Building Giant ATMs

Real estate prices, which had remained stagnant in real terms between 1988 and 2003—that is, they simply followed inflation—took off. Between 2003 and 2007 however, real estate prices rose by a phenomenal 84%
From Range Rovers to Bang & Olufsen designer electronics, there is no question Iceland went through a massive consumer boom (see GV issue 6, 2011). In fact, as Guðmundur Jónsson, Professor of Economic History at the University of Iceland, has pointed out, the Icelandic consumption boom was one of the largest in all of Western Europe. Taking the entire boom period 1995–2007, private consumption grew by 60% in Iceland—only Ireland (which experienced a similarly spectacular housing and financial bubbles) saw a larger growth in private consumption.
And while this growth in consumption is a characteristic of the entire twelve-year boom, it is striking how much of it took place during the financial bubble of the noughties. Between 2002 and 2007, private consumption grew by around 48%. And, as Guðmundur Jónsson has pointed out, it is impossible to understand this growth in consumption without looking at the growth in household debt. Debt as share of disposable household income, which had been growing since the beginning of the boom at an annually modest rate of 1,8%, really took off after 2003. The annual growth between 2003 and 2008 was a whopping 5,2%.
The great Icelandic consumption boom was fuelled by debt. Just like the Icelandic financial bubble and the real-estate bubble. Which leads one to wonder: How exactly are these phenomena linked?
FROM ‘SAVING ACCOUNTS’ TO ‘ATMS’
For most of the 20th century, Icelanders viewed their homes like savings accounts. During the post-war years, interest rates were set by law and bank deposits generally carried interest rates that were below the chronically high inflation rate. Under these circumstances real estate, or ‘concrete’, was among the only really generally safe investment or savings plan ordinary people had access to. Getting to own your own home, even if it required considerable sacrifices, was therefore something that responsible people were expected to do. Somehow, this idea of real-estate as a savings account transformed into the idea of using your home as a cash machine—a giant ATM.
This transformation of how people viewed the equity they had in their homes—as collateral for easy loans or hard earned savings—lies at the heart of the cultural transformation that explains the Icelandic consumer boom of the years prior to the financial crash of 2008.
During the post-war period, it had generally been pretty hard to get financing for buying a home. Homebuyers were expected to have a significant down payment, at least 10–20%, and nobody expected to start out in a single family home or townhouse. Home equity loans were granted by government authorities. The system changed several times over the period, but since 1989 housing finance funds provided up to 70% of the purchase price of a home. However, these loans were capped at relatively low amounts, in 2004 at less than 10 million ISK. Homebuyers could take out additional “top off” loans at reasonable interest from their pension funds or at higher interest through other channels. In addition, since 1979 all loans were indexed to inflation.
While housing prices generally held up to inflation, homeowners did not expect to build up equity through rising real-estate prices. Equity was built up the old-fashioned way, by paying down loans and by saving up money for a downpayment for a larger home.
ENTER THE BANKS
All of this changed when the newly privatised banks decided they wanted a piece of the real estate action. In August of 2004, the Icelandic banks began, for the first time, offering home equity loans.
The banks began by offering loans for 80%–90% of the purchase price of homes (later they would even go up to 100%). This move was hailed as revolutionary—the banks claimed in their advertisements that they were offering people “freedom!” and the banks offered new kinds of exotic loans—instead of the boring fixed interest loans offered by the government housing authority, people could get more exciting loans with variable interest rates. And instead of having their loans indexed to consumer prices, people could have them indexed to foreign currencies: Yen, Euros, Dollars or Swiss Francs. As it turned out, it was against the law to index loans to foreign currencies. But that is another story.
Real estate prices, which had remained stagnant in real terms between 1988 and 2003—that is, they simply followed inflation—took off. Between 2003 and 2007 however, real estate prices rose by a phenomenal 84%.
It is wrong to blame the banks for the entire housing bubble—prices had begun to rise in early 2003 as the government declared that the state housing finance authority would begin making 90% loans. But the entry of the banks brought an immediate spike in real estate prices. Between September 2004 and September 2005, prices rose by a staggering 33%.
In the summer of 2004, before the banks entered the mortgage business, a 130 square metre apartment in downtown Reykjavík cost around 17 million ISK. By late 2007 the same apartment went for 33 million ISK.
The banks understandably argued that this rise was a “correction”, that prices had been unreasonably low previously. But then again, if you rely on the analysts of investment banks, pretty much all price changes are “corrections”, be they bubbles or the inevitable crashes that follow them.
The price “correction”, in addition to the ready availability of up to 100% financing on new homes, meant that homeowners calculated they could afford pretty much anything. Rather than saving for a small starter home in need of fixing up, people would now take out a loan for the entire purchase price of a much larger apartment. And then an additional “home loan” for purchasing furniture. Many assumed this was safe, since price appreciation would quickly create equity in their homes. And in any case, people looked at the monthly payments, not the total debt burden.
The greatest change was that people could for the first time refinance, they could access the equity in their homes without selling. People could now use their homes as ATMs, taking out loans to remodel their kitchen or bathroom, upgrade their furniture or car or simply pay off credit card debts and the overdraft on their checking account. The result was a spending binge of historic proportions
DEBT AS FREEDOM
While the banks claimed they were being awfully responsible in their lending, advising people not to take out more loans than they actually needed or could repay, there is every reason to believe the opposite to be true. There are countless stories of loan officers who pressured people into taking out larger loans, even making house calls to convince people to refinance.
The banks’ advertisements paint a similar picture. Rather than discourage potential customers, advising them to take out smaller loans and limit their expectations, banking advertisements presented people images of how the good life could be bought on credit. Home equity loans were consistently advertised as being for either remodelling and maintenance, or for “reorganising” your personal finances, read: refinancing consumption debt and paying up overdrafts. With a clean slate, people could start all over!
The savings banks advertised “Real estate loans” that were intended for “purchasing a new home, refinancing and lowering monthly payments, remodelling or just about anything you can think of”. Mortgages and home equity loans were means to actualise dreams, dreams that need not be directly related to housing or real estate: they could literally be anything you could dream of.
The same theme surfaces in a 2007 advertisement by Kaupþing. Advertising ‘interest only’ loans, the bank boasted that “Kaupþing grows with you after you graduate”—promising recent university graduates 100% total financing on a new home, plus a 3.000.000 ISK “graduation loan” (people who took out those kinds of loans, paying only interest, could probably watch their debt grow, and grow!). The advertisements featured smart young people and Kaupþing’s promise that it would assist you in “making your dreams come true”, whether those dreams were “buying your first apartment” or “world travel”.
This emphasis on the banks as the primary dream-actualisers of the Icelandic people was a major and reappearing theme in bank advertisements during the boom. Freedom was another. SPRON, the largest savings bank, ran a large advertising campaign with the theme “Freedom”, featuring among other things, pictures of 19th Century Icelandic independence movement hero Jón Sigurðsson, and Gay Pride—arguing that just like Icelanders had fought for all kinds of freedoms, SPRON was now fighting for the financial freedom of consumers. In another “freedom” themed SPRON advertisement this freedom was articulated further: You now had the freedom to choose which foreign currencies your 40-year home mortgage was indexed to! Oh the joys and excitement of consumer freedom!
DREAM-ACTUALISERS OF THE ICELANDIC PEOPLE
Sure, not all bank advertisements emphasized frothy financial “freedom” through perpetual debt slavery. A sizable part of the advertisement budgets of Kaupþing, Glitnir and Landsbankinn appears to have been spent on associating the brand names with “Icelandicness” (the national foot- or handball teams, fishermen and the rugged nature), culture and the arts or some other positive attribute. As if the banks were telling the people that they were an inseparable part of the fabric of the nation, its culture and aspirations. Just as they were attempting to convince people that “the good life”, in a nice newly remodelled apartment and interest-only, Euro-indexed 100% home equity loan were really inseparable things.
This association of banks and debt with living a fulfilling life provides a necessary link between the housing boom and the explosion of private consumption and household debt. By selling consumers the idea of immediate gratification, your home as an ATM and “debt as freedom”, the banks both helped shape the atmosphere of overconsumption that pervaded Iceland and then provided people with the debt needed to finance this binge.