New Mortgage Crisis in Iceland: Could U.S. Be Far Behind?

asiablues's picture

By Dian L. Chu, Economic Forecasts & Opinions

The Icelandic financial crisis has been ongoing since 2008 when all three of the country's major commercial banks collapsed after they failed to refinancing their short-term debt and a run on deposits in the U.K.

In July, I talked about how Iceland is totally not a post-crisis miracle as Paul Krugman claims, but just how are things now with Land of Fire and Ice?  

Scary Economic Numbers

Some of the scary economic figures, courtesy primarily of the plunging Icelandic króna:

  • Inflation has soared 41 percent from January 2007 through September this year (see screen print from Bloomberg)
  • Real disposable incomes slumped 20.3 percent last year
  • Real wages fell 10.1 percent from the beginning of 2007 through August this year
  • 63 percent of the nation's mortgage is underwater
  • 40 percent of homeowners are "technically insolvent"

$2 Billion Mortgage Write-off - Who Will Pay?

Bloomberg (clip below) reported that Iceland government last week proposed a debt relief bill to write off up to 220 billion króna ($1.99 billion) in mortgage loans. This is after about 8,000 protesters gathered outside parliament demonstrating their anger over rising homeowner insolvencies.

?Most of Iceland’s mortgage debt is inflation-linked.  So, what that means is that the principal has gone up 41% in three years, while everything from wage, income to real purchasing power has gone the opposite direction.

This debt relief sounds all nice and dandy, but the problem is a write-down of almost $2 billion is equivalent to about 8 percent of total assets at Iceland’s three biggest banks, their 2009 balance sheets show. 

Moreover,  Iceland’s pension funds, which hold most of the bonds behind the nation's mortgage debt, said they will try to block proposals.  If the banks are forced to take a flat write-off, the government most likely will need to cover the loss of pension funds, i.e. taking on more debt. 

Iceland, Ireland & Japan - Default Inevitable?

Separately, a WSJ article noted that during a speech at the Value Investing Congress in New York, Kyle Bass, head of $900 million hedge fund firm Hayman Advisors, says,

Iceland had sovereign debt of roughly 35% of its GDP. However, the country's three largest banks amassed roughly $200 billion of assets -- 10 times the country's GDP.   When the financial crisis hit and Iceland had to bail out its banks, the country's sovereign debt ballooned. 

According to Bass, right now, in terms of the size of banking systems relative to GDP. Iceland and Ireland are top of the list, thus post the highest sovereign debt risk.  Ireland's on balance-sheet obligations are about 85% of GDP, but the country's bank bailout program is another 50% of GDP. 

Meanwhile, Bass also warned that Japan may default in coming years. He said From 1989 to 2009, government debt grew 137%.  But since Japan's interest rate is close to zero (so is the United States), it will be getting more difficult to pile on debt without incurring higher interest payments, and increasingly will need to go abroad for financing.

Bass estimated Japan is currently paying about 9.5 trillion yen in interest. Every one percentage point increase in the interest rate increases Japan's interest payments by 10.5 trillion yen. 

Currency Debase - No Solution to Debt

Since this season is all about currency war to prop up economies, there's an increasing chorus from Washington to famed economists believing that the U.S. will become more competitive, thus creating more jobs, through massive dollar devaluation (50%) or wage deflation (the two are one of the same, in my opinion).

Chart Source: Google Finance

Well, we may take a look at Iceland to test that theory. 

Iceland's currency has devalued almost 60% since July 2006 (see chart), wages also fell, and aside from IMF's loan, Iceland's been held together mostly by "technical defaults" and capital control. 

While the currency devaluation might have helped the nation's export (while forcing debtors taking haircuts), the domestic inflation, and asset devaluation, most likely will wipe out the entire middle class (hence the "Angry Icelandic 8,000").

United States Not Far Behind?

Due to its size, massive resources and different macroeconomic makeup, the United States, although inching closer to Iceland, Ireland and Japan, in terms of debt levels, housing, mortgage and banking bust, has not quite fallen into the similar trap yet.

Nevertheless, US Federal debt is around 94.27% of GDP as of October, 2010, up from 57% just ten years ago.  CBO projected U.S. debt would reach 100% of GDP within a decade (the next five years seems more likely the way it's going).

Meanwhile, by observing crisis unravel in countries with fiscal situations not that different from the U.S. hopefully would serve as a warning and prophecy of things to come.  Whether the prophecy will be fulfilled is yet to be seen.

Related Reading: Debunking Paul Krugman's Icelandic Miracle 

Dian L. Chu, Oct. 23, 2010

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SWRichmond's picture

Separately, a WSJ article noted...Iceland had sovereign debt of roughly 35% of its GDP. However, the country's three largest banks amassed roughly $200 billion of assets -- 10 times the country's GDP.

When the financial crisis hit and Iceland had to bail out its banks

Framing the discussion, eh WSJ?  Well, we already know that WSJ will side with banksters on just about everything.  I, for one, am still trying to find the rule where it says that the taxpayers "have to" bail out banks.  Can anyone help me out here?

GoinFawr's picture

SWR Pins and points it again.

Best Regards

Shadowguv's picture

So the author notes that inflation in Iceland has been dramatic, 41% over (almost) 4 years, but also remarks that the bulk of their mortgages are inflation-linked. That certainly is not the case in the United States. Wouldn't significant inflation in US reduce the effective amount most homeowners owe? Are Irish and Japanese mortgages mostly inflation linked?



wintermute's picture

Inflation in the US reducing the effective amount of US mortgages is Bernanke's wet dream.

The problems are legion especially wages struggling to inflate and the oil price (and other commodities inflating faster than asset prices).

steve from virginia's picture

Ryan Chilcote's bit is ????

"linked" to inflation means what, exactly? Indexed (which is what it sounds like)?

Indexing is an issue with the 'inflation/devaluation' tactic. Most real estate loans worldwide are not indexed but benefits such as Social Security (in the US) are.

Inflation generally devalues loans (which are repaid in less valuable currency) but apparently this is not so in Iceland.

The other (opaque) lceland lesson is the risks of borrowing in foreign currencies and F/X in general. Countries in situations where such borrowings have appeal generally have F/X fundamentals that will turn around and bite the borrower or trader on the ass. It isn't just Iceland but the US carry trade which is linked in two ways to Treasury borrowing.

One is through the banks which fund the US government by carrying (arbitraging) the Treasury interest rate spread. Rates here are not under the US's control (in an international marketplace).

The other is via the dollar/foreign currency carries. Traders short dollars and use the funds to chase higher yields overseas. Returns from the F/X swap fund Treasuries. This trade requires a super low dollar interest rate however, this is somewhat self- generated. In otherwords, the larger the carry the lower the rate of the 'carried' currency.

Keep in mind the worldwide effort toward QE is not to generate more jobs but to fund competitive carries which in turn fund current account deficits. The more F/X competitition the greater the risk of unraveling carries. This turns around and adds to interest rate pressure! This in turn effects F/X volatility in a vicious cycle.

What happens then is a 'risk avalanche' that can crimp treasury sales and the US becomes Iceland in a hurry.

Pemaquid's picture

Excellent article!  Too bad the story doesn't get told more here in the US of A.  This baby boomer grew up hearing horror stories of the great depression, so debt avoidance has always been a top priority.  The awful downside of debt is now a family issue with one of our children walking away from a mortgage, after continually borrowing against the rising value of the home.  The other children are still in their homes but are seriously underwater.  We blame greed and a failure of a system that allowed people to borrow in excess of what was prudent.  Back in 2006 a niece informed me that she and her husband were buying a home in the D.C. area for $350K. (smallish older place needing much work)  I advised her to wait a few years, trying my best to explain why house prices were abnormally high in relation to incomes.  She was concerned that they would be priced out of the market if they waited and bought the place, as fate would have it, at the very top of the bubble.  I wish I could feel good about pre-warning the bunch of them but don't.  I wish at least one of them would say "we should of listened to you" but nothing has been heard.  Sounds like many in Iceland were like my family and are now having to deal with the consequences.  Too bad they expect the government to pay the price for their bad decisions.

hardcleareye's picture

I have experienced similar events that you described with my family and friends.  It is painful to watch, there is no pleasure in saying "I told you so".  I fear the worst is yet to come.  History is ripe with examples of economic instability leading to armed conflict.

snowman's picture

Hooligan: yes - I went to Iceland a few times re: foreign debt. I got a very blunt message to take back "get lost the investors aren't getting any money back. You were dumb enough to give it to crooks. What are you going to do - take our volcanos? Go ahead and do us a favor." Naturally the canned response was "this will make it very difficult for you to raise money again". Smarty-pants on the other side smiled and said "so? We'll manage" I later got a tour of their fishing industry. Obviously they were right. The lenders deserved to get shafted for not proper due diligence (always the same problem), instead of supporting the real economy (fisheries, natural resources, geothermal)

snowman's picture

I find this write-up fairly ignorant, bit not disputing the main economic facts (inflation, debt etc). Iceland is in trouble, but not going down the toilet, and is such a small and highly specialized economy consisting of a population the size of a small phone book you can't compare them to any other. I am troubled by the continued fascination of this very little country. Drawing parallels to other economies is impossible. They sell fish and are self sustainable, and have been for centuries. They dabbled in "western greed and lifestyle" and got burned by the handful of idiots who fooled them. Now back to doing what they have been for ages. Living off the land and sea. This isn't the first time.

hooligan2009's picture

Well said, snowman! Pity the guys who lent the money to the Icelandic banks didn't have the same attitude, or the guys lending (per capita) to the even too bigger to fail banks aren't doing the same thing now!

bigkahuna's picture

These guys are going through a hard time. The last thing any of us should do is make lite of their situation. You would not want them doing it to us (USA) when it happens here. People here do not know poverty. The people who have known poverty know that they never want to go back to it. It is very serious.

BigDuke6's picture

You sort of feel sorry for the icelanders but they are the ones who brought the vengeance of the lord down upon their middle classes by hunting whales n'shit.

They are like bad gamblers who dress up in bikinis down at the local hot springs and expect you to soap their backs.

Eh? Ken what ah mean, jimmy?

pachanguero's picture

You sort of feel sorry for the icelanders but they are the ones who brought the vengeance of the lord down upon their middle classes by hunting whales n'shit.""


Whales are food and there is no god.  No go watch whale wars and remember half of us root for the Japs

hooligan2009's picture

I think US Debt to GDP (official Government, excluding Fraudie and Funny) will be more than 100% in around 6 months. And including Fraudie and Funny, is more like 140%.

Government Debt GDP chart here:

Government Deficit to GDP chart

and Deficit As Pct GDP&state=US&color=c&local=s

Funny owes or guarantees 3.2 trillion;jsessionid=GJGGUVL1HELOTJ2FQSHSFGI

and Fraudie owes 2.2 trillion

Now Fraudie and Funny have assets since they own c.60% of all houses in the US, but nonetheless, reporting a 97% Debt to GDP ratio is not helpful!

Of course, no-one knows what the assets are of the rest of the US Federal and State Governments since those people responsible are as useless in calculating and disclosing assets as they are at liabilities. 


wintermute's picture

Good points.

Also GDP is constantly overstated, like unemployment is understated. So the true ratio is worse.

FDIC and AIG can be added to the Fraudie and Phoney overhang.

Akrunner907's picture

Overall debt/GDP is important, but what is more pressing and more of a causation for failure is the debt service/tax revenue.  Debt service/tax revenue has a greater impact on the economy as it has a ripple effect on the 70 percent of the economy that is based on consumer spending - especially when you add the governmental spending as another consumer.  The government spending levels are no different than what ever American goes through when they have a budget; unfortunately, the average American does not have an employer they can go back to time and time again and ask for a raise and get it.  



hooligan2009's picture

Very good point! Of course, regulated fed interest rates also hide the truth. Who would have thought that we would live in such times, where the Fed set all interest rates, regardless of credit and yield curve risk or supply/demand! Communist Russia maybe, or Poland before Solidarnosc.

Here's a table of total tax take to GDP over time:

Note how, since the Fed "popped the internet bubble" in 2000, US taxes dropped from a peak share of GDP of 20.6% to just 14.8% in 2009, with the same 14.8% projected for 2010 (right down at the bottom right).

Income taxes dropped from 10.2% of GDP in 2000 to 6.4% (a 37% drop) and corporate taxes dropped from 2.1% to 1.0% (a more than 50% drop).

Just to put the US tax take in the context of other countries and to reflect the impact of political society from the perspective of others, here's a comparison per country.

Note Europe @ c.40% tax take to GDP and the US @28%, over 2007/8/9, with Zimbabwe @ 49% and Japan at 28%. Can make current fiscal deficits on top of that to see how the tax hikes needed to bring to balance. E.g say Europe deficit = 40%, deficit = c.8% tax hike needed to bring to balance = 20%, US with deficit of 9% of GDP, taxes at 28% = tax hike of 33%.

Of course, spending cuts are going to be a lot more in terms of spending (but the same as the deficits in terms of GDP).


RockyRacoon's picture

Time to continue the retrenchment.  Gotta get some more gold.

tim73's picture

Well, Iceland will say eventually, "Talk to the fishes, we don't pay, now get the hell out of my island!". Defaults are nothing new, in matter of fact sometimes necessary for a country. With Iceland more than necessary, 10 times of GDP is simple unpayable. Then 10 years later few remembers (like with Russia...) and economists are all excited about the new "miracle" growth of that country. 

Oracle of Kypseli's picture

The smaler the country, the more apparent the reality that government can not fix things. "Zero sum game?"

The larger the country, the longer the extend and pretend can go on. But, when the inevitable default comes. Turn off the lights world.

If you have children, teach them to grow food, fish and brake everything that requires batteries.

We just got our own little plot in the Andes

wintermute's picture

Absolutely. Size of economy only increases the timescale from boom to collapse. It does not change the mathematics. The advantage size has is that lessons can be learned.

Confucius said that an intelligent man learns from his own mistakes, but a wise man learns from the mistakes of others.

It seems that few of the US politicians are wise.

Ron Paul is wise - but can he get the power needed to go with it?

hardcleareye's picture

Ron Paul only sees some of the big picture.

StychoKiller's picture

Moreover,  Iceland’s pension funds, which hold most of the bonds behind the nation's mortgage debt, said they will try to block proposals.  If the banks are forced to take a flat write-off, the government most likely will need to cover the loss of pension funds, i.e. taking on more debt.

Again, someone wanted free lunches!  Sorry folks, but the results of Socialism seem pretty universal to me:  Everyone becomes "Equally" poor!

AnAnonymous's picture

An excellent post which sums the story pretty well and the destined shallow economics science.

Capitalism is everything and anything that works and the rest what loses. There is no other shared definition of capitalism.

Now Iceland is relabelled a socialist country whereas shortly before the crisis, when everything rolled on, they ranked high on capitalistic ladders. Their successes were due to free entrepreneurship high density, low corruption etc.

Their little ponzi scheme comes to maturation and as fast as that, they suddenly become socialist.

The fact is that Iceland has started an expansion course and that expansion is running its natural course.

Instead of sticking to the fact, there is now a new class of ideologues (economists, traders...) closer to priest class, just living as well as the priest class in old times and selling their propaganda.

The priests sold that the Earth was flat, the Sun revolved around the Earth, people used to live millenia etc... They enjoyed what the society of their times had best to offer. They lived better than a today bum who knows that the Earth is rounder than flat, Earth revolves around the Sun, people cant live millenia...

The priests sold the same scam. When everything goes fine, that is because you showed the due respect to their god. You are a capitalist. When stuff turned sour, you no longer showed the due respect to their god. You've become a socialist.

Wooooo, and millions of people around the world make heaps of money thanks to that. Selling to everyone they deserve, that they deserve even more than anyone else what they get out of society.

hardcleareye's picture

Good form, couldn't have said it better myself.

GoinFawr's picture

Quack quack, ".. someone wanted free lunches!" Quack quack quack, "...but the results of Socialism seem pretty universal to me:" quack quack quack quackwiwy quack.

Ronald Reagan's ghost called: he wants his broken record back.

Norway contradicts you.

Sweden contradicts you.

Finland contradicts you.

Good luck with that whole 'witless loyalty' meme.

Iceland was robbed by the same greedy graspers blagging you to this day. Icelanders made the correct decision and told them to go f themselves, unlike the US which continues to gently stroke them by squeezing Americans for generations to come. At least Icelanders are now in the process of picking up the pieces, the worst is yet to come for you (if you're American).

Yah, I'd tap out now too if I were you.

The count is now at (5) that have hit the mat...

Oracle of Kypseli's picture

The word  "Equally" brings the below thought:

To be politically correct, you must hate everyone "equally".

litoralkey's picture

There is a pretty large condo development on the docksides that have the smallest housing units in the country... and were being sold at prices similar to Oslo and Copenhagen... Worst design you'd ever see.... all units are empty, eventually will be torn down...

Magnus and Drifa outside their home in the suburb of Ulfarvatn. Promised to be a prominent and well to do suburbia, nowadays is like a ghost town with unfinished homes. Out of the expected 6.000 only a handful of people is living here. Ulfarsvatn.



jeff montanye's picture

aren't there places in china and the u.s. like that?  seems i saw on youtube....