Sigrún Davíðsdóttir's Icelog

This week, an Althing investigative commission delivered long awaited – or long dreaded – report on the Housing Finance Fund. It was even worse than expected, outlining greater than expected losses. It outlines how political connections – mainly the Progressive Party, now leading the government – systematically put the party’s interest before the HFF’s. The losses 1999-2012 could amount to ISK270bn, 16% of Icelandic GDP, possibly more. Add this to another blunder – the losses of the Central Bank of Iceland from repo deals with the Icelandic banks prior to the collapse – also causing a sovereign loss of 16% of GDP and it seems that Icelanders pay a lot for the political parties putting their own interests before the country’s.

,,… unfortunately, one can’t but sincerely admit that one had lots of doubt but this is what was agreed as the government was formed in 2003. If it hadn’t been done, that government would not have come into being.” This is how Geir Haarde minister of finance 2003-2007 (leader of the Independence Party 2005-2009, prime minister 2006-2009) described to the Special Investigative Commission on the financial collapse in Iceland how the 2003 coalition of the Independence Party and the Progressive Party came into being. In the elections that year, the Progressive Party campaigned on raising the mortgage level to 90% of the purchase price. In order to save the coalition of the two parties, led by the Independence Party, that party agreed to turn the Progressive campaign promise into policy. The vehicle was the Housing Finance Fund, HFF.

This policy turned out to fuel a boom that was already building up. Haarde was aware of the danger but, concludes the SIC report, his estimate was “that the expected loss for society (from this policy) was an acceptable cost to society for keeping the two ruling parties in power.”

We now know that the cost of this policy might be the somewhat unacceptable loss of ISK270bn, €1.68bn, 16% of GDP. Ironically, it now falls on the present coalition of these two parties, this time under Progressive leadership, to take a decisive step to end the Fund’s misery.

A new report (unfortunately only in Icelandic; not even an English summary), published earlier this week by an Althing investigative commission, tells the story of these huge losses and how the fund was used for political purposes. The report lays political networks bare, showing how political connections were favoured over merit and experience and how the fund continuously added to the coffers of companies connected to the Progressive Party. Regulators failed and foreign criticism, i.a. coverage in 21 reports by the OECD and the IMF, was systematically ignored. – The Fund itself disputes the numbers in the report, saying the losses are at most ISK64bn. However, the fund only put forth this number without any documentation in a press release and has not answered other matters raised in the report.

HFF, the Progressive power sphere and regulators who failed

The core of the problems was changes to the financing of the HFF and changed lending rules in 2004. The Independence Party had for some time worked on changing the issuing of HFF bonds so they would appeal to foreign investors. In 2003 the Progressive Party had campaigned on raising the mortgage level to 90% of purchase price. The changed issuance caused an immediate loss in 2004 of ISK21bn. A simple error in calculation added another ISK3.5bn, to the loss, bringing it to almost ISK25bn. Higher lending levels increased the risk and did over time cause higher levels of non-performing loans. The Fund started lending to property developers and companies, both increasing risk and losses.

The immediate loss of ISK25bn was just the beginning. Over the years, the faulty decisions taken in 2004 have caused snowballing losses, which now stand at ISK103bn of loss already on the books with the addition of foreseeable loss of 167bn, in total ISK270bn. The Fund claims the losses mainly stem from the collapse of the banks but according to the report the main losses stem from changes to the Fund in 2004. In a nutshell, it is a saga of the intertwining of political power and a public institution, the HFF.

The political connection surface in various ways. Fjárvaki, a subsidiary of Kaupfélag Skagfirðinga (once part of the Icelandic co-op movement, strongly connected to the Progressive Party and still part of the “Progressive sphere”), signed a deal to sell software to HFF. In the end the deal was terminated without Fjárvaki fulfilling it. Yet, HFF paid Fjárvaki an amount equal to the sales price. This is only one part of the HFF’s many highly questionable connections to Progressive-connected entities. And only one of innumerable similar stories in the report.

Then there is the glaring incompetence. With the 2004 changes in laws the Fund was obliged to have a proper risk management system. A Swedish consultancy, Capto, delivered the system and ran it to begin with. When the HFF staff took over it seems they neither understood it nor were able to run it, rendering the risk management useless. To make things worse, the Financial Services Authorities, FME, did not react to the Fund’s flawed risk assessment.

On the whole, all regulators and institutions, which were supposed to supervise and regulate the HFF failed. Part of the problem was that the fund was drowning in money as banks were venturing into mortgage lending, wooing clients with lower interest rates than the HFF. With changed rules, borrowers could pay up their HFF without penalties, meaning the HFF was drowning in money it could not invest at rates high enough to meet its own financing costs.

Through 2005, HFF lent ISK95bn to banks and other financial institutions, thereby financing the banks’ own mortgage lending, which was crowding out the Fund’s own mortgages – and in addition fuelling a boom. The report criticises the Central Bank of Iceland for not taking any action, thereby failing its role as a guardian of price stability.

The fervent denial of criticism

Although the extent of corrupt procurement and lack of expertise were first laid bare in the new report, the flawed public housing policy and the risk to the sovereign through the HFF’s state guarantee have been clear from the beginning and indeed heavily criticised by international organisations such as the IMF and the OECD.

The new report trawls through 21 reports from these two organisations from 1999-2012. The Fund’s clear problems and its compromising position has been a permanent fixture in reports from both organisations and still are. Yet, the various governments during all these years have ignored the warnings. And there is still no plan in place to end the Fund’s loss-making misery. The new report concludes that by not heeding the relentless warnings, Icelandic authorities have undermined their trust abroad.

In general and over all these years the intertia to solve the HFF’s problems has always been stronger than all reasoning and advice given by international experts. The question is why this inertia was so strong. The answer is twofold – there was the profound ignorance within the fund and lack of expertise. Secondly, political interests – mostly, though not solely, the interests of the Progressive Party – have been stronger than the general interest of the country. This is what invariably happens when political interest overrides merit and expertise. To the Irish and the Italians these will be familiar stories.

The present echo of ignored warnings

When Icelanders disapprove of foreign criticism of Icelandic issues, their standard answer is that foreigners do not understand the special circumstances in Iceland. The truth is of course that general rules of economics apply in Iceland as elsehwere. But it is difficult to follow any enlightened advise when political interests and connections subsitute normal reasoning.

There are now some disturbing similarities to events in 2003 and what later ensued. As then, the Progressive Party wooed voters in the spring elections with promises of debt relief almost every expert not connected to the Progressive Party warns against. The party’s promise of wide-spread debt-relief to those who are too well-off to have been eligible to earlier debt-relief offers draws criticism from the CBI as well as from the OECD and the IMF. The warning choir is loud and clear and singing from the same hymn sheet: these plans threaten financial stability and could cause inflation, all too familiar to Icelanders.

In a recent interview (in Icelandic) prime minister Sigmundur Davíð Gunnlaugsson said it did not worry him what the different “acronyms” (meaning international organisations such as the IMF and the OECD) thought of the planned debt relief. These organisations rarely welcomed radical actions such as those planned by the government, Gunnlaugsson said. In his speech on the Icelandic national day, June 17, the prime minister said that Icelanders would not let international organisations dictate what can be done for Icelandic households.

It is expensive to live in a country that is badly goverened or where corruption – difficult to avoid that word in relation to the HFF – is allowed to add its poisonous cost to every transaction. The corrupt practices, disregard for competence and expertise and political favours in HFF have so far cost Iceland 16% of its GDP and yes, more might be to come. Losses stemming from the CBI’s repo transactions with the banks before the collapse amount to another 16% of GDP. Consequently, these two mistakes have caused losses equivalent to about a third of Iceland’s GDP, the cost shared by Icelanders for bad political calculations.

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