some of you may know in spring this year
the pirate party of Iceland
appointed me to the Supervisory Board of
the Atlantic Central Bank and as a
consequence I have to say that I’m
speaking today as a private citizen and
nothing I say should be in any way
interpreted as being the opinion of
either the central bank or its
supervisory committee so we all tend to
take loans for granted we never look at
the small print pick out an apartment go
into a bank ask nicely sign on the
dotted line and hopefully live happily
ever after do that in Iceland and you
could be making a terrible mistake
that will haunt you financially for the
rest of your life and the reason for
that is that a very common form of loan
in Iceland is called theft tree Clan a
negatively amortized index-linked loan
and when Icelanders talk about these
loans they typically say nobody will
ever believe how crazy they are and I
have to agree with them about that if
you know anything at all about finance
then the words negatively amortized are
probably already ringing some lam bells
index-linked loans are loans that are
structured so that at any rate of
inflation above about two to three
percent the amount of interest that
you’re paying is linked to the rate of
inflation and this extra amount is added
to the loan capital the amount you owe
so instead of shrinking like it does
with every form of loan used everywhere
else in the world the amount you owe
actually grows over time and the result
of this is that the amount you have to
pay also grows over time now I said
anywhere else in the world and
negatively amortized loan is rightly
regarded as a very risky very dangerous
way to borrow and typically they’re
supposed to only be for sophisticated
investors
and sophisticated investor is a code
word in the financial industry that
typically means sucker here in Iceland
for over 20 years they were government
policy now you may be wondering how any
country gets itself into a situation
where they’re making negatively
amortized loans the only form of lending
that anyone can take out and to
understand that we actually have to go
back over 45 years now to the breakup of
the post-war financial regulatory
structure the Bretton Woods scheme to
which Iceland was a signatory member
which broke up essentially under the
weight of its own contradictions in the
1970s most countries during this period
experienced a very high rate of
inflation but ultimately they recover
from it unfortunately here in Iceland
the government makes the mistake of
printing money into an unregulated
banking system and the result of that is
Iceland’s first hyperinflation now
hyperinflation as Venezuela
unfortunately is currently finding out
is one of the most destructive forces
you can unleash on any society the rapid
increase in the money supply and the
corresponding rapid increase in prices
very quickly breaks apart the invisible
network of financial relationships that
is essentially holding the economy
together and most countries don’t
survive a hyperinflation either
economically or socially ISIL and to
it’s great credit has actually managed
to do this twice
and the reason for that is that Iceland
is actually a very strong democracy and
as a democracy it comes together in
emergencies as a single society and
tries to solve problems together and so
was the first hyperinflation when the
prices really started to escalate a
number of seemingly common sensical
measures were taken in order to try to
tackle the problem first of all wages
were linked to inflation so that people
could afford to buy things like food
then an attempt was made to control
prices this actually never works
if you’re trying this with
hyperinflation but you can’t blame
people for trying and then as the kroner
was rapidly depreciating Iceland
successfully resorted to barter
internationally to trade and that
resulted in a country becoming addicted
to polish chocolate and finally at the
end of this process the decision was
made to link loans to inflation and this
also was for seemingly sensible reasons
because loans aren’t just being made by
evil bankers they’re also being made by
people like pension funds and housing
corporations and student loans who need
that money in order to pay their pension
obligations and make new loans for
students and they were losing the value
of their loans and something had to be
done to equalize things for them because
the problem ultimately of hyperinflation
is it doesn’t take too many years of it
before anyone can just take their
monthly salary walk into the bank and
pay off their entire loan there and then
and the problem at some level isn’t the
argument itself the problem is what
happens in the banking system
if you index loans to inflation and what
it does is it essentially causes a
feedback loop now I got interested in
this because as a computer scientist
I’ve built a simulation of the banking
system
and when I started looking into how all
of this worked I found something very
disturbing about these loans and
essentially what they’re doing is
creating a feedback loop embedded in the
very core as a financial system here in
Iceland
now feedback loops are fun if you’re an
engineer but we don’t typically
recommend that they’re used for critical
systems actually not like the banking
system a feedback loop is essentially
when some sort of real-time process
feeds back on itself continuously so for
example if you start heating the Earth’s
climate you melt the North Pole there’s
less ice there the heat that’s reaching
the earth more of it is absorbed by the
earth and less of it is reflected back
into space so the earth heats up even
faster and as this goes round and round
well Iceland is getting noticeably
warmer in the summer Canada is probably
also enjoying the heat and Florida is
going to end up having to be evacuated
that’s a feedback loop and the way
index-linked loans work well the
question is what exactly happens in the
banking system if you link loans to
inflation
well banks tting systems create money I
think most people understand that now
what and people get a bit hot under the
collar about this but what they tend to
miss out is that when you repay a loan
that money is actually destroyed and
also if a loan has to be written off so
most well-regulated banking systems
actually exists in the state of slow and
fairly steady expansion and that’s
probably in balance fairly good for the
economy but what happens if you link the
capital of an existing loan to inflation
and they you allow that to increase well
what happens in the Icelandic banking
system is there’s a matching increase in
the money supply that money is
recognized by the banks as profits is
paid out to their employees or to
dividend holders as dividends and that
actually increases the money supply that
increases inflation so these loans that
are linked to inflation themselves cause
and that’s a huge problem now if you
talk to Icelandic economists about these
loans they typically credit them with
being the thing that ended the first
hyperinflation there isn’t actually any
evidence for that if you look at the
monetary figures what you see is that
the money supply continued to increase
several years after these loans were
introduced eventually the government
stopped printing money slowly after that
the banking system started to stabilize
there were some additional feedback
loops that have been introduced by
linking in salaries to prices and
eventually as the system was starting to
slow down everybody sat down in the
national wage agreement and agreed to
decouple basically prices and salaries
and inflation very rapidly dropped after
that and system stabilized at the
beginning of the 90s one of the
consequences of that is your personal
experience of these loans depends very
much on when you took them out take one
out in the 80s and you may well never
pay it back but at least your salary was
directly indexed to inflation so you
could keep up with payments take one out
in the 90s a period of relatively low
inflation here and a very stable system
and although these loans are very
expensive relative to their equivalent
compound interest rate loans in Europe
or in America you could still probably
keep ahead and pay back the loan
appropriately take one out in the 2000s
after the banking system was deregulated
and the second hyperinflation occurs
between 2006 to 2008 and the resulting
increase in the capital has pretty much
wiped out financially most of the
Icelandic households with these loans in
fact most of the people with loans from
that period have either defaulted on
them and over 10,000 households were
foreclosed on here as a result of the
2008 crash or there in this is only like
status of having to be forced to pay as
much as they can every month but
but with no real prospect of ever fully
repaying the loan that’s bad enough but
one of the other consequences of the
deregulation in 2000 was that compound
interest rate loans also became
available so now in Iceland do you have
a choice you can either take out an
index-linked loan or you can take out a
compound interest rate loan all
negatively amortized loans start off
cheaper than their compound interest
rate alternative because you’re not
paying enough interest to cover the full
amount that you should be paying so that
additional amount gets added to the
capital but it doesn’t take very many
years of repaying this give that
happening before the resulting growth in
the amount you owe overcomes the initial
cheapness of the loan and you end up
paying considerably more than somebody
who took out the compound interest rate
loan did in comparison but the thing is
the compound interest rate loan starts
off being more expensive so what’s
happening at the moment is that if
you’re well paid if you’re well off you
can afford to take out a compound
interest rate loan and most people do if
you’re not as well paid you are forced
to take out an index-linked loan a much
more expensive loan and one that you’re
at a huge disadvantage right at the
beginning so we have a system in some
sense where well-off rich well-paid
people get cheap loans and not so
well-off people get very expensive loans
which doesn’t make a whole lot of sense
but what this is essentially doing is
creating a rapidly growing wealth gap
because the people with compound
interest rate loans actually benefit
from inflation their loan repayments are
constant and as their salaries increased
the proportion of the loan gets cheaper
and people with index-linked loans well
actually those loans are causing
additional inflation and we’re talking
about people like nurses teachers
doctors builders the people
on whom society depends the bedrock of
society are being forced to take out
these very risky very dangerous loans
because at the end of the day Iceland
can’t control inflation lots of other
things cause inflation you know if
there’s an oil crisis is this war in the
Middle East if there’s a trade war
all of this can cause inflation and it
won’t serve any economic purpose that
these loans are linked to it and that
the the payments are suddenly escalating
and I think we have to ask ourselves is
this really what we want because this
isn’t a 1970s anymore we can control the
system we don’t have to let it control
us now to individuals the best advice
you can give I’m afraid is don’t take
out one of these loans or if you do have
one do everything you can to refinance
it into a compound interest rate loan
sell the car walk to work do everything
you can to just afford a compound
interest rate loan the first few years
of that will royally suck I completely
agree you won’t have a disposable income
right but as salaries increased with
inflation you will be ahead of the game
much quicker than you could possibly
realize and very quickly because your
loan payment as a percentage of salaries
essentially reducing every year you’ll
be ahead of the game and hey you’ll be
joining the new Icelandic upper-class as
you know that is the situation for
everybody with a compound interest rate
loan for the 80 percent of households of
Icelandic households that currently have
index-linked loans that’s not the case
you can get you can get a two to three
percent loan in America or Europe now if
you want to buy an apartment buy the
apartment pay the loan off quickly come
back and buy a house here with a
compounded straight loan in cash that is
terrible advice for any society to have
to give its young people or we sit down
as a community as a society and we
finish the work that the National wage
Commission left undone 40 years ago we
basically find some kind of way to get
these loans out of the economy and
probably a way that nobody will like but
ultimately one that everybody can live
with and we fix this problem before it
becomes another macroeconomic disaster
for Iceland because otherwise due to
essentially a mistake that was made 3040
years ago we are all going to be trapped
in this evolving and rapidly escalating
wealth gap that’s being created by these
loans now as a computer scientist I am
required to have the professional
humility to fix my mistakes and my
software to fix my bugs and I would like
to gently suggest that it is well
overdue that we expect our economists to
you [Applause]
the pirate party of Iceland
appointed me to the Supervisory Board of
the Atlantic Central Bank and as a
consequence I have to say that I’m
speaking today as a private citizen and
nothing I say should be in any way
interpreted as being the opinion of
either the central bank or its
supervisory committee so we all tend to
take loans for granted we never look at
the small print pick out an apartment go
into a bank ask nicely sign on the
dotted line and hopefully live happily
ever after do that in Iceland and you
could be making a terrible mistake
that will haunt you financially for the
rest of your life and the reason for
that is that a very common form of loan
in Iceland is called theft tree Clan a
negatively amortized index-linked loan
and when Icelanders talk about these
loans they typically say nobody will
ever believe how crazy they are and I
have to agree with them about that if
you know anything at all about finance
then the words negatively amortized are
probably already ringing some lam bells
index-linked loans are loans that are
structured so that at any rate of
inflation above about two to three
percent the amount of interest that
you’re paying is linked to the rate of
inflation and this extra amount is added
to the loan capital the amount you owe
so instead of shrinking like it does
with every form of loan used everywhere
else in the world the amount you owe
actually grows over time and the result
of this is that the amount you have to
pay also grows over time now I said
anywhere else in the world and
negatively amortized loan is rightly
regarded as a very risky very dangerous
way to borrow and typically they’re
supposed to only be for sophisticated
investors
and sophisticated investor is a code
word in the financial industry that
typically means sucker here in Iceland
for over 20 years they were government
policy now you may be wondering how any
country gets itself into a situation
where they’re making negatively
amortized loans the only form of lending
that anyone can take out and to
understand that we actually have to go
back over 45 years now to the breakup of
the post-war financial regulatory
structure the Bretton Woods scheme to
which Iceland was a signatory member
which broke up essentially under the
weight of its own contradictions in the
1970s most countries during this period
experienced a very high rate of
inflation but ultimately they recover
from it unfortunately here in Iceland
the government makes the mistake of
printing money into an unregulated
banking system and the result of that is
Iceland’s first hyperinflation now
hyperinflation as Venezuela
unfortunately is currently finding out
is one of the most destructive forces
you can unleash on any society the rapid
increase in the money supply and the
corresponding rapid increase in prices
very quickly breaks apart the invisible
network of financial relationships that
is essentially holding the economy
together and most countries don’t
survive a hyperinflation either
economically or socially ISIL and to
it’s great credit has actually managed
to do this twice
and the reason for that is that Iceland
is actually a very strong democracy and
as a democracy it comes together in
emergencies as a single society and
tries to solve problems together and so
was the first hyperinflation when the
prices really started to escalate a
number of seemingly common sensical
measures were taken in order to try to
tackle the problem first of all wages
were linked to inflation so that people
could afford to buy things like food
then an attempt was made to control
prices this actually never works
if you’re trying this with
hyperinflation but you can’t blame
people for trying and then as the kroner
was rapidly depreciating Iceland
successfully resorted to barter
internationally to trade and that
resulted in a country becoming addicted
to polish chocolate and finally at the
end of this process the decision was
made to link loans to inflation and this
also was for seemingly sensible reasons
because loans aren’t just being made by
evil bankers they’re also being made by
people like pension funds and housing
corporations and student loans who need
that money in order to pay their pension
obligations and make new loans for
students and they were losing the value
of their loans and something had to be
done to equalize things for them because
the problem ultimately of hyperinflation
is it doesn’t take too many years of it
before anyone can just take their
monthly salary walk into the bank and
pay off their entire loan there and then
and the problem at some level isn’t the
argument itself the problem is what
happens in the banking system
if you index loans to inflation and what
it does is it essentially causes a
feedback loop now I got interested in
this because as a computer scientist
I’ve built a simulation of the banking
system
and when I started looking into how all
of this worked I found something very
disturbing about these loans and
essentially what they’re doing is
creating a feedback loop embedded in the
very core as a financial system here in
Iceland
now feedback loops are fun if you’re an
engineer but we don’t typically
recommend that they’re used for critical
systems actually not like the banking
system a feedback loop is essentially
when some sort of real-time process
feeds back on itself continuously so for
example if you start heating the Earth’s
climate you melt the North Pole there’s
less ice there the heat that’s reaching
the earth more of it is absorbed by the
earth and less of it is reflected back
into space so the earth heats up even
faster and as this goes round and round
well Iceland is getting noticeably
warmer in the summer Canada is probably
also enjoying the heat and Florida is
going to end up having to be evacuated
that’s a feedback loop and the way
index-linked loans work well the
question is what exactly happens in the
banking system if you link loans to
inflation
well banks tting systems create money I
think most people understand that now
what and people get a bit hot under the
collar about this but what they tend to
miss out is that when you repay a loan
that money is actually destroyed and
also if a loan has to be written off so
most well-regulated banking systems
actually exists in the state of slow and
fairly steady expansion and that’s
probably in balance fairly good for the
economy but what happens if you link the
capital of an existing loan to inflation
and they you allow that to increase well
what happens in the Icelandic banking
system is there’s a matching increase in
the money supply that money is
recognized by the banks as profits is
paid out to their employees or to
dividend holders as dividends and that
actually increases the money supply that
increases inflation so these loans that
are linked to inflation themselves cause
and that’s a huge problem now if you
talk to Icelandic economists about these
loans they typically credit them with
being the thing that ended the first
hyperinflation there isn’t actually any
evidence for that if you look at the
monetary figures what you see is that
the money supply continued to increase
several years after these loans were
introduced eventually the government
stopped printing money slowly after that
the banking system started to stabilize
there were some additional feedback
loops that have been introduced by
linking in salaries to prices and
eventually as the system was starting to
slow down everybody sat down in the
national wage agreement and agreed to
decouple basically prices and salaries
and inflation very rapidly dropped after
that and system stabilized at the
beginning of the 90s one of the
consequences of that is your personal
experience of these loans depends very
much on when you took them out take one
out in the 80s and you may well never
pay it back but at least your salary was
directly indexed to inflation so you
could keep up with payments take one out
in the 90s a period of relatively low
inflation here and a very stable system
and although these loans are very
expensive relative to their equivalent
compound interest rate loans in Europe
or in America you could still probably
keep ahead and pay back the loan
appropriately take one out in the 2000s
after the banking system was deregulated
and the second hyperinflation occurs
between 2006 to 2008 and the resulting
increase in the capital has pretty much
wiped out financially most of the
Icelandic households with these loans in
fact most of the people with loans from
that period have either defaulted on
them and over 10,000 households were
foreclosed on here as a result of the
2008 crash or there in this is only like
status of having to be forced to pay as
much as they can every month but
but with no real prospect of ever fully
repaying the loan that’s bad enough but
one of the other consequences of the
deregulation in 2000 was that compound
interest rate loans also became
available so now in Iceland do you have
a choice you can either take out an
index-linked loan or you can take out a
compound interest rate loan all
negatively amortized loans start off
cheaper than their compound interest
rate alternative because you’re not
paying enough interest to cover the full
amount that you should be paying so that
additional amount gets added to the
capital but it doesn’t take very many
years of repaying this give that
happening before the resulting growth in
the amount you owe overcomes the initial
cheapness of the loan and you end up
paying considerably more than somebody
who took out the compound interest rate
loan did in comparison but the thing is
the compound interest rate loan starts
off being more expensive so what’s
happening at the moment is that if
you’re well paid if you’re well off you
can afford to take out a compound
interest rate loan and most people do if
you’re not as well paid you are forced
to take out an index-linked loan a much
more expensive loan and one that you’re
at a huge disadvantage right at the
beginning so we have a system in some
sense where well-off rich well-paid
people get cheap loans and not so
well-off people get very expensive loans
which doesn’t make a whole lot of sense
but what this is essentially doing is
creating a rapidly growing wealth gap
because the people with compound
interest rate loans actually benefit
from inflation their loan repayments are
constant and as their salaries increased
the proportion of the loan gets cheaper
and people with index-linked loans well
actually those loans are causing
additional inflation and we’re talking
about people like nurses teachers
doctors builders the people
on whom society depends the bedrock of
society are being forced to take out
these very risky very dangerous loans
because at the end of the day Iceland
can’t control inflation lots of other
things cause inflation you know if
there’s an oil crisis is this war in the
Middle East if there’s a trade war
all of this can cause inflation and it
won’t serve any economic purpose that
these loans are linked to it and that
the the payments are suddenly escalating
and I think we have to ask ourselves is
this really what we want because this
isn’t a 1970s anymore we can control the
system we don’t have to let it control
us now to individuals the best advice
you can give I’m afraid is don’t take
out one of these loans or if you do have
one do everything you can to refinance
it into a compound interest rate loan
sell the car walk to work do everything
you can to just afford a compound
interest rate loan the first few years
of that will royally suck I completely
agree you won’t have a disposable income
right but as salaries increased with
inflation you will be ahead of the game
much quicker than you could possibly
realize and very quickly because your
loan payment as a percentage of salaries
essentially reducing every year you’ll
be ahead of the game and hey you’ll be
joining the new Icelandic upper-class as
you know that is the situation for
everybody with a compound interest rate
loan for the 80 percent of households of
Icelandic households that currently have
index-linked loans that’s not the case
you can get you can get a two to three
percent loan in America or Europe now if
you want to buy an apartment buy the
apartment pay the loan off quickly come
back and buy a house here with a
compounded straight loan in cash that is
terrible advice for any society to have
to give its young people or we sit down
as a community as a society and we
finish the work that the National wage
Commission left undone 40 years ago we
basically find some kind of way to get
these loans out of the economy and
probably a way that nobody will like but
ultimately one that everybody can live
with and we fix this problem before it
becomes another macroeconomic disaster
for Iceland because otherwise due to
essentially a mistake that was made 3040
years ago we are all going to be trapped
in this evolving and rapidly escalating
wealth gap that’s being created by these
loans now as a computer scientist I am
required to have the professional
humility to fix my mistakes and my
software to fix my bugs and I would like
to gently suggest that it is well
overdue that we expect our economists to
you [Applause]
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