Iceland Has a Mortgage Disaster, Too

Iceland's Prime Minister, Johanna Sigurdardottir, is pushing for one of the world's most ambitious debt relief programs as she takes on the International Monetary Fund and bank creditors.

Before 2008, Iceland's privatized banks borrowed liberally from foreign lenders to expand. So did ordinary homeowners, who took out mortgages denominated in Swiss francs and euros at much lower rates than were available in kronur, the local currency.

It all worked as long as the krona was strong. Then credit dried up worldwide, the krona crashed, and the cost of servicing all that foreign-denominated debt jumped. The IMF extended an emergency loan in exchange for pledges of austerity, and a left-wing government under Sigurdardottir took over in early 2009.

As Sigurdardottir, 68, put it in an e-mail to Bloomberg News, she is the first Prime Minister in Iceland's history who "has taken over the task of literally resurrecting Iceland from the ruins of collapse. It's demanded a new modus operandi."

Sigurdardottir, known as Johanna, now faces a crisis of her own. In early October a demonstration of beleaguered homeowners demanded relief from their mortgages. To protect the 39 percent of households whose homes are worth less than their mortgages, Sigurdardottir initially promised to examine the homeowners' proposal that lenders forgive $2 billion in mortgage debt, equal to 15 percent of Iceland's economic output.

That pledge triggered a storm of protest from the banks and pension funds. "We don't support general write-offs on loans," says Hrafn Magnusson, managing director of the Icelandic Pension Funds Assn. The funds rely on bonds backed by local mortgages to support pension payments. The unions that depend on the pensions are rallying to the funds as well. Unless the pension groups agree to a deal, Sigurdardottir will struggle to pull off her rescue mission. "It will become unbearable for the government to hold on to power if it fails," says Birgir Gudmundsson, a political science professor at the University of Akureyri in Iceland's north.

The Prime Minister has backed away from her original position and focused on three other ideas: Extending a moratorium on foreclosures, even though the government agreed earlier with the IMF to end "temporary post-crisis measures"; allowing bankrupts to walk away from their debt after two years, a big concession in Europe where personal bankruptcy laws are often tougher than in the U.S.; and banning the banks' practice of indexing foreign-denominated loans to the exchange rate. The last proposal, if enacted, would cut each household's foreign-denominated debt by $13,500, on average.

Sigurdardottir, a former flight attendant, has focused mostly on social issues in 32 years in politics. "To enter the fray at a time of complete distrust in politics, she steps forward and is, in the minds of many, 'Holy Johanna,'" says Gudmundsson. "She's had the image of always looking out for the people." Now she has to combine compassion with the hard politics of austerity.

The bottom line: Iceland's crisis is prompting the government to seek debt relief for homeowners. Banks and pension funds are pushing back.

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