There are two reasons for this: First, exchange rate movements and foreign exchange market conditions can be of critical importance to domestic financial institutions; and second, the personnel and other service elements necessary to build up two effective institutions in this field are limited. The Central Bank of Iceland published its last Financial Stability report in May 2008. The present report has been written without confirmed information on the banks’ and savings banks’ balance sheets, operations, and ownership structure. Consequently, it is not possible to assess the status of the banking system as a whole, as has been done in previous reports. Nonetheless, the Bank considered it important to issue a Financial Stability report at this time, both to document certain information on the financial crisis and the subsequent  BIS Review 136/2009  3  recovery work, and to discuss anticipated projects related to the regulation and supervision of financial activities. It is important to note that this report does not attempt to present a comprehensive analysis of the causes of the banks’ collapse, nor does it pass judgment on the actions taken by the Government and the supervisory authorities prior to the crash. In recent years, the Central Bank has engaged in broad-based contingency work in preparation for a possible financial crisis, in collaboration with domestic authorities and supervisory institutions, and with foreign central banks. That work is not discussed in the present report.
The first school, usually identified with Professor Paul Krugman of MIT, is best summarized by the two fashionable phrases “crony capitalism” and “Asian values.” The emphasis here is on inept domestic policies, inefficient resource allocation to politically connected individuals, unrealistic speculation - particularly in real estate - and imprudent public spending, all fuelled by over-borrowing, poor bank supervision, extreme moral hazard, and a hubristic attitude generated by several years of fast growth. The trends were unsustainable, and the Nemesis came with a loud and very messy bursting of bubbles throughout the region. Asia’s downfall, says Professor Krugman, “was a punishment for Asian sins, even if the punishment was disproportionate to the crimes.” The second school, led by Professor Jeffrey Sachs of Harvard, sees the crisis in less moralistic terms. The turmoil, he says, was a classic financial panic: a run on the banks and mass capital flight exacerbated by the maturity mismatch of many Asian banks and the currency mismatch of many Asian borrowers. This was accompanied by speculative attacks on currencies and the collapse of asset values. While this approach stresses the fragility of many of the banking systems in the region, it maintains that the Asian economies were in relatively healthy shape according to the usual indicators, and that the magnitude of the crisis far exceeded the faults and errors of individual jurisdictions. Both the Sachs and the Krugman schools have much in common. But their logic points in different directions.