Reykjavík Grapevine - 17.06.2011, Page 14

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The Reykjavík Grapevine
Issue 8 — 2011
Analysis | Bubbles
How many newly constructed, empty apartment complexes line the
outskirts of Reykjavík? At least nine, although they might be as many
as FIVE BILLION. Who knows?
From Range Rovers to Bang & Olufsen
designer electronics, there is no ques-
tion Iceland went through a massive con-
sumer boom (see GV issue 6, 2011). In
fact, as Guðmundur Jónsson, Professor
of Economic History at the University of
Iceland, has pointed out, the Icelandic
consumption boom was one of the larg-
est in all of Western Europe. Taking the
entire boom period 1995–2007, private
consumption grew by 60% in Iceland—
only Ireland (which experienced a simi-
larly spectacular housing and financial
bubbles) saw a larger growth in private
consumption.
And while this growth in consump-
tion is a characteristic of the entire
twelve-year boom, it is striking how
much of it took place during the finan-
cial bubble of the noughties. Between
2002 and 2007, private consumption
grew by around 48%. And, as Guð-
mundur Jónsson has pointed out, it is
impossible to understand this growth
in consumption without looking at the
growth in household debt. Debt as share
of disposable household income, which
had been growing since the beginning
of the boom at an annually modest rate
of 1,8%, really took off after 2003. The
annual growth between 2003 and 2008
was a whopping 5,2%.
The great Icelandic consumption
boom was fuelled by debt. Just like the
Icelandic financial bubble and the real-
estate bubble. Which leads one to won-
der: How exactly are these phenomena
linked?
FROM ‘SAVINGS ACCOUNTS’ TO
‘ATMS’
For most of the 20th century, Iceland-
ers viewed their homes like savings
accounts. During the post-war years,
interest rates were set by law and bank
deposits generally carried interest rates
that were below the chronically high in-
f lation rate. Under these circumstances
real estate, or ‘concrete’, was among the
only really generally safe investment or
savings plan ordinary people had access
to. Getting to own your own home, even
if it required considerable sacrifices, was
therefore something that responsible
people were expected to do. Somehow,
this idea of real-estate as a savings ac-
count transformed into the idea of using
your home as a cash machine—a giant
ATM.
This transformation of how people
viewed the equity they had in their
homes—as collateral for easy loans or
hard earned savings—lies at the heart
of the cultural transformation that ex-
plains the Icelandic consumer boom of
the years prior to the financial crash of
2008.
During the post-war period, it had
generally been pretty hard to get financ-
ing for buying a home. Homebuyers
were expected to have a significant down
payment, at least 10–20%, and nobody
expected to start out in a single family
home or townhouse. Home equity loans
were granted by government authori-
ties. The system changed several times
over the period, but since 1989 housing
finance funds provided up to 70% of
the purchase price of a home. However,
these loans were capped at relatively low
amounts, in 2004 at less than 10 million
ISK. Homebuyers could take out addi-
tional “top off” loans at reasonable inter-
est from their pension funds or at higher
interest through other channels. In addi-
tion, since 1979 all loans were indexed to
inflation.
While housing prices generally held
up to inflation, homeowners did not ex-
pect to build up equity through rising
real-estate prices. Equity was built up the
old-fashioned way, by paying down loans
and by saving up money for a downpay-
ment for a larger home.
ENTER THE BANKS
All of this changed when the newly
privatised banks decided they wanted
a piece of the real estate action. In Au-
gust of 2004, the Icelandic banks began,
for the first time, offering home equity
loans.
The banks began by offering loans
for 80%–90% of the purchase price of
homes (later they would even go up to
100%). This move was hailed as revo-
lutionary—the banks claimed in their
advertisements that they were offering
people “freedom!” and the banks offered
new kinds of exotic loans—instead of the
boring fixed interest loans offered by the
government housing authority, people
could get more exciting loans with vari-
able interest rates. And instead of having
their loans indexed to consumer prices,
people could have them indexed to for-
eign currencies: Yen, Euros, Dollars or
Swiss Francs. As it turned out, it was
against the law to index loans to foreign
currencies. But that is another story.
Real estate prices, which had re-
mained stagnant in real terms between
1988 and 2003—that is, they simply
followed inflation—took off. Between
2003 and 2007 however, real estate pric-
es rose by a phenomenal 84%.
It is wrong to blame the banks for
the entire housing bubble—prices had
begun to rise in early 2003 as the gov-
ernment declared that the state housing
finance authority would begin making
90% loans. But the entry of the banks
brought an immediate spike in real es-
tate prices. Between September 2004
and September 2005, prices rose by a
staggering 33%.
In the summer of 2004, before the
banks entered the mortgage business,
a 130 square metre apartment in down-
town Reykjavík cost around 17 million
ISK. By late 2007 the same apartment
went for 33 million ISK.
The banks understandably argued
that this rise was a “correction”, that
prices had been unreasonably low pre-
viously. But then again, if you rely on
the analysts of investment banks, pretty
much all price changes are “corrections”,
be they bubbles or the inevitable crashes
that follow them.
The price “correction”, in addition
to the ready availability of up to 100%
financing on new homes, meant that
homeowners calculated they could af-
ford pretty much anything. Rather than
saving for a small starter home in need
of fixing up, people would now take out
a loan for the entire purchase price of
a much larger apartment. And then an
additional “home loan” for purchasing
furniture. Many assumed this was safe,
since price appreciation would quickly
create equity in their homes. And in any
case, people looked at the monthly pay-
ments, not the total debt burden.
The greatest change was that people
could for the first time refinance, they
could access the equity in their homes
without selling. People could now use
their homes as ATMs, taking out loans
to remodel their kitchen or bathroom,
upgrade their furniture or car or simply
pay off credit card debts and the over-
draft on their checking account. The
result was a spending binge of historic
proportions
DEBT AS FREEDOM
While the banks claimed they were be-
ing awfully responsible in their lending,
advising people not to take out more
loans than they actually needed or could
repay, there is every reason to believe the
opposite to be true. There are countless
stories of loan officers who pressured
people into taking out larger loans, even
making house calls to convince people to
refinance.
The banks’ advertisements paint a
similar picture. Rather than discourage
potential customers, advising them to
take out smaller loans and limit their ex-
pectations, banking advertisements pre-
sented people images of how the good
life could be bought on credit. Home
equity loans were consistently adver-
tised as being for either remodelling and
maintenance, or for “reorganising” your
personal finances, read: refinancing
consumption debt and paying up over-
drafts. With a clean slate, people could
start all over!
The savings banks advertised “Real
estate loans” that were intended for “pur-
chasing a new home, refinancing and
lowering monthly payments, remodel-
ling or just about anything you can think
of”. Mortgages and home equity loans
were means to actualise dreams, dreams
that need not be directly related to hous-
ing or real estate: they could literally be
anything you could dream of.
The same theme surfaces in a 2007
advertisement by Kaupþing. Advertising
‘interest only’ loans, the bank boasted
that “Kaupþing grows with you after you
graduate”—promising recent university
graduates 100% total financing on a new
home, plus a 3.000.000 ISK “graduation
loan” (people who took out those kinds of
loans, paying only interest, could prob-
ably watch their debt grow, and grow!).
The advertisements featured smart
young people and Kaupþing’s prom-
ise that it would assist you in “making
your dreams come true”, whether those
dreams were “buying your first apart-
ment” or “world travel”.
This emphasis on the banks as the
primary dream-actualisers of the Ice-
landic people was a major and reap-
pearing theme in bank advertisements
during the boom. Freedom was another.
SPRON, the largest savings bank, ran
a large advertising campaign with the
theme “Freedom”, featuring among
other things, pictures of 19th Century
Icelandic independence movement hero
Jón Sigurðsson, and Gay Pride—argu-
ing that just like Icelanders had fought
for all kinds of freedoms, SPRON was
now fighting for the financial freedom
of consumers. In another “freedom”
themed SPRON advertisement this free-
dom was articulated further: You now
had the freedom to choose which foreign
currencies your 40-year home mortgage
was indexed to! Oh the joys and excite-
ment of consumer freedom!
DREAM-ACTUALISERS OF THE ICE-
LANDIC PEOPLE
Sure, not all bank advertisements em-
phasized frothy financial “freedom”
through perpetual debt slavery. A siz-
able part of the advertisement budgets of
Kaupþing, Glitnir and Landsbankinn ap-
pears to have been spent on associating
the brand names with “Icelandicness”
(the national foot- or handball teams,
fishermen and the rugged nature), cul-
ture and the arts or some other positive
attribute. As if the banks were telling the
people that they were an inseparable part
of the fabric of the nation, its culture and
aspirations. Just as they were attempting
to convince people that “the good life”,
in a nice newly remodelled apartment
and interest-only, Euro-indexed 100%
home equity loan were really inseparable
things.
This association of banks and debt
with living a fulfilling life provides a
necessary link between the housing
boom and the explosion of private con-
sumption and household debt. By sell-
ing consumers the idea of immediate
gratification, your home as an ATM and
“debt as freedom”, the banks both helped
shape the atmosphere of overconsump-
tion that pervaded Iceland and then
provided people with the debt needed to
finance this binge.
Building Giant ATMs
The Icelandic housing bubble examined
Words
Magnús Sveinn Helgason
Photography
Julia Staples
Real estate prices, which
had remained stagnant in
real terms between 1988 and
2003—that is, they simply
followed inflation—took off. Be-
tween 2003 and 2007 however,
real estate prices rose by a
phenomenal 84%