Iceland's left wing post-crisis government was ousted from power in the election on 27th April. Even if foreign media had actually praised PM Johanna Sigurdardottir and an her crew, they had to face the reality of other austerity governments, you don't get popular by cutting services and raising taxes.
Johanna Sigurdardottir, Prime Minister of Iceland 2009-2013, the world's first openly gay PM.
The austerity measures Iceland had to endure were really not that bad though, compared to many other crisis countries. The IMF rescue deal allowed the Government to gradually close the whooping post-crash budget deficit. (46% in 2008!) But the government didn't really succeed convincing their people that they'd done a pretty decent job. They also had to manage disunity in their own ranks and failed at achieving some (maybe too grand) goals such as renewing the constitution and overhauling the fish quota system.
The big winners of the election are the centrist Progressive party lead by 38 year old Sigmundur Gunnlaugsson, who right now is now attempting to form a new government with the right-wing Independence party. Gunnlaugsson doubled his party's following by promising substantial debt relief to ordinary homes. Not everyone believes in his free-lunch-at-no-cost plans.
Sigmundur Gunnlaugsson, possible new PM?
To understand Icelanders' debt frustration, one should remember that in 2008, the rate of the Icelandic króna against other major currencies fell by about 50%, mid-year 2007 you paid 82 kr for a Euro, by the end of 2008 the rate was at 170 kr. It has not recovered much, fluctuating between 150 and 170 kr ever since. In effect this meant that ordinary savers lost half of the real value of their money, if you calculate in a "real" currency, and salaries were cut by half!
Of course, this massive devaluation of the króna was not all bad, since it gave the export industries a boost and in effect lowered salaries drastically without the difficulties of having to cut nominal wages. Devaluation is psychologically much easier than lowering the nominal salary figure you get paid. (Nobel laureate economist Paul Krugman has hailed this as a terrific advantage of Iceland, not being stuck with a too strong currency like southern European crisis countries, and one explanation of Iceland's survival and relatively smooth path to recovery from the bank implosion, though the so-called "Icelandic miracle" has been a matter of debate.)
Having had chronic inflation pretty much all 20th century, Iceland has made much use of inflation indexed loans, since 1979 or so. An indexed loan means that if inflation is 4%, your loan goes up by 4%. That is, in addition to the nominal interest. That means that if the interest is 4%, you really pay 8% total interest that year (4% nominal interest + 4% index increase, to cover the 4% "loss" of value). I know this sounds strange to readers in most countries, but this is one way try to maintain the value of money in a high-inflation economy. But as many clever solutions to complex problems it does create a set of new problems.
Inflation in Iceland 1956-2012 (source)
So let's go back to 2008-2009; with the sudden fall of the króna, inflation went up and in less than a year the principal of your indexed mortgage went up by 20%, while housing prices decreased and wages essentially were unchanged. All in all, in 2008-2012, regular indexed housing loans went up by roughly 40%, whereas nominal salaries went up on average by 25% (in Icelandic krónur, which, as mentioned earlier, are still worth only half of what they were five years ago).
Gunnlaugsson, the victorious Progressive leader, fist entered politics in 2009 when he was surprisingly elected party chairman shortly after the bank crash. (He really deserves a whole blog post all for himself!) He proposed in 2009 that all indexed loans should be cut by a flat 20% discount (the surprise "shock" rise of the index in '08-'09). No other party thought that was feasible and instead the left-wing government that took power in 2009 devised measures to help out some of the heavily debted households with specific debt relief programs. (This to some meant that reckless spenders were being helped while more prudent households were left with their "shock" loans.)
Gunnlaugsson however stuck to his idea that dept must be reduced across the line. One problem is that a big portion of housing loans are lent by the state Housing Financing Fund, which is mostly financed by pension funds. So general debt relief of 20% would mean that pension funds would essentially face the same loss, unless the state (tax payers) somehow cover the costs.
In the campaign for the 2013 election, the Progressives came up with a magic bullet plan to relieve debt without hurting the housing creditors! See if you can follow:
The current banks in Iceland are mostly owned by foreign creditors, keep in mind that the previous banks defaulted (the bankruptcy of Kaupthing bank was the 6th biggest in world history, Landsbanki and Glitnir came in as no. 10 and 11 in the world record list, respectively). Enormous sums were written off but the remaining assets went to the creditors of the banks. A lot of the assets have since changed hands, the bulk now in the hands of foreign equity funds (they got these assets pretty cheap when recovery was still uncertain).
Icelanders don't want their entire bank system in the hands of "vulture funds", and the equity funds don't want to be stuck with their money for too long here. Problem is, they cannot exchange their Icelandic króna assets to foreign currency, that would drive the rate of the króna through the floor, and there simply isn't enough currency around, even if all the IMF-lent currency reserve funds were used up. (This is why we still have capital controls in place.)
The thinking now is that in order for the creditors to release their funds the Government will somehow have to negotiate their exit on a severely discounted króna rate, something like a 60-70% discount, and even that will still be problematic. Along comes Gunnlaugsson and his creative advisers and claim that the discount will create a balance in the books of the Government and that this "money" can be used to lower everyone's housing debts without any loss to the housing creditors. Believe it or not, this is actually what Gunnlaugsson sold to his electorate.
There seems to be a lot of caveats here, to say the least. Won't somebody have to buy the bank assets for "full price" from the Government? Should not the Government instead reduce the enormous public debt (which, at effectively 130% of GDP, is borderline sustainable), instead of lowering everyone's mortgage? Can we convince foreign equity funds that their krónur are only worth a fraction of their rate, while still maintaining faith in the face value of our krónur?
So there are interesting times ahead in Icelandic politics. Few people really think that the bold Mr. Gunnlaugsson's ideas are realistic, but his electorate seemed to think that at least he cared about their problems. If his magic would work we might actually deserve the envy of other European crisis countries, where many believe that Iceland stood up to the whole international banking establishment, did not bail out banks, jailed the bankers and relieved indebted homes, which is not quite true.
Let's see what happens. I'll try to keep you updated!
Independence Party chairman Bjarni Benediktsson and Sigmundur Gunnlaugsson, during a break in their early-stage government forming negotiations in a summer house by Þingvallavatn. Relatively young, but to some their parties are still too tied to the Icelandic 'Old boys' crony capitalism.
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