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The huge significance of the foreign currency loan ruling

As we reported a few days ago, the Icelandic Supreme Court passed a ruling last week that loans indexed to foreign currencies are illegal in Iceland.

For anyone unfamiliar with the concept, Sigrún Davíðsdóttir explains over on her blog [also exposing the further incompetence of the Icelandic bankers, as if we didn’t have overkill on that front already].

The significance of this ruling is colossal. It means that thousands of people are now cut down from the noose in which they have been hanging since the economy melted down. Fréttablaðið quoted a social worker today who has been working with people who have had nothing left over at the end of the month when their loan payments are made — all because of the massive weight of the foreign currency loans.

It also means that the lenders are now being forced to take a share of the responsibility for making the loans — something which was previously the full responsibility of the loan taker.

One of the best discussions I have seen on the subject is in a post written by one Helgi Jóhann Hauksson, whose blog I was reading for the first time. He writes:

The loan agreements between the public and loan or credit institutions are never close to being an agreement between two equals, as representatives from those companies like to maintain. If conflict arises due to default, the debtor cannot afford to hire legal counsel due to lack of funds. The legal profession essentially operates to serve the wealthy and powerful who pay the lawyers’ fees, and therefore all legal precedents and judicial settlements on loans and credit-related matters are completely one-sided.

The credit institutions draw up the loan agreements and inherent terms with the help of an army of the most expensive lawyers, and the loan takers are then presented with those predetermined conditions.

Debtors must trust that the general terms of such contracts have been carefully thought out and are both legal and fair, and have been supervised and approved by the government before they are presented and printed. After all, standard contracts are subject to laws designed to protect consumers, as well as laws that apply to credit institutions and terms of loans.

It is only when people do not have adequate funds to meet their payments (or to hire legal counsel) that they are faced with the fact that the credit institutions hold all the power and show no mercy if people have not met the criteria of the contracts, as assessed by the credit institutions themselves.

He goes on to describe some of the brutal ways in which people have had their homes or cars repossessed, and finishes by saying:

The full posse of the legal profession [in Iceland] has, for 100 years, since the founding of the University of Iceland, exclusively served the creditors and capitalists in their purest form. All legal precedents are on that side, on the side of the creditors and capitalists, because the others hardly ever get a chance to plead their cases. On top of this, attorneys have been granted exclusive rights to legal proceedings, so people cannot even enjoy the assistance of more knowledgeable or experienced friends or relatives to plead their case, since they are simply turned away from the defendant’s table by the judge, and forbidden from speaking.

What is unusual now is that the economic collapse has put so many people unexpectedly in the position of feeling on their own skins the modus operandi of the credit institutions and university-educated debt collectors, that many others have had to experience after being hit by illness or personal trauma. However, their complaints have never been heard.

This new situation is currently being discussed at ever level of Icelandic society, from the government to the credit institutions to debtors’ associations to water-cooler gatherings. The actual implementation of the law is yet to be determined, i.e. how the changes will be carried out, the loans calculated, repayments made, whether or not people should make payments if bills arrive next month, etc. etc. One thing is sure, though — if anyone tries to meddle with this ruling, there will be hell to pay.

Comments

comments

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  • Michael Lewis June 21, 2010, 8:03 pm

    I think you are missing a moral hazard. And, I think its somewhat one-sided.

    People accepted loan terms and now the courts are effectively defaulting on them for them. The prudent, who didn’t benefit will have to pay their share of the cost. Shifting the cost from the debtor to those people who will now pay higher price to borrow in Iceland (the costs have to go somewhere).

    You could argue that there wasn’t “information asymmetry” and that the people taking out these loans didn’t understand or didn’t have the risks explained them. I’m not so sure. In the UK for example, ignorance isn’t considered a defence. The only defence would be that risks were deliberately hidden.

    In effect the courts have simply – on behalf of debtors – defaulted on that debt. I think there is a good moral argument that there will be many prudent people who are victims of this action.

  • Michael Schulz June 21, 2010, 8:42 pm

    Hasn’t the government in personam Prime Minister and Minister Economics taken a stand essentially absolving governance – them selves – from any mea culpa!? Now politics seem to be saying the banks have to be held accountable not as a matter of the banks responsiblity but innocence of polity! Don’t let either banks nor politics get away with it.
    Cheers,
    Michael

  • Joerg June 21, 2010, 8:51 pm

    It’s definitely another chapter of incompetence of Icelandic bankers and their supervisors. I’m just afraid that the bill will have to be paid by the general public. And it’s raising ambiguous feelings, seeing that people, who acted financially more prudent, will have to bail out those, who were taking risks.

  • Mike June 21, 2010, 9:00 pm

    This is great news. I spent some time last year with an English lady who now lives in Iceland. Somehow on top of a busy family life she was having to work four or five jobs to try and pay off one of these crazy Yen-denominate loans.

  • RK in Los Angeles June 21, 2010, 9:00 pm

    Michael Lewis:

    Your argument is similar to saying that those who financed their real estate with subprime mortgages in the US are responsible for the recession and deserve no aid. It is true that consumers need to make more and better educated choices but that wont happen all by itself, there needs to be a push from higher places to make that happen. Everyone makes bad choices every now and then, taking out a bad loan shouldnt mean your life as you know it is gone. Here in the USA you as a consumer can walk away from a bad loan and start over again thanks to more humane bankruptcy laws. In Iceland you are never free from your debt, you never get a clean slate with the laws the way they currently are.

    Also let me remind you or inform you if you dont realize this that the Icelandic crown is so weak against other currencies now that people are paying 2-3 times higher car payments than before. Those people that have tried to stop paying lose their car but still have to fulfill their contractual obligations. Some end up losing their house after they have lost their car. And then there are some that have lost a lot more than their possessions and real estate.

    “In the UK for example, ignorance isn’t considered a defence.”

    I would really not go there too much. Because now I have to ask you: If ignorance is not an excuse, then what is the excuse for the British for your extraordinarily bad choices of PMs for the past 2 decades? Because us Icelanders, our only true excuse for our bad choices is in fact ignorance. When compared to the alternatives (malice, spite, power hunger, greed, and good old fashioned bullying tactics) I personally would like to believe the best about us all, the British included.

  • Michael Lewis June 21, 2010, 10:50 pm

    > “… and pay off one of these crazy Yen-denominate loans.”

    One wonders why she took our a Yen denominated loan. Did she have a view on the Japanese economy, its monetary policy etc… ? Not that I think there is anything evil about foreign currency loans. Could she reasonable have been expected to take responsibility and understand the risks she faced?

    Now here in the UK, if you are an average joe on the street – you don’t need an investment bank to manage FX – if you have some foreign currency needs (or loans) – you can pick up the phone and call a retail FX house and they will see you a strip of forwards , locking in a rate today for your liability.

    Perhaps people here have the risk explained more clearly.

    >Your argument is similar to saying that those who financed their real >estate with subprime mortgages in the US are responsible for the >recession and deserve no aid.

    No, I’m simply saying that some of the cost of bailing out people – is being paid by those that chose not to take on loans, not to take on the risk, but are still being asked to pay for them … that’s slightly unfair and does create a moral hazard.
    This doesn’t mean I have no sympathy for those affected, I’m sure most of us think “there but for the grace of god go I …” – I’m just not convinced this type of default is the best way to help. i.e. fairly crudely forcing the cost onto those that never benefited.

    > British for your extraordinarily bad choices of PMs for
    > the past 2 decades?

    In the UK we don’t elect a PM, we elect MPs. The political parties chose their leaders. That’s why we ended up with Gordon Brown. Some of the other were ok …

  • Bromley86 June 21, 2010, 10:57 pm

    There is no excuse (in the sense of an opt-out) for any poor choices made by previous UK governments, which is why we’ll be paying for them. Likewise Iceland for its. There may be excuses (in the sense of reasons) for poor choices made by individuals/governments anywhere, but that’s a different matter.

    To be honest, I’d be amazed if ignorance was a valid legal defence in Iceland (or, indeed, anywhere).

    As to the fairness of FC loans, just remember that if these loans had been made correctly, then they’d stand (as they have for many businesses that borrowed actual FC rather than ISK). So if you walked into a bank, they handed you yen and then you converted that immediately to krona and went and bought a car, then that loan would not be overturned.

    All that happened is that the banks handed out krona rather than FC. The fact that those loans were essentially FC loans was, I understand, known by everyone who took them. They chose to believe (as frankly most would) that even if something horrible happened, that the currency would not devalue as much as it did.

  • RK in Los Angeles June 22, 2010, 2:28 am

    “No, I’m simply saying that some of the cost of bailing out people – is being paid by those that chose not to take on loans, not to take on the risk, but are still being asked to pay for them … that’s slightly unfair and does create a moral hazard.”

    That is always the argument against any bailout. There are two very important factors here: Iceland does regard itself as a Scandinavian country which sometimes (not often enough IMO) looks to their neighbors as a role model. Those who dont vote for the Independent Party are voting for the Center or Left. So you can see that many of us dont really have a problem with bailouts or the general concept of spreading the loss so that those who were worst affected can be relieved from their burdens, especially not when its serving the People and not Corporations.

    Furthermore, although I dont have a personal experience with these loans and have been away for 14 years but keeping a close eye, it seems like these loans were heavily pushed on the consumers. A loan is a consumer product. This product was seriously defected and has imposed real hardship on the Icelandic people – in many cases more so than the actual kreppa. Last weeks ruling reveals that the loans were never legal.

    Re. Who you elect: Parties choose their leaders. When you cast your vote for any given party you are also voting for a leader by default.

    Margaret Thatcher, John Major, Tony Blair, Gordon Brown. JM may have been ok (to be honest I cant really remember Major that well), the rest pretty horrific IMO. Whether you agree with me or not, it was the statement about Brits not being able to plead ignorance as a defense that brought to mind the sound of that rock breaking the glass walls. While at least some of us are looking within and trying to figure out what happened and why, it might be a good idea for other countries to do the same. And statements like that are likely to evoke anger on the very same day your PM played the big bully on the playground.

  • RK in Los Angeles June 22, 2010, 2:35 am

    Bromley:

    “To be honest, I’d be amazed if ignorance was a valid legal defence in Iceland (or, indeed, anywhere).”

    I am not a lawyer, but my significant other is and interestingly enough this morning when I was reading this comment thread to him he wanted to add that “informational asymmetry” is in fact a consideration in the US legal system, especially when it comes to contracts and related matter. Again I am not educated in the laws so I cannot communicate this with the proper verbs but I can ask him to if its needed.

  • Don in Seattle June 22, 2010, 3:23 am

    I must be missing something here, from the comments I have read.

    I’m not really sure how the Supreme Court in Iceland works, but most courts that are the final disposition for legal matters, render both an affirming and dissenting viewpoint in their remarks. I would love to read what the Icelandic Supreme Court had to say, on both sides of this isuue.

    The real question is what was the law that existed in Iceland when the first loan was made that eventually found its way to a court disposition.

    The botton line is this; the court has ruled that loans indexed to foreign curriencies are, and were, illegal under Icelandic law.

    As far as I can understand, the Icelandic Supreme Court is not making new law, only passing judgement on a case that has made it to their court, based upon Icelandic law in place at the time the original case was made.

    As such, they are only interpreting the law, as it existed, in light of the conditions of a case brought before the court.

    Am I wrong in thinking this?

    Such loans never should have been made, and because the covenants of the loans were in violation of Icelandic law at the time the loan was entered into, the entire loan contract is null and void.

    The banks might have been unscrupulous in making the loan; the people stupid for accepting the terms of the loan. It doesn’t matter. The terms of the loan were in violation of Icelandic law, and as such, an uninforceable, illegal contract by both parties was entered into.

    There is no moral hazard here. Both parties signed a loan agreement that has been determined to be made in violation of Icelandic law. As such, both parties share culpability.

    It remains to be seen how any settlement works out, but it seems to me that the court has said all such indexed loan contracts are illegal under Icelandic law in existence at the time the loans were entered into, and as such, illegal; null and void.

  • Stephen Cowdery June 22, 2010, 4:13 am

    @ Michael Lewis: “One wonders why she took our a Yen denominated loan. Did she have a view on the Japanese economy, its monetary policy etc… ? Not that I think there is anything evil about foreign currency loans. Could she reasonable have been expected to take responsibility and understand the risks she faced?”

    She took out the loan because the banks sold it as being prudent.

    The loans were illegal, they were fraudulently marketed as being legal by the banks. Punishing the victim, while all too common, is the moral hazard here.

  • goupil June 22, 2010, 8:00 am

    Wait a minute. Do you mean the big Icelandic bank holders who have abused their position to give themselves huge loans etc. will go Scot free (no offense to the Scots intended) ?
    :))

  • Peter - London/Krakow June 22, 2010, 8:46 am

    These loans seem mindbogglingly stupid and are illegal in most countries except to the most sophisticated (and rich) borrower. Obviously consumer protection failed completely in Iceland.

    But, claiming ignorance of the risks is just not believable. Icelanders were apparently very well versed in the nature of currency volatility and especially that of the ISK as it was all over the place. The rate of interest were far better, so the risk/reward aspect must have been very clear – it was a gamble.

    Complaining about the odds after you have taken a gamble and lost is simply shirking your responsibility. Maybe thats an Icelandic/Nordic trait born of the social system?

  • D_Boone June 22, 2010, 9:31 am

    Lets not miss the main point here. This is not moral hazard or alternatively a “politically acceptable” judgement by the court to help people who took these risky loans at the expense of those who made the loans. There are other more appropriate avenues to address these issues.

    The facts are that the loans were clearly illegal and this has been upheld after judicial review. The social lesson is that if you break the law you must bear the consequences and that includes those that invested their money in or with businesses making these loans.

    To me the “moral lesson” if there is one is those who loan money should a) keep within the law and b) realize that loans where the terms shovel all the risk onto the borrower (escalator clauses, FX loans, indexing….) may be counterproductive. I hope everyone learns it well.

  • hildigunnur June 22, 2010, 10:18 am

    You should hear and see the wailing and screaming of the loan institutions here, when the ruling went through and ever since. Apparently they hadn’t for a moment even considered that the ruling might not go in their favour.

  • sylvia hikins June 22, 2010, 10:19 am

    What I can’t understand is why people (all people, not just Icelanders) decide (and it IS their decision) to live so much above their means. It’s the ‘I want it all and I want it now approach’. And of course, people are conned into believing that they need all these consumer thingies. Well there’s always a price to be paid. I’m glad you have this ruling, but some of the comments are right in that those who have been moderate in managing household incomes will now be subsidising those who chose to buy now and pay later. The debt doesn’t just disappear into thin air. My real sympathies go to people who were buying essentials, like a home, and got caught up in all of this. They really are riding the nightmare.
    sylvia from viking wirral

  • Michael Schulz June 22, 2010, 12:08 pm

    No moral issues? No political moral isues? No issue of proper law enforcement? No issue of banking oversight? No issue of consumer protection? I don’t get it !
    They are all issues and they are for real ! And that’s precisely why the government was quick to distance herself from all responsibilities as they fear accountability. Its the very same corrupted politics as practiced in the past – now projecting a bleak future. Lets hope there will be a Best Party going national and people will vote those politics of old down.
    Cheers,
    Michael

  • Petri Aho June 22, 2010, 12:08 pm

    It’s not just people who live above their means, it’s what the whole economic structure relies on. Money is created by taking loans, but the interest isn’t, so to pay the interest more money needs to lent. Now when the whole system is built on the principle of loans, this monster we have created does its best to make sure everybody takes loans and consumes as much as possible since that’s what the economic growth requires and it’s hard to fight back when they keep pushing newer, fancier products to you all the time and giving you great deals to pay them later.

    I’m not an economist though, but that’s how it was explained to me. It just seems to me that when the culture of consumerism has been let to grow rampart, people’s objectivity and common sense just fails to see the risks.

    PS. I have no car, I live rental and I have no debts, but I certainly don’t feel like a better person, more like a bum.

  • Michael Lewis June 22, 2010, 12:39 pm

    “The loans were illegal, they were fraudulently marketed as being legal by the banks. ”

    No, they were perfectly legal at the time. Now they are illegal, it is a default of debt in all but name.

  • DD June 22, 2010, 1:19 pm

    The economy is based on borrowing. Staying away from borrowing might be a wise choice regarding one’s personal financial security and keeping a person away from financial troubles, but if this was everybody’s choice it it would be a disaster. The problem is to define the line of the “safe” borrowing that can keep us from personal financial troubles and at the same time keeps economy go. I bet it’s not a simple task…

  • DD June 22, 2010, 1:21 pm

    >>> No, they were perfectly legal at the time.<<<

    Links to prove this statement?

  • Sigvaldi Eggertsson June 22, 2010, 3:11 pm

    Sylvia, most of the personal debt here in Iceland was used to pay for essentials such as housing or cars (there is a higher percentage of owner-occupied property in Iceland than anywhere else I know of and car is essential in almost all of Iceland because the public transportation system is quite minimal) and I think most of these foreign currency loans were used for short term loans such as for cars (1-3 years mostly)
    The reports of wild consumerism in Iceland have a basis in fact but are much exaggarated.

  • Bromley86 June 22, 2010, 3:19 pm

    RK

    Re. Informational asymmetry. Funnily enough, Michael seems to have touched on that in his first post (although I think “wasn’t” was a typo).

    I’ll admit that I hadn’t heard of the term before, but I think I can appreciate the gist of what it means. In this case, I can’t see it being a key factor, in that the banks couldn’t really be expected to know that the ISK was going to fall so far. So both parties knew that the exchange rate could and would fluctuate. The actual calculation to determine how much you owe on a ISK 10m FC loan when the exchange rate doubles isn’t a difficult one.

  • Virgile June 22, 2010, 3:56 pm

    the “funny” things in this story is that everyone in charge knew that was totally illegal but no one did anything. Even Valgerður ( the ex minister of finance/ business, who admitted that the privatisation of the bank was a scam….) said that she knew it was illegal…….

    The other very funny things is that…Icelanders still strongly support the independence party and dodson…..who are RESPONSIBLE for this…..

  • kevin oconnor,waterford ireland June 22, 2010, 4:18 pm

    @Petri Aho yes exactly make housing affordable, ban mortgages, cars you can save your way to a €1000 cheap banger,credit cards who needs them when you can get a prepaid top up one like me,Mortgages I am nearly 50 don’t bother you only drop dead after 25yrs of paying all that interest, poor credit rating wonderful,problems at work no problem just be unemployed like me and I too live rental but I feel like a better person ha ha.

  • kevin oconnor,waterford ireland June 22, 2010, 5:05 pm

    @Michael Lewis yes I can see where you are coming from on the prudent bailing out the “reckless”, but moral hazard is all the rage these days check out the low interest rates for prudent savers to give people with large mortgages an easier time, plus the Anglo-Irish carry on we have here, maybe the system just sucks, my mum and dad got a terraced house in 1962 for £20,000 in todays money, and the system in Iceland with the indexing of loans (not wages though you notice comrade citizen) sucks particularly badly, I think they should bring in Jingle mail like they have in Yankee land all through the world, bank gives you a hard time just chuck the keys in their letterbox before scurrying to the airport to get on an Irish Airforce Jet aka Ryanair for a new life somewhere else.