A Real Credit Solution

Iceland Credit Raters Miss Resurrection After Failing to Predict Collapse

The credit rating companies that were too slow in predicting Iceland’s economic collapse in 2008 may be underestimating the strength of its resurrection.

Fitch Ratings said in May it may take two years for the island to shed its junk status, while Moody’s Investors Service and Standard & Poor’s give Iceland their lowest investment grades. That hasn’t deterred investors from trying to buy twice the amount offered in last month’s $1 billion bond sale as the island returned to global capital markets less than three years after its banks defaulted on $85 billion in debt.

“When you look at how successful that auction was, it’s clear that investors are now crunching the numbers themselves and that the credit grades from the rating agencies are less relevant,” Valdimar Armann, an economist at Reykjavik-based asset manager Gamma, said in a July 4 interview.

Iceland’s experience shows the rating companies may be overcompensating after failing to identify some of the risks that led to the global financial crisis, said Armann. While Moody’s kept a Aaa rating on Iceland until five months before its banks collapsed, reluctance to raise the island’s credit grade now is blocking the country’s access to a broader investor base. Debt derivatives show the low ratings may be unwarranted as credit default swaps on Iceland indicate it’s less likely to default than euro member Spain.

“If things turn out better than expected, the rating can move up,” said Paul Rawkins, a senior director at Fitch in London, in a phone interview. Still, there are “uncertainties that need to be taken into account,” he said.

Rating cuts in Europe have had “significant” spillover effects in the region, revealing a potential to stoke instability, the International Monetary Fund said in a March report. Cuts to levels near the lowest investment grade for “relatively large economies” have hurt other countries sharing the euro, the IMF said.

European officials are trying to involve private investors in a new Greek bailout without raters labeling the arrangement a default. Greece needs more aid after last year’s 110 billion- euro ($160 billion) rescue proved insufficient.

Iceland, which averted a sovereign default by refusing to bail out bank bondholders, will see economic growth of 2.2 percent this year and 2.9 percent in 2012 as its budget deficit narrows to 1.4 percent of gross domestic product, the Organization for Economic Cooperation and Development estimates. The 17-member euro region will grow 2 percent this year and next, the OECD said May 25.

Compare Iceland to the US in its growth rate and budget deficit:

US deficit:   10.9% of GDP
US growth:   1.5% according to the IMF September forecast
Net growth: -9.4%

Iceland deficit:   1.4% of GDP
Iceland growth:  2.2%

Net growth:     +0.8%

The United States and the European Union need to learn from this experience.  Even entities as large as nations and trading blocs can't bail out the banks continually.  Banks must be allowed to go bust or the nation will instead.


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