Published November 11, 2014
At a press conference on Monday, ministers introduced the implementation of the Government’s upcoming debt relief measures for house-owners. Regarding the measures, the government’s policy platform has stated that through “specifically directed actions, the government will address the debt problem of Icelandic households, which has resulted from the unforeseeable increase in the principal of inflation-indexed loans as a result of the financial system collapse.”
The platform also suggests that this might be the world’s “first instance where universal relief of this type is applied.” The operation, which will see 80 billion ISK (≈ € 550 mi) transferred from the state budget to loan accounts, divided over three years, is called “Leiðréttingin” or “The Correction.”
The idea of such extensive debt relief for home-owners was promoted by the Progressive Party, during its 2013 election campaign. Prime minister since the party’s subsequent landslide victory, Sigmundur Davíð has been the idea’s main spokesperson among authorities. The implementation and success of the measures are seen by many as the most significant touchstone for his government.
The measures, at times called the country’s “most expensive election promise,” have been heavily criticized, since their conception. During the Progressive party’s 2013 campaign, members and supporters of most other parties condemned the proposal as populist and unrealistic, a promise that would either not be fulfilled or drastically upset economic stability and the Treasury.
Former member of Alþingi, Þór Saari, is among those who criticize that the operation is nowhere drastic enough to be called universal, and thereby less than just. Meanwhile, one outlet of the Independence Party’s libertarian arm, Andríki.is, has opposed the Correction, as the “nationalisation of private debt”.
A report, prepared by the University of Iceland’s Institute of Economics for the Financial Ministry in 2012 sort of seemed to partly support both arguments, claiming that the near-future benefits in disposable income, gained by measures of this kind, would be much lower than the Treasury’s cost of the operation. They cited an example, claiming that a couple receiving a 2 million ISK (≈ € 13,000) reduction, would thereby only gain a 100 thousand ISK (≈ € 650) increase in annual income. Similar numbers are now given a very different spin by Government representatives.
Government spokespeople describe the transfer as a correction of the negative effects the 2008 bank collapse had on people’s outstanding housing mortgages, spoken of as a “presumption failure,” since home buyers before 2008 could not foresee the oncoming crisis. The total 100 billion ISK provided by the Treasury will, according to Government spokespeople, fully rewind the effects on housing mortgages, of any inflation surpassing 4% in the years 2008-2009. The measures are introduced as the first of many to be taken to “create a more wholesome environment for households and finance markets”.
More than half of the country’s 125,000 households will be directly affected as recipients of debt relief. 74,000 households applied. 69,000 successful applicants will see their debt service deflate immediately, by an average 1.3 million ISK (≈ € 9,000). According to the government’s FAQ: “No regard is had for income, assets or other debts when the reduction to the mortgage principal is calculated,” but there is an upper limit to the benefits, which will in no case exceed 4 million ISK (≈ € 26,000).
Anyone who had an outstanding, inflation-indexed housing mortgage in 2008 and 2009 is possibly entitled to benefit from the measures, regardless of whether the loan has since been fully paid or not. Alongside the 80 billion ISK provided by the Treasury, homeowners will be encouraged, by tax exceptions over the next three years, to use “payments which would otherwise go to a private pension fund to pay down their housing mortgages”, a measure estimated to bring 70 additional billions to the debt reduction.
The tax exceptions are said to cost the Treasury another 20 billion, leaving total direct costs of the operation at 100 billion ISK (≈ € 700 million). Examples taken by the government, show households reducing the principal of their mortgage by up to 20% and monthly debt service by up to 15%. This, again according to the publicity material shared at the press conference, will increase the disposable income of participants by 17% by the year 2017.
According to government spokespeople, the operation will be fully financed by an augmented tax on larger financial institutes, which took effect with this year’s budget. Alongside the tax spike, an exception previously made for financial institutes undergoing liquidation has been temporarily lifted. Authorities claim that by these measures, the Treasury avoids borrowing and any state guarantees and that the correction will have no effect on Treasury revenues.
According to Alþingi’s Treasury Committee’s estimates, the bank tax boost should have delivered 23 billion ISK (≈ € 150 mi) to the Treasury this year. This November, the Prime Minister announced that the bank tax has delivered even higher revenues, totalling at 35 billion ISK (≈ €230 mi) this year. According to Monday’s introduction, this financing will be concluded in 2016, a year earlier than previously expected.
At least one bank’s winding-up board, that is Glitnir’s, has declared its intention to protest the tax, and pursue the case in courts if necessary. The Finance Minister has replied that the Treasury is fully authorized to take the measures, and if the banks will sue, the State is prepared to fight back.
“The Government is placing people at the forefront by responding to the failed premises with positive incentives, to give everyone an opportunity for the future. Highly indebted households need help to work their way out of difficulties. The cost of failure to act would be higher for Icelandic society: Icelandic households would be left to struggle with debt and unemployment, leaving an entire generation with nothing.” – Government Policy platform’s FAQ about the Correction.
The idea of a “presumption failure” or “failed premises” has become the basis of public policy during Sigmundur Davíð’s administration. The policy platform’s FAQ briefly explains the notion, citing “torpedoed economic growth and purchasing power,” “sky-rocketing” inflation, a “major contraction in wages,” and “the plunging ISK exchange rate” as reasons for a “slower recovery than previously experienced following a contraction,” proving a “heavy burden for Icelandic households”. On the failed premises, it concludes: “In the Government’s estimation, people who owed inflation-indexed housing loans during the period 2007-2010 had no premises to foresee the events which completely transformed the basis for their borrowing. ”
Prime Minister Sigmundur Davíð Gunnlaugsson emphasises four sorts of reasons behind the measures, categorizing them as economic reasons: the Correction is supposed to increase leeway and accelerate growth in the economy; reasons of justice: borrowers should not carry the risk of inflation alone; reasons of equality: the forms of loans should not “decide a household’s fate” and reasons of fairness: the damage done to house-owners by the recklessness of financial institutes must be corrected.
An analysis done by consultancy Analytica ehf. for the Prime Ministry a year ago, reportedly indicated that “the macroeconomic impact of the actions … will be relatively mild, although they could have a considerably stimulating effect on residential housing investment.”
As noted above, 69,000 house-owning households benefit directly. These are, according to the Prime Ministry’s numbers, mainly members of “younger generations”, defined as anyone 55 years old or younger. Over 2,000 of the receiving households will now jump from a negative to a positive capital position, in relation to their real estate: that is, until now they owed more than they owned, but will, at the onset of the operation, own more than they owe. The country’s ratio of household debt to annual income will decrease by 11%. Among the desirable economic effects enumerated in the Correction’s publicity material is a predicted raise in the housing market, and lower inflation levels.
Effects on the wealthy and the poor
According to publicity material, around three quarters of the Correction’s recipients, earn less than 7 million ISK (≈ € 45,000) annually, if applying as individuals, or less than 16 million ISK (≈ € 105,000) in cases of couples or larger households. That leaves a quarter of recipients, with higher earnings than that. Asked about those wealthier benefits recipients in Monday’s Kastljós, Sigmundur Davíð said that 7 million ISK is not far away from average income. “There are not tens of billions going to people with high incomes. That is not correct. Medium income is not high income. Recipients with high incomes are few in number and they do not receive tens of billions.”
The minister added that among the recipients there will be, however, people who are not in dire need. “Not a lot of people, though, I do not think that’s correct.” He said that the operation would not significantly lower debts of people with high income. “But there are some who would survive without the correction. That is correct.” He emphasized, however, that “it has been clear from the outset that this is not a case of giving money to people, but of returning wealth that had been abducted.” The principle involved he said, is that when you give something back to its rightful owner, you don’t ask first if the person really needs it.
The Correction is intended for homeowners, indebted or not, and does not apply to renters. Finance Minister Bjarni Benediktsson has indicated that other measures might be taken to ameliorate their situation, but, so far, none have been announced. Meanwhile, rent keeps rising dramatically. As reported, Halldór Auðar Svansson, Reykjavík city council member on behalf of the Pirate Party noted this after Monday’s press conference, saying it is “meaningless to talk about how exactly the debt relief will affect the worst off amongst homeowners when the worst off group [of all], renters, are left trapped in poverty.”
(Psst! They will make you work longer!)
The Institute of Economics’ 2012 report stated that “those who benefit the most by the reduction of housing mortgages are mostly 30-55 year olds. Those who will pay the costs, inasmuch as they exceed the gains, of the measures, are others, younger and older, and even, to some extent, later generations. They will pay the debt in the coming decades through higher taxes and less public services.”
The report specifically noted mortgages provided by pension funds. According to the report, at the end of 2011, outstanding loans provided by the funds were worth, in total, 177 billion ISK (≈ € 1.2 billion). Supposing those are mainly housing mortgages, the funds would suffer serious losses in case of debt reductions. These losses would then be covered by public funds, the State Treasury and municipalities, or, in the case of private funds, by a reduction of the funds’ obligations. As a countermeasure, the institute proposed raising the retirement age by 1 to 3 years. Earlier this November, without referring to this context, Alþingi’s Committee on the Reconsideration of Social Security, announced that it will propose precisely such measures, later this year or early next year.
Economics Professor Friðrik Már Baldursson has claimed that, whichever way, eventually, the public will pay for the transfer, as banks will respond to the tax hike by boosting their own interest margin. Meanwhile, Helgi Hjörvar, member of Alþingi on behalf of the social-democrats’ Coalition is only one among many critics who claim that the costs have been transferred back onto the public already, via the recently proposed VAT hike on food products, claiming it will cost households, in total, about as much as they might stand to gain from the Correction. The actual ratio between the two amounts remains disputed.
Effects on the Housing Financing Fund
The 2012 report, cited above, claims that the public Housing Financing Fund (ÍLS) would suffer the greatest negative impact of a debt relief package for home-owners. The fund’s equity ratio, at around 2.5%, is already only half of what is required by regulation, the report warned. Since the fund is State-owned, a drastic reduction of its outstanding loans would, the report found, negatively affect the Treasury. Unequivocally, the report stated: “it is clear that an operation of this kind would make the fund bankrupt”.
Last year, the International Monetary Fund (IMF) issued a similar warning, that a debt relief package of this sort would, by encouraging the settlement of debts, threaten the already somewhat tense stability of the ÍLS. A critical mass of settlements would, they claimed, make it hard for the fund to refinance. At the time, Sigurður Erlingsson, Chair of ÍLS, responded by admitting some uncertainties surround the plan, but that such an operation would nonetheless positively effect the fund’s loan portfolio. “All in all, one doesn’t feel bad about this,” he commented.
When asked about potential effects on the ÍLS by RÚV’s Kastljós on Monday, Prime Minister Sigmundur Davíð chose not to comment, saying he did not have all the technical details at hand, after which the conversation focused on manners, and then dissolved.
If you think you might be entitled to the Correction, you may still apply here.