Household Financial Fundamentals of Varying Ages in the 2008 Crisis and Recovery: Iceland Case Study

Abstract

The Great Recession of 2008 had devastating consequences for households in Iceland, as real estate prices dropped, loans soared, and households’ net worth evaporated, leading to a substantial increase in the number of bankruptcies. This case study examines how households of varying age groups were affected by the crisis and the subsequent recovery. It explores both the context of market developments and governmental intervention and their effects on household financial fundamentals, i.e. liabilities, real estate, savings, income and net worth. It does so through an analysis of aggregated data on household balance sheets and income, according to specified age bins motivated by life-cycles. The thesis finds that the crisis and recovery of the Icelandic economy has affected households of differing ages in asymmetrical ways. These asymmetries are due to the underlying risk inherent in the differing age groups as leverage ratios are higher for younger individuals, resulting in more volatile movements of net worth for this group. Our findings show that the different age groups have all experienced increases in net worth in the recovery, but that there have been different factors driving this growth – ‘29 and younger’ driven by decreases in debt, ‘67 and older’ by increases in asset prices, and ‘30-49’ and ‘50-66’ driven by both effects. Four key factors contributed to the recovery of households. First, the government facilitated the recovery by operationalizing Debtor’s Ombudsman to assist distressed households, prohibiting currency linked loans and implementing two debt-relief programs. Second, real estate owners benefitted from rising asset prices in the recovery. Third, households’ total income is now more represented by permanent sources of income, as opposed to transitory sources. Finally, the government’s regulations targeting the provision of credit, has incentivized financial institutions to carry on their main competency as intermediaries of capital.