Ukip’s sinister double bill and failed political leadership

Until early this year it seemed unlikely that an extreme idea lingering for two decades on the political fringe could turn into a mainstream choice preferred by majority of British voters as happened on June 23. Ukip’s leader Nigel Farage declared victory: he has for decades championed leaving the European Union but that was only half of his political double bill.

“The phrase, ‘I’m not racist, but…’ could be invented for some of the things Farage has done in politics,” Tory MP Damian Green said on BBC’s Daily Politics on the day Farage announced his resignation as Ukip’s leader. Stressing he was not accusing Farage of being a racist, Green added: ”He encourages feelings that are unhelpful and destructive, and that’s what he’s always done for his political career.”

Farage denies it, leading “Leave” politicians also deny it but in addition to the Ukip fanfare policy of leaving the European Union, Farage and Ukip have unashamedly brought something else to British politics, propagated by the whole “Leave” campaign: xenophobia and outright racism.

The political legacy of the victorious Farage is not only Brexit but the destructive sentiment of xenophobia, particularly appealing to older voters. However, Brexit would never have happened without support from established politicians, most notably Tory politicians like Boris Johnson, Michael Gove, Andrea Leadsom and Labour politicians like Gisella Stewart. With their support, the once so extreme view of leaving the EU, laced with xenophobia, is now mainstream.

The treacherous road from January 22 2013 to June 23 2016

In a speech on 22 January 2013 Prime Minister David Cameron promised to renegotiate UK’s membership of the European Union: no later than 2017 should the British people be given a “simple choice” of a continued EU membership on renewed terms – or leaving the EU.

As so many of his generation in the Tory party Cameron had never shown any particular interest in European matters but the EU has always come handy when a scapegoat was needed: all evil came from Brussels, the brilliance from Tory policies and their leaders.

Given the momentous pledge in 2013, Cameron’s attitude towards the EU was strangely enough no more enthusiastic than earlier. So, after eleven years as a Tory leader and six years as prime minister two months of campaigning didn’t make up for his earlier disinterest in all things European.

At the time of Cameron’s pledge, Farage’s Ukip was enjoying a record following of 10% in the polls, also worrying for Labour. Cameron was not prepared to call a referendum to rid the Tory party of dissident anti-EU ideas and Ukip’s influence.

What Cameron and those around him didn’t seem to understand or didn’t believe was that Ukip’s speak was permeating the mind of so many Tory MPs underpinning not only Brexit but also the other part of the Ukip double bill: the xenophobia and racism. These two currents united in the “Leave” campaign where the political pondus of the likes of Johnson and Gove gave wings to Ukip’s mission.

The “simple choice” of 1975 v the muddled choice in 2016

The seeds for the Brexit disaster were already sown by Cameron when it came to posing the 2016 referendum question: the choice was no longer simple, as it had indeed been in 1975, but a muddled one.

In 1973 the British Tory government led by Edward Heath, decided to join the European Community, a decision tested in a referendum under Labour’s Harold Wilson in 1975; 67% of those voting said yes. Although the motives and arguments were manifold the question – to join or not – was clear and unequivocal.

The recent referendum had a clear “yes” option in the “Remain” but the “no” option, “Leave,” was ambiguous. Wrapped up in the “Leave” was Ukip’s original goal of Britain leaving the EU, never a mainstream opinion in Britain until the referendum – and the stated goal of many Tories inter alia Boris Johnson who argued for his position by claiming Britain would secure a better deal by voting “Leave.”

Bumpy start… towards ashen Tory faces

Farage’s “out” and the “get a better deal” propagated by non-Ukipers gave the “Leave” campaign a bumpy start. Interviews with the Tory “Leavers” waving the “better deal” gave rise to the obvious question what would qualify for a “better deal” leading to unexciting answers.

With the “Take control” slogan things took a better turn for the “Leavers.” Although that also invited convoluted discourse – control of what and what would this new era of British control imply – this slogan could be connected to all relevant issues, be it immigrants or the NHS.

Now, the various sentiments awoken earlier by the fringe Ukip could easily be merged into mainstream Tory speak, useful not only to unruly Tory backbenchers but to leading Tories like Johnson and Gove.

As the voting stations closed June 23 Farage still seemed to believe his long-time apparently so ludicrous goal of pulling Britain out of the EU was lost; seven hours later he was a triumphant if stunned winner.

Contrast Farage’s celebratory appearance with the funeral demeanour of Johnson and Gove when they finally made a public appearance late Friday morning. Their ashen faces indicated they realised they would now need a plan, which they didn’t have. Demagogy and burning ambitions are two sentiments notoriously difficult to harness – a few days later their political fortunes had turned but that is another story.

Farage, leading a fringe party, didn’t feel obliged to have a plan. He had wanted a Brexit, getting it was all he needed to claim victory and he could resign (though given his career of resignations it’s a different matter if he really is leaving politics).

The Ukip xenophobia: from extreme to mainstream

Damian Green’s epitaph of Farage building his political career by encouraging destructive ideas sums up one view of Farage’s political contribution.  Farage may fade out of UK politics but his message lingers on among those who took note of his message as they had never before. Not because his message was better or different than it has been for decades but because established and leading politicians adopted and legitimised his stance.

By adopting Farage’s stance on the EU, Brexit supporters like Gove and Johnson, not to forget Andrea Leadsom, also propagated the other part of the Ukip’s political bill, the xenophobia with a whiff of racism. Here, the “Remain” stance of the Labour leadership, especially Jeremy Corbyn, was lamentably weak.

Leading Brexiters from the two big parties vehemently deny xenophobic intentions and undertones but that is too late: thanks to the Brexiters outside of Ukip these views have entered the political discourse. Again, what once was extreme is now mainstream.

The once so loony and laughable

To be exact, this legitimation hasn’t only happened in the last few months. For years, instead of rebutting the often hugely misleading statements from Ukip on immigration with facts and figures established mainstream politicians came to echo the Ukip view. Also, by not engaging the fact that concerns on immigration were the embodiment of simmering anger over political failures since the 1980s was lost.

Already in 2006 Cameron called Ukip “a bunch of … fruticakes and loonies and closet racists mostly.” Like Cameron, established politicians saw Ukip as a crazy fringe party: there was no need to argue with Ukip, no need to correct Ukip-ers’ misleading statements. In the media, largely sympathetic to Ukip’s views, the party was often ridiculed but almost in an endearing underdog way with Farage clowning on BBC’s Have I Got News For You.

With time, there was the seducing option for established politicians to use these sentiments for their own political advantage inter alia by blowing problems with immigration out of all proportions and blaming the immigration on EU rules.

The referendum “Leave” campaign showed that Ukip had by now shaped the immigration debate: further, its views were legitimised by Tory “Leavers” campaigning for a cause earlier only touted by Ukip with arguments earlier only used by Ukip. – This is the grin the parting Farage leaves in British politics.

Danish echoes

The Danish political environment is fundamentally different from the British one but similarly to what has been happening in Britain, xenophobic sentiments, tinged with racism permeated Danish politics in the years up to the elections in 2001. Ukip’s sister party Danish National Party emanating these ideas, jumped from a fringe position with 7% of votes to being the third largest party with 12% of votes and a decisive influence.

In the previous years DNP, founded in 1995 but an offspring of 1970s right-wing currents, had put pressure on the established parties, both the centre-right parties and the Social Democrats, leading many politicians to concede to and echo the DNP view instead of debating it. Buoyed by its 2001 results DNP came to shape Danish immigration policy and the political language: what could earlier not be said had been legitimised. With 21% of votes in the 2015 DNP is now the second largest party in Denmark after the Social Democrats.

Interestingly, in Denmark immigration hasn’t been blamed on EU but been a domestic bone of contention. In spite of sceptic EU-attitude there is no appetite in Denmark to leave the EU and hasn’t been for years. DNP, which used to be anti-EU has without fanfare abandoned its anti-EU stance.

There is however a Danish Brexit effect: opinion polls show increased support for Danish EU membership and less appetite for a Danish referendum on membership. Before the British referendum 40% of Danish voters wanted a referendum on Danish EU membership, 60% preferred to stay in the EU and 22% wanted to leave; now these numbers are respectively 32%, 70% and 18%.

Abdicating political responsibility

When David Cameron, under pressure from Ukip, promised a referendum he might have been lured by an easy game against “loony fruitcakes.” Following an albeit narrow win in the 2014 Scottish referendum and in the 2015 general elections he lost the EU referendum and together with that loss, xenophobia and worse has come to stay in British political debate.

The economist Joseph Schumpeter (1883-1950) claimed the welfare system would be in danger when the sense of entitlement to gain from it was greater than the will to contribute to it. Similarly, democracy is in danger when politicians take it too much for granted and can’t be bothered to argue with ideas that undermine it. After all, being in power means not only having power to take action but also to sway and influence opinion.

Cross-posted on Icelog.

Ireland and Iceland: when cosiness kills

The fate of the Irish and the Icelandic banks are intertwined in time: as the Irish government decided on a blanket guarantee for the Irish banks, the Icelandic government was trying, in vain, to save the Icelandic banks. In spite of the guarantee six Irish banks failed in the coming months; the government bailed them out. The Icelandic banks failed over a few days. Within two months the Icelandic parliament had decided to set up an independent investigative committee – it took the Irish government almost seven years to set up a political committee, severely restricted in terms of what it could investigate and given a very limited time. The Irish report now published is better than nothing but far from the extensive overview given in Iceland: it lacks the overview of favoured clients and the favours they enjoyed.

A small country with a fast-growing banking sector run by managers dreaming of moving into the international league of big banks. To accelerate balance sheet growth the banks found businessmen with a risk appetite to match the bankers’ and bestowed them with favourable loans. Lethargic regulators watched, politicians cheered, nourishing the ego of a small nation wanting to make its mark on the world. – This was Iceland of the Viking raiders and Ireland at the time of the Celtic tiger, from the late 1990s, until the Vikings lost their helmets and the tiger its claws in autumn 2008.

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In the company of good books: recommended reading for Jeremy Corbyn

Jeremy Corbyn will no doubt discover that the wisdom of crowds isn’t always enough nor is meeting with busy world-famous economists and other wise-men and -women four times a year. Here are some books to hone his arguments and stimulate and inspire the intellectually inquisitive mind.

The distorting effect of debt and how to avoid socialising losses and privatise the profit

I’m almost finished reading House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again by Atif Mian, Princeton and Amir Sufi, Chicago University. I had bought it even before Mark Carney recommended it; it was recommended to me soon after it was published last year.

No doubt Corbyn knows why debt is harmful, why fueling the housing market with debt is dangerous and why it is ominous that household debt in the UK is high. But in order to clarify and stimulate the mind Mian and Sufi’s book is both an essential and timely read, also to argue against the received wisdom that banks are different from other companies and need to be saved – no, they don’t.

The two economists have formulated what they call “the primary policy lesson of bank support: To prevent runs and preserve the payment system, there is absolutely no reason for the government to protect long-term creditors and shareholders of banks.” – So true (as Icelanders know). Alors, an essential read, also to gather sensible arguments in the debate on banks and banking, debt and the housing market, all topics that the new Labour leader needs to be as skillful in debating as he is cultivating his allotment.

The anti-social mixture of aggressive tax planning, tax evasion and offshore havens

Tax and the revenue lost to society due to the anti-social mixture of aggressive tax planning, tax evasion and offshore havens are close to Corbyn’s heart. To my mind, the most illuminating writer on these matters right now is the French economist Gabriel Zucman, who studied with Thomas Piketty (they have written articles together) and who has recently (and sadly) left the London School of Economics for Berkeley. I read his little book on tax havens when it came out in French last year but now it has luckily been published in English, called The Hidden Wealth of Nations.

Much of the material is on-line and much of the reasoning is put forth in his 2013 articleThe missing wealth of nations: are Europe and the U.S net debtors or net creditors? where Zucman i.a. points out “that around 8% of the global financial wealth of households is held in tax havens, three-quarters of which goes unrecorded.” – Yes, things to work on.

Inequality, health and wealth

These days, not only the lefties are preoccupied with inequality – not only is it socially harmful in terms of wasting and wasted human resources but it also hampers growth. An easy and insightful read, the harvested fruits of a lifetime of studying these issues, is gathered in The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality, published in 2010.

As an economist at the World Bank, the author Branko Milanovic (blogs here) worked on these issues long before they turned into a fashionable topic beyond the left margin of politics. And being an economist with a wealth of fabulous statistics at his finger tips he is both brilliant at choosing and presenting intriguing numbers, also with some striking graphs.

The book that led me to reading Milanovic’ book was another very different but equally weighty book, also harvesting a life time of studying these issues. Angus Deaton’s The Great Escape: Health, Wealth and the Origin of Inequality, was published two years ago and I had the pleasure of listening to Deaton present his book in London last year.

Deaton is a professor at Princeton and the inspiration for the book is partly his own family story of better lives in the generations spanning the 19th and into the 20th century. He investigates inequality not only from the perspective of wealth but also health. One point is that better health not only depends on money but good institutions.

The great escape of the title is the escape from hunger and poverty, spanning centuries in historical overview. A riveting and optimistic read, though far from wishful thinking, i.a. on development. The clear conclusion is that concentrated wealth in the hands of few is now being used to buy influence on policy making for narrow special interests, not the general good of society.

The synthesis of privatisation

Again, Corbyn will not need to be exhorted in his doubts on privatisation but it is always good to gather insight and arguments for familiar causes, especially when you spend most of your waking hours arguing and reasoning for your points of view.

I read The Commanding Heights by Daniel Yergin and Joseph Stanislaw when it came out in 1998. At the time its full title was The Commanding Heights: the Battle Between Government and the Marketplace that is Remaking the Modern World (the latter part was changed in a later edition to The Battle for the World Economy; I prefer the old one, more telling; here is a 3 parts documentary based on the book). Readers of Lenin will recognise where ,,commanding heights” stems from.

At the time, I read it more or less in one go and have since given away several copies because I think that everyone remotely interested in politics should read it. Agree or not, it is essential to understand the driving forces behind privatisation especially for those who want to question them. I have for a long time meant to re-read it, would be interesting, considering events since the book was published.

The book is often taken to have been one big bravo for globalisation and privatisation but that was not my impression at the time. After all, the authors strongly warn against special interests and stress the need for legitimacy.

And something for the soul

Apart from reading up topics that nourish his political thinking and reasoning the soul must not be forgotten. Here I suggest two books that tell stories of the have-nots in different parts of Europe in the 1930s, shaped by circumstances and ideas of that time.

Independent People by the Icelandic Nobel price winner in 1955 Halldór Laxness was published in 1934. Inspired by Laxness’ infatuation with communism and socialism, it tells the story of Bjartur, a dirt-poor crofter who fights for living independent of others, without realising that his strife goes against his own interests.

Carlo Levi’s novel, Christ stopped at Eboli, is the memoir of his political exile in a remote part of Southern Italy, Basilicata, in the years 1935-1936, not published until 1945. In Iceland, the cold harsh climate made for a difficult life but in Italy the heat and the barren earth was no less harsh. Written by brilliant and reflecting minds, both books are further demonstrations of the topic above: debt, private ownership and inequality.

Cross-posted with

Iceland’s recovery: myths and reality (or sound basics, decent policies, luck and no miracle)

Icelandic authorities ignored warnings before October 2008 on the expanded banking system threatening financial stability but the shock of 90% of the financial system collapsing focused minds. Disciplined by an International Monetary Fund program, Iceland applied classic crisis measures such as write-down of debt and capital controls. But in times of shock economic measures are not enough: Special Prosecutor and a Special Investigative Committee helped to counteract widespread distrust. Perhaps most importantly, Iceland enjoys sound public institutions and entered the crisis with stellar public finances. Pure luck, i.e. low oil prices and a flow of spending-happy tourists, helped. Iceland is a small economy and all in all lessons for bigger countries may be limited except that even in a small economy recovery does not depend on a one-trick wonder.

“The medium-term prospects for the Icelandic economy remain enviable,” the International Monetary Fund, IMF, wrote in its 2007 Article IV Consultation
Concluding Statement, though pointing out there were however things to worry about: the banking system with its foreign operations looked ominous, having grown from one gross domestic product, GDP, in 2003 to ten fold the GDP by 2008. In early October 2008 the enviable medium-term prospect were clouded by an unenviable banking collapse.

All through 2008, as thunderclouds gathered on the horizon, the Central Bank of Iceland, CBI, and the coalition government of social democrats led by the Independence party (conservative) staunchly and with arrogance ignored foreign advice and warnings. Yet, when finally forced to act on October 6 2008, Icelandic authorities did so sensibly by passing an Emergency Act (Act no. 125/2008; see here an overview of legislation related to the restructuring of the banks and here more broadly on economic measures).

Iceland entered an IMF program in November 2008, aimed at restoring confidence and stabilising the economy, in addition to a loan of $2.1bn. In total, assistance from the IMF and several countries amounted to ca. $10bn, roughly the GDP of Iceland that year.

In spite of mostly sensible measures political turmoil and demonstrations forced the “collapse government” from power: it was replaced on February 1 2009 by a left coalition of the Left Green party, led by the social democrats, which won the elections in spring that year. In spite of relentless criticism at the time, both governments progressed in dragging Iceland out of the banking mess.

After the GDP contracted by 4% in the first three years the Icelandic economy was already back to growth summer 2011 and is now in its fifth year of economic growth. In 2015, Iceland became the first European country, hit by crisis in 2008-2010, to surpass its pre-crisis peak of economic output.

Screenshot 2015-09-23 12.33.59

Iceland is now doing well in economic terms and yet the soul is lagging behind. Trust in the established political parties has collapsed: instead, the Pirate party, which has never been in government, enjoys over 30% following in opinion polls.

Compared to Ireland and Greece, Iceland’s recovery has been speedy, giving rise to questions as to why so quick and could this apparent Icelandic success story be applied elsewhere. Interestingly, much of the focus of that debate is very narrow and in reality not aimed at clarifying the Icelandic recovery but at proving or disproving aspects of austerity, the euro or both.

Unfortunately, much of this debate is misleading because it is based on three persistent myths of the Icelandic recovery: that Iceland avoided austerity, did not save its banks and that the country defaulted. All three statements are wrong: Iceland has not avoided austerity, it did save some banks though not the three largest ones and did not default.

Indeed, the high cost of the Icelandic collapse is often ignored, amounting to 20-25% of GDP. Yet, not as high as feared to begin with: the IMF estimated it could be as much as 40%. The net fiscal cost of supporting and restructuring the banks is, according to the IMF 19.2% of GDP.

Screenshot 2015-09-23 12.49.35

Costliest banking crisis since 1970; Luc Laeven and Fabián Valencia.

As to lessons to avoid the kind of shock Iceland suffered nothing can be learnt without a thorough investigation as to what happened, which is why I believe the report, a lesson in itself, by the Special Investigative Commission, SIC, in 2010 was fundamental. Tackling eventual crime, as by setting up the Office of the Special Prosecutor, is important to restore trust. Recovering from a collapse of this magnitude is not only about economic measures and there certainly is no one-trick fix.

On specific issues of the economy it is doubtful that Iceland, a micro economy, can be a lesson to other countries but in general, the lessons are simple: sound public finances and sound public institutions are always essential but especially so in times of crisis.

In general: small economies fall and bounce fast(er than big ones)

The path of the Icelandic economy over the past fifty years has been a path up mountains and down deep valleys. Admittedly, the banking collapse was a major shock, entirely man-made in a country used to swings according to whims of fishing stocks, the last one being in the last years of the 1990s.

Screenshot 2015-09-23 12.58.57

(Statistics, Iceland)


Sound public finances, sound institutions

What matters most in a crisis country? Cleary a myriad of things but in hindsight, if a country is heading for a major crisis make sure the public finances are in a sound state and public authorities and institutions staffed with competent people, working for the general good of society and not special interests – admittedly not a trivial thing.

Since 1980 Icelandic sovereign debt to GDP was on average 48.67%, topped at almost 60% around the crisis in late 1990s and had been going down after that. Compare with Greece.

Screenshot 2015-09-23 13.04.51

Trading Economics

Same with the public budget: there was a surplus of 5-6% in the years up to 2008, against an average of -1.15% of GDP from 1998 to 2014. With a shocking deficit of 13.5% in 2009 it has since steadily improved, pointing to a balanced budget this year and a tiny surplus forecasted for next year. Again, compare with Greece.

Screenshot 2015-09-23 13.17.01

Trading Economics

As to institutions, the CBI has been crucial in prodding the necessary recovery policies; much more so after change of board of governors in early 2009. Sound institutions and low corruption is the opposite of Greece, where national statistics were faulty for more than a decade (see my Elstat saga here).

Events in 2008

In early 2007, with sound state finances and fiscal strength the situation in Iceland seemed good. The banks felt invincible after narrowly surviving the mini crisis on 2006 following scrutiny from banks and rating agencies (the most famous paper at the time was by Danske Bank’s Lars Christensen).

Icelanders were keen on convincing the world that everything was fine. The Icelandic Chamber of Commerce hired Frederic Mishkin, then professor at Columbia, and Icelandic economist Tryggvi Þór Herbertsson to write a report, Financial Stability in Iceland, published in May 2006. Although not oblivious to certain risks, such as a weak financial regulator, they were beating the drum for the soundness of the Icelandic economy.

But like in fairy tales there was one major weakness in the economy: a banking system with assets, which by 2008 amounted to ten times the country’s GDP. Among economists it is common knowledge that rapidly growing financial sector leads to deterioration in lending. In Iceland, this was blissfully ignored (and in hindsight, not only in Iceland: Royal Bank of Scotland is an example).

Instead, the banking system was perceived to be the glory of Icelandic policies in a country that had only ever known wealth from the sea. Finance was the new oceans in which to cast nets and there seemed to be plenty to catch.

In early 2008 things had however taken a worrying turn: the value of the króna was declining rapidly, posing problems for highly indebted households – 15% of their loans were in foreign currency, i.a. practically all car loans. The country as a whole is dependent on imports and with prices going up, inflation rose, which hit borrowers; consumer-price indexed, CPI, loans (due to chronic inflation for decades) are the most common loans.

Iceland had been flush with foreign currency, mainly from three sources: the Icelandic banks sought funding on international markets; they offered high interest rates accounts abroad – most of these funds came to Iceland or flowed through the banks there (often en route to Luxembourg) – and then there was a hefty carry trade as high interest rates in Iceland attracted short- and long-term investors.

“How safe are your savings?” Channel 4 (very informative to watch) asked when its economic editor Faisal Islam visited Iceland in early March 2008. CBI governor Davíð Oddsson informed him the banks were sound and the state debtless. Helping the banks would not be “too much for the state to swallow (and here Oddsson hesitated) if it wanted to swallow it.” – Yet, timidly the UK Financial Services Authority, FSA, warned savers to pay attention not only to the interest rates but where the deposits were insured the point being that Landsbanki’s Icesave accounts, a UK branch of the Icelandic bank, were insured under the Icelandic insurance scheme.

The 2010 SIC report recounts in detail how Icelandic authorities ignored or refused advise all through 2008, refused to admit the threat of a teetering banking system, blamed it all on hedge funds and soldiered on with no plan.

The first crisis measure: Emergency Act Oct. 6 2008

Facing a collapsing banking system did focus the minds of politicians and key public servants who over the weekend of October 4 to 5 finally realised that the banks were beyond salvation. The Emergency Act, passed on October 6 2008 laid the foundation for splitting up the banks. Not into classic good and bad bank but into domestic and foreign operations, well adapted to alleviating the risk for Iceland due to the foreign operations of the over-extended banks.

The three old banks – Kaupthing, Glitnir and Landsbanki – kept their old names as estates whereas the new banks eventually got new names, first with the adjective “Nýi,” “new,” later respectively called Arion bank, Íslandsbanki and Landsbankinn. Following the split, creditors of the three banks own 87% of Arion and 95% of Íslandsbanki, with the state owning the remaining share. Due to Icesave Landsbanki was a different case, where the state first owned 81.33%, now 97.9%.

In addition to laying the foundation for the new banks, one paragraph of the Emergency Act showed a fundamental foresight:

In dividing the estate of a bankrupt financial undertaking, claims for deposits, pursuant to the Act on on (sic) Deposit Guarantees and an Investor Compensation Scheme, shall have priority as provided for in Article 112, Paragraph 1 of the Act on Bankruptcy etc.

By making deposits a priority claim in the collapsed banks interests of depositors were better secured than had been previously (and normally is elsewhere).

When 90% of a financial system is swept away keeping payment systems functioning is a major challenge. As one participant in these operations later told me the systems were down for no more than ca. five or ten minutes during these fateful days. All main institutions, except of course the three banks, withstood the severe test of unprecedented turmoil, no mean feat.

The coming months and years saw the continuation of these first crisis measures.

It is frequently stated that Iceland, the sovereign, was bankrupted by the collapse or defaulted on its debt. That is not correct though sovereign debt jumped from ca. 30% of GDP in 2008 until it peaked at 101% in 2012.

IMF and international assistance of $10bn

That fateful first weekend of October 2008 it so happened that there were people from the IMF visiting Iceland and they followed the course of events. Already then seeking IMF assistance was discussed but strong political forces, mainly around CBI governor Davíð Oddsson, former prime minister and leader of the Independence party, were vehemently against.

One of the more surreal events of these days was when governor Oddsson announced early morning on October 7 that Russia would lend Iceland €4bn, with maturity of three to four years, the terms 30 to 50 basis points over Libor. According to the CBI statement “Prime Minister Putin has confirmed this decision.” – It has never been clarified who offered the loan or if Oddsson had turned to the Russians but as the Cypriot and Greek government were to find out later this loan was never granted. If Oddsson had hoped that a Russian loan would help Iceland avoid an IMF program that wish did not come true.

On November 17, 2008 the Prime Minister’s Office published an outline of an Icelandic IMF program: Iceland was “facing a banking crisis of extraordinary proportions. The economy is heading for a deep recession, a sharp rise in the fiscal deficit, and a dramatic surge in public sector debt – by about 80%.”

The program’s three main objectives were: 1) restoring confidence in the króna, i.a. by using capital controls; 2) “putting public finances on a sustainable path”; 3) “rebuilding the banking system… and implementing private debt restructuring, while limiting the absorption of banking crisis costs by the public sector.”

An alarming government deficit of 13.5% was now forecasted for 2009 with public debt projected to rise from 29% to 109% of GDP. “The intention is to reduce the structural primary deficit by 2–3 percent annually over the medium-term, with the aim of achieving a small structural primary surplus by 2011 and a structural primary surplus of 3½-4 percent of GDP by 2012.” – This was never going to be austerity-free.

By November 20 2008 IMF funds had been secured, in total $2.1bn with $827m immediately available and the remaining sum paid in instalments of $155m, subject to reviews. The program was scheduled for two years and the loan would be repaid 2012 to 2015.

Earlier in November Iceland had secured loans of $3bn from the other Nordic countries together with Russia and Poland (acknowledging the large Polish community in Iceland). Even the tiny Faroe Islands chipped in with $50m. In addition, governments in the UK, the Netherlands and Germany reimbursed depositors in Icelandic banks, in all ca. $5bn. Thus, Iceland got financial assistance of around $10bn, at the time equivalent of one GDP, to see it through the worst.

In spite of a lingering suspicion against the IMF, both on the political left and right, there was never the defiance à la greque. Both the “collapse coalition” and then the left government swallowed the bitter pill of an IMF program and tried to make the best of it. Many officials have mentioned to me that the discipline of being in a program helped to prioritise and structure the necessary measures.

Recently, an Icelandic civil servant who worked closely with the IMF staff, told me that this relationship had been beneficial on many levels, i.a. had the approach of the IMF staff to problem solving been an inspiration. Here was a country willing to learn.

Part of the answer to why Iceland did so well is that the two governments more or less followed the course set out in he IMF program. This turned into a success saga for Iceland and the IMF. One major reason for success was Iceland’s ownership of the program: politicians and leading civil servants made great effort to reach the goals set in the program. – An aside to the IMF: if you want a successful program find a country like Iceland to carry it out.

Capital controls: a classic but much maligned measure

For those at work on crisis measures at the CBI and the various ministries there was little breathing space these autumn weeks in 2008. No sooner was the Emergency Act in place and the job of establishing the new banks over (in reality it took over a year to finalise) when a new challenge appeared: the rapidly increasing outflow of foreign funds threatened to sink the króna below sea level and empty the foreign currency reserves of the CBI.

On November 28 the CBI announced that following the approval of the IMF, capital flows were now restricted but would be lifted “as soon as circumstances allow.” De facto, Iceland was now exempt from the principle of freedom of capital movement as this applies in the European Economic Area, EEA. The controls were on capital only, not on goods and services, affected businesses but not households.

At the time they were set, the capital controls kept in place foreign-owned ISK650bn, or 44% of Icelandic GDP, mostly harvest from carry trades. Following auctions and other measures these funds had dwindled down to ISK291bn by the end of February 2015, just short of 15% of GDP. However, other funds have grown, i.e. foreign-owned ISK assets in the estates of the failed banks, now ca. ISK500bn or 25% of GDP.

In addition, there is no doubt certain pressure from Icelandic entities, i.e. pension funds, to invest abroad. The Icelandic Pension Funds Association estimates the funds need to invest annually ISK10bn abroad. Greater financial and political stability in Iceland will help to ease the pressure. (Further to the numbers behind the capital controls and plan to ease them, see my blog here).

With capital controls to alleviate pressure politicians in general have the tendency to postpone solving the problems kept at bay by the controls; this has also been the case in Iceland. The left government made various changes to the Foreign Exchange Act but in the end lacked the political stamina to take the first steps towards lifting them. With up-coming elections in spring 2013 it was clear by late 2012 that the government did not have the mandate to embark on such a politically sensitive plan so close to elections.

In spring 2015, after much toing and froing, the coalition of Independence party led by the Progressive party presented a plan to lift the controls. The most drastic steps will be taken this winter, first to bind what remains from the carry trades and second to deal with the estates, where ca. 80% of their foreign-owned ISK assets will be paid as a “stability contribution” to the state. (I have written extensively on the capital controls, see here). The IMF estimates it might take up to eight years to fully lift the controls.

It is notoriously difficult to measure the effects of capital controls. It is however a well-known fact that with time capital controls have a detrimental effect on the economy, as the CBI has incessantly pointed out in its Financial Stability reports.

In its 2012 overview over the Icelandic program the IMF summed up the benefits of controls:

“… as capital controls restricted investment opportunity abroad, both foreign and local holders of offshore króna found it profitable to invest in government bonds, which facilitated the financing of budget deficit and helped avoid a sovereign financing crisis.” – Considering the direct influence of inflation, due to CPI-indexation of household debt, the benefits also count for households.

Again, measuring is difficult but the stability brought by the controls seems to have helped though the plan to lift them came none too soon. Some economists claim the controls were unnecessary and have only done harm. None of their arguments convince me.

Measures for household and companies

Icelandic households have for decades happily lived beyond their means, i.e. household debt has been high in Iceland. The debt peaked in 2009 but has been going down rapidly since then.



Already in early 2008, the króna started to depreciate versus other currencies. From October 2007 to October 2008 the changes were dramatic: €1 stood at ISK85 at the beginning of this period but at ISK150 in the end; by October 2009 the €1 stood at ISK185.

Even before the collapse it was clear that households would be badly hit in various ways by the depreciating króna, i.a. due to the CPI-indexation of loans as mentioned above. In addition, banks loaded with foreign currency from the carry trades had for some years been offering foreign currency loans, in reality loans indexed against foreign currencies. With the króna diving instalments shot up for those borrowing in foreign currency; as pointed out earlier, 15% of household debt was in foreign currency.

The left government’s main stated mission was to shield poorer households and defend the welfare system during unavoidable times of austerity following the collapse. In addition, there was also the point that in a contracting economy private spending needed to be strengthened.

The first measure aimed directly at households was in November 2008 when the government announced that people could use private pension funds to pay down debt.

Soon after the banking collapse borrowers with loans in foreign currency turned to the courts to test the validity of these loans. As the courts supported their claims the government stepped in to push the banks to recalculate these loans.

In total, at the end of January 2012 write-downs for households amounted to ISK202bn. For non-financial companies the write-downs totalled ISK1108bn by the end of 2011 (based on numbers from Icelandic Financial Services Association). In general, Icelandic households have been deleveraging rapidly since the crisis.

Screenshot 2015-09-23 13.48.55



Governments in other crisis countries have been reluctant to burden banks with the cost of write-downs and non-performing loans. In Iceland, there was a much greater political willingness to orchestrate write-downs. The fact that foreign creditors owned two of the three banks may also have made it less painful to Icelandic politicians to subject the banks to the unavoidable losses stemming from these measures.

Changes in bankruptcy law

In 2010 the Icelandic Bankruptcy Act was changed. Most importantly, the time of bankruptcy was shortened to two years. The period to take legal action was shortened to six months.

There are exemptions from this in case of big companies and bankruptcy procedures for financial companies are different. However, the changes profited individuals and small companies. In crisis countries such as Greece, Ireland and Spain bankruptcy laws has been a big hurdle in restructuring household finances, only belatedly attended to.

… and then, 21 months later, Iceland was back to growth

It was indicative of the political climate in Iceland that when the minister of finance, trade and economy Steingrímur Sigfússon, leader of the Left Green party, announced in summer 2011 that the economy was now growing again his tone was that of an undertaker. After all, the growth was “only” forecasted to be around 2%, much less than what Iceland had enjoyed earlier. Yet, this was a growth figure most of his European colleagues would have shouted from the rooftops.

Screenshot 2015-09-23 13.59.29

Abroad, Sigfússon was applauded for turning the economy around but he enjoyed no such appreciation in Iceland.

As inequality diminished during the first years of the crisis the government could to a certain degree have claimed success (see on austerity below). However, the left government did poorly in managing expectations. Torn by infighting, its political opponents, both in opposition and within the coalition parties never tired of emphasising that no measures were ever enough. That was also the popular mood.

The króna: help or hindrance?

Much of what has been written on the Icelandic recovery has understandably been focused on the króna – if beneficial and/or essential to the recovery or curse – often linked to arguments for or against the EU and the euro.

A Delphic verdict on the króna came from Benedikt Gíslason, member of the capital controls taskforce and adviser to minister of finance Bjarni Benediktsson. In an interview to the Icelandic Viðskiptablaðið in June 2015 Gíslason claimed the króna had had a positive effect on the situation Iceland found itself in. “Even though it (the króna) was the root of the problem it is also a big part of the solution.”

Those who believe in the benefits of own independent currency often claim that Iceland did devalue, as if that had been part of a premeditated strategy. That however was not the case: the króna has been kept floating, depreciating sharply when funds flowed out in 2008. The capital controls slammed the break on, stabilising and slowly strengthening the króna.

Lately, with foreign currency inflows, i.a. from tourism, the króna has further appreciated but not as much as the inflows might indicate: the CBI buys up foreign currency, both to bolster its reserve and to hinder too strong a króna. Thus, it is appropriate to say that the króna float is steered but devaluation, as a practiced in Iceland earlier (up to the 1990s) and elsewhere, has not been a proper crisis tool.

Had Iceland joined the EU in 1995 together with Finland and Sweden, would it have taken up the euro like Finland or stayed outside as Sweden did? There is no answer to this question but had Iceland been in the euro capital controls would have been unnecessary (my take on Icelandic v Greek controls, see here). Would the euro group and the European Central Bank, ECB, have forced Iceland, as Ireland, to save its banks if Iceland had been in the euro zone? Again, another question impossible to answer. After all, tiny Cyprus did a bail-in (see my Cyprus saga here).

On average, fisheries have contributed around 10% to the Icelandic GDP, 11% in 2013 and the industry provided 15-20% of jobs. Fish is a limited resource with many restrictions, meaning that no matter markets or currency fishing more is not an option.

Tourism has now surpassed the fishing industry as a share of GDP. Again, depreciating króna could in theory help here but Iceland is not catering to cheap mass tourism but to a more exclusive kind of tourism where price matters less. Attracting over a million tourists a year is a big chunk for a population of 330.000 but my hunch is that the value of the króna only has a marginal effect, much like on the fishing industry: the country’s capacity to receive tourists is limited.

Currency is a barometer of financial soundness. One of the problems with the króna is simply the underlying economy and the soundness of the governments’ economic policies or lack of it, at any given time. Sound policies have often been lacking in Iceland, the soundness normally not lasting but swinging. Older Icelanders remember full well when the interests of the fishing industry in reality steered the króna, much like the soya bean industry in Argentina.

The króna is no better or worse than the underlying fundamentals of the economy. In addition, in an interconnected world, the ability of a government to steer its currency is greatly limited, interestingly even for a major currency like the British pound. What counts for a micro economy like Iceland is not necessarily applicable for a reserve currency.

Needless to say, the króna did of course have an effect on how Iceland fared after the collapse but judging exactly what that effect has been is not easy and much of what has been written is plainly wrong. (I have earlier written about the right to be wrong about Iceland; more recent example here). In addition, much of what has been written on Iceland and the króna is part of polemics on the EU and the euro and does little to throw light on what happened in Iceland.

Iceland: no bailouts, no austerity?

There have been two remarkably persisting stories told about the Icelandic crisis: 1) it didn’t save its banks and consequently no funds were used on the banks 2) Iceland did not undergo any austerity. – Both these stories are only myths, which have figured widely in the international debate on austerity-or-not, i.a. by Paul Krugman (see also the above examples on the right to be wrong about Iceland) who has widely touted the Icelandic success as an example to follow. Others, like Tyler Cowen, have been more sceptical.

True, Iceland did not save its three largest banks. Not for lack of trying though but simply because that task was too gigantic: the CBI could not possibly be the lender of last resort for a banking system ten times the GDP, spread over many countries.

When Glitnir, the first bank to admit it had run out of funds, turned to the CBI for help on September 29 2008, the CBI offered to take over 75% of the bank and refinance it. It only took a few days to prove that this was an insane plan. The CBI lent €500m to Kaupthing on the day the Alþingi passed the Emergency Act, October 6 2008, half of which was later lost due to inappropriate collaterals. This loan is the only major unexplained collapse story.

The left government later tried to save two smaller banks – a futile exercise, which only caused losses to the state – and did save some building societies. The worrying aspect of these endeavours was the lack of clear policy; it smacked of political manoeuvring and clientilismo and only added to the high cost of the collapse, in international context.

As to austerity, every Icelander has stories to tell about various spending cuts following the shock in October 2008. Public institutions cut salaries by 15-20%, there were cuts in spending on health and education. (Further on cuts see IMF overview 2012).

With the left government focused on the poorer households it wowed to defend benefit spending and interest rebates on mortgages. These contributions are means-tested at a relatively low income-level but helped no doubt fending off widening inequality. Indeed, the Gini coefficients have been falling in Iceland, from 43 in 2007 to 24 in 2012, then against EU average of 30.5. (See here for an overview of the social aspects of the collapse from October 2011, by Stefán Ólafsson).

In addition, it is however worth observing that although inequality in general has not increased, there are indications that inter-generational inequality has increased, as pointed out in the CBI Financial Stability Report nr. 1, 2015: at end of 2013 real estate accounted for 82% of total assets for the 30 to 40 years age group, compared to 65% among the 65 to 70 years old. The younger ones, being more indebted than the older ones are much more vulnerable to external shocks, such as changes in property prices and interest rates. Renters and low-income families with children, again more likely to be young than older people, are still vulnerable groups.

In the years following the crisis the unemployment jumped from 2.4% in 2008 to peak of 7.6% in 2011, now at 4.4%. Even 7.6% is an enviable number in European perspective – the EU-28 unemployment was 9.5% in July 2015 and 10.9.% for the euro zone – but alarming for Iceland that has enjoyed more or less full employment and high labour market participation.

Many Icelanders felt pushed to seek work abroad, mostly in Norway, either only one spouse or the whole family. Poles, who had sought work in Iceland, moved back home. Both these trends helped mitigate cost of unemployment benefits.

Austerity was not the only crisis tool in Iceland but the country did not escape it. And as elsewhere, some have lamented that the crisis was not used better to implement structural changes, i.a. to increase competition.

The pure luck: low oil prices, tourism and mackerel

Iceland is entirely dependent on oil for transport and the fishing fleet is a large consumer of oil. Iceland is also dependent on imports, much of which reflect the price of oil, as does the cost of transport to and from the country. It is pure luck that oil prices have been low the years following the collapse, manna from heaven for Iceland.

The increase in tourism has been crucial after the crisis. Tourism certainly is a blessing but the jobs created are notoriously low-paying jobs. As anyone who has travelled around in Iceland can attest to, much of these jobs are filled not by Icelanders but by foreigners.

Until 2008, mackerel had never been caught in any substantial amount in Icelandic fishing waters: the catch was 4.200 ton in 2006, 152.000 ton in 2012. Iceland risked a new fishing war by unilaterally setting its mackerel quota. Fishing stocks are notoriously difficult to predict and the fact that the mackerel migrated north during these difficult years certainly was a stroke of luck.

The non-measureables: Special Prosecutor and the SIC report

As Icelanders caught their breath after the events around October 6 2008 the country was rife with speculations as to what had indeed happened and who was to blame. There were those who blamed it all squarely on foreigners, especially the British. But the collapse also changed the perception of Icelanders of corruption and this perception has lingered in spite of action taken against individuals. This seems to be changing, yet slowly.

Screenshot 2015-09-23 14.47.49

When Vilhjálmur Bjarnason, then lecturer at the University of Iceland, now MP for the Independence party, said following the collape that around thirty men (yes, all males) had caused the collapse, many nodded.

Everyone roughly knew who they were: senior bankers, the main shareholders of the banks and the largest holding companies, all prominent during the boom years until the bitter end in October 2008. Many of these thirty have now been charged, some are already in prison and other fighting their case in courtrooms.

Alþingi responded swiftly to these speculations, by passing two Acts in December: setting up an Office of a Special Prosecutor, OSP and a Special Investigative Committee, SIC to clarify the collapse of the financial sector. These two Acts proved important steps for clearing the air and setting the records straight.

After a bumpy start – no one applied for the position of a Special Prosecutor – Ólafur Hauksson a sheriff from Reykjavík’s neighbouring town Akranes was appointed in January 2009. Out of 147 cases in the process of being investigated at the beginning of 2015, 43 are related to the collapse (the OSP now deals with all serious cases of financial fraud).

The Supreme Court has ruled in seven cases related to the collapse and sentenced in all but one case; Kaupthing’s second largest shareholder and three of the bank’s senior managers are now in prison after a ruling in the so-called al Thani case. – Gallup Iceland regularly measures trust in institutions. Since the OSP was included, in 2010, it has regularly come out on top as the institution enjoying the highest trust.

As to the SIC its report, published on 12 April 2010, counts a 2600 page print version, which sold out the day it was published, with additional material online; an exemplary work in its thoroughness and clarity.

The trio who oversaw the work – its chairman then Supreme Court judge Páll Hreinsson (now judge at the EFTA Court), Alþingi’s Ombudsman Tryggvi Gunnarsson and Sigríður Benediktsdóttir then lecturer in economics at Yale (now head of Financial Stability at the CBI) – presented a convincing saga: politicians had not understood the implication of the fast growing banking sector and its expansion abroad, regulators were too weak and incompetent, the CBI not alert enough and the banks egged on by over-ambitious managers and large shareholders who in some cases committed criminality.

How have these two undertakings – the OSP and the SIC – contributed to the Icelandic recovery? I fully accept that the effect, as I interpret it, is subjective but as said earlier: recovery after such a major shock is not only about direct economic measures.

Setting up the OSP has strengthened the sense that the law is blind to position and circumstances; no alleged crime is too complicated to investigate, be it a bank-robbery with a crowbar or excel documents from within a bank. The OSP calmed the minds of a nation highly suspicious of bankers, banks and their owners.

The benefit of the SIC report is i.a. that neither politicians nor special interests can hi-jack the collapse saga and shape it according to their interests. The report most importantly eradicated the myth that foreigners were only to blame – that Iceland had been under siege or attack from abroad – but squarely placed the reasons for the collapse inside the country.

The SIC had a wide access to documents, also from the banks. The report lists loans to the largest shareholders and other major borrowers. This clarified who and how these people profited from the banks, listed companies they owned together with thousands of Icelandic shareholders.

The SIC’s thorough and well-documented saga may have focused the political energy on sensible action rather than wasting it on the blame game. Interestingly, this effect is no less relevant as time goes by. To my mind, the atmosphere both in Ireland and Greece, two countries with no documented overview of what happened and why, testifies to this.

In addition, the report diligently focuses on specific lessons to be learnt by the various institutions affected. Time will show how well the lessons were learnt but at least heads of some of these institutions took the time and effort, with their staff, to study the outcome.

A country rife with distrust and suspicion is not a good place to be and not a good place for business. Both these undertakings cleared the air in Iceland – immensely important for a recovery after such a shock, which though in its essence an economic shock is in reality a profound social shock as well.

I mentioned sound institutions above. Their effect is not easily measureable but certainly well functioning key institutions such as ministries, National Statistics and the CBI have all been important for the recovery.


In its April 2012 Ex Post Evaluation of Exceptional Access Under the 2008 Stand-by Arrangement the IMF came up with four key lessons from Iceland’s recovery:

(i) strong ownership of the program … (ii) the social impact can be eased in the face of fiscal consolidation following a severe crisis by cutting expenditures without compromising welfare benefits, while introducing a more progressive tax system and improving efficiency; (iii) bank restructuring approach allowing creditors to take upside gains but also bear part of the initial costs helped limit the absorption of private sector losses by public sector; and (iv) after all other policy options are exhausted, capital controls could be used on a temporary basis in crisis cases such as Iceland, where capital controls have helped prevent disorderly deleveraging and stabilize the economy.

The above understandably refers to the economic recovery but recovering from a shock like the Icelandic one – or as in Ireland, Greece and Cyprus – is not only about finding the best economic measures, though obviously important. It is also about understanding and coming to terms with what happened.

As mentioned above, I firmly believe that apart from classic measures regarding insolvent banks and debt, both sovereign and private, the need to clarify what happened, as was done by the SIC and to investigate alleged criminality, as done by the OSP, is of crucial importance – something that Ireland (with a late and rambling parliamentary investigation), Greece, Cyprus and Spain could ponder on. All of this in addition to sound institutions and sound public finances before a crisis.

The soul lagging behind

In the olden days it was said that by traveling as fast as one did in a horse-drawn carriage the soul, unable to travel as fast, lagged behind (and became prone to melancholia). Same with a nation’s mood following an economic depression: the soul lags behind. After growth returns and employment increases it takes time until the national mood moves into the good times shown by statistics.

Iceland is a case in point. Although the country returned to growth, with falling unemployment, in 2011 the debate was much focused on various measures to ease the pain of households and nothing seemed ever enough.

The Gallup Expectations monitor turned upwards in late 2009, after a steep fall from its peak in late 2007, and has been rising slowly since. Yet it is now only at the 2004 level; the Icelandic inclination to spending has been sig-sawing upwards. – Here two graphs, which indicate the mood:

Screenshot 2015-09-23 14.31.48

Screenshot 2015-09-23 14.34.23

With plan in place to lift capital controls, the last obvious sign of the 2008 collapse will be out of the way. Implementation will take some years; a steady and secure execution this coming winter will hopefully lift spirits in the business community.

Living intimately with forces of nature, volcanoes and migrating fish stocks, and now tourists, as fickle as the fish in the ocean, Icelanders have a certain sangue-froid in times of uncertainty. Actions by the three governments since the collapse have at times been rambling but on the whole they have sustained recovery.

A sign of the lagging soul is that growth has not brought back trust in politics. Politicians score low: the most popular party now enjoying ca. 35% in opinion polls, almost seven years after the collapse and four years since turning to growth, is the Pirate party, which has never been in government.

Recovery (probably) secured – but not the future

As pointed out in a recent OECD report on Iceland the prospect is good and progress made on many fronts, the latest being the plan to lift capital controls: “inflation has come down, external imbalances have narrowed, public debt is falling, full employment has been restored and fewer families are facing financial distress. “

However, the worrying aspect is that in addition to fisheries partly based on cheap foreign labour the new big sector, tourism, is the same. Notoriously low productivity – a chronic Icelandic ill – will not be improved by low-paid foreign labour. Well-educated and skilled Icelanders are moving abroad whereas foreigners moving to the country have fewer skills. Worryingly, there is little political focus on this.

As the OECD points out “unemployment amongst university graduates is rising, suggesting mismatch. As such, and despite the economic recovery, Iceland remains in transition away from a largely resource-dependent development model, but a new growth model that also draws on the strong human capital stock in Iceland has yet to emerge.”

Iceland does not have time to rest on its recovery laurels. Moving out of the shadow of the crisis the country is now faced with the old but familiar problems of navigating a tiny economy in the rough Atlantic Ocean.

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Corbyn’s European context and the challenge to turn popularity into power

After barely making it on to the ballot paper, Jeremy Corbyn beats even Tony Blair’s 1994 record and gathers 59.5% support for leadership. Anti-establishment parties have been sprouting in Europe but the fairly unique aspect of Corbyn’s success is his rise within an old and established party. Much is made of his (self-proclaimed) socialism. Yet, it is more likely that Corbyn gathered support not because he is a socialist but in spite of being one. Getting elected as a leader was the easy bit; leading will be the truly tricky part unless Corbyn proves to be a political virtuoso – and the European left will be watching.

For his opponents, it seems easiest to attack Jeremy Corbyn for being a socialist as the majority of voters are clearly without the slightest leaning in that direction. However, if personality matters as much as politics that tactic is bound to fail to scare voters away from him. To my mind, Corbyn was not voted for his socialism but in spite of it – in times of personality politics his ideas seem as much part of him as his beard compared to what I call patch-work politics stitched together from focus-group material and political advisers.*

Given the earlier success of Tony Blair and another charismatic politician Bill Clinton it became received wisdom that no political career could possibly be successful without their kind of flashy charisma. Also here, Corbyn disproves so far the accepted wisdom: he is serious at rallies and often grumpy in the media but what he says fits him like his beard.

Compared to recent political stars in Europe Corbyn is the only outsider in an old party to challenge the party elite and be voted as a leader. The last outsider achieving was Margret Thatcher elected as Tory leader in 1975. As Corbyn, she was not expected to last long. Famously, Thatcher and later Blair proved themselves to be eminent at capturing the nation’s mood. Briefly, Corbyn has done the same but a lasting success will only arise if he can use his popularity to create a Labour power base. The European left will be watching.

What matters is not left or right but the outsider-image

In times of slow growth and contraction, there has been no lack of new European parties of discontent and anger. The Italian Movimento Cinque Stelle, M5S rose on the fame of its leader Beppe Grillo, accountant and comedian, a year older than Corbyn. M5S has more or less imploded: Grillo was good at being angry in public but useless at organising a party machine.

The Greek Syriza, born on the old-style Greek left, shot to fame with its energetic leader Alexis Tsipras. Unable to fulfil his promises, he now fights an election and might be losing the surge that brought him to power in February. New political movements in Spain – the left Podemos, the activist “idignados” and Ciudadanos on the right – will no doubt influence the coming elections there. Again, unclear if these parties can turn popularity into power.

In the stable North long-simmering far-right anti-establishment sentiments have grown stronger in Finland, Sweden and Denmark. In Iceland, the Pirate party got 5% in the election in spring 2013, just enough to get into Parliament but has been scoring over 30% in polls since early this year.

Compared to once upon a time voters are now not only less wedded to one party but also travel back and forth between left and right. Considering the volatility of voters it seems to make more sense to see these new-comers as an expression of discontent with old parties rather than necessarily as a sign of swing to the left or right in the respective countries. It is more a question of who appeals strongest to the party-unfaithfuls and disillusioned at any given time.

This also seems to be the context for Corbyn – there is no indication that British voters are swinging to the left. After all, Ukip did well in last elections. Given the chance, voters turn against the political establishment and embrace something new.

The irony is that the new is now a 66 years old leftie backbencher, in Parliament since 1983, echoing the socialism of his youth, generally unknown to others than his Islington voters, whom he has served by mostly being in opposition to the Labour party leadership at any given time.

The lack of left response to 2008

The singular aspect of the Western crisis that surfaced in 2007 was the fact that it was created by banks and their, for the society at large, unhealthy and anti-social activities in the years up to 2007.

Strangely enough, Labour let itself be ensnared by the opposition’s narrative during the 2015 spring elections that it had mismanaged the economy during its years in power, 1997 to 2010. Fettered by this narrative Labour kept quiet about the fact that Labour and the Tories, united in its admiration for an apparently booming finance industry, shared the laissez-faire view of scaled-back regulation. During the boom, neither party worried about weak regulators and underfunded and little-loved Serious Fraud Office and Inland Revenue.

The underlying public anger surfaced in the Occupy movements and grass-root activities, largely ignored by the old and established parties both in Britain and elsewhere. In the 2010 elections Liberal democrats rose on the 2008 anger but were unable to turn that surge of popularity into lasting power.

Yet, political elites might well have found a convincing response to 2008. Politicians on the right could argue for the capitalism of creation. It is not necessarily in the capitalistic spirit to let a sector, that in theory should be serving and nurturing the economy, tie up so much capital in its own money spinning activities that went so disastrously wrong, causing calamity for the rest of society.

More surprisingly, European established left parties have mostly not responded to the crisis in any meaningful way and Labour is one of them. No leading Labour politicians seems i.a. interested in a coherent investigation of the UK banks’ activities before and after 2007. One reason why I notice the underlying anger it that hardly a week goes by without hearing someone mention the Icelandic example of investigating financial fraud related to the 2008 collapse.

This silent space has been Corbyn’s to occupy, rhetorically asking if teachers, nurses etc. caused the financial crisis and weaving into it his anti-austerity stance. Quite remarkably, seven years on from 2008 and with the economy growing again, this old anger and frustration is still a fertile ground as Corbyn has now discovered and demonstrated.

From a private election machine to a party machine

According to Corbyn, he had an army of sixteen thousand volunteers working for him. Quite something in an era of shrinking membership in established political parties. It is difficult to believe that this machine was put together in only three months – more likely, supportive trade unions provided him with all it took to build a smooth-running operation.

If Corbyn the Labour leader translates his success into convincing policies backed by the Labour party he and his party will unavoidably become a leading light on the European left as New Labour once was. However, his challenges are formidable. He must i.a. enthuse the Labour party machine as he did with his own private election machine.

Corbyn must also grapple with anchoring his messages into policies that gather support within in the party. A received wisdom in politics is that no one goes anywhere without a supportive media. Given that Corbyn uses every opportunity to kick the media, possibly perceiving it as part of the establishment and to strengthen his outsider-image, it will be interesting to see how he fares versus the media: if he will change course and court it or if he continues his adversarial angry attitude.

When new Labour rose to power in 1997 they did not only lead Britain but set the tone for the whole of the European left. New Labour is no longer new but old and stale and the top-trend post has been empty for a while. The most recent contender was Syriza. With popularity and power Tsipris shot to fame among the European left who flocked to Greece to meet Syriza’s leading lights. I.a. Italian prime minister Matteo Renzi avidly courted Tsipras but, as others, quickly seemed to realise there was little to fetch.

The European left, lately poor of success stories, will be following Corbyn closely though his anti-EU stance will make some Europeans wary. As seen in many European countries over the last few years, anger and frustration may gather popularity; but unless sustained by action and comprehensive policies it has little staying power and wanders on to the next eye-catching political promise-bidder.

*See my earlier blog on Corbyn and patch-work politicians.

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Greek politics and poisonous statistics – an on-going saga

Why the Troika and the EU member states find it so difficult to trust Greece

The word “trust” has been mentioned time and again in reports on the tortuous negotiations on Greece. One reason is the persistent deceit in reporting on debt and deficit statistics, including lying about an off market swap with Goldman Sachs: not a one-off deceit but a political interference through concerted action among several public institutions for more then ten years.

As late as in the July 12 Euro Summit statement “safeguarding of the full legal independence of ELSTAT” was stated as a required measure. Worryingly, Andreas Georgiou president of ELSTAT from 2010, the man who set the statistics straight, and some of his staff, have been hounded by political forces, also Syriza. Further, a Greek parliamentary investigation aims at showing that foreigners are to blame for the odious debt, which should not be paid while there is no effort to clarify a decade of falsifying statistics.

In Iceland there were also voices blaming its collapse on foreigners but the report of the Special Investigation Committee silenced these voices. – As long as powerful parts of the Greek political class are unwilling to admit to past failures it might prove difficult to solve its results: the excessive debt and deficit.

“This is all the fault of foreigners!” In Iceland, this was a common first reaction among some politicians and political forces following the collapse of the three largest Icelandic banks in October 2008. Allegedly, foreign powers were jealous or even scared of the success of the Icelandic banks abroad or aimed at taking over Icelandic energy sources. In April 2010 the publication of a report by the Special Investigation Committee, SIC, effectively silenced these voices. It documented that the causes were domestic: failed policies, lax financial supervision, fawning faith in the fast-growing banking system and thoroughly reckless, and at times criminal, banking.

As the crisis struck, Iceland’s public debt was about 30% of GDP and budget surplus. Though reluctant to seek assistance from the International Monetary Fund, IMF, the Icelandic government did so in the weeks following the collapse. An IMF crisis loan of $2.1bn eased the adjustment from boom to bust. Already by the summer of 2011 Iceland was back to growth and by August 2011 it completed the IMF programme, executed by a left government in power from early 2009 until spring 2013. Good implementation and Iceland’s ownership of the programme explains the success. For Ireland it was the same: it entered the crisis with strong public finances and ended a harsh Troika programme late 2013; its growth in 2014 was 4.8%.

For Greece it was a different story: high budget deficit and high public debt were chronic. From 1995 to 2014 it had an average budget deficit of -7%. Already in 1996, government debt was above 100% of GDP, hovering there until the debt started climbing worryingly in the period 2008 to 2009 – far from the prescribed Maastricht euro criteria of budget deficit not exceeding 3% and public debt no higher than 60% of GDP. Both Greek figures had however one striking exception: they dived miraculously low, below their less glorious averages in time for joining the euro. Yet, only the deficit number ever went below the required Maastricht criteria, which enabled Greece to join the euro in 2001.

Greece had an extra problem not found in Iceland, Ireland or any other crisis-hit EEA countries: in addition to dismal public finances for decades there is the even more horrifying saga of deliberate hiding and falsifying economic realities by misreporting Excessive Deficit Procedure, EDP and hide debt and deficit with off market swaps.*

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What Icelandic business practices can (possibly) tell us about China

Many controlling shareholders in China have pledged shares as collaterals for bank loans – this was a common practice in Iceland up to the October 2008 banking collapse. Now, this practice seems to be causing suspensions of trading in shares in China. If this is indeed a widespread Chinese practice the well-studied effects in Iceland provide a chilling lesson: when the steady rise of Icelandic share prices, both in banks and other companies stopped and prices fell this practice turned into a major calamity for the banks and companies involved. In hindsight, it was a sign of an incestuous and dysfunctional business environment. The Icelandic experience was well covered in the 2010 report by the Icelandic Special Investigation Committee, SIC, and provides food for thought for other countries where these practices surface.

One of the most stunning and shocking findings of the Icelandic SIC report was the widespread use of shares as collaterals for loans in all Icelandic banks, small and large but most notably the three largest ones – Kaupthing, Landsbanki and Glitnir.

It is necessary to distinguish between two types of lending against shares as practiced in Iceland: one is a bank funding purchase of its own shares, with only the shares as collaterals. The other type is taking other shares as collaterals.

These loans with shares as collaterals were mainly offered to the banks’ largest shareholders – in the big banks these were the main Icelandic business leaders – their partners and bank managers. In the smaller banks local business magnates who in many cases were partners to those Icelandic businessmen who operated abroad, as well as in Iceland. Thus, this practice defined a two tier banking system: with services like these to a small group of clients – that I have called the “favoured clients” – and then normal services for anyone else.

As a general banking model it would not make sense – the risk is far too great. But this lending mechanism and the ensuing stratospheric risks seem to have been entirely unobserved by not only the regulators in Iceland but also abroad where the Icelandic banks operated.

The SIC report, published 10 April 2010, explained in depth the effects of shares as collaterals: when share prices fell the banks could not make margin calls without aggravating the situation further. Consequently the banks lost their independent standing vis à vis their largest shareholders and clients – effectively, the banks and the business elite were tied to the same mast on the same ship and all would sink together in case the ship ran aground (as then happened).

Being familiar with the Icelandic pre-collapse situation it was with great interest that I read an article in the FT,* explaining what might be the reason behind the suspended trading in shares of almost 1500 Shanghai- and Shenzen-listed companies, mostly on the ChiNext stock exchange:

“Some analysts believe the suspensions are instead related to one of the scariest “known unknowns” surrounding the market meltdown — just how many controlling shareholders have pledged their shares as collateral for bank loans.”

If this is indeed the case the Icelandic experience indicates a truly scary outlook and dysfunctional Chinese banking. There might be further troubles ahead.

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Greece and Iceland, controls and controls

Now that Greece has controls on outtake from banks, capital controls, many commentators are comparing Greece to Iceland. There is little to compare regarding the nature of capital controls in these two countries. The controls are different in every respect except in the name. Iceland had, what I would call, real capital controls – Greece has control on outtake from banks. With the names changed, the difference is clear.

Iceland – capital controls

The controls in Iceland stem from the fact that with its own currency and a huge inflow of foreign funds seeking the high interest rates in Iceland in the years up to the collapse in October 2008, Iceland enjoyed – and then suffered – the consequences, as had emerging markets in Asia in the 1980s and 1990s.

Enjoyed, because these inflows kept the value of the króna, ISK, very high and the whole of the 300.000 inhabitants lived for a few years with a very high-valued króna, creating the illusion that the country was better off then it really was. After all, this was a sort of windfall, not a sustainable gain or growth in anything except these fickle inflows.

Suffered, because when uncertainty hit the flows predictably flowed out and Iceland’s foreign currency reserve suffered. As did the whole of the country, very dependent on imports, as the rate of the ISK fell rapidly.

During the boom, Icelandic regulators were unable and to some degree unwilling to rein in the insane foreign expansion of the Icelandic banks. On the whole, there was little understanding of the danger and challenge to financial stability that was gathering. It was as if the Asia crisis had never happened.

As the banks fell October 6-9 2008, these inflows amounted to ISK625bn, now $4.6bn, or 44% of GDP – these were the circumstances when the controls were put on in Iceland due to lack of foreign currency for all these foreign-owned ISK. The controls were put on November 29 2008, after Iceland had entered an IMF programme, supported by an IMF loan of $2.1bn. (Ironically, Poul Thomsen who successfully oversaw the Icelandic programme is now much maligned for overseeing the Greek IMF programme – but then, Iceland is not Greece and vice versa.)

With time, these foreign-owned ISK has dwindled, is now at 15% of GDP but another pool of foreign-owned ISK has come into being in the estates of the failed bank, amounting to ca. ISK500bn, $3.7bn, or 25% of GDP.

In early June this year, the government announced a plan to lift capital controls – it will take some years, partly depending on how well this plan will be executed (see more here, toungue-in-cheek and, more seriously, here).

Greece – bank-outtake controls

The European Central Bank, ECB, has kept Greek banks liquid over the past many months with its Emergency Liquid Assistance, ELA. With the Greek government’s decision to buy time with a referendum on the Troika programme and the ensuing uncertainty this assistance is now severely tested. The logical (and long-expected) step to stem the outflows from banks is limit funds taken out of the banks.

This means that the Greek controls are only on outtake from banks. The Greek controls, as the Cypriot, earlier, have nothing to do with the value or convertibility of the euro in Greece. The value of the Greek euro is the same as the euro in all other countries. All speculation to the contrary seems to be entirely based on either wishful thinking or misunderstanding of the controls.

However, it seems that ELA is hovering close to its limits. If correct that Greek ELA-suitable collaterals are €95bn and the ELA is already hovering around €90bn the situation, also in respect, is precarious.

How quickly to lift – depends on type of controls

The Icelandic type of capital controls is typically difficult to lift because either the country has to make an exorbitant amount of foreign currency, not likely, a write-down on the foreign-owned ISK or binding outflows over a certain time. The Icelandic plan makes use of the two latter options.

Lifting controls on outtake from banks takes less time, as shown in Cyprus, because the lifting then depends on stabilising the banks and to a certain degree the trust in the banks.

This certainly is a severe problem in Greece where the banks are only kept alive with ELA – funding coming from a source outside of Greece. This source, ECB, is clearly unwilling to play a political role; it will want to focus on its role of maintaining financial stability in the Eurozone. (I very much understand the June 26 press release from the ECB as a declaration that it will stick with the Greek banks as long as it possibly can; ECB is not only a fair-weather friend…)

Without the IMF it would have been difficult for Iceland to gather trust abroad in its crisis actions – but Greece is not only dependent on the Eurozone for trust but on the ECB for liquidity. Without ELA there are no functioning Greek banks. If the measures to stabilise the banks are to be successful the controls are only the first step.

*Together with professor Þórólfur Matthíasson I have earlier written on what Icelandic lessons could be used to deal with the Greek banks. – Cross-posted at

Austrian banks and FX lending: tip-toeing authorities and households as carry traders (part 1)

Austria was one of the eleven founding members of the Eurozone in January 1999 but the Austrians never quite put their money where their mouth was: Austria is the only euro country where households flocked to take out foreign currency loans. About three quarters of these loans are coupled with repayment vehicles. Unfortunately, the Austrian authorities have known for more than a decade that the repayment vehicles add risk to the already risky FX loans: the crunch time for domestic foreign currency loans will be in 2019 and later when 80% of these loans mature. – This is the saga of authorities that knew full well of the risks and yet allowed the banks to turn households into carry traders.

Foreign currency loans are “… not suitable as a mass market product” – This was the lesson that the Austrian Finance Market Authority, FMA, had already in 2008 drawn from the extensive foreign currency, FX, lending to Austrian households; only in 2013 did the FMA state it so clearly. Long before these risky loans shot up by 10-15%, following the dramatic Swiss decap from the euro in January 2015, the risks were clear to the authorities.

From 1995, Austrian banks had turned a finance product, intended only for specialised investments, into an everyman mass-market product. Contrary to other founding euro countries, the euro did not dampen the popularity of the FX loans, mostly in Swiss francs, CHF. Austrian banks expanded into the neighbouring emerging markets, offering the same product there. Consequently, Austrian banks have turned households at home and abroad into carry traders.

From the beginning, the FMA and later also the Austrian Central Bank, ÖNB had been warning the fast-growing financial sector, with kind words and kid-gloves, against FX loans to unhedged households. The warnings were ignored: the banks raked in fees, FX lending kept rising until it topped (on unadjusted basis) in 2010, not in 2008 when the FMA claimed it banned FX lending.

FX loans in Austria are declining: in 2008 270.000 households had FX loans, 150.000 in March 2015. In February 2015 the FX loans to households amounted to €26bn, ca 18% of household loans. With maturity period of ten to 25 years serious legacy issues remain.

Further, three quarters of these loans, ca. €19.5bn, are coupled with repayment vehicle, sold as a safety guarantee to pay up the loans at maturity. Ironically, they now risk doing just the opposite: according to FMA the shortfall by the end of 2012 (the latest available figure) stood at €5.3bn. An FMA 2013 regulation to diminish this risk will only be tested when the attached FX loans mature: 80% of them are set to mature in or after 2019.

Added to the double risk of the domestic FX loans and the repayment vehicles are FX loans issued by small and medium-sized Austrian banks in the Central European and South-Eastern European, CESEE (the topic of the next article in this series). All this risk is susceptible to multiple shocks, as the IMF underlined as late as January 2014: “Exchange rate volatility (e.g., CHF) or asset price declines associated to repayment vehicles loans (RPVs) could increase credit risk due to the legacy of banks’ FCLs to Austrian households.”

Consequently, as stated by the ÖNB in April this year, seven years after the 2008 crisis FX loans “continue to constitute a risk for households and for the stability of the Austrian financial system” – a risk well and clear in sight since Austria became one of the founding euro countries in 1999. There are still significant challenges ahead for Austrian Banks. Nonperforming loans are rising – Austrian banks are above the European average, very much due to Austrian banks’ operations in CESEE.

Add to all of this the Hypo Alpe Adria scandals and the Corinthia guarantees and the Austrian hills not alive with the sound of music but groaning with well-founded worries, to a great extent because Austrian authorities did not react on their early fears but allowed banks to continue the risky project of turning households into carry traders – yet another lesson that soft-touch regulation does work well for banks but not for society.

Kid-gloves against a mighty and powerful banking (and insurance) sector

There are over 800 banks in Austria, but the three largest, Erste, Raiffaisen and UniCredit Bank Austria, “account for almost half of total bank assets” according to the IMF, which in 2013 pointed out that the financial system, “dominated by a large banking sector,” faces “significant structural challenges, especially the smaller banks.”

Six Austrian banks, three of which are Raiffeisenbanks in different parts of Austria, were included in the ECB Asset Quality Review in October 2014. As expected, the Österreichische Volksbank, partially nationalised, did not pass but the others did. However, the Austrian banks require an additional loan provisioning of €3bn.

The size of the banking sector as a ratio of GDP has been rising, at 350% by mid 2014. The expansion of small Austrian banks in CESEE, where non-covered non-performing loans in these banks’ operations are high, is a serious worry. As is the sector’s low profitability, seen as a long-term structural risk, as is a domestic market dominated by a few big banks and large CESEE exposures.

Theoretically, unhedged borrowers alone bear the risk of FX loans but in reality the risk can eventually burden the banks if the loans turn into non-performing loans en masse, which make these loans significant in terms of financial stability as the IMF has been warning about for years.

Intriguingly, already in 2013 the IMF pointed out that Austria needed to put in place a special bank resolution scheme and should not await the formal adoption of the EU Directive on bank recovery and resolution. It should also pre-empt the coming EU Deposit Guarantee Scheme Directive and the Basel Committee on Banking Supervision (BCBS) Core Principles for Effective Deposit Insurance Schemes as minimum standards. However, the progress in this direction has been slow.

Austrian FX loans: from a specialised product to everyman mortgage

In the mid 1990s Austrian households cultivated an appetite for FX loans, unknowing that they were indeed turning into carry traders without the necessary sophistication and knowledge. The trend started in the 1980s in Vorarlberg, the Bundesland in Western Austria where many commute for work to neighbouring Switzerland and Liechtenstein.

At the end of the 1980s 5% of household loans in Vorarlberg were in FX, compared to the Austrian average of 0.2%. From 1995 there was a veritable Austrian boom in FX lending, with borrowers preferring the CHF, and to a lesser degree, the Japanese yen, to the Austrian Schilling. This trend only got stronger as the interest rate differential between these currencies and the Schilling widened.

Quite remarkably, the introduction of the euro January 1 1999 did not dampen the surge: the Austrians kept their faith to the currency of their Swiss neighbours. At the end of 1995 FX loans to individuals amounted to 1.5% of total lending; in 2000 this had risen to 20%. The popularity of the FX loans was clear: in December 2000 82% of household loans issued that month were in FX. Even though the CHF appreciated by over 6% in 2000 it did not affect the popularity of the FX loans. The FX selling machine was well-oiled.

Since household debt in Austria was fairly low, Austria being among the lower middle group of countries as to the debt-to-equity ratio, the ÖNB was relatively relaxed about these changes – but not quite: already in its first Financial Stability report, published in 2001, it underlined the risk of FX lending and borrowing.

FX loans issuance to Austrian households continued to increase. In 2004, 12% of households reported a mortgage in FX. The trend topped in 2006, after which the demand fell. By the end of 2007 the FX loans, measured in euro, amounted to €32bn, i.e. almost 30% of the volume of loans issued. Here it is interesting to keep in mind that with the exception of few months annual growth rates of FX loans to households have always exceeded the growth of household loans in the domestic currency, until late 2006.

FX loans in Austria are declining: 2008 270.000 households had FX loans, 150.000 in March 2015 but the size of the problem is by no means trivial: in December 2014 “18.9% of the total volume of loans extended to Austrian households was still denominated in foreign currency;” in February 2015 the FX loans to households amounted to €26bn.

There are also indications that because the FX loans seemed cheaper than the euro loans households tended to borrow more. The ÖBN has pointed out that the growth in household borrowing in 2003 to 2004 “can to a large part be attributed to foreign currency loans.” As I have mentioned earlier, the fact that FX loans seem cheaper than loans in the domestic currency, lends them the characteristics of sub-prime lending, i.e. leads to households borrowing more than sensible, thus yet fuelling the FX risk.

This FX lending boom did not only signify borrowers’ taste for carry trade but also that financial products, earlier only on offer for large-scale investments had now become an everyman product, as was ominously pointed out in the first ÖBN Financial Stability report 2001.

Why did (only) Austrians turn into a nation of carry traders?

Nowhere in Europe were FX loans to households as popular as in Austria, as the ÖBN noted in its first Financial Stability report in 2001. At the introduction of the euro, FX loans had been popular in various European countries. Around 2000 Austria stood out but so did Germany where FX loans were being issued at the same rate as in Austria. But only in Austria did the trend continue.

The question is why Austrian households favoured FX over euro loans.

A study in the December 2008 Financial Stability report sketched a profile of Austrian household borrowers, based on an Austrian 2004 wealth survey of 2556 households. The outcome suggested “that risk-loving, high-income, and married households are more likely to take out a housing loan in a foreign currency than other households. Housing loans as such are, moreover, most likely taken out by high-income households. These findings may partially assuage policy concerns about household default risk on foreign currency housing loans.” – This profile only tells who was most likely to choose FX loans over domestic loans, not why this group in Austria differed from the same social groups in the other euro countries.

As I have explained earlier, FX loans often characterise emerging markets, as in the CESEE, where Austrian banks have indeed promoted them, or in Asia in the 1980s and the 1990s. FX tend to gain ground in newly liberalised markets, as in Australia in the 1980s. Then there is Iceland where the banks, fully privatised in 2003, expanding and borrowing abroad, hedged themselves by issuing FX loans, also to households.

FX loans are often an indication of instability where people try to bypass a fickle domestic currency, the apparition of bad policies and feeble politicians. In addition, there are interest rate margin, which may look tempting, if one ignores the fact that currencies rarely have a stable period of more than a few years, making them risky as an index for mortgages, normally runnig for ten to twenty years or more.

None of this is particularly fitting for Austria or any more fitting for Austria than the other mature European economies.

As always when FX loans turn into a problem, the banks blame the borrowers for demanding these highly risky products. If this were the case it could only happen because banks do not fulfil their duty of care, of fully informing the clients of the risks involved. As an Australian banker summed up the lessons of the Australian FX lending spree in the 1980s: “…nobody in their right mind, if they had done a proper analysis of what could happen, would have gone ahead with it (i.e. FX loans).”

According the ÖNB’s December 2008 Financial Stability report banks did claim there was so much demand for these loans that in order to be competitive they had to issue FX loans. But Peter Kolba from the Austrian Consumers Association, Verein für Konsumentinformation, VKI, disagrees that the demand came from the customers: in an information video he claims the loans were very much peddled by the banks, which reaped high fees from these loans.

It is indeed interesting that from 1995 to 2000 Austrian banks experienced a veritable fee surge of 75%, part of which the ÖNB attributed to the increase in FX lending. For the banks there was an extra sugar coating on the increased FX lending profits: “the interest rate and exchange rate risks are borne largely by the borrowers. However, the risk of default by debtors has increased the risk potential of such operations” – the possibility of a default did of course expose the banks to a growing FX risk.

There is one aspect of the Austrian FX lending, which seems to have greatly underpinned their popularity: the loans were widely sold by agents, paid directly for each loan, thus with no incentive to inform clients faithfully about the risk. In addition, the same agents often sold the repayment vehicles, thus reaping profits twice from the same customer.

As summed up by ÖNB’s spokesman Christian Gutlederer (in an e-mail to me) there were specific Austrian structural weaknesses: “Presumably, the interplay of the role of financial service providers, extensive media coverage and rational herding behaviour would offer the most plausible explanation for the popularity of such products in Austria. Tax incentives provided one additional layer: payments of life insurance premiums (the most important kind of repayment vehicle loans) and, in some cases, interest payments for mortgages can be deducted from the tax base.”

The above caused an Austrian FX loans surge, contrary to other euro countries. In addition, the fact that the authorities were so timid in clamping down on the risky behaviour of the banks is worth keeping in mind: the lesson for policy makers is to act decisively on their fears.

Lessons of domestic FX loans: “not suitable as mass product”

Being so aware of the risk the ÖNB and the FMA, have over the years taken various measures to mitigate the risk stemming from the FX lending, though timidly for the first many years.

Already in 2003 the FMA issued a set of so-called “Minimum Standards” in FX lending to households but this did little to dampen rise in FX loans to Austrian households. In 2006, the FMA and the ÖNB jointly published a brochure for those considering FX loans, warning of the risk involved. At the time, businesses were less inclined to take out FX loans: whether the brochure or something else, there was a decline in FX loans 2006 but only temporary.

Andreas Ittner, ÖBN’s Director of Financial Institutions and Markets worried at the time that “private borrowers in particular are unaware of all of the risks and consequences.” FMA Executive Director Kurt Pribil found it particularly worrying that “people seem to be unaware of the cumulative risks involved and of the implications this might have, especially if you consider the length of the financing.”

Though contradicted by the rise in FX lending to households, the two officials emphasised that restrictions put in place in 2003 were working. There was though a clear unease at the state of affairs: “At the end of the day, any foreign currency loan is nothing more than currency speculation.”

On October 10 2008, during turbulent times on the financial markets, the FMA “strongly recommended” that banks to stop issuing FX loans to households. The FMA has since repeatedly claimed FX loans were “banned” in 2008 but that was not the wording used at the time. Funnily enough there is no press release in the ÖBN web archive from this date related to the October restrictions. In its 2014 Annual Report it talks of the autumn 2008 measures “de facto ban” on issuance of new FX loans to households.

According to the IMF, in 2013, the measures “introduced in late 2008 to better monitor and contain FC liquidity risks, by encouraging banks to diversify FC funding sources across counterparties and instruments, and lengthen FC funding tenors.”– There was no ban, not even a “de facto ban.”

FMA’s 2003 “Minimum Standards” for FX lending were revised in 2010. By then, the FMA and the ÖNB had been warning about the FX loans for a decade or longer. In spite of the “non-ban” 2008 measures, it was only in 2010 that Austrian banks “made a commitment to stop extending foreign currency loans associated with high levels of risk, in line with supervisory guidance provided to this effect (“guiding principles”).” In January 2013 the FMA issued revised the “Minimum Standards,” also taking into account recommendations by the European Systemic Risk Board, ESRB.

All of these warnings are in tip-toeing and kid-glove central bank and regulator speak: there is no doubt that behind these Delphic utterances there were real concern. All along, Austrian authorities have underlined that these standards were not rules and regulations, more a kind advice to the banks to act more sensibly.

The IMF has over the years voiced concern in a much stronger tone and language than the Austrian authorities. As late as January 2014 the IMF underlined the possibility of multiple shock: “Exchange rate volatility (e.g., CHF) or asset price declines associated to repayment vehicles loans (RPVs) could increase credit risk due to the legacy of banks’ FCLs to Austrian households.”

It was not until 2013, five years after the crisis hit and, counting from 2000 when the FX lending had soared, numerous currency fluctuations later that the FMA finally had a clearly worded lesson for the banks and their household FX borrowers: “foreign currency loans to private consumers are not suitable as a mass product…”

Another dimension of FX lending risks: other shocks accompany exchange volatility

In the FMA’s latest regular FX lending overview, from December 2014 it points out that following initiatives to limit the risk on outstanding FX loans, as well as what it there (as elsewhere) calls ban in 2008 on new loans, the volume of borrowings has been falling: outstanding FX loans to private individuals, as a share of all outstanding loans end of September 20014 is now at 19.1%; 95% of these loans are denominated in CHF, the rest mostly in Japanese yen.

Correctly stated, the FX lending is declining but the devilish nature of FX loans is that the principal is affected by chancing rates of the currency the loans are linked to. The number of loans issued may have been declining – the ÖNB points out FX loans to Austrian borrowers have indeed been declining since autumn 2008 but the real decline in the FX lending has been “offset by the appreciation of the Swiss franc.” As seen from ÖNB data the loans did indeed not top until 2010 (see Table A11).

The ceiling set by the Swiss National Bank, SNB, in late summer 2011 helped stabilise the exchange rate – but this stability ended spectacularly in January this year.

What further adds to the risk of FX lending is that it is easy to envisage a situation where banks and borrowers are not hit only by a single shock wave stemming from currency fluctuations but by other simultaneous shocks, such as a slump in asset prices; again something that the ÖNB has underlined, i.a. as early as in the bank’s Financial Stability report April 2003.

If several private borrowers would become insolvent due to rising exchange rates, “the simultaneous and complete realization of the above-mentioned collateral would considerably dampen the price to be achieved.” Thus, banks with a high percentage of foreign currency loans incur a concentration risk, which would endanger financial stability in the region, if the collaterals needed to be sold. It is an extra risk that the banks with the highest share of FX lending were small and medium-sized regional banks in Western Austria; in some cases up to 50% of total assets were FX loans.

Repayment vehicles = no guarantee but an even greater risk

The fact that the majority of Austrian domestic FX loans comes with a repayment vehicle has often been cited as a safety net for FX borrowers and consequently for the banks. This is however a false safety and both the ÖNB and the FMA, as well as foreign observers such as the IMF have, again for a long time, understood this risk.

In order to gauge the risk it is necessary to understand the structure of the FX loans: almost 80% of the FX loans are balloon loans, i.e. the full principal is repaid on maturity: interest rates, according to the LIBOR of the currency and repriced every three months, are paid monthly. The FX loans can normally be switched to euro (or any other currency) but at a fee; another aspect in favour of the bank is a forced conversion clause, allowing the bank to convert the loan into a euro loan without the borrower’s consent.

The repayment vehicle is usually a life insurance contract or an investment in mutual fund, paid into the scheme in monthly instalments. The majority of those who have taken out the FX loans coupled with repayment vehicle have done so via an agent, clearly an added risk as mentioned above.

Consequently, for borrowers there is a twofold risk attached to FX loans with repayment vehicle: firstly, there is the currency risk related to the loans themselves; second there is the real risk of a shortfall in the repayment vehicle, clearly born out by the volatility in 2008. As pointed out in the ÖNB’s Financial Stability October 2008 report  the repayment vehicles “in addition to other risks, are exposed to exchange rate risk.”

The ÖNB had however been aware of the repayment vehicle risk much earlier than 2008. Already in its Financial Stability October 2002 report, the risk was spelled out very clearly: the repayment vehicles “usually do not serve to hedge against exchange rate or interest rate risk; rather, they add risk to the entire borrowing scheme.”

If the repayment vehicle does not perform well enough to cover the principal of the FX loan one may try to switch to other investments but at a cost. “If the performance of these repayment vehicles cannot keep up with the assumptions used in the provider’s model calculations, the borrower, who is already exposed to high exchange rate and interest rate risk, becomes exposed to even greater risk.”

In short: on maturity, there is high risk that the repayment investment will not cover the loan, i.e. the alleged safety net has a hole in it. In the present environment of low interest rates it is a struggle to avoid this gap.

Following a 2011 survey there was already a growing shortfall in sight, according to an FMA statement in March 2012. At the time, FX loans with repayment vehicle amounted to €28.6bn. By the end of 2008 the shortfall had been €4.5bn, or 14% of the loan volume. End of 2011 the shortfall in cover amounted to ca. €5.3bn, at the time 18% of the outstanding loans; the increase between 2011 and 2012 had been €800m, an increase in the shortfall by 22%.

In 2013 the FMA put in place regulation, which obliges the insurance companies to create provisions from their own profits should these repayment vehicles fail. This will however only be tested when the attached FX loans mature: 80% of them are set to mature in or after 2019; a “significant redemption risks to Austrian banks” according to the ÖNB in December 2014.

The ÖNB and the FMA are indeed paying extra attention to the interplay between FX loans and the repayment vehicles: the two authorities are conducting a survey in the first quarter of 2015 to uncover the risks posed by these two risk factors, the FX loans and the repayment vehicles. Somewhat wearily, the ÖNB points out that the two authorities have been warning against these loans for more than ten years. Though reined in and declining FX loans still “continue to constitute a risk for households and for the stability of the Austrian financial system.”

Austrian consumer action in sight

Following the Swiss decap in January the Austrian Consumer Association, VKI, has taken action to inform FX borrowers on their options.

The Austrian FX loan agreements normally have a “stop-loss” clause, seemingly a protection for the borrower to limit sudden losses because of currency appreciation. Sadly, following the Swiss decap in January many FX borrowers have discovered that this clause did not limit their losses. These clauses have been the cause of many queries made at the VKI. The FMA, claiming it can not act on this, has advised borrowers to bring the matter to the attention of the banks, but gave the end of February 2015 as a deadline; a remarkably short time.

VKI is also advising FX borrowers to try to negotiate with the banks regarding coast of converting CHF into euro loans or loss incurred from the FX loans compared to euro loan, arguing that these costs should not be carried by the borrowers alone but shared with the bank.

As elsewhere, the Austrian banks have taken fees for administering the FX loans, typically 1 to 2%, as if they had incurred costs by going into the market to buy CHF in connection to the FX loans. However, as elsewhere, the Austrian loans are CHF indexed, not actual lending in FX. In the Árpad Kásler case the European Court of Justice, ECJ, ruled that this cost was illegal since there were no actual services carried out. Consequently, this might be of help to Austrian FX borrowers; also that part of the ruling, which obliges banks to inform clients properly.

If these actions take off this could mean a considerable hit for the banks. After all, 150.000 households have FX loans of €25bn in total, not a trivial sum.

Given the fact that so many of these loans and the repayment vehicles were sold through agents their responsibility for informing clients has to be tested at some point: it is inconceivable that important intermediaries between banks and their clients bear no responsibility at all for the products they arrange to be sold.

As in other countries, Austrian FX borrowers have already been heading for the courts. So far, the cases are few but have at least in some cases been positive for the borrowers.

The question is whether Austrian politicians will be firmly on the side of the banks or if they will come to the aid of FX borrowers. But there really is good reason for political attention, given that the problem certainly is still lingering. It should also be of political concern that the ÖNB and the FMA chose to treat banks with kid-gloves lightly – though full well knowing that the products being sold to consumers were highly explosive and hugely risky both to the borrowers and the country.

* This is the second article in a series on FX lending in Europe: the unobserved threat to FX unhedged borrowers – and European banks.The next article will be on Austrian banks and FX lending abroad. The series is cross-posted on Icelog.

This time, no different from earlier: FX risk hidden from borrowers

The Swiss Franc unpegging from the euro 15 January this year brought the risk of foreign currency borrowing for unhedged borrowers yet again to the fore. In Central, Eastern and South-Eastern Europe lending in Swiss Franc and other foreign currency, most notably in euros, has been common since the early 2000s, often amounting to more than half of loans issued to households. The 2008 crisis put some damper on this lending, did not stop it though and in addition legacy issues remain. Now, actions by foreign currency borrowers in various countries are also unveiling a less glorious aspect: mis-selling and breach of European Directives on consumer protection. Senior bankers involved in foreign currency lending invariably claim that banks could not possibly foresee FX fluctuation. Yet, all of this has happened earlier in different parts of the world, most notably in Australia in the 1980s.

“The 2008-09 financial crisis has highlighted the problems associated with currency mismatches in the balance sheets of emerging market borrowers, particularly in Emerging Europe,” economists at the European Bank of Reconstruction and Development, EBRD, Jeromin Zettelmeyer, Piroska Nagy and Stephen Jeffrey wrote in the summer of 2009.*

In the grand scheme of Western and Northern European countries this mismatch was a little-noticed side-effect of the 2008 crisis. But at the EBRD, focused on Central, Eastern, South East European, CESEE, countries, its chief economist Erik Berglöf and his colleagues worried since foreign currency, FX, lending was common in this part of Europe. FX lending per se was not the problem but the fact that these loans were to a great extent issued to unhedged borrowers, i.e. borrowers who have neither assets nor income in FX. This lending was also partly the focus of the Vienna Initiative, launched in January 2009 by the EBRD, European and international organisations and banks to help resolve problems arising from CESEE countries mainly being served by foreign banks.

In Iceland FX lending took off from 2003 following the privatisation of the banks: with the banks growing far beyond the funding capacity of Icelandic depositors, foreign funding poured in to finance the banks’ expansion abroad. Icelandic interest rates were high and the rates of euro, Swiss Franc, CHF and yen attractive. Less so in October 2008 when the banks had collapsed: at the end of October 2007 1 euro stood at ISK85, a year later at ISK150 and by October 2009 at ISK185.

After Icelandic borrowers sued one of the banks, the Supreme Court ruled in a 2010 judgement that FX loans were indeed legal but not FX indexed loans, which most of household loans were. It took further time and several judgements to determine the course of action: household loans were recalculated in ISK at the very favourable foreign interest rates. Court cases are still on-going, now to test FX lending against European directives on consumer-protection.

In all these stories of FX loans turning into a millstone around the neck of borrowers in various European countries senior bankers invariably say the same thing: “we couldn’t possibly foresee the currency fluctuations!” In a narrow sense this is true: it is not easy to foresee when exactly a currency fluctuation will happen. Yet, these fluctuation are frequent; consequently, if a loan has a maturity of more than just a few years it is as sure as the earth revolving around the sun that a fluctuation of ca. 20%, often considerably more, will happen.

Interestingly, many of the banks issuing FX loans in emerging Europe did indeed make provisions for the risk, only not on behalf of their clients. According to economist at the Swiss National Bank, SNB, Pinar Yesin banks in Europe have continuously held more foreign-currency-denominated assets than liabilities, indicating their awareness of the exchange-rate-induced credit risk they face.”

Indeed, many of the banks lending to unhedged borrowers took measures to hedge themselves. Understandably so since it has all happened before. Recent stories of FX lending misery in various European countries are nothing but a rerun of what happened in many countries all over the world in earlier decades: i.a., events in Australia in the 1980s are like a blueprint of the European events. In Australia leaked documents unveiled that senior bankers knew full well of the risk to unhedged borrowers but they kept it to themselves.

It can also be argued that given certain conditions FX lending led to systematic lending to CESEE clients borrowing more than they would have coped with in domestic currency making FX lending a type of sub-prime lending. What now seems clear is that cases of mis-selling, unclear fees and insufficient documentation now seem to be emerging, albeit slowly, in European FX lending to unhedged borrowers.

FX lending in CESEE: to what extent and why

A striking snapshot of lending in Emerging Europe is that “local currency finance comes second,” with the exception of the Czech Republic and Poland, as Piroska Nagy pointed out in October 2010, referring to EBRD research. With under-developed financial markets in these countries banking systems there are largely dominated by foreign banks or subsidiaries of foreign banks.

This also means, as Nagy underlined, that there is an urgent need to reduce “systemic risks associated with FX lending to unhedged borrowers” as this would remove key vulnerabilities and “enhance monetary policy effectiveness.”

Although action has been taken in some of the European countries hit by FX lending, “legacy” issues remain, i.e. problems stemming from prolific FX lending in the years up to 2008 and even later. In short, FX lending is still a problem to many households and a threat to European banks, in addition to non-performing loans, i.e. loans in arrears, arising from unhedged FX lending.

The most striking mismatch in terms of banks’ behaviour is evident in the operations of the Austrian banks that have been lending in FX at home in Austria the euro country, but also abroad in the neighbouring CESEE countries. In Austria, FX loans were available to wealthy individuals who mostly hedged their FX balloon loans (i.e. a type of “interest only” loans) with insurance of some sort. Abroad however, “these loans in most cases had not been granted mostly to relatively high income households,” as somewhat euphemistically stated in the Financial Stability report by the Austrian Central Bank, OeNB in 2009.

There is plenty of anecdotal evidence to conclude that during the boom years banks were pushing FX loans to borrowers, rather than the other way around. Thus, it can be concluded that the FX lending in CESEE countries was a form of sub-prime lending, that is people who did not meet the requirements for borrowing in the domestic currency could borrow, or borrow more, in FX. This would then also explain why FX loans to unhedged borrowers did become such a major problem in these countries.

Where these loans have become a political issue FX borrowers have often been met with allegations of greed; that they were trying to gain by gambling on the FX market. In 2010 Martin Brown, economist at the SNB and two other economists published a study on “Foreign Currency Loans – Demand or Supply Driven?” They attempted to answer the question by studying loans to Bulgarian companies 2003-2007. What they discovered was i.a. that for 32% of the FX business loans issued in their sample the companies had indeed asked for local currency loan.

“Our analysis suggests that the bank lends in foreign currency, not only to less risky firms, but also when the firm requests a long-term loan and when the bank itself has more funding in euro. These results imply that foreign currency borrowing in Eastern Europe is not only driven by borrowers who try to benefit from lower interest rates but also by banks hesitant to lend long-term in local currency and eager to match the currency structure of their assets and liabilities.”

In other words, the banks had more funding in euro than in the local currency and consequently, by lending in FX (here, euro), the banks were hedging themselves in addition to distancing themselves from instable domestic conditions. A further support for this theory is FX lending in Iceland, which took off when the banks started to seek funding on international markets. (The effect on banks’ FX funding is not uncontested: further on reasons for FX lending in Europe see EBRD’s “Transition Report” 2010, Ch. 3, esp. Box 3.2.)

The Australian lesson: with clear information “…nobody in their right mind… would have gone ahead with it”

Financial deregulation began in Australia in the early 1970s. Against that background, the Australian dollar was floated in December 1983. In the years up to 1985 banks in Australia had been lending in FX, often to farmers who previously had little recourse to bank credit. However, the Australian dollar started falling in early 1985; from end of 1984 to the lowest point in July 1986 the trade-weighted index depreciated by more then a third. Consequently, the FX loans became too heavy a burden for many of the burrowers, with the usual ensuing misery: bankruptcy, loss of homes, breaking up of marriages and, in the most tragic cases, suicide.

The Australian bankers shrugged their shoulders; it had all been unforeseeable. FX borrowers who tried suing the banks lost miserably in court, unable to prove that bankers had told them the currency fluctuations would never be that severe and if it did the bank would intervene. As one judge put it: “A foreign borrowing is not itself dangerous merely because opportunities for profit, or loss, may exist.” The prevailing understanding in the justice system was that those borrowing in FX had willingly taken on a gamble where some lose, some win.  

But gambling turned out to be a mistaken parallel: a gambler knows he is gambling; the FX borrowers did not know they were involved in FX gambling. The borrowers got organised, by 1989 they had formed the Foreign Currency Borrowers Association and assisted in suing the banks. The tide finally turned in favour of the borrowers and against the banks; the courts realised that unlike gamblers the borrowers had been wholly unaware of the risk because the banks had not done their duty in properly informing the FX borrowers of the risk. But by this time FX borrowers had already been suffering pain and misery for four to five years.

What changed the situation were internal documents, two letters, tabled on the first day of a case against one of the banks, Westpac. The letters, provided by a Westpac whistle-blower, John McLennan, showed that when the loan in question was issued in March 1985 the Westpac management was already well aware of the risk but said nothing to clients. Staff dealing with clients was often ignorant of the risks and did not fully understand the products they were welling. When it transpired who had provided the documents Westpac sued McLennan – a classic example of harassment whistle-blowers almost invariably suffer – but later settled with McLennan.

As a former senior manager summed it up in 1991: “Let us face it – nobody in their right mind, if they had done a proper analysis of what could happen, would have gone ahead with it.” (See here for an overview of some Australian court cases regarding FX loans).

FX borrowers of all lands, unify!

“Probably like a lot of other people (.) I felt that the banks knew what they were doing, and you know, that they could be trusted in giving you the right advice,” is how one Westpac borrower summed it up in a 1989 documentary on the Australian FX lending saga.

This misplaced trust in banks delayed action against the banks in Australia in the 1980s and in all similar sagas. However, at some point bank clients realise the banks take their care of duty towards clients lightly but are better at safeguarding own interests. As in Australia, the most effective way is setting up an association to fight the banks in a more targeted cost-efficient way.

This has now happened in many European countries hit by FX loans and devaluation. At a conference in Cyprus in early December, organised by a Cypriot solicitor Katherine Alexander-Theodotou, representatives from fifteen countries gathered to share experience and inform of state of affairs and actions taken in their countries regarding FX loans. This group is now working as an umbrella organization at a European level, has a website and aims i.a. at influencing consumer protection at European level.

Spain is part of the euro zone and yet banks in Spain have been selling FX loans. Patricia Suárez Ramírez is the president of Asuapedefin, a Spanish association of FX borrowers set up in 2009. She says that since the Swiss unpegging in January the number of Asuapedefin members has doubled. “There is an information mismatch between the banks and their clients. Given the full information, nobody in their right mind would invest all their assets in foreign currency and guarantee with their home. Banks have access to forecasts like Bloomberg and knew from early 2007 that the euro would devalue against the Swiss Franc and Japanese Yen.”

As in Australia, the first cases in most of the European countries have in general and for various reasons not been successful: judges have often not been experienced enough in financial matters; as in Australia clients lack evidence; there tends to be a bias favouring the banks and so far, only few cases have reached higher instances of the courts. However, in Europe the tide might be turning in favour of FX borrowers, thanks to an fervent Hungarian FX borrower.

The case of Árpád Kásler and the European Court of Justice

In April 2014 the European Court of Justice, ECJ, ruled on a Hungarian case, referred to it by a Hungarian Court: Árpád Kásler and his wife v OTP Jelzálogbank, ECJ C?26/13. The Káslers had contested the bank’s charging structure, which they claimed unduly favoured the bank and also claimed the loan contract had not been clear: the contract authorised the bank to calculate the monthly instalment on the basis of the selling rate of the CHF, on which the loan was based, whereas the amount of the loan advanced was determined by the bank on the basis of the buying rate of the CHF.

After winning their case the bank appealed the judgement after which the Hungarian Court requested a preliminary ruling from the ECJ, concerning “the interpretation of Articles 4(2) and 6(1) of Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts (OJ 1993 L 95, p. 29, ‘the Directive’ or ‘Directive 93/13’).”

In its judgment the ECJ partly sided with the Káslers. It ruled that the fee structure was unjust: the bank did not, as it claimed, incur any service costs as the loan was indeed only indexed to CHF; the bank did not actually go into the market to buy CHF. The Court also ruled that it was not enough that the contract was “grammatically intelligible to the consumer” but should also be set out in such a way “that consumer is in a position to evaluate… the economic consequences” of the contract for him. Regarding the third question – what should substitute the contract if it was deemed unfair – the ECJ left it to the national court to decide on the substitute.

Following the ECJ judgement in April 2014, the Hungarian Supreme Court ruled in favour of the Káslers: the fee structure had indeed favoured the bank and was not fair, the contract was not clear enough and the loan should be linked to interest rates set by the Hungarian Central Bank. – As in the Australian cases Kásler’s fight had taken years and come at immense personal pain and pecuniary cost.

Hungarian law are not precedent-based, which meant that the effect on other similar loan contracts was not evident. In July 2014 the Hungarian Parliament decided that banks lending in FX should return the fee that the Kásler judgement had deemed unfair.

The European Banking Authority, EBS is the new European regulator. The ECJ ruling in many ways reflects what the EBA has been pointing from the time it was set up in 2011. In its advice in 2013 on good practice for responsible mortgage lending it emphasises “a comprehensive disclosure approach in foreign currency lending, for example using scenarios to illustrate the effect of interest and exchange rate movements.”

Calculated gamble v being blind-folded at the gambling table

“Since the ECJ judgment in the Kásler case, judges in Spain have started to agree with consumers from banks,” says Patricia Suárez Ramírez. So far, anecdotal evidence supports her view that the ECJ judgment in the Kásler case is, albeit slowly, determining the course of other similar cases in other EU countries.

The FX loans were clearly a risk to unhedged borrowers in the countries where these loans were prevalent. If judgements to come will be in favour of borrowers, as in ECJ C?26/13, the banks clearly face losses: in some cases even considerable losses if the FX loans will have to be recalculated on an extensive scale, as did indeed happen in Iceland.

Voices from the financial sector are already pointing out the unfairness of demands that the banks recalculate FX loans or compensate unhedged FX borrowers. However, it seems clear that banks took a calculated gamble on FX lending to unhedged borrowers. In the best spirit of capitalism, you win some you lose some. The unfairness here does not apply to the banks but to their unhedged clients, who believed in the banks’ duty of care and who, instead of being sold a sound product, were led blind-folded to the gambling table.

*The first draft was written in July 2009; published 2010 as EBRD Working Paper.

This is the first article in a series on FX lending in Europe: the unobserved threat to FX unhedged borrowers – and European banks.The next article will be on Austrian banks, prolific FX lenders both at home and abroad, though with an intriguing difference. The series is cross-posted on Icelog.

See here an earlier article of mine on FX lending, cross-posted on Fistful of Euros and my own blog, Icelog