Iceland Recovers from a Financial Crisis with Debt Writedowns

In Iceland, rock-throwing brought criminal justice to the financial sector, wrote down debts healing balance-sheets and lead to a strong recovery out of a terrible economic situation. Omar R. Valdimarsson, who has been covering Iceland’s recovery for Bloomberg, has this great piece, Icelandic Anger Brings Debt Forgiveness in Best Recovery Story:

Icelanders who pelted parliament with rocks in 2009 demanding their leaders and bankers answer for the country’s economic and financial collapse are reaping the benefits of their anger.

Since the end of 2008, the island’s banks have forgiven loans equivalent to 13 percent of gross domestic product, easing the debt burdens of more than a quarter of the population, according to a report published this month by the Icelandic Financial Services Association….

The island’s households were helped by an agreement between the government and the banks, which are still partly controlled by the state, to forgive debt exceeding 110 percent of home values…Once it became clear back in October 2008 that the island’s banks were beyond saving, the government stepped in, ring-fenced the domestic accounts, and left international creditors in the lurch. The central bank imposed capital controls to halt the ensuing sell-off of the krona and new state-controlled banks were created from the remnants of the lenders that failed…

Iceland’s special prosecutor has said it may indict as many as 90 people, while more than 200, including the former chief executives at the three biggest banks, face criminal charges.

In case anyone wants to check it out, here’s the IMF report from August 2011 on Iceland:

Household debt restructuring. The pace of household debt restructuring is also
accelerating. The number of applications for debt relief under the measures agreed in
December 2010 (involving mortgage writedowns to 110 percent of the property
value) had been significantly lower than expected, but shot up in June as the deadline
for submitted applications approached. As of mid-July, the Office of the Debtor’s
Ombudsman had received some 3400 applications for debt mitigation, of which about
a third are under formal (voluntary) negotiations. The three commercial banks expect
to complete the household debt restructuring process by end-2011.

Here’s what I’d like to know more about.  Iceland has just a little over 300,000 people in it, so it is roughly the size of St. Louis.  They are dealing with under 10,000 mortgages for negotiations, a sizable amount of which are voluntary.

America has over 10 million underwater households, and virtually no voluntary writedowns.  There’s a debate between those who think mortgage servicers aren’t writing down mortgages on properties about to go into foreclosure because they have terrible incentives (they are indifferent or profit when mortgages go into foreclosure) or because they aren’t resourced to do it.  They are too-thin of an operation, purposely designed to scale up and be run on the cheap, without the technology, staff or funding to handle what is essentially the underwriting of a brand new loan.  They lack the local knowledge, the embeddedness within community and direct, consistent contact with struggling homeowners.

Beyond the obvious government pressure to get the debt overhang worked out, I wonder if these are working better on the voluntary scale because of how small Iceland is.  And if we had done things to localize the knowledge and practice of the foreclosure market, by mandatory mediation programs and allowing for bankruptcy courts to handle debt, we’d also have ended up with a stronger recovery.

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8 Responses to Iceland Recovers from a Financial Crisis with Debt Writedowns

  1. Tom M says:

    Looking at the amount of GDP written off, 13%, would have meant a 1.7 T loss for mortgage lenders and the nationalization of institutions. Looks about right for the size of the stimulus that might have pulled the US out of the recession sooner.
    Of course, bankers would be prosecuted under the plan. What is wrong with that? Might have meant a different outcome in the 2010 mid-terms.

  2. Jon Smith says:

    I think that your gut instinct is very likely right. As far as I can see, there is no way you could easily scale up such a system of remuneration for a country as large as the US.

  3. Drill Rigs says:

    Maybe if we multiply the numbers by the actual debt we have we could make a dent in the US but this formula is for not a lot of debt when you look at the hole the US is in.

  4. jpe says:

    It’d be easier for is to forgive debt if the UK owned all our debt, I’d suspect.

  5. Pingback: You Love the Bailouts, Didn't You Hear it on the News? |

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