Saturday, April 27, 2013

Icelanders questioning myth of post-crisis success

A Bloomberg article looks at Icelanders questioning the success of their policies for handling the financial crisis.  This dissatisfaction highlights the need to implement the Swedish Model correctly.

Regular readers will recall that Iceland adopted the Swedish Model and required its banks to recognize upfront the losses on the excess debt in the financial system.  These losses were determined by balancing what a borrower could afford to pay and ensuring that the debt write-down did not create equity for the borrower.

Initially, this implementation of the Swedish Model produced the desired results.  The real economy and social contract were protected.  This was shown in the resumption of economic growth.

However, there was one major flaw in Iceland's implementation of the Swedish Model.  This flaw was the failure to deal with the simple fact that the majority of Iceland's mortgages are linked to inflation.

On the one hand, government policy attempted to reduce the mortgages to what the borrowers could afford to pay.  On the other hand, inflation from devaluation of Iceland's currency made the mortgages unaffordable again.

Iceland is once again looking at making the banks take losses.

This time it needs to make all mortgages that are written-down fixed rate mortgages.

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