Did Iceland forgive the majority of its citizens’ mortgage debt?

An unbelievable story, the source of which appeared to be a single Spanish-language news broadcast, made the blogosphere rounds yesterday: Iceland is forgiving nearly all of its citizens’ mortgage debt!

According to the report, the government of Iceland “put politicians and bankers on the bench of the accused” in response to the public outcry after the near-collapse of Iceland’s banking system and an embarrassing bailout by the IMF in 2008.  The context of the report implies that the cancellation of debt (and, presumably, the forced disposal or write-off of mortgage-based bank assets by the government) was done as a sort of punishment for the irresponsible fiscal policies of the banks.  The report lauds the actions of the Iceland government as “a very different way from the one chosen by the rest of Europe to overcome the crisis.”

Hmmm … “different” for sure.  And mostly untrue.  Here’s a more accurate picture of Iceland’s debt restructuring program: “IMF Says Targeted Debt Reduction Policies Can Work

In the case of Iceland the situation was more difficult, due in part to the much bigger proportion of the population that was affected, and to the wide presence of foreign currency mortgages.

The government and the newly constructed Icelandic banks developed a template to be used in case by case restructuring discussions between borrowers and lenders. The templates facilitated substantial debt write-downs designed to align secured debt with the supporting collateral (i.e bring the loan into line with the value of the house) and align debt service with the ability to repay.

The IMF found that such case by case negotiations safeguard property rights and reduce moral hazard, but they take time. As of January of this year, only 35% of the case by case restructuring applications had been processed. To speed things up, Iceland has introduced a debt forgiveness plan which writes down deeply underwater mortgages to 110% of the households’ pledgeable assets.

It noted that only when a comprehensive framework was put in place and a clear expiration date for relief measures announced that debt write-downs finally took off. As of January 2012, 15 to 20% of all Icelandic mortgages have been or are in the process of being written down.

…which sounds a lot more reasonable and realistic than the Spanish language report, which appears to be highly inaccurate.  Even in a small nation like Iceland (320,000 citizens) the process of re-evaluating home values and restructuring mortgages to more closely match those values (along with the current financial situations of borrowers) is a slow and time consuming process.  And of course it would be an utter disaster if banks were forced to simply erase a significant portion of their assets, regardless of how well-intentioned the reasons were.  But it’s good that Iceland is making a serious attempt at helping honest borrowers keep their homes and pay back their mortgage loans.

It’s also reassuring to see that they’ve put the heads of both politicians and bankers on the chopping block, which is more than I can say for our own government.

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