Sunday, 29 April 2012

Did Icelandic households receive a major debt forgiveness?

"tkn" asked me in a comment to How to create a housing bubble? whether it was true that the Icelandic households had had their debt forgiven in any major amount. This is, unfortunately, not true. The short answer is that Icelandic households had 196.3 billion ISK (about 1.0 billion pounds) "forgiven" of their debts. That's about 12% of GDP.

But that's not really it. According to the "Icelandic Broadcasting Company" (IBC instead of BBC) the write-offs consisted of:

  • 43.6 billion ISK due to the 110% act: if your mortgage was worth more than 110% of the market value of your property you could apply for, but not necessarily get, debt forgiveness to the point where the rest of your debt would be 110% of the market value. This, along with the next point, was organised and, of course, hailed by the government as a "significant" act to lessen the debt burden of households.
  • "Abstract debt relief" provided for 6.2 billion ISK of the total 196.3 billion. This part was for individuals and couples that were in "serious" debt difficulties.

Those two points above were public initiatives. The next two were incidental!

  • According to Act no. 38/2001, linking the principal of debt to the exchange rate was illegal. This was nevertheless done. Nearly every single "foreign currency loan" (they weren't really loans in foreign currencies, they were merely loans in Icelandic krona where the principal fluctuated with the exchange rate of the krona) to households was illegal. When it was finally ruled, by the Supreme Court, that this was illegal, the banks had to recalculate the nominal value of the "foreign currency loans". The Central Bank provided the rules how to but those rules were disputable to say the least since they were retroactive! Roughly 108 billion ISK of mortgage debt was "written off" due to this but using that phrase is deceiving since the loans were illegal in the first place. In fact, two months ago a ruling was passed by the Supreme Court that touched on those loans and the result of the ruling was negative for the banks. But the banks, two months later, have not amended their debt collection methods accordingly. And people are getting frustrated. 
  • The recalculation of illegal exchange-rate-linked car loans, similar to the illegal mortgages, caused households debt to be lowered by 38.5 billion ISK.

Total: 196.3 billion ISK.

So this is the debt relief that Icelandic households received. However, due to the peculiar way of indexing the nominal value of mortgages to the Consumer Price Index, the inflation in Iceland has caused the principal of those indexed loans to grow. How much exactly, I do not know, but back-of-the-envelope calculations yield roughly 360 billion ISK since September 2008.

But it's maybe unfair of me to set this figure right next to the write-offs of 196 billion that the households got, incidentally or not. After all, this 360 billion figure is just a representative of how mad the mortgage system is in Iceland.

So I am afraid I must shatter the hopes of anti-debt activists and their ideas of Iceland. Unfortunately, the debt of Icelandic households is still around and it probably amounts to roughly as much, as a share of GDP, as it did before the collapse of October 2008.

Friday, 6 April 2012

How To Create a Housing Market Bubble

You allow the banks to lend out as much as they want. Graphically, that would be something like this:

New loans to households in millions of krona (we use . instead of , to represent ,000s). In August 2004 the banks entered the mortgage market with at-that-time revolutionary type of mortgages: 25 or 40 years and 4.2% real interest rates (the principal was indexed to the CPI) which later were lowered to 4.15% due to fierce competition in getting people to borrow money. The result was a housing boom of extraordinary heights (see next graph) which is being corrected through inflation, although the recent spur of mortgage growth is halting that much needed correction. Many thanks to Thorvardur Olafsson and Karen Vignisdottir at the Central Bank of Iceland for the data.

What do the colours mean? Blue: mortgages in ISK, red: mortgages indexed to the value of foreign currencies (loans in ISK where the principal fluctuates with the value of ISK in foreign currencies), green: car loans in ISK, yellow: car loans in ISK but indexed to the value of foreign currencies. The indexation to foreign currencies was later (2011) ruled out to be illegal according to law from 2001 (a long story but rather representative of the scandalous workings of the Icelandic financial system).

Here is the house prices saga in Iceland:

House prices in Iceland according to Thjodskra

And people seriously say that we had a financial crisis because of the collapse of Lehman and other problems in international markets?! Please, this was a home-made problem, and we still haven't solved it!