Sigrún Davíðsdóttir's Icelog

Debt “Correction” outlined – but funding (still) a pie in the sky

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The “Correction” – that is the nickname now given by the Icelandic government to its planned debt relief. It could potentially cut ISK150bn, ca 9% of GDP, 920m, off the private mortgage stock; the maximum amount on each mortgage will be ISK4m (cf press release here in English). Of the ISK150bn ISK80bn is expected to be written off, according to certain criteria, whereas ISK70bn is estimated to come from tax relief as the Treasury waives taxes on payments used to pay down mortgages instead of paying towards a private pension. It effectively means that the Treasury is guaranteeing to pay the mortgage companies ISK150bn over the next four years.

At a press conference today to introduce the long-awaited and much promised debt relief prime minister Sigmundur Davíð Gunnlaugsson said that these measures will herald a new beginning for Icelandic families. However, Iceland did indeed turn to growth already by mid 2011 and has been in growth since.

Minister of finance and leader of the Independence Party Bjarni Benediktsson estimated that the cost of the collapse of the Icelandic banks now amounted to ISK200bn (GDP ca 1700bn). Since the cost is so great – and more could be coming – something should be done for homes, or so he said, to correct the hit that households took when the inflation rose, as a consequence of the sinking króna 2007-2010. Much was said about justice and fairness at the meeting, less on how this is going to be funded.

So far, the focus has been on not increasing the sovereign debt or risking the Icelandic credit rating. This is what the press release states on the funding: “The action requires the Treasury to serve as an intermediary in financing and implementing it. There is no need to establish a debt relief fund, as the action will be fully financed.”

This stipulates that contrary to what the government has said before, the state is indeed responsible for financing the new plan. And contrary to what the prime minister has been saying for a long time the funding is not coming from the winding-up process of the estates of Glitnir and Kaupthing. Funds he has earlier said could easily and justifiably be within the reach of the government.

According to (as I understood it) Benediktsson and chairman of the debt relief working group Sigurður Hannesson (here are his slides, in Icelandic) the methodology is that after calculating the amount each loan can be written down by, this amount is put apart – by middle of next year – and will then be paid off over 4 years by the Treasury. Thus, from mid next year each mortgage holder, fulfilling the criteria, will only paying off the written-down mortgage.

As to the Treasury, this new liability will be paid off with a new banking tax, levied on both operating and defunct (i.e. estates) banks. For operating banks deposits are the base, for estates the claims. The tax on the estates was tentatively announced when the 2014 budget was presented this autumn. At the time, the outline was unclear. The estates have indicated that there is no tax base in estates of collapsed banks and will most likely challenge the proposed tax.

As Benediktsson pointed out, some years ago a new bank tax was put on operating banks, annually bringing ISK1bn in for the Treasury. In comparison, the proposed tax is calculated to bring the Treasury ISK37.5bn next year.

It may all come down to semantics but a plan that partly relies on a disputed tax, which might be ruled illegal, can to my mind not be judged to be funded. And since the Treasury is an intermediary in a potentially unfunded plan it is taking on some risk – some added risk. Also, if the estates are to be used as a tax base for the next four years, the government seems to be underlining that they will not be wound down and assumedly the capital controls kept in place.

As to the effect on the economy it is both said to be only mild – and to be beneficial for consumption and growth. It will add 3.7% to inflation over 4 years, not trivial in a country with chronic inflation. Greater consumption will increase imports, with the unavoidable negative impact on the current account and the króna rate. It is forecast to stimulate the property market, which some already see as showing signs of overheating. That is good for the construction sector but less for other sectors. The measures are not thought to stimulate investment and the export sectors, which is what is needed to boost the current account, which again is needed to abolish the currency controls. – So far, there is no comparative analysis of what these ISK150bn could do for the country if used i.a. to pay off sovereign debt or for some infra structure projects.

Still plenty of question marks, these are just my first impressions – and they might change as more is revealed of the plan.

As pointed out on Icelog earlier, some Independence Party MPs had earlier indicated skepticism. I have heard of some discontent within the party. An ex-leader of young conservatives has already said the plan is worse than he expected. How the plans fare in parliament will not be clear immediately since the Bills needed to put this plan into action are not yet written.

Update 1.12. 2013: 

*Clarifications: the mortgages now being “corrected” are not currency loans but indexed loans that jumped up when inflation rose 2007 to 2010. Currency loans (or some types of currency loans) have earlier been deemed illegal. Banks, which had issued these loans, have had to recalculate them and write-down substantial amounts. The two ministers introducing the new measures have said that it now is time that the banks, which behaved so badly before the collapse, should shoulder some of the burden. In reality, the banks have already been hit by write-downs resulting from the currency rulings. – The banks now functioning are not the old banks but new banks created with deposits from the old banks.

*Here is the legal opinion from the Kaupthing estate to the Icelandic parliament re taxing bank estates. Given that both Glitnir and Kaupthing doubt the estates constitute a legal base the coming measures will most likely be challenged in court. It will be intriguing to how the courts, first the Reykjavík District Court and then the Supreme Court, rule in a case where the government has already acted on its own assessment of the legality of these actions.

Update 4.12. 2013:

According to IFS Greining, the Icelandic CDS has jumped up 11% since the weekend. That is at least an indication of how market forces outside of Iceland view the ,,correction.” Unfortunately, I do not have a link to this since the IFS website is behind a payment wall. – It is most likely that the fact that the funding is not secure, that it will hit the Housing Finance Fund, already deemed a sovereign risk by IMF and others and that the Treasury is a de facto guarantor has an effect on the CDS.

Follow me on Twitter for running updates.

Written by Sigrún Davídsdóttir

November 30th, 2013 at 6:54 pm

Posted in Iceland

10 Responses to 'Debt “Correction” outlined – but funding (still) a pie in the sky'

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  1. Sigrun,

    Thanks for your account. I note however that Reuters have reported that “The government said it would finance the measure through tax hikes on financial institutions and a haircut on around $4 billion in debts owed to overseas investors in Iceland’s failed banks, which collapsed in late 2008.”

    On the face of it, this appears to be contrary your assertion that “funding is not coming from the winding-up process of the estates of Glitnir and Kaupthing.” Could you have missed something? Or do you think Reuters are in fact referring to the proposed application of the tax to the defunct banks, and not to an additional haircut?


    1 Dec 13 at 10:11 am

  2. It’s not entirely clear to me what Reuters is here referring to but it seems to be what the government had said earlier: that it would use tax hikes (surfaced in the 2014 budget, presented in autumn but not clearly outlined) to fund part of the budget and a haircut on the ISK assets of the estates to fund debt-relief measures.

    However, in the new debt-relief measures the haircut does not appear, only measures that the government is itself funding for the time being until it can later recover the funds by taxing operating banks and the estates of fallen banks. As pointed out above the tax on the estates will no doubt be contested in court.

  3. Thanks Sigrun. That’s what I understood too. You have no doubt seen the summary of the opinion of the Kaupthing WuC, submitted to the parliamentary Economic and Trade Committee on 28 October 2013, re “certain flaws in Chapter V of the Bill proposing amendments to the Bank Tax Act No. 155/2010”:


    1 Dec 13 at 1:30 pm

  4. Thanks for the link; yes, had seen the opinion but only in Icelandic. Will now add it to my text.

  5. Of the statement on behalf of the Icelandic government that it is now time to punish the banks for behaving so badly in the past, I make 2 observations. As far as the now defunct banks are concerned, these tax proposals punish their creditors, not the banks themselves. The creditors have already suffered huge losses as a result of past actions of the banks, for which the creditors were not remotely responsible. Secondly, the banks didn’t misbehave – its directors did. So who should be punished: the creditors who are the victims of the banks’ collapses, or those actually responsible for what happened?

    Laurence Godfrey

    1 Dec 13 at 4:16 pm

  6. You are right that taxing estates of fallen banks punishes creditors. In Iceland, coalition politicians keep pointing out that creditors are reaping enormous profits, then meaning not the pre-collapse bondholders but hedge funds that bought post-collapse. And because of these alleged profits they can be taxed. That is i.a. how the politicians come to this conclusion that the estates should be taxed.

  7. Yes Sigrun – that is indeed the mantra your coalition politicians repeat endlessly. It makes for a good story (while glossing over the sorry fate of those who were obliged to sell their claims at huge losses to these hedge funds, for whom there can be no relief). But it conveniently ignores the fact that the measures they propose will also punish those pre-collapse creditors who remain, and (indirectly) the ordinary depositors – not bondholders – who entrusted their hard-earned savings to one of the overseas subsidiaries of these banks (or to banks which were taken over by them in a final fling before the fall). Where is the justice in that? When will punishment be meted out not to the victims but to the perpetrators?


    2 Dec 13 at 9:31 am

  8. Sigrun, if your government is sincere, then the injustice we’ve noted could be addressed by taxing only the hedge funds etc. that bought debts post collapse. Or taxing only genuine profit, rather than monies recovered or monies claimed in the bank liquidations. But it isn’t sincere, is it, because it is intentionally misleading the electorate as to who has gained by Iceland’s losses?

    laurence g

    2 Dec 13 at 9:50 am

  9. Precious little is published in the French press except from a conservative paper:
    “L’OCDE avait recommandé, il y a quelques mois, des mesures pour soulager les plus fragiles. Finalement, la remise de dette profitera à tous, sans conditions de ressources. «80 % à peu près des ménages vont être directement touchés, mais tous les Islandais vont en tirer profit, entre autres grâce à une croissance (économique) et un pouvoir d’achat accrus», explique le premier ministre. Cette mesure, dont le coût dépasse 900 millions d’euros, devrait être financée par la taxation des banques”
    Looks to me like a distorted account ie:
    It is an OECD recommendation.
    It will boost the economy.
    The more debt you have the more you will benefit from a “Keynesian” stimulus QE and QED ?


    2 Dec 13 at 11:29 am

  10. […] Compared to the skepticism of many Icelandic economists (except those who worked on the debt relief or were somehow connected to it), it was surprising to see how positive Fitch Ratings review of the Icelandic debt relief plan is: Fitch deemed the program “appears” to be “fiscally neutral” but added that “another round of write-downs may dent investor perceptions of Iceland’s business environment, and the prospect of foreign bank creditors in the failed banks bearing most of the cost may make it more difficult to remove capital controls.” The program amounts to ISK150bn, 8.5% of GDP (see earlier report on Icelog). […]

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