From Joseph Stiglitz’ lecture in Iceland last year. From Lara Hanna’s blog.

“What kind of society do you want to create?”

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A big relief for those who have seen their loans double, but a major folly.

Yesterday I heard a Social Democrat explain how the Independence Party majority in Reykjavik’s city council was sitting pretty having adopted a Social Democratic hue.

It is outrageous to think that the Social Democrats are turning the same trick in government and playing Independence Party ball. Instead of erecting that fortress around Icelandic households and tackling the debts which are plaguing those who were financially responsible before the crash, the government and the banks have wasted no energy in saving those who loaded themselves with debt, and took those riskier currency loans instead of loans in ISK.

So who were able to get 90-110% loans in the preceding years? Who were avidly speculating in currency loans? Could that group be mostly comprised of bankers and business owners? Those who had higher wages which now have maybe been halved or more.

Consider the cases of these fictional Icelanders:

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

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

Rewarding the risk takers? From which end of the spectrum is Arni Pall Arnason and the Social Democrats approaching the debt issue?

This is especially interesting following the revelations that the new banks got the loans transferred from the old banks at a 31-47% discount.

And then the Gylfi Magnusson, minister of economic affairs has said that the banks are unable to write off loans for average customers because they have to write off such huge amounts for businesses. Others say that that is not true, those were left in the old banks. Which is it? We don’t know because there is extreme breakdown of communication from the government to its people.

So the government which was going to erect a fortress appears to be building a future on building new banks on the backs of average customers and writing off loans for those who took the highest risks

This is all the more galling since there has been an array of advice from world class economists like Stiglitz, Zingales and others available to the government. But maybe the 110% folly is just preferable for some reason? Maybe Icelandic politicians have not been trained to look outside themselves and their own ranks for solutions.

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It is sort of like thanking the arsonist for bringing a bucket of water to the fire he started himself.

Stiglitz, speaking in Copenhagen is still vary of the IMF’s involvement in Iceland. Its plans are likely to lead to increased unemployment. “The fund’s fuse is short, which means that if states don’t do what it proposes, then it will delay its actions. It is a negative signal and that is why many are now considering whether Icelanders should thank the IMF for stepping in one year ago and tell it that there is a balance in the system, there is no emergency situation and as a democratic state we need the citizens to get together and discuss further action. There are many things at stake but full employment is the most important.”

Stiglitz says that the huge budget cuts demanded by the IMF would lead to higher unemployment in Iceland. “They say that the cost of obtaining trust is to have large reserves, the cost of the reserves are high interest rates. The cost is equivalent to the budget cuts in health or education and Icelanders should ask themselves whether it is worth it.”

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You might need to install the Microsoft Silverlight Player. It will only take a few moments.

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Here is a translation of an opinion piece by me that was published last week at the Silfur Egils blog;

Bankruptcy is ahead on the marketplace of ideas as far as solutions to the massive debt facing Icelandic households is concerned.

A fortress around the households in Iceland promised by the government has turned out to be one around financial institutions. The latest news claim that the foreign creditors of Byr S&L are writing off a part of the institution’s debt. Could that possibly be because they realise that if they claim the debt as a whole, then it will be the kiss of death for an operational financial system in Iceland? Much in the same way, operating a household in Iceland is close to becoming impossible, if a write off in household debt will not occur.

There are two reasons that necessiate a write-off in foreign currency loans. On one hand, the debtors were in a weak position when negotiating with strong financial institutions that held all the cards as far as inside information on the real value of the ISK and markets in general. Early 2008, voices could be heard from within Icelandic commercial circles, whispers about the magic number 180, which is where the banks were supposed to be directing the ISK. What chance do ordinary borrowers stand against a system which works so blatantly against their interests?

On the other hand, Icelanders run towards foreign currency loans in the past few years and the collapse of the ISK that followed, is the best evidence we have of the long lost confidence of Icelanders in their currency and the economic management of their country.The commercial sector of Iceland has set its aim towards the Euro for years because it realises the destructive powers a sensitive micro-currency in an open economy has on businesses and households. Previous governments’ stubborn use of methods fit for much larger economies has left behind a scorched earth. A sensible man would never feed a mouse the same way he feeds an elephant, even though learned papers would suggest he should.

That is also why the terrible effects borne by price indexed loans in ISK must be corrected. Economists such as Gudmundur Olafsson are prone to misleading the public by likening their mortgages to the purchase of horses. He uses the analogy of when a man borrows ten horses from him, he expects ten horses back. He makes no mention of the responsibility bestowed upon him as the lender to provide the borrower with healthy horses instead of limpering and diseased ones. If he fullfills that obligation then it is easy to return the ten horses. If not then the borrower is at a terribly unfair disadvantage.

In civilized societies, consumers are guaranteed the right to return faulty products in exchange for money back or products that work. Seeing the capital of a mortgage grow by 25% in three years, in spite of 25% of the original amount being paid onto it, indicates that the product is faulty, even dangerous. It should be the right of consumers to return the product or at least get one that works.

Traffic has been limited on the marketplace of ideas, as far as solutions to the household debt are concerned. The Progressive Party put forth a hasty campaign promise of 20% debt relief across the board. Their solutions are lacking in debt and the party does not seem to have cared enough to extend their reach, probably not until the next election. It also has to be said in all honesty that after the shenanigans of the last two decades the Progressive Party has put itself in such a position that their ideas are automatically distrusted. That is why it is just about impossible for the government to accept their solution, even though it would never say so openly. The idea is dead in the water even though it keeps rearing its ugly head too often.

On the other hand the government itself has displayed an incredible lack of ideas. The ideas and suggestions of Gylfi Magnusson and Steingrimur J. Sigfusson have revolved around helping only those who are in the most dire need of help. That way of doing things is sorely lacking in transparency. Is it for example possible that the same indidviduals are at advantage, who got warning calls from banks and officials in the weeks leading up to the crash in 2008, and managed therefore to get away with what they could while it was still worth something? Settling these things behind closed doors is not likely to build trust but more on that later.

Then recently Thorolfur Matthiasson, professor of economics at the University of Iceland came forward with yet another solution. To tie people’s mortgage payments to their income. Supported by ideas of Icelandic economists who are lucky enough to live abroad and have their income in a stable currency, people who only seem to have macroeconomical tools at their disposal. Their understanding of running households appears miniscule. Today, student loans are collected this way, and those who have dealt with that system know that not all is well with that arrangement. It is faulty as it uses last years’ income as a benchmark, not the current one’s, and of course the loans are price indexed so the capital grows like an insatiable monster while the borrower attempts to pay them back. (Little regard is also made for other debts the person might hold)

There are more ideas around, but to introduce new products into beforementioned marketplace you have to cut through the noise. One that has gotten little or no attention but has been thought out better than most is the Zingales-plan. Luigi Zingales is a professor at the University of Chicago who has suggested that the creditors and borrowers negotiate a write-off up to 30-50%. Instead the creditor is entitled to 30-50%  of the sales profit from said property if it is sold in the future. This is the framwork but of course it can be laid out according to respective scenarios. The idea revolves around borrowers and creditors making an agreement towards the future, with both parties interests tied together. This was the gist of an idea proposed by Joseph Stiglitz at a seminar at the University of Iceland last week. The media failed to respond, as most of them were sitting outside the lecture hall, waiting to ask Stiglitz effortless questions.

And there we have arrived at the heart of the problem. Icelandic academics and politicians have so far been found to be wanting in ideas that inspire such trust in the Icelandic system that people become willing to build a future, form businesses and raise future generations. The homemade solutions that have been in the spotlight so far are limp compared to the solutions of Zingales and Stiglitz.

It is time to prevent the households’ bankruptcy at the marketplace of ideas. Even though the Progressive Party makes a lot of noise about its way, it is mostly beneficial as a campaign promise. Even though Thorolfur Matthiasson is well-meaning, there is no solution or hope included in his suggestions. Solutions must be explored that tie together the future intersts of households and financial institutions. Therefore we should spend more time on examining what Zingales and Stiglitz have suggested.

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Stefan was on the panel at the University of Iceland last week with Joseph Stiglitz. He was also in attendance when Milton Friedman visited Iceland in 1984 and has now compared the two events as different “watersheds”.

The aura surrounding Friedman’s visit according to Stefan was one of “we know best and are in this together”. That of course was a libertarian laissez-faire economic view of the world.

Stiglitz’s visit on the other hand might be seen as the wake up call to a more sensible view of how things work in reality. A return to a Keynesian outlook.

Reality bites when one considers the considerable influence libertarians still vield in Iceland. They are not about to learn from their mistakes, they are determined to blame them on something else and get things going their way again as soon as possible.

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All the main points from the meeting are discussed and framed in such a manner that they are easily understood, and not just by economists.

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Maybe that is why MP Lilja Mosesdottir misunderstood Stiglitz’ recommendations towards loan reductions for Icelandic households. At Eyjan.is today she is quoted as saying that Stiglitz was positive towards a solution like the 20% way put forth by the Progressive Party. She says he recommends evening out the gain begotten by debtors through multi-layered taxation.

Maybe Lilja doesn’t understand English well enough, or maybe the reporter who wrote the story was unaware of what really went on.

It is true that this was a part of the solution he said he liked to be considered. But the first one was the one where creditors reduce a mortgage by 20-50%, but in turn they would get a cut in the sales profits when the home would be sold.

A great idea. Have you heard it before???

Stiglitz also brought up the issue of the sale of natural resources, especially through Public/Private entities. He said that the public part usually put up over 90% of the funding, the private part got 50% of the profits and the public part would assume all liabilities in the end. Stiglitz encouraged Icelanders to make sure that the profit derived from their natural resources would not go abroad.

But the evening news were all about Stiglitz’ comments on Iceland’s relationship with IMF. And Channel 2 and the State Broadcasting Channel published such identical stories that you wonder why they just didn’t send one interviewer and one cameraman? They certainly didn’t seem to be listening to his speech.

This angle was probably concieved from yesterday’s interview at Silfur Egils where this staunch critic of the IMF claimed the fund was actually not doing so bad in Iceland. He thinks the response of the previous government to get the fund involved at the critical time last year was correct and that the IMF’s actions so far have been very fair. But he raises the question of where to go from now, whether the fund’s involvement is still needed. Only Icelanders can answer that question was his take on this, and there went this week’s non-news item.

Stiglitz said most economists today were running towards Keynes. He denounced those who had maintained that the private sector always outperformed public enterprise. In one aspect they were right though. The public sector certainly could not lose money as well as private industries had.

Stiglitz cheekily did not want to blame the Financial Authorities too much for their part in the collapse. When a thief robs someone you don’t blame the cops he said. And in this case the cops had been paid not to be there.

He also called for transparancy from the government and cited his battle in the US to get information released from the AIG bailout regarding what the bailout money was actually used for. A needed reminder as the solvency committees of the failed Icelandic banks assume the role of kingmakers in society without any transparancy.

According to the evening news, yes both channels finished off their stories this way, the Icelandic government would like to offer Stiglitz an advisory role. They would do well to get this man onboard.

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The place was packed, so much that people had to stand and sit in every corner. Many were not even able to get inside.

The press was there, as usual taking photos and newsreels for tonight’s evening news. Actually the photographers for the daily’s were early, the TV crew arrived late.

What caught my attention was that as Stiglitz was in the middle of his speech, and actually describing how he would solve the household crisis (reader and avid commentator to this site Vilhjalm A. would be pleased to know it is the Zingales plan), the newscasters were sitting outside the hall, talking amongst themselves.

Now I cannot wait to see the evening news and how they serve the story of Stiglitz’ brilliant input into the Icelandic crisis. Will the newscasters ask relevant questions? Or are they just sitting on the outside?

I’ll write more on the seminar itself later tonight. I just wish we had this sort of intellectual thinking close to our government here but I guess we’ll have to do with a visit for now.

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