Asymmetrical Information - Megan McArdle
01.22.13 5:15 PM ET
How Well is Iceland Doing?
Via Tyler Cowen, a rather impassioned pushback on the notion that "old creditors & IMF to go jump, nationalised banks, arrested the fraudsters, gave debt relief and is now growing very strongly, thanks". This narrative has been very popular recently, particularly on the left.
Its author, who lives in Iceland, argues that the banks actually got off pretty well, and moreover, that the country's very peculiar debt markets are making it hard for families to get by:
There has been plenty of debt relief here. The the top 1% has had almost all of their debt written off, for example. Wasn’t that nice of the banks?
For the rest of us, the picture is a lot more complicated.
Household debt in Iceland comes in two forms.
A. Loans linked to a currency index.
B. Loans linked to the consumer price index.
Loans of the type A more than doubled during the collapse. Those that owed a million ended up owing two million, etc.. There has been a modicum of debt relief for the currency loans because they were blatantly illegal.
The routine has devolved into the following idiocy:
An almost bankrupt Icelander takes the bank to court because the loan was illegal. (2011) (2012)
The court forces the bank to write the loan down.
The government maintains that the court’s decision does not set a precedence and sets a law that limits the extent of the debt relief. Example
An almost bankrupt Icelander takes the bank to the court because the loan was illegal, and the ensuing legislation by the government was illegal, winning the case. E.g..
This goes round and round and round. The Icelandic government has fought debt relief tooth an nail, with every resource and tool available. They have in every way possible been the banking system’s crony.
The type B loans are a bit more complicated and require more explanation.
Normally, when loans are linked to the consumer price index (a rare thing in and of itself in other countries) the payments increase in line with inflation.
The Icelandic system is different. If you borrow 100 000 kroner and a year passes with 10% inflation (not unusual in the post crash era, inflation has ranged from 4% to 20%) then at the end of the year you will own 110 000 kroner, even if you have been paying interest. This means that if your mortgage is of this type B, you will never manage to pay it off, because Iceland has never in the history of having its own currency managed to have low inflation.
The Icelandic kroner was introduced in 1922 at parity with the Danish krona and has since then lost 95.95% of its value. Inflation is endemic and permanent in Iceland.
Most loans in Iceland are of the type B, price index-linked loans.
Like other people who have commented on this, I don't have much way to verify it, because none of us speaks Icelandic. But it certainly does seem as if Iceland is ripe for reform of its mortgage structure, which, if it works as alleged, seems frankly insane.
I would note one thing, however: whatever its debt dynamics, Iceland still has about five-and-a-half-percent unemployment. I know a lot of nations who would trade any number of banking rules to put the overwhelming majority of their population back in work.