Though only a tiny country of 320,000, Iceland made international headlines in 2008 when its banks defaulted on $85 billion, exemplifying the dangers of financial deregulation. But this year, Iceland’s economy will outgrow the euro area and the developed world on average.
Since the end of 2008, Iceland’s state-controlled banks have forgiven loans for more than a quarter of the population, a total equivalent to 13 percent of its annual gross domestic product. Despite shrinking 6.7 percent in 2009, Iceland’s economy is projected to expand 2.4 percent this year and next, compared with 0.2 percent in the euro area. And while Iceland’s recovery does not provide a complete parallel to U.S. economic woes, the island’s nascent success does demonstrate how loan forgiveness can help reignite a struggling economy. According to Icelandic economist Thorolfur Matthiasson:
“The lesson to be learned from Iceland’s crisis is that if other countries think it’s necessary to write down debts, they should look at how successful the [forgiveness of debt exceeding] 110 percent [of home values] agreement was here. It’s the broadest agreement that’s been undertaken.”
Some U.S. lawmakers are trying to follow Iceland’s example. Three members of Congress — in an exceedingly rare act of bipartisanship — have introduced a bill with the potential to help hundreds of thousands of struggling homeowners while also saving taxpayer dollars.
The bill would mandate principal-reduction pilot programs at government-controlled mortgage financiers Fannie Mae and Freddie Mac. Essentially, the bill allows “underwater” home owners to reduce their monthly payments in exchange for a portion of the future price appreciation on the home, known as “shared appreciation.” With the extra equity, homeowners would greatly reduce the chance of foreclosure. Principal reductions would also save these government-run companies — and thus taxpayers — billions of dollars compared to other foreclosure-prevention measures.