Could the Icelandic Banking Collapse of 2008 have been Prevented? The Role of Economists in its Unfurling

In 2008 the three main banks in Iceland collapsed. The proximate cause was the freezing of the short-term international money markets, initiated by the subprime crisis, on which the Icelandic banks depended. However, concern about the Iceland banks and their rapid growth was expressed by, amongst others, the international rating agencies and the IMF a couple of years earlier, causing a temporary mini-crisis. Moreover, there is strong evidence that the banks would have become insolvent even without the subprime crisis. The Icelandic parliamentary Special Investigation Commission came to the conclusion that 2006 was the last date by which the excessive growth of the banks could have been curtailed and the collapse possibly averted. Yet there was a marked difference in opinion at the time about the viability of the Icelandic banks. A clean bill of health was given by two influential reports by Mishkin and Portes, just prior to the collapse. However, severe reservations about the Icelandic financial system were expressed by Wade. These contrasting views were widely debated in the media and elsewhere and may well have influenced foreign potential and actual depositors in the banks. This paper analyses the disparate arguments put forward and contrasts it with the actual outcome. It considers the influence of economists in public policy debates and draws some methodological conclusions.