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Scandal of the day: Financial Services Authority knew that foreign currency loans were illegal

About a month ago, I mentioned that a ruling had been passed in a district court declaring that all Icelandic car loans tied to foreign currencies were [are] illegal.

As many readers will know, these loans are among the most serious consequences of the kreppa for normal citizens in Iceland. Car dealerships pushed them incessantly [one woman I talked to said that the dealership had strongly advised her to take a foreign currency loan, even though she planned to buy her car outright, because she could earn more interest by keeping her money in the bank] — and thousands of Icelanders went for it. I venture to say that almost all car loans issued in 2006-2008 were tied to foreign currencies.

Of course, when the króna plummeted by around 100 percent virtually overnight in October 2008, those loans shot up. In some cases they even tripled or quadrupled [depending on the currency in which they were issued].

Anyway, obviously the district court ruling is highly significant. It was appealed to the Supreme Court and a ruling is pending [but probably won’t be delivered until sometime this autumn].

HOWEVER, it has now transpired that the Icelandic Financial Services Association apparently KNEW that the loans were illegal as early as 2001.

Channel 2 news last night reported on a commentary prepared in 2001 by the head of the Association, Guðjón Rúnarsson, in response to a proposed parliamentary bill on interest rates and indexing. In the commentary, he writes:

As the law is today (and will be unless the bill is changed) it is illegal to issue loans in Icelandic krónur that are tied to a foreign currency.

The bill was subsequently passed – unchanged – meaning that it remained illegal to issue those sorts of loans. Nevertheless Icelandic financial institutions gleefully continued to do so over the subsequent seven years.

And now? If they are forced to make corrections [as it seems the government is planning to make them do] they will most likely go bankrupt. Meaning we, the taxpayers, have to foot [yet another] bill.

Helvítis fokking fokk.

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  • Lars Magne Sunnanå March 14, 2010, 1:32 pm

    When will we know wether or not this will break the banks? And is this connected in any way to the lawsuits against foreign currency loans on houses?

  • sylvia hikins March 14, 2010, 2:07 pm

    Just when are the perpetrators of these lies and fraudulent activities going to be taken to account? They should be put to trial, and if found guilty, have all of their assets stripped, lose their jobs and pensions and where serious enough, imprisoned. This isn’t a witch-hunt. This is a justice system working on behalf of the people of Iceland who have been so wronged in this debacle. OK, you can live without your 4 x 4 if it is repossessed. But you can’t live comfortably in a society where trust in public bodies and business has been blown away.
    sylvia from viking wirral

  • Michael Lewis March 14, 2010, 2:08 pm

    I think I commented on this before, lets be honest, at some point you really have to ask people to take responsibility. Taking out a loan and an unhedged FX exposure – no way should the tax payer bail out people who obliged themselves. I can’t believe any adult in Iceland wasn’t aware that foreign exchange rates can vary. Forget about legalities – people who took them out should pay the price.

    (As a side note, anyone living in the UK with all the savings in Sterling – even though you’ve seen Brown destroy sterling by 25-30% against a basket of currencies: be aware that Brown and Labour are more than capable of destroying more value. Jim Rogers is rarely wrong on long term bets.)

    “strongly advised her to take a foreign currency loan”
    Well, she should have said No. Presumably this woman wasn’t a child? Above the age of 15? As an adult she shouldn’t complain, but live with the fact that she made choices and stop blaming other people.

  • alda March 14, 2010, 2:17 pm

    Lars – we don’t know, probably not until the Supreme Court has ruled. And I’m not sure I know what lawsuits you’re referring to regarding the house loans.

    Sylvia, when the investigation has reached that point, I believe.

    Michael Lewis – “strongly advised her to take a foreign currency loan” Well, she should have said No. Presumably this woman wasn’t a child? Above the age of 15? As an adult she shouldn’t complain, but live with the fact that she made choices and stop blaming other people.

    — Did I say she was complaining? I did not, and she did say No. Perhaps YOU should refrain from judging other people before you have all the facts.

  • MishaBear March 14, 2010, 2:32 pm

    You know Michael, I understand what you are saying, but in Iceland a lot of people where recommended to go that route by a financial advisor or their bank advisor; and most of the times, for loans that were much more consistent than a car loan.

    In a perfect world, one would suppose that a financial advisor should know better than you what is the right way to do things, otherwise you won’t even need a financial advisor. And if you add that Iceland (still) seems to me a country that relies a lot on mutual trust, it is not difficult to figure out how this mess could have happened.

    My father worked for 30 and more years in a bank, in Italy, and among other things, he was the person in charge of approving loans and recommending clients the best route to get the money. He worked in Italy, but in a small city, so his clients were also friends or people he knew: they always followed his recommendations.

  • MishaBear March 14, 2010, 2:35 pm

    Argh, wish I could edit the post! “people where” is obviously “people were”. This happens when you don’t have enough sleep.

  • American Lawyer March 14, 2010, 2:35 pm

    @Michael Lewis “at some point you really have to ask people to take responsibility”
    Undoubtedly true, but the essence of moral hazard and fraud is information asymmetry. The auto finance people knew more than the consumers–about the relevant laws, and the incentives they were given to push the loans–which they used to their advantage. I assume that they did not make full disclosure, so it’s hard to say that they share NO responsibility for the losses.
    A just solution would be to shift at least some liability to the persons who profited from the foreign currency loans, their attorneys, and to the entities that made pushing the loans so attractive.

  • Bromley86 March 14, 2010, 2:56 pm

    Well, she should have said No. Presumably this woman wasn’t a child?

    Let’s say that she had, like many did, given in to temptation and taken the loan. That would in your eyes be her fault.

    But what of the financial insitution offering the loan? Does it bear no responsibility for pushing out currency linked loans? Especially as it might reasonably be expected to appreciate the risks more than your average car buyer.

    Then there’s the actual legality of it. If the institution knew that it was illegal (and as the FS Association knew, you can bet the institutions themselves also did), how would that alter your opinion?

    And if the FME and government knew, as they must have at some level, then would that have no impact on your position?

  • Andrew (the other one) March 14, 2010, 3:05 pm

    Why did the Financial Services Authority not enforce the law of the land? I know that they (along with their UK counterparts) had a doctrine of “a light regulatory touch”, but that is just “hands off, let the banks do as they please!”.

  • Rik Hardy March 14, 2010, 4:00 pm

    Yet another bill to foot?
    No, Alda, we just let them go bankrupt and join the ranks of the unemployed.
    With the base upon which Iceland is built in terminal freefall, can someone suggest to me a basis upon which it is possible to live here, other than pure hope?
    Sure, I love the country, sure, I love my work and sure, I love the people, but isn’t it like living in Disneyland – only possible for a day or two and too expensive anyway?
    As has so often been the case on “Silfur Egils”, today people were again pointing out that nothing of importance is being done about the systemic problem, which is that nobody here WANTS to change, and their denial tends to lead them either into nationalistic jingoism or into depressive withdrawal and isolation, both of which are deadly.

  • Michael Lewis March 14, 2010, 4:22 pm

    “Did I say she was complaining?”
    No, you just implied it by the context.

  • Michael Lewis March 14, 2010, 4:25 pm

    >Does it bear no responsibility for pushing out currency linked loans?

    Yes, it does, when the person defaults. Like non-recourse mortgages, there should be a limit to how far a bank can go in recovering funds for things like car loans. i.e. shouldn’t be able to bankrupt someone. Until we get these sorts of arrangements in retail banking – you’ll always have these problems – the retail bank will just sit back and think “we still make money if 8 out of 10 pay up” – if they shouldered some more of the risk – that would be better.

    Of course it would mean that some people wouldn’t get loans.
    And politicians would then force retail banks to loan to loan to these people, as Clinton did.

  • idunn March 14, 2010, 5:50 pm

    If the Supreme Court decision stands, will these car loans continue, denominated now in Icelandic Krona?

    Which financial institutions have such exposure, and if it bankrupted them all could Iceland afford to see them go? Will the end result devolve to the taxpayer, or only the shareholders and owners of such institutions?

    What steps are being taken for proper oversight and regulation of financial institutions in future?

  • James March 14, 2010, 6:12 pm

    The financial institutions were selling illegal products and therefore must compensate consumers for their loss. Consumers shouldn’t share any responsibility for illegal products they were sold by financial institutions acting unlawfully under a regulator that was acting negligently. But no-one will be prosecuted for any of this illegality and Norway will eventually bail it all out, so expect the moral hazard to return in a decade or so…

  • Peter - London March 14, 2010, 10:15 pm

    “The financial institutions were selling illegal products and therefore must compensate consumers for their loss. ”

    Not everyone took out a foreign currency loan, some opted to pay more (I heard a figure of 25% ) to avoid the currency risk.

    You see, thats the point; they knew they were gambling on the exchange rate but decided that it was a risk worth taking.

    So what do you do? undo the currency losses? What about those who gained from the previous rise in the Krona? they will be looking at a big bill , as they profited from these loans.

    The only sensible way to deal with it is to ban the loans and convert to Krona at the current exchange rate, which is what I expect will happen.

  • Marc March 14, 2010, 10:19 pm

    I think the debate should not be so much about what one Michael Lewis thinks about this but more about the moral dilemma that Alda hinted at in her post:

    Citizens were deceived into taking risks that were not legal for them to take on by trusted counterparties, therefore the companies that were complicit to these schemes should suffer.

    Citizens (like Alda) that had nothing to do whatsoever with the binge credit years in Iceland will be forced to foot the bill when it is presented to the banks offering these fraudulent loans.

    This seems to be a dilemma that is quite difficult to resolve. In my opinion the banks should be forced to eat the losses, and to ease taxpayers’ pain in the long run they should be nationalised in some way (possibly for decades to come) to compensate for the hardship they caused. That would give Iceland the time to prepare for proper regulatory oversight before they can move to privatise these institutions again.

  • Michael Lewis March 14, 2010, 11:02 pm

    @Marc
    “I think the debate should not be so much about what one Michael Lewis thinks about this but more about the moral dilemma that Alda hinted at in her post”

    Erm … she didn’t hint and we’re talking about the same thing.

    “Citizens were deceived into taking risks that were …”

    Naive – yes. Deceived – questionable. I’m afraid to say that the you can’t simply absolve personal responsibility. I find it very hard to believe that any average adult didn’t know that foreign exchange rates vary. You don’t need to know how to price a power reverse dual currency note to realise that somedays the exchange may be up and others down. And, if it moves a lot, you may be out of pocket.

    In the UK I believe that these loans typically have a ‘cooling off’ period – 14 days (I think), so, during this period if someone thinks they’ve been taken in by a pushy salesman – they can rip up the agreement. Is there something similar in Iceland? If not, that would be a first step.

  • Joerg March 14, 2010, 11:20 pm

    I seem to have learned, that almost nobody is going to be convicted in Iceland for doing illegal business in banking. Not least for this reason, I would expect that in the end not the profiteers but the taxpayers are going to pay a price.

    The particular problem in this case is, that the banks and companies, who offered those loans, are already bankrupt. So, if they are supposed to take part of the burden back, it’s the taxpayers again, who will have to suffer.

    What about those, who took out foreign currency linked loans and paid them back before 2008? They certainly made a profit as well as those, who received commission by pushing the sale of this illegal product to willing gamblers. It’s definitely a moral nightmare.

  • Angel March 14, 2010, 11:29 pm

    Alda, my husband and I were one of those who bought a car on foreign loan. As mentioned above, we would have gained more interest on our money if it sat in the bank than paying the car outright which we actually thought about doing. We are kicking ourselves now as our car payments have doubled each month. Nothing much we can do about it now but just wait to see if the courts actually do something about the illegal loans. Now I just tell people I bought a Honda and am paying for a Hummer.

  • Angel March 14, 2010, 11:40 pm

    As for the comments about people taking responsibility, I do understand and agree wholeheartedly. I do think though that you just have to live in Iceland and know what times were like back then. Times were good in Iceland and we were none the wiser of the upcoming events, I think most people here felt untouchable. No one in this country thought that the Icelandic Kronur would have plummeted as it did. I still can not believe it.

  • The Fred from the forums March 15, 2010, 1:57 am

    “Forget about legalities – people who took them out should pay the price. ”

    In that case, the lenders will (continue to) profit from illegal activity.

  • Andrew (the other one) March 15, 2010, 4:40 am

    Quis custodiet ipsos custodes?

    Who was supposed to be watching the financial services agency? Was it the finance ministry by any chance? The people who made the law making those loans illegal, which was then ignored by their own enforcement agency.

    Incompetence or corruption?

  • D_Boone March 15, 2010, 7:29 am

    I tend to agree with Michael (Lewis) that the people who took these FX loans bear some responsibility (and therefore suffer some of the losses). However, the loans were illegal so the banks and shareholders should also bear some of the burden as well. The manager’s and director’s should be in jail. Dare I say it, the bond holders should suffer a haircut as well…..

    Sorry nobody gets a get out of jail free card. Of course that is a perfect world.

  • Eliza March 15, 2010, 9:12 am

    There is a confusion in the post : the Financial Services Association – SFF – is a mere association of bankers. It has no authority whatsoever. It mustn’t be confused with the Financial Services Authority – FME – which is the authority supervising the financial sector.

  • alda March 15, 2010, 10:01 am

    Eliza – no confusion. The post merely points out that the FSA of Iceland knew. Presumably if they are an interest group working on behalf of financial services companies they would have alerted those companies to this rather glaring issue? Or at the very least, those bankers who make up the association knew and would thus have been remiss in their duties at the bank.

  • Ásdís March 15, 2010, 10:27 am

    I think perhaps Michael Lewis’s posts in this thread are the most patronizing towards the average citizen of Iceland (and in fact most of the western world) that I have seen in a long time.
    The western world is for the most part built on trust in specialists.
    If your car/washer/other appliance breaks down you take it to a certified repairman and he tells you whether it is worth fixing, and as you have no grounds to doubt him, you have to take his recommendations in good faith. The same applies to other specialists: doctors, plumbers, dentists, accountants, lawyers, and so on. If you are not an expert in the field you must rely on the advice of others. You responsibility is to try to pick a reliable advisor.
    Those who were the specialists in financial affairs in Iceland recommended these car loans (there were a few who didn’t but most did).
    I take responsibility for having taken their advice. And am paying my loan even though it has doubled from the projected future payments we were shown at the time, but I resent being likened to a child because of it. We were aware that foreign exchange rates vary and asked for a worst-case-scenario prediction at the time. The amounts we were shown were nothing like what we are experiencing now. The worst-case-scenario was such that we figured that it was within a manageable margin for us.
    This does not make us stupid/childish. We believed in the wrong advisors like almost everyone else. Yes, of course we hoped to gain from it, compared to the terms available in other loans these loans were presented as being better for the consumer. But is this not what you should be doing as an average consumer, try to find the most beneficial terms available?

  • Michael Lewis March 15, 2010, 3:34 pm

    @Ásdís
    “The western world is for the most part built on trust in specialists.”
    I thought it was built off Judeo-Christian ethics.

    The answer to:
    “But is this not what you should be doing as an average consumer, try to find the most beneficial terms available?”
    Is simply: No. That’s why sensible people in the UK left their savings with HSBC, Nationwide, conservative banks that didn’t pay the more ‘beneficial’ rates of Icesave.

    Risks are worth taking – when you understanding them, sadly, and this -is- an issue for Icelandic authorities: did people really understand the risks?

    To me, I have to say, the risks seem common sense. It appears other people think otherwise…

  • Ásdís March 15, 2010, 4:49 pm

    @Michael Lewis
    “@Ásdís
    “The western world is for the most part built on trust in specialists.”
    I thought it was built off Judeo-Christian ethics.”
    This reply certainly proves my point about the patronizing tone of your comments. You do no answer my point about the dependance on specialist but make a flippant rebuttal aimed at making my argument seem of no account.

    Regarding: “That’s why sensible people in the UK left their savings with HSBC, Nationwide, conservative banks that didn’t pay the more ‘beneficial’ rates of Icesave. ”
    This just proves my point. If “conservative banks” in the UK had offered deals similar to Icesave the English public would certainly have put their money in those accounts. They rely on trusted specialists in making their decisions like the Icelandic people did.
    You seem to assume that the ones pushing the foreign currency loans were some unknown or minor dealers in the financial market. All the banks of Iceland did push these loans. The conservative and the newcomers. Online baks and the oldest and most respected ones. How was the average consumer supposed to know they were not a good idea? It has nothing to do with being “sensible” or a lack of “common sense” as you so delicately put it.
    If the rumors described in Alda’s posts are true and they were knowingly dishonest does not that mitigate the responsibility of the average consumer?

  • idunn March 15, 2010, 5:33 pm

    As has been alluded to here, it occurs to me now what few may have imagined in the early years of this century: that the entire banking system of Iceland would collapse. In the euphoria of the time it might even have seemed imprudent not to take the same loans everyone else was, or at least hard to resist the temptation and questions from fellows, ‘why not?’ More than a few might even have questioned the variable rates of such loans, but who would have imagined, or been believed, that the Krona would collapse?

    If our world financial system operates on trust, it still remains too often the men behind the curtain that would not have us see behind it, and our inclination not to want to. But at times we should, or at least an honest representative who takes a great interest in such things. For we have all learned certain downsides in not doing so.

  • Michael Lewis March 15, 2010, 6:41 pm

    @Ásdís
    “flippant rebuttal aimed at making my argument seem of no account.”
    I would genuinely contend that the western civilisation is based broadly on Judeo-Christian ethics, rather than what you seem to suggest: “built on trust in specialists.”

    “If “conservative banks” in the UK had offered deals similar to Icesave the English public would certainly have put their money in those accounts. ”

    At the risk of sounding laconic and copying the original laconic reply:

    If.

    The convervative banks by their nature would not have offered Icesave like deals – history shows they did not when competitors were offering better deals. They relied upon their customers seeing through deals such as Icesave.

    Thats why invetors prefer say Swiss debt to that issued by DR Congo.

    “How was the average consumer supposed to know they were not a good idea? ”
    By asking – “Is there a limit to how much I am exposed to exhange rate movements?”

    As I say, to me, that is a common sense question to ask if you are taking out a loan in a foreign currency. Others see it differently.

    Yes, companies have a duty to ensure that the risks are explained to those taking out loans. They should have made it clear with a statement “Downside risk: unlimited.” perhaps.

  • wally March 15, 2010, 8:34 pm

    @Michael Lewis.
    You seem to be skirting a very good point made my Ásdis. In Iceland all the banks were doing it. Even the oldest and most conservative. You failed to address this, merely stated that it would never happen. Which with the track of record of British banking of late quite simply dare i say it sounds naive and childish.

  • Michael Lewis March 15, 2010, 11:15 pm

    Sorry Wally but you seem to have ignored my last post. Nationwide and HSBC didn’t mass market these sorts of loans. Though one could argue that the likes of HSBC and Standard Chartered are more Hong Kong banks than British ones. The UK has many excellent banks – some bad ones, but more good than bad.

    There may have been no conservative Icelandic banks, they were all equally poor perhaps. They were all poor. That doesn’t mean people were -forced- to borrow in foreign currencies.

    So, this isn’t skirting the issue: if you think local banks are bad – choose other ones. I for example like DBS Bank, Singapore.

    The lesson being: if other people aren’t doing their homework – its not an excuse to not do your own homework.

  • Andrew (the other one) March 16, 2010, 2:36 am

    “Financial Services Association – SFF – is a mere association of bankers. It has no authority whatsoever. It mustn’t be confused with the Financial Services Authority – FME – which is the authority supervising the financial sector.”

    So a professional association of banking companies knew the loans were illegal, but didn’t bother telling their member companies. Or the companies did know, but deliberately broke the law.
    And the financial supervisor, FME, didn’t know about this? They didn’t know the laws they were supposed to enforce?

    Incidently, did you know that many MBA programs and commerce degrees don’t include courses in Business Ethics?!

    It’s amazing that the financial sector lasted as long as it did!

  • Ásdís March 16, 2010, 9:15 am

    @ Michael Lewis “I would genuinely contend that the western civilisation is based broadly on Judeo-Christian ethics”
    I am sure you can, but it is beside the point, which was that we rely on specialists in making decisions. This is something that can be criticized, sure. But it is not unique to those that took out car-loans in foreign currency but a fact of life for most people (Although, it seems there are exceptions).

    “So, this isn’t skirting the issue: if you think local banks are bad – choose other ones. I for example like DBS Bank, Singapore.”

    You are seriously proposing that an average, say school-teacher, in Iceland should have realized 2006 that all the banks in the country were offering dubious car-loans and should have contacted a bank half-way around the world and asked them to finance his car-loan to buy a 3 year old Toyota. I am sure DBS bank, Singapore would have jumped at the chance!
    It is becoming clear that you live on another planet than the rest of us mortals. But then they say that hindsight is perfect.

  • Michael Lewis March 16, 2010, 11:22 am

    Ásdís , the comment wasn’t ‘beside the point’ as you yourself drew attention to it earlier, but lets move on to your other point:

    “You are seriously proposing that an average, say school-teacher, in Iceland should have realized 2006 that all the banks in the country were offering dubious car-loans and should have contacted a bank half-way around the world and asked them to finance his car-loan to buy a 3 year old Toyota.”

    I am suggesting that the average Icelander should have said to the company offering loans:

    “Is there a limit to how much I would pay if exchange rates move against me?”

    I think that is basic common sense. Take out a loan – in a currency you earn you wage in, anything else is taking a risk. A self evident risk.

    As I’ve said, others see it differently.

    As for banking overseas: Erm… what do you think Icesave was in the UK ? Plenty of school-teachers and the like banked with Icelandic banks in the UK. Any reason why Icelanders couldn’t do likewise and bank with overseas banks?

    I’d point out that these aren’t “premier” services, DBS opening balance needs to be about 50 SGD if I recall.

    i.e. designed for those of us that have to do a job for the next 35 years …..

  • Ásdís March 16, 2010, 12:47 pm

    The Icelandic banks (and many others) had branches or subsidiaries in the UK, who offered the Icesave accounts and other services, but as far as I know, there are no foreign banks offering financial services in Iceland, then or now. At least not to the general public. There is some small difference in the size of the market which probably explains why. So this comparison is not viable.

    And say my hypothetical school-teacher had secured a loan from DBS, would that not have been in a foreign currency anyway? I kind of doubt they offer loans in Icelandic kronor.

  • DD March 16, 2010, 12:47 pm

    @Michael Lewis
    “I think that is basic common sense. Take out a loan – in a currency you earn you wage in, anything else is taking a risk. A self evident risk.”

    Yes, there is a risk. But you rely on specialist to tell you how big is this risk, at what circumstances , etc. Simple as this.
    “Is there a limit to how much …” may be a logical question for you to ask, considering your financial background , but I doubt any one without such would chose those exact words. “What are my risks?”, “What is the worst scenario?” , “What worst can happen?” are much more likely. I don’t know how many “specialists” had predicted the collapse of the Icelandic financial system, but I doubt anyone of them shared their knowledge to the car owners.

  • Bromley86 March 16, 2010, 4:08 pm

    Dadi has a piece on the still-at-discussion-stage write down of car loans to 110% of market value (although the example is a mortgage loan, the principle is the same):

    Consider the cases of these fictional Icelanders:

    A) Who took a 100% currency loan on a 30 million ISK home and has seen it go up to 60 million ISK. Market value today estimated at 25 million. Ends up with 27.5 million after the banks and the minister of social affairs have had their say.

    B) Who saved 10 million, bought a 30 million ISK home and has seen the 20 million loan go up to 24 million. Market value today estimated at 25 million. No write offs!

    Rewarding the risk takers? From which end of the spectrum is Arni Pall Arnason and the Social Democrats approaching the debt issue?
    http://www.economicdisasterarea.com/index.php/features/a-110-folly/