreclosures

Conclusions and Takeaways

• Financial institutions prioritized profit over ethical responsibility, leading to systemic failures
• Need for regulatory reforms to prevent future crises
• The importance of transparency and accountability in financial markets
• Ongoing challenges with lobbying and political influence from the financial sector

Reflection on Current Financial Practices

• Call for stronger regulations in executive compensation and lending practices
• Recognition of the need for reform to protect consumers and ensure stability in the financial system