Shadow Boxing With The Banks

During a single week in early October, 154 Icelandic families quietly defaulted on their mortgages and had their homes put up for forced state auctions, or foreclosure sales. They aren’t the first families to be threatened with the loss of their homes this year, and based on current trends, they won’t be the last. Rather, these families are part of a steadily increasing number of Icelanders whose bankruptcy is precipitated by compounding loan interest and skyrocketing principals, victims of what MIT graduate and researcher Dr. Jacky Mallet referred to in this paper as “the most unique instrument of financial self-destruction over the last 30 years.”

“So even as you are making monthly payments on your loan, the amount you owe is actually increasing—drastically.”

Index-linked loans, or Verðtryggð lán, as they’re called, make up at least 85% of the Icelandic mortgage market, according to The Homes Association of Iceland. This association, which represents about 10% of Iceland’s homeowners, is currently suing bank lenders for providing misinformation about the benefits of these loans. It also contends that just as foreign currency loans were deemed illegal in 2010, index-linked loans are in violation of European Economic Area agreements, which ban “unfair terms in consumer contracts.”

Given that Prime Minister Sigmundur Davíð has been an outspoken critic of loan indexation—and organised much of his election campaign around promises of mortgage reform and debt relief—you might expect this lawsuit to have the government’s full and vocal support. The reality, however, is very different.

Index-Linked Mortgages: A (not so) short explanation

While index-linked loans are all too common in Iceland, they are dramatically different from the loans most commonly available to homeowners in other countries. They therefore deserve some explanation, although it is difficult to do this without a detailed discussion of Iceland’s longstanding problems with currency devaluation, hyperinflation, monetary expansion, and borrowing practices. However, the shortest and simplest explanation (still neither all that short nor that simple) is as follows:

Index-linked loans are negatively amortized, which means that they are structured in order to have extremely low initial payments. This sounds—and looks—like good news for borrowers, but it actually means that monthly repayments are not enough to cover the interest that is accruing, let alone the loan principal. So, even as you are making monthly payments on your loan, the amount you owe is actually increasing—drastically.

To make matters worse, in Iceland, on top of a base fixed interest rate, the principal of an index-linked loan is directly connected to the Consumer Price Inflation Index, and the repayment schedule is most often set to 40 years, versus say 25 years in the US. In a country with a history of hyperinflation, this is disastrous.

To illustrate this more concretely, take an example offered by Vilhjálmur Bjarnason, the chair of the Homes Association. When researching home loans available to him in 2005, Vilhjálmur looked at an index-linked mortgage. The loan he wanted was for 26 million ISK with a 4.15% fixed interest rate. Estimating for 3.5% inflation in the coming years, he found that under the terms of the index-linked loan, he would eventually be paying 120 million ISK back to the bank. In reality, however, Iceland has had 8–9% inflation over the last eight years. So had he taken a loan of 26 million ISK in 2005, Vilhjálmur’s loan principal would have mushroomed to a total of 560 million ISK.

“For people from other countries, it’s very difficult to understand these loans,” he says. “They say, why did you let the government and the bank rob you every day for 30 years?”

Tilting at foreclosures

For three years, Vilhjálmur has dedicated himself to fighting for loan and mortgage reform in Iceland. He gets no salary for his work, although he works full time and has four children at home. He works out of what used to be his office when he was a real estate agent, a profession he worked in for 20 years.

“The main reason I got into this,” Vilhjálmur explains, “is because I had been advising so many people to take foreign currency loans.”

Vilhjálmur himself opted for one of the now-illegal foreign currency loans for his home in 2005, and lost his home in a foreclosure sale after the crash. Under current Icelandic law, even if the courts determine that the conditions of a loan agreement were illegal, individuals who have already gone bankrupt and lost their homes cannot recover any of their assets. So despite the fact that the loan, which drove his family into bankruptcy has now been determined to be illegal, there is no way for Vilhjálmur and his wife to recover their property.

After the crash, it was deemed advisable to transfer these loans into Icelandic index-linked loans, but despite the fact that their legality is also being challenged, the banks continue to foreclose on families who are defaulting on their loan payments.

“One of the things I have been working on,” he says, “is that you should be able to get your house and your collateral back. If you go bankrupt, there should be a special loan officer who then takes over your property, but does not immediately sell it. This is an issue that the government never talks about. They just talk about what will happen to people after foreclosure. But then you are accepting the foreclosures, not stopping them.”

Vilhjálmur is frequently in contact with members of parliament, presenting the Homes Association’s case, and requesting rectification of current mortgage and borrowing laws.  One of the individuals he regularly approaches about this matter is Minister of the Interior Hanna Birna Kristjánsdóttir. He happened to have a meeting already scheduled with her the week that the 154 families had their homes put up for sale. Following this meeting, Vilhjálmur says, Hanna Birna made a statement to the press, saying that loan providers’ constitutional rights could not be overturned, and moreover, that in consideration for the individuals who have already lost their homes, it would be immoral to change the foreclosure process now.

“It’s as if you have an open mine shaft,” Vilhjálmur says, “but you decide to leave it open out of respect for the people who have already fallen down there.”

He wonders about Hanna Birna’s position. “Why is she so aggressive in defending the banks? Why is she not defending our homes? She is our minister and the constitution is for the people, not for companies. If I could understand her reasoning, I could fight against it. Right now, I’m like Don Quixote.”

For the greater good

According to Vilhjálmur, it has actually been extremely difficult to get any public comment whatsoever from a government official on these matters. Most often, his presentations and petitions are met with nearly unilateral stonewalling. “It is like fighting an invisible foe,” he says. “No one is really opposing me—they just aren’t doing anything about it.”

But then this also begs the question of where the public stands on the matter—and just where are the individuals who have lost their homes?

According to the Homes Association, 15% of registered voters signed a petition for the abolishment of index-linked loans, and they say that polls have indicated that as much as 80% of the Icelandic public supports such reform. And there have been sporadic news reports and testimonials from Icelanders who are facing foreclosures. But there is also indication of a growing despondency among those at risk of mortgage default.
Vilhjálmur and the Homes Association offer their advice and support to homeowners facing foreclosure, and will accompany them to the hearings where their situations are reviewed. In the case of the 154 families who had their homes put up for auction in October, however, only one individual came to the Homes Association and requested assistance. He says that none of the other families even attended the hearings in which their assets were seized.

“We are trying to tell people: ‘you have to defend yourselves, you have to do something,’” he says. “It has been five years [since the crash], and people are just…seriously, they are sleeping. But we shouldn’t have to do this—the government should have done it.”

Should the court rule in favour of the Homes Association, and deem index-linked loans—like the foreign currency loans before them—illegal, the hope is that there would be a substantial basis for reforming mortgage and foreclosure practices in Iceland. If, on the other hand, the Homes Association does not win their case in Iceland, Vilhjálmur says that they have no intention of dropping the matter. Rather, they will take the issue to the European Free Trade Association court, as Iceland is an EFTA member. “What is illegal, is illegal,” he says. “We will never stop.”