Overview of Government initiative on household debt in response to financial crises

1. Overview of Government initiative on household debt in response to financial crises Nordic Conference on Housing 26th of November 2009 Yngvi Örn Kristinsson, economist External Advisor on housing debt

2. Purpose of measures Strengthen economic recovery Minimize losses for households and creditors Avoid social problems resulting from increased debt burden and potential insolvencies Reach a consensus as much as possible on a permanent solution in order to move from talking to action

3. Prior emergency measures Autumn 2008: Freezing of payments Beginning 2009: Payment Equalisation for price indexed mortgages May 2009: Payment Equalisation of foreign currency mortgages Spring 2009: New legislation on court administ- ered Payment Restructuring based a Nordic model to ensure social concerns for insolvent households

4. Government initiative in November 2009 Four main pillars: A temporary legal framework for Out of Court work-outs for houshold and corporate debt due to financial crises A specialist commission to monitor fairness of treatment Work-out procedures agreed jointly by creditors for severely distressed households with reference to the new legislation Wholistic approach to household debt Main consideration that households can retain suitable housing and one car Debt burden adjusted debt service capacity and debt adjusted Potential write-off deferred for three years Modification of Payment Equalisation of price indexed an foreign currency mortgages, potential lengthening of maturity capped at three year based on agreement with financial institutions Payment Equalisation extended to household automobile loans, potential lengthening of maturity capped at three year, based on agreement with financial institutions Payment Equalisation to ensure that debt service burden similar as in early 2008 prior to crash

5. Clear purpose and foundation Capacity to service debt is the basis for debt rescheduling or debt restructuring General and transparent work-out rules to speed debt restructuring Unusual circumstances demand special measures out side of court jurisdiction to speed debt adjustment Necessary to minimize social costs from insolvency procedures as much as possible

6. More on Special Debt Restructuring Based on an agreement between household and creditors Targetted at serverely distressed households where Payment Equalisation does not match debt service burden and debt service capacity Based on long-term assessment of debt service capacity Wholistic approach, encompasses all household debt Joint work-out procedures of creditors to ensure uniformity treatment, speed creditor agreement How it works Debt is adjusted to debt service capacity Debt not servicable deferred “Excess” assets sold or overtaken by creditors Excess debt written off after 3 years Social goals to ensure That households retain suitable housing One family car Managable debt service burden

7. More on Payment Equalisation Payment equalisation is a effectively a rule based debt rescheduling Periodic payments of loans are regulated by a special index Maximum debt service burden fixed at defined point in time (reference payment, and follows the special index from that point onwards If payment according to the terms of the loan exceeds the indexed reference payment the excess is deferred If indexed reference payment exceeds payment according to terms of the loan the actual payment will the indexed reference payment while some deferred payments are outstanding. Deferred payments carry terms according to original loan Special index = Wage index x Employment rate

8. Example of Payment Equalisation Assumptions: For simplicity: Loan taken 1. Jan. 2008, amount 1000 kr., price indexed Annuity payment = 60 kr. Reference period 1. Jan. 2008 All indexes assumed at 100 1. Jan. 2008 Price index now 120 (20% inflation over period) Special payment equalisation index now 100 (unchanged) How it works now: Payment according to original terms = 72 (= 60 x 1,2 ) Regulated payment = 60 (= 60 x 1,0 ) Payment deferred = 12 =72 - 60

9. Example – mortgage, 10 m.kr. on 1.7.2007

10. Example – car loan, 2 m.kr. on 1.7.2007

11. Learning from history Iceland experienced severe fall in real wages and house prices in 1983 – 1985 that resulted in arrears of payments and negative equity position. Payment Equalisation was applied sucessfully at that time Reference index for Payment Equalisation different (wages only, now wages and unemployment rate) Present application more general (mortgages and car finance) and potential extension of maturity capped. Credid institutions assume the risk. Payment Equalisation expected to be helpful for most distressed households Banks expect that 4000 – 5000 households will need Special Debt Restructuring

12. Speedy application of measures is important Expectations of magical solution of debt problem unrealistic Restoring household equity to inflated pre-crises levels is not reasonable Safety in housing and family well-being main concern Problems are diverse and unevenly distributed that makes a general debt forgiveness impractical and socially costly Main critic of the measures is a demand for a general debt forgiveness

13. Cost of General Debt Forgiveness The figure shows a stylised example where expected losses of mortgages is 10% for all mortgage lenders 10% flat reduction of debt would nearly double expected write-off of mortgage lenders as seen on the diagram Mortgages now amount to 1400 billion krónur 10% corresponds to 140 billion kronur – roughly one years return of household income tax or more than the new equity to recapitalise two of the new banks