From Iceland — IMF Urged “Debt Restructuring Outside Courts”

IMF Urged “Debt Restructuring Outside Courts”

Published February 4, 2011

IMF Urged “Debt Restructuring Outside Courts”

According to one of the American diplomatic cables released by WikiLeaks, Mark Flanagan, chief of the IMF team in Iceland, advised the Icelandic government to encourage the restructuring of private sector debt outside of the legal system.
In a December 2009 cable entitled ‘ICELAND NEEDS FINANCIAL AUSTERITY’, Sam Watson, the former charge d’affaires and current DCM at the US Embassy in Reykjavík, reported to the State Department that Flanagan implored Iceland “to look at ways to facilitate debt restructuring outside of the courts.” In Watson’s words, Flanagan offered the advice due to “the small size of the court system,” in which 48 judges preside over all cases.
When asked to specify what sort of proceedings Flanagan was referring to and why he believed them to be necessary, an IMF spokesperson refused to comment, saying that it was rare for staff to comment on leaks.
Despite Flanagan’s concerns over the number of judges within the Icelandic judicial system, according to, Iceland has the 16th highest number of judges per capita in the world; the United States—the country with the largest prison population in the world—is ranked 22nd on the same list.

What does it mean?

With the majority of Icelanders equating the IMF to the institutional version of a stranger with candy, it would come as little surprise if Flanagan’s advice raised a few eyebrows. Already sceptical of the IMF’s priorities, Icelanders are bound to wonder what Flanagan intended by advocating “debt restructuring outside of the courts,” especially when considering that the protracted legal battle over foreign currency indexed loans was awaiting an important judgment at the time the cable was wired.
But for whatever reason Flanagan dished the wisdom in question, the government may have taken the advice to heart. Prior to the completion of the IMF’s most recent review—its fourth since credit lines were opened in 2008—the government announced plans to allocate additional resources to encourage debt-restructuring negotiations between troubled debtors and creditors. Typical debt restructuring scenarios include “bondholder haircuts”—when creditors agree to scale back interest payments to ensure the debtor’s financial solvency—and debt-for-equity trades, whereby creditors downsize interest payments in return for a share of profits if the house or business is sold.
 In a letter to the IMF, the government detailed these plans, which are aimed at bringing heavily indebted households, small and medium enterprises and their respective creditors to the bargaining table. To prod heavily burdened households towards non-litigious deliberations, the government has expanded funding for the Debtors’ Ombudsman, and had the banks agree to offer a write-down of mortgages to 110% of the mortgaged asset’s value. As far as troubled-but-viable small and medium enterprises are concerned, the government intends to incentivise debt restructuring. While it did not detail how it intended to enact such a plan in its letter to the IMF, the government stated that legislation concerning unpaid taxes resulting from debt and tax liabilities related to debt-write-down was imminent. The government also intends to offer a mortgage payment subsidy to lower income households in distress, which will be financed by a levy on financial transactions.  
“Moral hazard”
While such an agenda seems innocuous and forthright, it may not allay concerns that the deck will be stacked in favour of the banks when considering the legal challenges that may arise in the coming months. What might debtors lose by rushing into a quick settlement? If judges find that fraudulent acts perpetrated by bankers affect the status of certain loans, will squeezed households and businesses rue a hastily mediated settlement? And what if there are further rulings, which broaden the number of unlawfully issued foreign currency loans? Will households and small businesses regret dashing to restructure interest payments then?
In the view of the IMF (and the government), expedited voluntary settlements are crucial to Iceland’s recovery because the situation is complicated by the fact that certain individuals and businesses are in arrears with a multitude of institutions. Moreover, Flanagan warned against the “moral hazard” of aiding “nonviable borrowers.” But while it can’t be doubted that certain households acted irresponsibly and don’t deserve any assistance, couldn’t the same be said for the old banks and their foreign creditors who have succeeded them? Is there not moral hazard in forcing heavily-indebted households to pony up cash when banking executives’ significant obligations vanish into thin air? And what ever happened to due diligence? Is a bondholder haircut the best way forward when bondholder chemotherapy isn’t even on the table?
“Voluntary” agreements
The government and IMF believe that “across-the-board write-down of debt, case-by-case restructuring, reductions in loan-to-value ratios across-the-board restructuring” would be “too costly and ineffective”. Yet they are also bent on recapitalising the banks, despite the fact that many MPs believe that the financial sector is still too large. Unsurprisingly, the government, intent on “fully restoring the health of the banking sector,” consulted the “corporate and banking sectors” when formulating its plans. Expect an Icelander with ties to the Social Democrats to own West Ham United by 2014.
 Whether IMF officials stir in their beds at night worrying about the welfare of Icelanders and the stability of Iceland, or whether they actually intend for the government to corral debtors into “voluntary” agreements when the law may have otherwise reduced their hardship, the Icelandic people could be forgiven for suspecting that the latter scenario is closer to the truth.  With a litany of legal complaints surrounding matters related to debt and a public weary of close ties between the state and big business, it wouldn’t be a stretch to predict that many households will take their chances with further litigation. Certainly this leak does nothing to improve the IMF’s reputation as an opaque debt collector for multinational financiers, despite the best efforts of the IMF external relations department.
It’s only natural for institutions to tiptoe around their skeletons; the manual for standard operating procedure at Guantanamo, for one, instructed guards to deceive the Red Cross. However, if dirty secrets exist, combing through records might reveal more than expected. Like Julian Assange said in a recent interview with The Guardian: “Any form of large-scale abuse must be systemised.”

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