By Olafur Arnarson, Michael Hudson and Gunnar Tomasson
Today, from Greece to Iceland, governments are acting as enforcers or even as collection agents on behalf of the financial sector — and Iceland stands as a dress rehearsal for this power grab.
The problem of bank loans gone bad has thrown into question just what should be a “fair value” for these debt obligations. The answer will depend largely on the degree to which governments back the claims of creditors. The legal definition of how much can be squeezed out is becoming a political issue pulling national governments, the IMF, ECB and financial agencies into a conflict, pitting banks, vulture funds and debt-strapped populations against each other.
This polarising issue has broken out in Iceland with the country now suffering a second round of economic and financial distress stemming from the collapse of its banking system in October 2008. Stuck with bad loans and bonds, foreign investors in the old Icelandic banks and their institutional investors sold their bonds and other claims for pennies on the dollar to hedge funds commonly known as vulture funds.
At that time, Iceland’s government owned 100 per cent of all three new banks, which were raised from the debris of the old, bankrupt banks. It intended for the banks to pass on to the debtors the discount on assets they had received from the old banks. This was supposed to be what “fair value” meant: the low market valuation at that time. It was supposed to take account of the reasonable ability of households and businesses to pay back loans that had become unpayable as the currency had collapsed and import prices had risen accordingly.
The IMF entered the picture in November 2008, advising the government to reconstruct the banking system in a way that “includes measures to ensure fair valuation of assets [and] maximize asset recovery.” In fact, the government negotiated an agreement with the hedge funds which is now seen as so loose as to give them a hunting licence on Icelandic households and businesses.
These groups, viewed by some people as the scavengers of the financial system, are the bane of many states. But there is now a danger of such funds oppressing entire national economies.
Iceland’s case has a special twist. Icelandic mortgages and many other consumer loans are linked to the country’s consumer price index or, until recently, to the krona exchange rate against leading currencies. Creditors can not only demand 100 per cent of face value, but also add on the increase in debt principal from the indexing. Thousands of households face poverty and loss of property because of loans that, in some cases, have more than doubled as a result of the currency crash and subsequent price inflation.
Something has to give. But so far it is Iceland’s economy, not the funds in question. The new banks have written off claims on big corporate debtors but household debts acquired at 30 to 50 per cent of face value have been re-valued at up to 100 per cent. As a result unpayably high debts are kept on the books at transfer prices that afford a windfall to financial predators, dooming debtors to a decade or more of negative equity.
The problem is now becoming a global one. How are the IMF and ECB to respond? Will they prescribe the Icelandic-type model of collaboration between governments and hedge funds? Or should governments be given the power to resist funds striving to profiteer on an international scale, backed by international sanctions against their prey?
Populist rhetoric is crafted to mobilise the widespread financial distress and general discontent as an opportunity to turn losers against each other rather than at the creditors. Neo-liberals have persuaded the public to believe that banks are needed to “oil the wheels of commerce” — that is, provide the credit bloodstream that brings nourishment to the economy’s moving parts. Only under such crisis conditions can banks collect what has become a fictitious build-up of debt claims.
Foreclosure time is not sufficient, because much property has fallen into negative equity — about a quarter of US real estate. In Ireland market value of real estate covers only about 30 per cent of the face value of mortgages. So a bailout becomes necessary.
The banks turn over their bad loans to the government in exchange for government debt. The Federal Reserve has arranged over $2 trillion of such bank-friendly swaps. Banks receive government bonds or central bank deposits in exchange for their bad debts, accepted at face value rather than at mark-to-market prices.
At least in the US and Britain, the central banks can print as much domestic currency as is necessary to pay interest and keep these government bonds liquid. Public agencies then take on the position of creditor vis-à-vis debtors that can’t pay.
These public agencies then have a choice. They may seek to collect the full amount (or at least, as much as they can get), as in the case of Fannie Mae and Freddie Mac in the US. Or the government may sell the bad debts to vulture funds for a fraction of their face value.
In the US, banks receiving TARP bailout money were supposed to negotiate with mortgage debtors to write down the debts to market prices and/or the ability to pay. This was not done. Is this the future of Europe as well? If so, the present financial crisis will become the great windfall for banks. Whereas the past few centuries have seen financial crashes wipe out the savings and creditor claims that are the counterpart to bad debts, today we are seeing the bad debts kept on the books, but the banks and bondholders that provided the bad loans being made whole at taxpayer expense.
Olafur Arnarson is an author and columnist at Pressan.is. Michael Hudson is professor of Economics at the University of Missouri-Kansas City. Gunnar Tomasson is a retired IMF advisor.
