Case Study - Economic Turmoil in Latvia

Topics: Debt, Economics, Macroeconomics Pages: 3 (999 words) Published: July 1, 2013
Case study 4 – Economic Turmoil in Latvia

1.)In 2008 Latvia experienced a banking crisis that stemmed from a poorly regulated banking sector. The banking sector was using aggressive lending to grow the increased inflow of foreign capital, most of which came from Russia. This lead to a property bubble, similar to what was happening in the United States of America (US), prices were being bid up by borrowers who had access to cheap loans. Before the government could step in to control the bubble that was created the property bubble in the US burst sending a rippling affect through the world. This was hardest felt by the banking sector, which now had to reclaim their loans while investors were withdrawing their money as quickly as they could. This put the Latvian banks in a difficult position as much of the funds were tied up in debt capital. The Latvian government’s failure to rescue the nation’s largest bank continued with investors withdrawing their funds quicker and changing it to the euro. This made it very hard to keep the Lat pegged to the Euro. This was further exacerbated by currency speculators selling the Lat short, expecting the government to devaluate the currency. 2.)If the International Monetary Fund (IMF) had not stepped in the struggling Latvian banks would have defaulted on their loans to financial investors both domestic and foreign. The banking system would collapse as the government did not hold enough foreign currency to prop up the lat and keep the banks afloat. This would automatically put the country deep into a recession. Unemployment and poverty would be certain. The country could possible experience an exodus of countrymen looking for jobs in bordering countries. The European Union could drop Latvia from the EU to protect the entity. The Swedish and Finnish banking sector, and to an extent their economy, would also be in trouble because of the high investment by Swedish and Finnish banks in the Latvian banks. In short the country...

References: Weisbrot, M., 2012. Learning the wrong lessons from Latvia. [online] Available at: [Accessed 11 march 2013].
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