The severe economic destabilization in Iceland is part of a complex global financial crisis and is by no means an isolated event. However, the country, which is really skating on thin ice right now, has been hit particularly hard by this unprecedented financial storm due to the large size of the banking sector in comparison to the overall economy since the banks over there went on an unprecedented borrowing and lending spree that increased the amount of domestic credit from the banking system from 100% of GDP in FY2000 to nearly 500% in FY2007 and 850% in 2009.
A couple of excerpts from Michael Lewis writing in Vanity Fair on Iceland:
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.
An entire nation without immediate experience or even distant memory of high finance had gazed upon the example of Wall Street and said, “We can do that.” For a brief moment it appeared that they could. In 2003, Iceland’s three biggest banks had assets of only a few billion dollars, about 100 percent of its gross domestic product. Over the next three and a half years they grew to over $140 billion and were so much greater than Iceland’s G.D.P. that it made no sense to calculate the percentage of it they accounted for. It was, as one economist put it to me, “the most rapid expansion of a banking system in the history of mankind.” [via Vanity Fair]