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Foreign currency loans deemed illegal

The Icelandic supreme court ruled this afternoon that Icelandic loans indexed to a foreign currency are illegal.

This is hugely significant for thousands of people in this country.

As many of you will know, the foreign currency loans were one of the most serious consequences of the economic collapse for normal people in Iceland. Thousands of Icelanders had taken out these so-called “currency basket” loans to buy homes and cars, and when the Icelandic currency plummeted, their loans doubled, tripled and even quadrupled in value, with disastrous effects.

And now, they’ve been deemed illegal. Exactly what the implications of this are I’m not entirely sure [the World Cup dominates everything these days, so we don’t even get Kastljós in the evenings, which might help shed some light on the matter] — but it’s sure to be big.

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  • Paul H June 16, 2010, 10:22 pm

    Cool beans!

  • sylvia hikins June 17, 2010, 12:18 am

    I suppose the big question is, were the loans illegal when they were taken out prior to this ruling ie: have they always been illegal. Or are they only illegal from this afternoon? And what will this mean to outstanding debts?
    I must confess that I have never been anywhere that has such a conspicuous and in your face display of enormous street parked 4 x 4’s as I saw in Reykjavik last March. I can only assume that it is illegal to drive them cross country otherwise Iceland’s landscape could become a ruinous mess. Most that I saw were parked or cruising down Laugavegur, which with it’s sub-tarmac heating, never freezes! Irony indeed!
    sylvia from viking wirral

  • vikingisson June 17, 2010, 12:54 am

    What does conspicuous consumption have to do with the issue? I was there shortly after the crash and it appeared no more conspicuous than every suburb and city I’ve ever seen in N.A. In fact there was a feeling of embarrassment associated with it going by the looks on people’s faces. People often borrow beyond their means especially when they thought otherwise and get caught in a money crisis. Not that I feel sorry for the shenanigans that went on there are plenty of innocent people caught up in this.

    The loans weren’t illegal at the time and I can’t imagine new loans like the bad old days. Unless this is to keep money from flowing out to more stable currencies I’m not sure what this is about. Will existing loans be converted? Will this prevent predatory take overs from foreign sources?

  • sylvia hikins June 17, 2010, 1:52 am

    Conspicious consumerism has everything to do with it. The way people succumb (all people, not just Icelanders) to the pressures of displaying status through wealth, stoked up by advertising hype, and are drawn into buying things they can’t afford and don’t really need in a credit card culture that makes banks and loan companies rich. What was even more tragic is that so many people, especially young people, who needed a home, felt they had to buy before prices spiralled out of their reach, then had the markets crash around them.
    We all need to re-think our values.
    sylvia from viking wirral

  • Bryan de Boinville June 17, 2010, 2:46 am

    The implications may be more momentous than you even suspect. Under the provisions of the IMF Articles of Agreement, neither the courts of the UK nor any other IMF member could now enforce the agreements. See, Article VIII, Section 2 (b):

    (b) Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territories of any member. In addition, members may, by mutual accord, cooperate in measures for the purpose of making the exchange control regulations of either member more effective, provided that such measures and regulations are consistent with this Agreement.

    This issue is dealt with at length in Joseph Gold’s excellent series, The Fund Agreement and the Courts, available from IMF Staff Papers. The Articles may be found here: http://imf.org/external/pubs/ft/aa/aa08.htm

  • D_Boone June 17, 2010, 8:10 am

    This is indeed a major development. I understand it relates to foreign indexed loans since 1991 via http://www.mbl.is. Obviously, the banks breached some rule and offering the loans was illegal. Hence any contracts entered into were null and void. The full consequences are probably unclear at this point.

    Interesting indeed.

  • Michael Schulz June 17, 2010, 9:27 am

    Hope this is not a politically motivated decision. One will have to look at the full text of the courts reasoning. In the meantime one should remain suspicious not least as the entire justice system has been compromised by the same undoings that lead to Kreppa. E.g. judges, etc. were appointed along political faultlines, etc.. The judiciary has to go a long way to regain independence.
    Cheers,
    Michael

  • bret June 17, 2010, 10:30 am

    Lot of those SUVs are for carting tourists around. I’ve only flown in Iceland, but I think the single ring road was not the best in some places.

  • alda June 17, 2010, 12:39 pm

    On the question of SUVs — I agree that rampant consumerism exists in Iceland and probably the majority of SUV owners think of them as status symbols — at least in part. However, there ARE many places in Iceland that are out of reach of a normal family vehicle. I don’t own a SUV nor am I particularly a victim of consumerism, but I have often found myself wishing I owned one, if for no other reason than to be able to explore my country as I would like to.

  • Douglas June 17, 2010, 1:34 pm

    On the question of SUVs, Alda:
    borrow one / hire one / hitch a ride in one / rent one / take a tour in one – but don’t buy one.

  • Bromley86 June 17, 2010, 1:41 pm

    Have to admit that I don’t entirely understand Bryan’s point. However, presumably the contracts themselves were between the finance companies/banks in Iceland and the Icelandic consumers. Or were they directly with foreign banks?

    Either way though ISK loans were made. The question is now whether the government/banks will be allowed to attach standard loan terms retroactively. The government missed a trick; back when this all kicked off, it should have offered to take on the FC loans and convert them to indexed ones.

    I doubt that anyone would argue that those that took FC loans rather than the expensive indexed ones should not only be bailed out now that the risk has crystalised, but that they should only have to pay back the principal. Anyone who isn’t a lawyer representing people with those loans, that is 🙂 .

  • Michael Lewis June 17, 2010, 2:10 pm

    This is more or less a debt default, which carries with it a moral hazard. What about the prudent people who will now be , in part, paying the cost of this – the cost doesn’t go away because of a ruling. Its not magic, now, the cost is simply shared by people who never saw any benefit …

    As for taking out FC loans, I think some people will ‘get away with murder’ and some people were simple , hmmm …. naive, would be a kind way of saying it.

  • snowball June 17, 2010, 4:39 pm

    the outcome of this court ruling is relatively clear. the leasing companies (SP fjarmögnun for example) which provided the foreign currency might go bankrupt and the funding banks behind the leasing companies will have to take the losses. isnt db behind most of the currency loans? you can also call this court ruling a legalized pirate act :-), because it is a political decision.
    the interesting question is, why did the courts not intervene when the party was at full speed between 2002 and 2007? the lesson taught to investors is simple:
    > you cannot count on the currently existing laws in iceland
    > changes in favour of involved parties (this time indebted households) can occur anytime depending upon political tendency
    > this means that sensible foreign lenders will provide capital only at a much higher interest rate
    > or you get political lenders (read china) who will ask for much more than only higher interest rates

    however, now the chinese move makes total sense in the context of the unsolved icesave issue and such a court ruling. if all the old bridges for incoming capital are burnt you have to look for new ones.

  • Egbert June 17, 2010, 5:47 pm

    Alda wrote: “However, there ARE many places in Iceland that are out of reach of a normal family vehicle” and these are also the last places you want to drive a SUV – a 4×4 would be a different matter. SUVs are notoriously unstable and prone to rolling over.

  • Bromley86 June 17, 2010, 5:53 pm

    >but don’t buy one

    Until all the cancelled contracts flood the market.

  • D_Boone June 18, 2010, 9:47 am

    For the casual reader: as many here know the background and consequences of this decision has been very well described by Bjarni previously after an earlier lower court decision

    http://www.icenews.is/index.php/2010/02/14/court-rules-in-favour-of-icelandic-foreign-loan-holders/

    The bottom line is the loans were clearly *illegal* what is not clear is what now happens. Everybody here has suggested the loans could be “converted” into existing Icelandic indexed loans. To me this is animal excreta. I suspect a more likely scenario in most countries and I suspect Iceland as well is the loans are converted to Krona as at the time the loan was taken out and at the interest rate agreed at the time for the loan i.e. the creditor was at fault in shifting the exchange risk to the borrower and the appropriate penalty is that they now bear this risk instead.

    Comments please.

  • Bromley86 June 18, 2010, 1:04 pm

    >Comments please.

    Well, as I said, that would be a difficult moral position to justify. Of course, morals don’t necessarily have anything to do with this, but don’t for a second think that those borrowers were totally innocent. They knew that they were getting financing at a much lower rate because there was a risk, they just failed to consider the extreme.

    Presumably these car loans aren’t anything like the problem that the house loans are going to be (larger loans, longer periods). Given how weak the government has been on that issue, I wouldn’t expect any strong decisive action.

    BTW, you probably know this, but the loans don’t have to be converted because they were made in ISK. Your likely scenario is just that the (excessively low) interest rate, but not the indexation rate, is applied to that inital amount. If the loans had been made in foreign currency and then immediately converted then we wouldn’t be having this conversation.

  • vikingisson June 18, 2010, 7:00 pm

    @sylvia hikins, I understand your point about gluttony but it is still irrelevant to the laws old and new. Like I said I saw the same ugly status symbols there that I see almost anywhere. However even fiscally responsible buyers were hit by crushing debt once those indexed loans were 2 times or more higher. The propaganda in N.A. during the year before everything crashed was that “those dumb people” that got loans they could never pay are at fault, nothing wrong with the system. Now many more people are affected and it wasn’t the fault of those original buyers. (off topic, how many of those defaults were due to health bills and a lack of insurance?)

    I always thought that the indexed loans were a crazy and dangerous method of borrowing. Unless this was the only way to borrow money (even for domestic currency loans?) I’d be very nervous even when presented with favourable rates. No economic gain is perpetual, not even in North America.

    If this is going where it seems to suggest it is a very clever attempt to solve a problem but I doubt it would gain much traction and would remove any trust gains that Iceland might have had. Make the Beztu Party national and perhaps…..

  • Bromley86 June 18, 2010, 11:49 pm

    I always thought that the indexed loans were a crazy and dangerous method of borrowing.

    Time for me to trot out my usual point that loans in the UK & US (and everywhere else) are effectively indexed. No one is going to consistently lend out money at below inflation.

    So the HFF loans that were at something like 5% would not have been that low without indexation. No doubt it’s not quite that simple, but neither is (local currency) indexation the evil that it is often presented as.

    I believe, but am in no way sure, that most/all loans in Iceland were indexed.