Icelandic borrowers
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Below is an excerpt from 'Wall Street On The Tundra' by Michael Lewis, Vanity Fair, April 1, 2009.
***Use course terminology to briefly explain what was speculative about the behavior of the Icelandic borrowers, as described in this quote.
'For the past few years, some large number of Icelanders engaged in the same disastrous speculation. With local interest rates at 15.5 percent and the krona rising, they decided the smart thing to do, when they wanted to buy something they couldn't afford, was to borrow not krona but yen and Swiss francs. They paid 3 percent interest on the yen and in the bargain made a bundle on the currency trade, as the krona kept rising. The fishing guys pretty much discovered the trade and made it huge, says Magnus. But they made so much money on it that the financial stuff eventually overwhelmed the fish. They made so much money on it that the trade spread from the fishing guys to their friends.
It must have seemed like a no-brainer: buy these ever more valuable houses and cars with money you are, in effect, paid to borrow. But, in October, after the krona collapsed, the yen and Swiss francs they must repay are many times more expensive. Now many Icelanders especially young Icelanders own $500,000 houses with $1.5 million mortgages, and $35,000 Range Rovers with $100,000 in loans against them. To the Range Rover problem there are two immediate solutions. One is to put it on a boat, ship it to Europe, and try to sell it for a currency that still has value. The other is set it on fire and collect the insurance: Boom!'
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This explanation provides you a comprehensive argument relating to Icelandic borrowers
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The behavior of Icelanders was speculative because they borrowed Swiss francs and yen instead of Krona. They speculated on foreign exchange rates and enjoyed huge gains till their home currency increased in value. Further, they also indulged in arbitrate in interest rates when they borrowed in Swiss franc and yen at 3% which was far lower than the local interest rate of 15.5%.
The speculation on foreign exchange actually brought the Krona down and along with it wrecked the national economy. The excessive speculation by the citizens of Iceland actually led the central banks of Iceland to devaluate the Krona. The piece describes a foreign exchange speculative bubble that burst ...
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- BSc , University of Calcutta
- MBA, Eastern Institute for Integrated Learning in Management
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