Iceland’s Currency Controls Continue to Build Property Market Bubble

on Nov 7, 2012
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Iceland’s crisis-management policies are causing a continuous increase in housing prices, intensifying the threat of a potential property market bubble less than four years after a banking meltdown threw the economy into its worst recession, Bloomberg News reported on 6 November 2012.

**Currency Restrictions Cause Boom in Iceland’s Housing Market**
Statistics show that since April 2010, property prices in the country have jumped 17 per cent and are now just 1.7 per cent below their pre-crisis peak of March 2008. The recent boom stems from currency controls imposed in 2008, designed to protect Iceland from a mass capital exodus and prevent the collapse of its krona after Iceland’s main banks defaulted on $85 billion (£53 billion) of debt. Indeed, the currency restriction measures helped to drive a recovery from the recession, but they also left about $8 billion (£5 billion) in Icelandic krona held by offshore investors forced to keep their money in the country. With the government giving signals that currency controls will remain until at least 2015, funds are continuously flowing into one of the few longer-term investment options available in Iceland — real estate.

**Housing Bonds Also Preferred Target, But HFF at Risk**
As of late, offshore krona investors have also targeted housing bonds because of the attraction of Iceland’s $7.9 billion (£4.9 billion) mortgage market. The Housing Finance Fund (HFF), a state-backed mortgage provider, which covers about 60 per cent of Iceland’s home-loan market, has been the main housing bonds tool used by investors. Yet HFF is now losing ground to commercial banks which are expanding their product range in an effort to take over a larger share of the island’s mortgage market. As a result, according to rating agency Moody’s, the HFF is now at risk of missing payments to creditors with it relying on the state for support.

!m[Iceland’s Lawmakers Seek Prevention of Asset Bubble as Residential Property Pricse Rise ](/uploads/story/739/thumbs/pic1_inline.png)Senior analyst at Moody’s, Oscar Heemskerk, told Bloomberg: “The risk is that there may potentially be a default at the HFF level, which is not paid for in time by the government.” Yet, according to him, the government also has strong reasons to fulfil their implicit guarantee and therefore investors will most likely receive their money back.

**Property Market Situation Is “Abnormal” but Government Seeks to Correct Imbalances**
Chairman of the Parliament’s welfare committee in Reykjavik, Sigridur Ingibjorg Ingadottir, admitted that the asset bubble is expanding and said that “the development in the real estate market is abnormal.” And with the eccentricity in Iceland’s real estate market does not getting any better, the government is now seeking to correct the imbalances, which risk plunging the island into yet another boom-bust cycle just four years after the banking industry dragged the economy through its worst recession since World War II.

Ms Sigridur said: “There’s every reason to look into whether parliament should pass legislation to limit the investment options for offshore krona holders,” This should include “preventing investors from using offshore funds to invest in the real estate market,” she said.
Iceland also has to decide whether it wants to rescue the Housing Finance Fund. According to Styrmir Gudmundsson, a fund manager at Jupiter Capital Management, this could be achieved either through the pension system or the tax system. “So in fact this is a question on which generation should suffer the losses. The silver bullet solution is probably a mix of these two alternatives,” he said. Yet according to him, measures may not be taken at least until April next year, as politicians shy away from passing any costs on to taxpayers before the parliamentary elections.

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