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Mortgage Lending, and the Privatization of Welfare in Hungary and ... the public purse from the burdens of collective social insurance while simultaneously ...
Post-Socialist Housing meets Transnational Finance: Foreign Banks, Mortgage Lending, and the Privatization of Welfare in Hungary and Estonia Dorothee Bohle, Central European University, Budapest Review of International Political Economy, 2014, Vol. 21, No. 4, 913–948, http://dx.doi.org/10.1080/09692290.2013.801022 Pre-published version.

Abstract This paper asks how public policies have shaped the build-up of crisis prone housing finance markets and whether they have mitigated or reinforced the associated risks for citizens in East Central Europe. Analyzing the mortgage lending booms and bust in Hungary and Estonia, the paper finds that different policy priorities did not matter much for the build-up of the mortgage boom and the associated risks households had to face. Rather, early decisions for encompassing house privatization and the non-existence of mortgage markets have led to a pent-up demand for housing finance, while the transnationalization and EU convergence of the financial sector have provided the supply for mortgage lending from the early 2000s on. Policy makers in both countries, albeit to different degrees, have supported the mortgage boom and have by and large failed to correct for the risks of their population. In the wake of the global financial crisis, however policies started to sharply diverge. While the Estonian government has relied on market mechanisms and private market actors to cope with the crisis, the Hungarian

government engaged in far-reaching interventionist policies to unmake some of its devastating consequences for indebted houseowners. The paper explains its findings by the combination of different welfare state traditions and patterns of party competition.

Keywords Financial crisis, banks, mortgages, welfare state, Eastern Europe

1. Introduction

In his influential book “The Great Risk Shift”, Jakob Hacker (2006) looks at the various ways in which risk for American households has increased over the last decades. Increasingly precarious and flexible forms of employment, declining guaranteed pensions, and eroding health benefits are all signs of a massive shift of economic uncertainties from enterprises and collective insurance schemes to the shoulders of ordinary citizens. While some of this is linked to secular trends in the economy, simultaneously implemented policies of welfare state retrenchment and privatization have resulted in reinforcing citizens’ exposure to economic risks. Hacker draws some comfort from the fact that social policies in other parts of the world have succeeded better in sheltering the population. Recent work on European welfare states has confirmed that while the tendency towards shifting uncertainty onto individuals is ubiquitous, social policies and collective bargaining structures can still play an important role in mitigating the effects (e.g. Crouch and Keune 2012). 2

This paper looks at a particular instance of such a risk shift, namely the privatization of home ownership, which has exposed households to the uncertainties stemming from an increasingly deregulated financial market. It asks how policy interventions have contributed to increasing or decreasing these uncertainties, and what they have done to mitigate the consequences once the global financial crisis brought credit markets to a meltdown. In almost all OECD countries, over the last decades governments have been busy promoting private house ownership to rid the public purse from the burdens of collective social insurance while simultaneously providing their citizens with some alternative form of security. They relied increasingly on financial markets to provide access to affordable housing. This was achieved by deregulating traditionally highly regulated housing finance, resulting in more volatility, balance sheet mismatches, short term and increasingly risky investments, speculative bubbles, and ultimately in the global financial crisis of 2007-2009 (Schwartz 2009, Schwartz and Seabroke 2009). In the wake of the crisis, millions of households are exposed to the threats of overindebtedness and of losing their homes. Yet, as shown by Waltraud Schelkle (2012), while housing privatization and the buildup of a major crisis has been a common trend in many OECD countries, social policy interventions have mattered in distributing social hardship, and in mitigating the damage caused by the crisis. This paper builds on these insights by asking how public policies have shaped the build-up of crisis prone housing finance markets and whether they have mitigated or reinforced the associated risks for citizens in East Central Europe. While we have started to get a better understanding of these questions for the Western OECD countries, we still lack comparative literature on their East Central European counterparts. This is a surprising omission, given that 3

the latter have undergone the most dramatic privatization of housing and have much higher owner-occupation rates than most Western countries. Privatization of housing has coincided with the European integration of their financial systems and the foreign take-over of much of the banking sector, the combination of which has fuelled a major consumer and mortgage credit boom turned bust in the wake of the global financial crisis. How have policy interventions interacted with the financial sector in the build-up of mortgage markets? What, if anything, has been done to mitigate possible risks for households? How have governments dealt with the problem of overindebtedness in the aftermath of the crisis? For answers, I will explore the links between transnationalized financial systems, mortgage debt, public policies, and the risks that private households had to shoulder in two East Central European countries, Hungary and Estonia. The two countries share a number of similarities. They were forerunners in housing privatization and the transnationalization of their financial systems. Mortgage lending has played an important role in their growth paths of the 2000s, and the subsequent crisis. In both cases, mortgages were issued in foreign currencies – Swiss franc in Hungary, and euros in Estonia - thus exposing private households to a major exchange rate risk. Yet, as the literature on transformation in East Central Europe argues, economic and social policy priorities in both countries differ. Whereas Estonia has been a champion of radical promarket reforms and a minimal welfare state, Hungary is among the most welfarist countries in the region. The paper seeks to tease out if and how these policy priorities have shaped the build-up of the mortgage boom, the vulnerability of households in the current crisis, and the way how governments sought to protect their populations from the hardship of the crisis. I find that 4

different policy priorities did not matter much for the build-up of the mortgage boom and the associated risks households had to face. Rather, early decisions for encompassing house privatization and the non-existence of mortgage markets have led to a pent-up demand for housing finance, while the transnationalization and EU convergence of the financial sector have provided the supply for mortgage lending from the early 2000s on. Policy makers in both countries, albeit to different degrees, have supported the the mortgage boom and have by and large failed to correct for the risks of their population. While this finding would support authors who argue that in light of the deep transnationalization and Europeanization of financial systems, domestic policy preferences cannot achieve much, the aftermath of the crisis shows a different picture. From then on, policies started to sharply diverge. While the Estonian government has relied on market mechanisms and private market actors to cope with the crisis, the Hungarian government engaged in far-reaching interventionist policies to unmake some of its devastating consequences for indebted houseowners. The paper is structured as follows. The next section presents a snapshot comparison of the Hungarian and Estonian housing and mortgage booms and busts, and reveals the differences in their welfare states and party systems. Next, I will trace the origins and the development of mortgage credits in the two countries with a particular focus on politics and public policies (section three). Section four takes a closer look at the policies in both countries that aimed at coping with the debt crisis of their citizens. Section five discusses the findings by putting them in a broader regional comparison. The final section concludes.

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2. Mortgage lending, welfare states and the risk shift in Hungary and Estonia

2.1 Mortgage lending and the build-up of household vulnerabilities During the 2000s, citizens and the financial sector in both Hungary and Estonia got interconnected in ways that increased the instability of the financial system and exposed the population to a number of risks. One of the most salient features of this period was the massive inflow of credit to East Central Europe, a major share of which went into mortgage lending, triggering a construction and housing boom in many places. Between 2003 and 2008, average annual credit growth was almost 40 percent in Estonia, and 20 percent in Hungary. Much of the domestic credit expansion was driven by households rather than the corporate sector (table 1). Even if the overall share of credit to GDP was not high in an international comparison, it is rapid credit growth rather than its absolute magnitude which is a crucial predictor for financial crises (e.g. Enoch and Ötker-Robe 2007; Mitra, Selowsky and Zalduendo 2010; Pistor 2009). Some features of this debt boom exposed households to major uncertainties. Among these, the high share of foreign currency denominated loans stands out. In 2008, more than 80 percent of loans were taken out in foreign currency in Estonia, and more than 70 percent in Hungary (table 1). While the Baltic countries have had a long tradition of “D-markization”, foreign currency lending in Hungary took off only during the 2000s. Hungarians borrowed in Swiss franc rather than Deutsche mark or euros. For consumers, foreign currency loans were attractive because of the favorable interest rates, and banks had easy access to foreign currency funding at wholesale markets or their parent banks. Both parties seem to have blissfully ignored the

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exchange rate risks of foreign currency lending. A lasting depreciation of the local currency would pose a major problem for households, who did not hedge against this risk. Another major risk was related to the development of house prices. As can be seen from table 1, nominal house prices in Estonia increased more than 36 and in Hungary 12 percent annually between 2002-2006. According to Égert and Mihaljek, these are “rates unseen in the industrial world” (Égert and Mihaljek 2007, 4). During the same period, average nominal house prices grew by 11 percent in Ireland for instance. In Estonia, a veritable house price bubble built up during the 2000s (Brixiova, Vartia and Wörgötter 2007, Kallakmaa-Kapsta 2007, Lamine 2009). The burst of the bubble would inevitably inflict major costs on households and banks. Finally, in both countries, most mortgage loans were issued with adjustable interest rates, exposing households to the risk of interest rate hikes.

Table 1 about here

Thus, in both countries during the 2000s patterns of mortgage lending built up which left their populations highly vulnerable. The full extent of the exposure was revealed when the global financial crisis reached the region. In Estonia, the housing bubble started to burst in 2007, a year before the collapse of the Lehman brothers brought the global financial system down. Hungary became severely affected by the crisis in 2008, when a run on its currency and on one of its major banks forced the country to turn to the IMF to keep its economy afloat. A snapshot view on the exposure of the Estonian and Hungarian population in the early years of the crisis reveals similarities in the depth and some differences in the form that the vulnerability took 7

(Table 2). Thus, Estonian households were more likely to become overindebted and to be severely affected by negative home equity. They also stood a higher chance of being subject to forced sales of their homes than their Hungarian counterparts. In contrast, Hungarian households biggest vulnerability stemmed from the floating exchange rate. According to the calculations of Calmforss et al. (2012: 125-6), the forint depreciated by 34% between September 2008 and March 2009 relative to the Swiss franc.2 In addition, Hungarians were more likely to default on their debt than their Estonian counterparts. Moreover, a very high share of mortgages was in renegotiated foreclosure.

Table 2 about here

All in all, while there were some differences in the concrete forms in which the risk shift materialized in Estonia and Hungary, the foreign currency financed mortgage boom has exposed households in both countries to major economic uncertainties. How have welfare states and public policy priorities in both countries shaped the build-up of the mortgage boom, and what was done to mitigate the vulnerabilities of indebted homeowners in the wake of the financial crisis? To answer this question, it is necessary to shed some light on the general politics and policy preferences surrounding issues of welfare and the proper state-market mix in Hungary and Estonnia, before honing in on concrete housing and mortgage policies.

2.2 (Welfare)states and markets

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The literature on East Central European welfare states has stressed some particularities which sets them apart from their Western counterparts. Tomasz Inglot (2008), author of an unmatched study of the origins and development of welfare states in the region, argues that these are inextricably linked to the troubled histories of late nation and state building, political instability and authoritarianism, and foreign intervention. On the basis of his in-depth analysis of welfare states in the Visegrád group3, he concludes that these are “emergency welfare states” in that most of the programs and safety nets were built up during socio-economic or political emergencies, designed as temporary remedies, which however transformed into long lasting structures. Yet, layered, unfinished and partly incoherent as they are, these are welfare states in their own rights which have become as difficult to retrench as their Western counterparts. According to Inglot (2009, 75), “serious opportunities for transformative reforms only open up when the equilibrium between the processes of state-building as a whole, and welfare state-building in particular, is seriously undermined by the following factors: a change in the political regime (…most significantly the winning of national independence), a prolonged period of political instability and unrest, and/or a deep socioeconomic crisis”. He adds that while the Visegrád welfare states have developed through cycles of expansion and retrenchment, it takes two or three of these contingencies together to allow for radical change. Hungary’s “emergency welfare state” legacy is characterized by a relatively late maturation of the welfare state which was completed under the Kádár regime.4 Already in the 1980s, the expansion of the welfare state however clashed with the need for fiscal austerity, a pattern that would repeat itself in post-socialist Hungary. Fiscal pressures notwithstanding, Hungarian reformers in the early years of transition ushered in an expansion, rather than retrenchment of 9

welfare. They extended the inherited pension and early retirement schemes and family policies, and introduced new unemployment and social assistance programs. Although the new additions were not very generous, overall welfare efforts helped to protect at least parts of the population against the hardship of transformation. Over the 1990s and 2000s, however, welfare state expenditures became an increasing strain on the state budget, and public finances repeatedly spiraled out of control. At the same time, governments found it all but impossible to retrench the welfare state. This is because of two characteristics of the Hungarian party system. On the one hand, the political landscape quickly consolidated into two camps – a socialist-liberal at the center of which stands the communist successor party MSZP; and a nationalist-conservative around the Alliance of the Young Democrats (FIDESZ). As both blocs commanded a relatively equal share of electoral support, competition for votes has become extremely fierce (Enyedi 2006). On the other hand, welfare is an issue that most Hungarians and both parties support. As the two major blocs do not differ much in their position on the welfare state (Rohrschneider and Whitefield 2009), party competition in respect to welfare has often resulted in a politics of outbidding, this way further increasing fiscal pressures. In this context, relying on markets to provide welfare – a possibility in the field of housing - would become a tempting solution to solve political stalemates. Inglot’s analysis does not extend to the Baltic States, and indeed, the politics of welfare states and markets in Estonia have differed starkly. Here, the inherited welfare state fell victim to a triple challenge that post-socialist reformers had to confront – that of new state and nation building, political regime change, and a deep socio-economic crisis. Among these challenges, defending the newly independent state and promoting the status of the titular nation reigned 10

supreme. Estonian reformers sought a sharp break with the socialist past by enthusiastically endorsing the neoliberal ideology of privatization, deregulation, and a lean state. This ideology also extended to the welfare state (Bohle and Greskovits 2013). Radical pro-market reforms aimed at severing all ties with Russia, and signaling to European actors the commitment to market economy and western integration (Abdelal 2002). To signal credibility and lock-in the initial radical reform efforts, policy makers chose to build institutions that would tie their hands. The most consequential institution in this respect was the currency board, an extreme form of fixed exchange rate regime. In theory, currency board regimes rule out the mediating role central banks assume between external and domestic monetary requirements. Under this arrangement, discretionary monetary policy is precluded, central banks cannot offer credits to enterprises and the government, and only in exceptional circumstances are they allowed to lend to banks (Knöbl, Sutt and Zavoico 2002). In practice however, capital flows undermine the constraints of the current account balance, which is how Estonia’s borrowing spree of the 2000s could come about. As governments cannot borrow from the central bank, the currency board regime imposes strict budgetary discipline, thus acting as straightjacket for fiscal and social policies. Indeed, Estonia has run a budget surplus most of the time, and its public debt has consistently been among the lowest in the EU. Its social protection system has developed into one of the most meager in the EU, which can be characterized as a minimal welfare state (Vanhuysse 2009). Despite a substantial increase in inequality, poverty and unemployment especially during the first decade of transformation, neoliberalism and the minimal welfare state have by and large remained uncontested in Estonia. Elsewhere, I have argued that this is because reformers 11

offered a nationalist rather than welfarist social contract to their populations (reference to be added). That is, the goal of national independence was shared by a large majority of the citizens of the new state, who were ready to bring sacrifices to this aim. What they lost in terms of social safety and security, they gained in status and as members of an “imagined community” (Anderson 1991). At the same time, citizenship was initially denied and then only very gradually extended to most of Estonia’s Russian speaking population – close to 30 percent of the country’s residents - who were stronger affected by economic and social hardship, and had little to gain from the nationalist social contract. Not enfranchising the Russian speaking minority silenced a potentially important source of contestation (Pettai and Hallik 2002, Vanhuysse 2009, Bohle and Greskovits 2013). Nationalism and the restriction of citizenship left its mark on the Estonian party system, too. Estonia’s former communist party imploded, leaving the left of the political spectrum vacant. On the left-right dimension, party positions range from third way social democracy to national conservative. The polarization on economic and social issues is low, and no single political party is strongly supportive of the welfare state (Rohrschneider and Whitefield 2009). Furthermore, while the party landscape is fragmented, with multiparty coalition governments being the rule, there is continuity in government and policy making. Importantly, the economic liberal Reform Party has participated in government for all but three years since its foundation in 1994, and has come out strongest twice since 2007. Its influence on policy making has therefore been important. Existing literature on housing privatization and the mortgage boom has mostly focused on the consequences of the transnationalization and deregulation of the financial sector and the pent12

up demand for housing, and paid scant attention to the differences in welfare state traditions and economic and social policy priorities among the countries. Yet, we should assume that those have shaped housing policies, too. In the next section of the paper, I will therefore complement this literature with a focus on politics and policies surrounding the nexus of welfare, markets and housing in Hungary and Estonia.

3. States and markets in the housing boom

3.1 Common beginnings: homeowner-societies without housing markets The East Central European countries inherited relatively encompassing systems of social protection, including pension, sickness, disability and family benefits as well as public health care provision. In addition, governments heavily subsidized consumption of food, housing and energy. These legacies presented a formidable challenge to post-socialist reformers. On the one hand, existing welfare systems had to be adapted to a new set of problems, such as massive unemployment and the emergence of poverty. On the other hand, even more than the advanced capitalist states, the transforming countries faced important financial constraints on their major social programs. Under these pressures, all countries in the region reacted with far-reaching retrenchment and privatization of welfare. Transferring the pre-dominantly public housing stock into private hands was one of the first steps undertaken in this direction. Arguably, it were not only fiscal considerations that led to house privatization, but more broadly, embracing a new market order seemed incompatible with socially owned housing. In Hungary it was the socialist Kádár 13

regime which offered from the second half of the 1980s onwards sitting tenants the ability to buy their flat at favorable prices.5 Privatization took really off after the passing of the 1993 Housing Law which introduced the right to buy (Hegedüs and Szemzö 2010). In Estonia, most of the flats were also privatized to sitting tenants at low prices during the 1990s. In addition, restitution of property played an important role. As a result of privatization, Hungary and Estonia have among the highest owner occupation rates in the OECD. In the early 2000s, 84 percent of Estonian and 90 percent of Hungarian households lived in owner occupied accommodations (Palacin and Shelburne 2005, 6). By 2009, the respective numbers are 94 and 90 percent. This compares to 74 percent in Ireland, 68 in the US, or 40 in Germany (Andrews, Caldera Sánchez and Johansson 2011, 17). Private rental or social housing plays virtually no role in the two post-socialist countries. It is unlikely that social policy considerations played an important role in the privatization of housing. For Hungary, Hegedüs and Szemzö describe housing privatization as a hasty give-away. In Estonia, it was the prevailing neoliberal ideal that prescribed a passive role of the state in housing (Ojamäe 2009, 71). Governments were also not much concerned with reversing the inherited socialist patterns of stratification, “where higher status in the social and political hierarchy guaranteed a larger choice of housing” and “new homeowners acquired property that was heavily differentiated by the condition, location, and thus also market value”(Ojamäe 2009, 57). Thus people living in less favorable locations, and those who could not participate in the privatization (e.g. young people) faced stark disadvantages on the housing market. At the same time, the distribution of housing cross-cut people’s other socioeconomic positions. For example, Estonia’s Russian speaking minority, while without citizenship right, disenfranchised 14

and in highly vulnerable labor market positions, could participate equally in the housing privatization. It might therefore be the case that home ownership, as argued in the context of western societies, acted “as a legitimating factor in generating consent for greater income inequality” (Conley and Gifford 2006, 59). In both countries the high ownership rates were achieved without the institutions and policies that are normally part of a private real estate market. Institutions such as land registries, consumer credit rating agencies, or property appraisal firms were non-existent, and property rights and their enforcement had to be established. Banks were still undergoing transition, too. Estonia experienced a major banking crisis, and its banks were simply unable to offer long-term credits to consumers in the 1990s. In Hungary, despite the fact that the country was a forerunner in privatizing its financial sector to foreign owners, banks were not interested in issuing consumer loans (Rona Tas 2012, 157). At the same time, high unemployment, falling real wages, high inflation and a generally insecure economic environment also made consumers reluctant to borrow. The transformational recession in general, and the shortage of housing finance as well as the withdrawal of the state from providing housing also led to a collapse of residential construction during the 1990s, prolonging the trend of housing shortage inherited from socialism (Hegedüs and Várhegy 2000, Király et. al. 2008, Palacine and Shelburne 2005, Ojamäe 2009). Things started to change in the late 1990s and early 2000s. Arguably the most important change is the deep transnational integration of Hungary’s and Estonia’s financial system. Existing literature converges on the claim that this factor is largely responsible for the rapid credit growth, mortgage lending and the issuing of loans in foreign currencies. Thus, a number 15

of studies have shown that the combination of the region’s catching up with the institutional and regulative standards of a sound financial system, the privatization of the region’s banking sector, and the liberalization of capital movements, all of which were part of EU’s entry requirements allowed the region for a rapid catching up in financial matters (e.g. Enoch and Ötker-Robe 2007; Mitra, Selowsky and Zalduendo 2010; Pistor 2009). In addition, what set the region apart from Western Europe is the foreign ownership of its banking sector. From the early 2000s onwards, in particular Austrian, Italian and Swedish banks moved into the region. In 2005, the asset share of foreign banks was more than 97 percent in Estonia, and more than 82 percent in Hungary. The Estonian market is dominated by Scandinavian banks. The most important player is Swedish Swedbank, which took over the national savings bank and henceforth dominated mortgage lending. In this respect, the Hungarian development differed. Its national savings bank, OTP, has remained a major player in the Hungarian financial system. OTP successfully transformed itself in a private bank which not only kept a major market share at home, but also expanded aggressively abroad. Foreign banks were primarily motivated by the high returns on equity. They also had unique resources at their disposal to develop the East Central European credit markets. On the one hand, they could much more easily tap into foreign sources of credit expansion, usually through borrowing from their parent banks. This is reflected in the increase of foreign liabilities of banks in a large number of countries. On the other hand, they could initiate the development of new market segments, which had not existed prior to their entry. A most outstanding example is that of mortgage lending (e.g. Banai, Király and Várhegyi n.d.; Brixiova, Vartia and Wörgötter 2007). 16

Moreover, the perspective of EMU entry encouraged banks to issue foreign currency loans. In contrast to old EU member states, the new East Central European members did not have the option to opt out of the EMU, and in the early 2000s both Hungary and Estonia started to prepare for a changeover. As interest rates were typically higher in East Central Europe than in the eurozone, informal “euroization” allowed banks to offer loans on more favorable terms, whereas the perspective of an eventual EMU entry seemed to minimize the exchange risks for borrowers. How has state intervention in Hungary and Estonia supported the creation of mortgage and consumer credit markets? Have these two countries differed when it came to controlling banks, and to containing the risks involved – especially with foreign currency lending - for vulnerable households? To answer this question it is important to note that although the privatization of housing was an important step in retrenching the (inherited) welfare state, the degree to which private homeownership exposes households to the vagaries of financial markets depends on governmental interaction with these markets (Schelkle 2012). In this respect, neoliberal Estonia and emergency welfarist Hungary should differ.

3.2 Promoting mortgage lending A first difference in the build-up of the mortgage boom in Hungary and Estonia was that in the former, it was not banks, but a political stalemate around the need of welfare state retrenchment that was at its origin. The 1998 parliamentary elections in Hungary swept a nationalist-conservative government coalition to power, that could thrive on popular dissatisfaction with a major austerity program launched by the socialist predecessor 17

government in 1995. While the “Bokros package” - named after its architect Lájos Bokros - was hugely unpopular, it was however successful in improving Hungary’s external balance as well as its public finances. The FIDESZ-MDF8 coalition government had therefore both a mandate, and the economic room for maneuver to launch a Keynesian inspired economic program. It pursued a number of policies with the aim of boosting domestic output and consumption. Most important for our purpose was a program for generously subsidized housing loans, and grants for young families to build or buy houses. The program allocated substantial resources for interest rate subsidies on long-term mortgage loans and new housing construction. Nominal interest rates were fixed for borrowers, and the difference to market rates was paid as a subsidy to the banks. Initially, this policy only applied to new houses, but subsequently it was expanded to buying and enlarging existing dwellings as well. In addition, people who took a housing loan also received income tax exemption. Thus initial policies in Hungary promoted the formation of mortgage markets, fostered the profitability of banks, and sheltered consumers from changes in the interest rates (Hegedüs 2011, Rózsavölgyi and Kovács 2005, Palacine and Shelburne 2005, 11). The continuous expansion of the program however turned out to be financially unviable (Hegedüs 2011, 119). As the bulk of the fiscal costs related to the program only showed after the 2002 elections, it was now up to the new, socialist-liberal government coalition to find a solution to the problem. In 2003 and 2004 the Medgyessy government cut the tax exemptions for mortgage repayment, and reduced the scope of the housing loan subsidies. It is at this moment that banks stepped in to allow the Hungarian middle class to continue their only

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recently acquired consumer habits by issuing foreign currency loans. As can be seen from figure 1, foreign currency denominated housing loans only started to take off from 2004.

Figure 1 about here

It has to be noted that foreign banks played an important role in getting foreign currency loans off the ground. The domestic player OTP was the main winner of the publicly subsidized housing program. As the former national savings bank, it had a country-wide branch network. When the mortgage market started to develop, OTP set up its own mortgage bank designed to refinance the parent bank’s mortgage loans. OTP’s mortgage bank quickly conquered two thirds of the market share.9 As it had no privileged access to international money markets, it initially opposed the practice of foreign currency lending, but had later to give in to foreign competition (László 2011). In Estonia, public policies have also contributed to promoting the emergence of a mortgage market. Compared to the Hungarian approach, these policies were more aggressive, less concerned with sheltering households from possible risks, and foreign banks played a major role from the beginning on in bringing some of them about. Foreign bank penetration also led to high concentration and steep competition among the major players, which ccelerated the lending boom. The four largest banks account for 97% of the housing loan market (Tamm 2007). More than in other countries, the Estonian tax system is geared towards promoting home ownership (OECD 2009: 83). Already in 1993, an income tax act offered the possibility of 19

deducting interest payments for housing loans interests from taxable income, and exempted gains from selling certain residential properties from taxation. From 2001 onwards, taxes on reinvested profits were abolished, which contributed to real estate investments of enterprises. In 1999, the Mart Laar government followed the proposal of Hansabank to design a credit support scheme. Hansabank was Estonia’s largest universal bank, which also acquired Estonia’s OTP counterpart, the Estonian savings bank. Swedish Swedbank acquired 50 percent of Hansabank shares in 1998, took it fully over in 2005, and turned it into a full member of the Swedberg group. Hansabank also expanded to neighboring countries Latvia and Lithuania (Swedbank no date). The credit scheme adopted by the Laar government and administered by the Credit and Export Guarantee Fund (Kredex) guaranteed parts of the downpayments of loans for young families and for tenants in restituted houses. This way, banks could reduce the required minimum down payments. While this policy was crucial for making access to credits easier, households also became exposed to the risk of overindebtedness. The subsequent deepening of the mortgage market happened on private initiative. Banks reduced the requirements for down payments further, extended the maximum maturity of housing loans, introduced revolving credit cards and home equity loans. These measures made housing loans accessible for lower income households as well, although the share of households in this group that took mortgage loans remained small compared to that of higher income households (Brixiova, Vartia and Wörgötter 2007; Kallakmaa-Kapsta 2007; Lamine 2009, OECD 2009, author’s correspondence with a communication specialist from Swedbank, July 16, 2012). From the beginning on, mortgage loans were predominantly issued in euro (figure 2). 20

Figure 2 about here

3.3 Why foreign currency-lending? Foreign currency lending is risky for banks and even more for consumers. While banks can hedge against their foreign currency exposure, consumers do not have such instruments at their disposal.10 What made banks and consumers take these risks, and how did bankers, governments and regulators perceive them? The straightforward answer is that for all actors involved, foreign currency mortgage lending proved to be so much more lucrative that they neglected the risks. The comparatively lower interest rates associated with foreign currency lending allowed banks to expand the mortgage market, and it made loans affordable for consumers, a development most welcomed by politicians for whom a booming housing market increased chances for their reelection. This straightforward logic however played out differently in Hungary and Estonia. In line with earlier patterns identified, foreign currency loans emerged out of a political stalemate related to financing public welfare in Hungary, whereas in Estonia, it seemed a logical choice very much in line with its pro-market policies and institutions. At the origin of the interest rate differential between HUF and foreign currency loans were contradictory preferences of the Hungarian National Bank (MNB) and the socialist-free democratic government coalition under Péter Medgyessy (2002-2004; see, also for the following Greskovits 2006, Committee … of the Hungarian Parliament 2012). The Medgyessy government which already inherited from its predecessor lax fiscal discipline, added a number of pro-welfare measures to boost the domestic economy which further derailed the country’s 21

fiscal position. To stabilize the forint and force the government to reign in public finances, the MNB raised its interest rates. Conflicts over fiscal and monetary policies also prevented a fast change-over to the euro, initially envisaged for 2006. The government “tried to ease the pain of adjustment to the Maastricht Criteria by making fiscal adjustment conditional on relaxed monetary policy. It argued that lower interest rates, a weaker forint, somewhat higher inflation, and less depressed growth could reduce the magnitude of shocks…and enhance actors’ capacity to gradually adjust” (Greskovits 2006, 184). The MNB, whose governor Zsigmond Járai was Finance Minister in the previous FIDESZ-MDF government before being appointed to the MNB in 2000, insisted however on the opposite sequence, that is he required fiscal tightening before agreeing to a laxer monetary policy. In this he was backed by the major opposition party which, “for political reasons of domestic electoral and party competition… was eager to see the Medgyessy government trapped between unpopular fiscal adjustment and a failure to comply with the macroeconomic convergence criteria” (Greskovits 2006, 185). Eventually, the central bank prevailed. Over the 2000s, the MNB maintained high interest rates. At the same time, successive governments were incapable of reigning in the fiscal debt and deficits. As a result, Hungary not only failed to meet the EMU convergence criteria, but the persistently high interest rates also made borrowing in foreign rather than domestic currency much more attractive (Figure 3).

Figure 3 about here

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According to the findings of a Parliamentary sub-committee established in 2011 to investigate the cause of the foreign exchange debt, the interest rate difference is also what made households borrow in foreign currencies: “The reductions of the subsidy program from 2003 onwards and the abolition of the 6% maximum interest … in the subsidized programs made HUF loans very expensive from one day to the next. The interests of HUF loans grew to 16%. Thus the customers started to choose the FX loans based on their much lower interest rates. They based their decisions only on the differences in interests and did not calculate the long term dangers.” The committee also finds that customers were not sufficiently informed about the risks associated with foreign currency borrowing (Committee … of the Hungarian Parliament 2012). The institutional and political development in Estonia could not have been more different. As noted above, here a currency board arrangement has been backed up by a neoliberal economic philosophy shared by all major political parties and governments throughout the 1990s and the 2000s. The country was also strongly committed to joining the eurozone. After accession to the European Union, Estonia became part of the exchange rate mechanism ERM II. The only obstacle to joining the euro over the 2000s was the persistently high inflation rate. Against this background, it is perhaps not all that surprising that Estonian policy makers and regulators did not consider foreign currency loans as particularly risky. Indeed, in 2009, in the height of the mortgage crisis, the Estonian Central Bank countered criticism from the EU by stating that “given the Estonian currency board system and economic policy goals, the denomination of generally long-term housing loans in euros may be considered natural” (Estonian Central Bank 2009: 34). Indeed, for Estonian regulators, loans in euro were not treated as foreign currency at 23

all. As the currency board was pegged against the euro (and before that, the German mark), euro positions were not taken into account in the calculation of capital requirements on foreign exchange risk (author’s Interview with a representative of the Estonian Financial Supervisory Authority, July 5, 2012). For consumers it is safe to say that they shared the sense of basic security that the currency board protected them against the risk of devaluation. Even financially literate people, who had profited from the slightly lower kroon interest rates in the mid 2000s (see figure 4) saw no problems in converting their kroon mortgages into euros in 2008, when the kroon interest rates were raising again. Arguably, less financially literate borrowers were not even aware that there was a risk involved. Banks did little to explain the risk to their customers, and the repayment schedule for loans was stated in kroons rather than euro (author’s interview with a representative of the Estonian Financial Supervisory Authority, July 5, 2012).

Figure 4 about here

While foreign currency lending was not considered risky, regulators started to get warnings about unsustainable lending from the Swedish Central Bank and other international and national institutions. As early as 2003, the Estonian Central Bank issued warnings to the commercial banks that reminded them “of the need to balance the risks currently posed by overactive consumption, low interest rates and increasing competition in the financial sector”, and in 2005 Prime Minister Ansip warned the population about an imminent bubble (Gunter 2004, Esti Päevaleht 2005). It was however only in 2007 that the Estonian Financial Supervisory 24

Authority (EFSA) started to react by increasing capital requirements on mortgages. Regulators also involved banks in discussions about possible dangers, but intense competition prevented them from changing their lending behavior (Baltic Times 2004, author’s interview with a banker of Nordea Bank, July 4, 2012). What is more surprising is that in Hungary - with its managed rather than fixed exchange rate, its Swiss franc rather than euro loans and its persistent fiscal problems – it took regulators, banks and consumers a very long time to become aware of the exchange rate risk.11 Initially political and economic actors believed that the country would soon enter the eurozone, even if perhaps not as early as 2006, and this would eliminate the exchange risk. According to the Hungarian economist László Csabá, all actors believed they were playing by the rules of a “convergence game” (personnel communication, December 19, 2011). They assumed that in the run-up to the EMU, a convergence of interest rates and a real appreciation of the currency would occur quite naturally. In this perspective, foreign currency loans did not seem risky. It is true that Hungarian banks issued loans mostly in Swiss franc, and regulators were aware of this anomaly. The Hungarian Financial Supervisory Authority however looked into the issue and found that historically, there was little fluctuation in the exchange rate of Swiss franc to the German mark. They thus concluded that there was little risk in Swiss franc lending (personnel communication Péter Mihaly, December 23, 2011). This perception however started to change from 2005 onwards. The Hungarian National Bank, the Financial Supervisory Authority, and the IMF signaled warnings that too much foreign currency exposure might make the country vulnerable. There is also ample evidence that leading politicians of the governing and opposition parties were aware of the risks of foreign 25

currency lending.12 However, according to a testimony of former MNB governor Zsigmond Járai in front of the parliamentary sub-committee, the Gyurcsány and Bajnai administrations, and the Financial Supervisory Authority remained entirely passive in respect to the issue (BBJ 2011). Two factors might explain the passivity of the socialist governments. First, a fast decrease of the government’s popularity after Gyurcsány’s infamous “lie speech” is likely to have made the government reluctant to introduce measures that would have negatively affected people’s material well-being, and further reduced the sources of growth for a country that had already been growing only sluggishly due to its imbalanced macroeconomic policies.13 Second, banks were keen on continuing to lend in foreign currencies, as this carry trade was a very lucrative business for them. Still in May 2008, Péter Felscuti, president of the Hungarian Banking Association, found it unnecessary to limit foreign currency lending. A month later, László Balássy, CEO of Citibank thought it unlikely for the forint exchange rate to fall (László 2011). Banks were also unduly optimistic because they could tap into seemingly limitless sources of liquidity. The same article quotes a manager of one of the Austrian banks in Hungary, who in early 2008 at a training session in Vienna was told by the regional bank manager that “money is plentiful; it just needs to be invested. If the resources of the parent bank are not enough, then we can always raise funds at the interbank markets. There are no problems with investing in Hungary”(László 2011, own translation).

3.3 Summary To sum up, the types of welfare states and party systems did not make much of a difference for housing privatization and the establishment of mortgage markets. In both countries the deep 26

socioeconomic crises at the beginning of the transformation and the commitment to establishing a market economy encouraged governments to privatize housing. To some degree, this could even count as “social policy on display” (Schelkle 2012, 61) as housing privatization counterbalanced vulnerabilities stemming from labor market positions. Governments supported private house ownership and the build-up of mortgage markets with various policies, such as privatization at preferential prices, tax exemptions, and subsidized credits. At the same time, privatization created “market opportunities for financial firms”(ibid), which were aptly exploited by foreign banks, who entered both countries in the run-up to the EU accession. What is more, policy makers in none of the countries were particularly concerned with the risk involved with privatized housing and mortgage finance. Where we see a difference, however, is the magnitude of the lending boom, and the types of risks households had to shoulder. In Estonia, where housing can be considered a replacement for welfare, an unwavering commitment to pro market policies led to a much faster credit growth and induced a housing bubble, too, exposing households to the risks of overindebtedness and negative equity. At the same time, the fixed exchange rate regime and the sound macroeconomic policies it entailed limited the interest rate and exchange rate risks to some degree. In contrast, in Hungary housing is just one – albeit important – element of welfare. Governments’ inability to retrench major social insurance programs made them increasingly willing to rely on markets to provide the necessary resources. This is what happened in respect to mortgage lending. At the same time, the country’s fiscal calamities created major uncertainties in respect to the exchange and interest rates. Thus, Hungarian households, although overall less indebted than their Estonian counterparts, had to face major risks related to the exchange and interest rates. How did the 27

similarities and differences play out in the crisis, informed crisis management and what were the effects for households?

4. Mitigating the risks – emergent welfarist and neoliberal solutions

4. 1 Hungary: from privatization of risks to a new layer of emergency welfare In October 2008, Hungarian currency and stock markets plunged, and credits dried up. In order to boost confidence in the forint and to get access to foreign currency liquidity, the Hungarian government had to turn to the IMF. The crisis affected indebted households particularly negatively, as the forint exchange rate devalued sharply, especially against the Swiss franc with its newly acquired status of a safe haven. According to the IMF, “Debt service for holders of Swiss franc loans has indeed increased sharply….. Seventy percent of CHF debt was incurred at HUF-CHF levels of 145–165 vs current levels of around 240, implying a 60 percent increase due to the weaker exchange rate alone. Furthermore, despite monetary easing in Switzerland, the CHF interest rate burden has not fallen as it has in Poland––the second largest holder of CHF loans––due to weaker consumer protection laws regarding interest rates and higher risk premia” (IMF 2012, 19). According to calculations by the Ministry of National Economy, monthly repayment rates of an average mortgage increased from ca. 40.000 HUF in 2007 to 57.000 HUF by spring 2009, and 65.000 HUF by June 2011 (Committee… of the Hungarian Parliament 2012). Despite this increasingly difficult situation for households, the Gordon Bajnai administration (2009-2010) was not primarily concerned with solving the looming debt crisis of its citizens. Its 28

most urgent tasks, as defined by the IMF stand-by agreement, were to reign in the public debt and deficit, both of which had entirely spiraled out of control. The government took however also some policy measures to mitigate the exchange rate risks of households. Thus in 2009, a bailout plan for individuals with payment difficulties was announced. As the conditions of the program seemed quite restrictive, the number of participants has however been low. The government also addressed another problem that indebted consumers faced, namely bank’s practices to unilaterally change their contracts and pass on their increasing operation costs to the customers. Again, the government chose a quite soft approach, as it asked the banks to voluntarily agree on a code of conduct (Molnár 2010, 16). The government also faced some uncertainty with regards to its highly transnationalized financial system. By 2008, a debate erupted about the exposure of foreign parent banks in the region. By that time, international claims by Austrian Banks in Eastern Europe amounted to 35 percent of Austria’s GDP resulting from cross-border foreign currency lending, and to 70 percent if lending in local currencies by Austrian subsidiaries in East Central European countries are included. The figures for Italian banks are 5 and 10 percent, respectively (Mitra, Selowsky and Zalduendo 2010, 99-100). Once the global financial crisis broke out, and these banks started to have difficulties raising funds, their commitment to Eastern Europe was no longer guaranteed, and it was widely feared that they might withdraw from the region. Moreover, while Western governments rushed to bail out “their” banks, they were not in a hurry to cover these banks huge loan books in the East. In this situation the IMF and EBRD launched the socalled Vienna Initiative, a series of accords signed by several East Central European states with ten major European banks and the IMF to maintain the presence of exposed banks. In the 29

agreements, parent banks committed to support their subsidiaries in the region, roll-over their credits, and capitalize them adequately. In those countries that had stand-by agreements with the IMF, banks made their commitment dependent on host countries’ governments sticking to the IMF backed programs (EBRD 2009, 18; but see the contribution of Epstein in this volume for a critical evaluation of the significance of the Vienna Initiative). In addition, the Hungarian government was forced to bailout its domestic banks. OTP Bank, FHB and the Hungarian Development Bank altogether were provided with government loans of around 700 billion forint (EBRD 2009, 13). With all measures combined, a banking crisis could be avoided. Austerity and economic adjustment carried fruits, foreign banks stayed put, the exchange rate recovered, and people kept borrowing, albeit at a lower level. Things however took a different turn with the coming to power of the FIDESZ government in May 2010. The parliamentary election in spring 2010 gave FIDESZ an unprecedented two third majority in the Parliament. As well known, the government used this stellar victory to radically alter Hungarian political and economic institutions (e.g. Bánkuti, Halmai and Scheppele 2012). One of the cornerstones of Prime Minister Viktor Orbán’s economic program has been his fight for independence from “a world symbolized by banks, multinationals and a bullying IMF” (Oszkó 2012). Right after the Orbán government took office, the IMF suspended bail-out loan talks with Hungary on the grounds that the government failed to give detailed information about its plans for budget consolidation. Soon after, Orbán declared that his government adheres to the agreed budget deficit target, but would find its own ways to do so rather than following those of the IMF and the EU. A senior official in Orbán’s administration announced that “[i]t's an economic freedom fight. We are getting back 30

the financial independence of the country” (quoted at Openeuropeblog, 2010). Among the weapons of the economic freedom fight were special taxes levied on banks, insurance companies and other financial services. These taxes, announced on June 8, 2010 as one of 29 measures to redress the economic situation, were to be levied at 0.5 percent of banks’ assets over 50 billion forint for a period of three years, starting with 2009. The taxes were three times higher than similar ones planned in other European countries (Bloomberg News, 2010). The government stepped up its “unorthodox economic policies” with the proclamation of war against “debt slavery” in autumn 2011. This fight addressed specifically the issue of foreign currency loans in Hungary. Speaking on state radio in October 2011, Orbán “gave the example of a person who owes more than the initial loan after years of repayment. ‘That’s what is called debt slavery,’ he said. ‘I don’t want to live in a country where 1 million people must face debt slavery. I’ll change this.’” (Quoted in Groendahl, Gergely and Schneeweiss 2011). At the core of this fight have been two sets of measures. On the one hand, the government has been looking into legal possibilities to hold former politicians accountable for the accumulation of Hungary’s public and private debt between 2002 and 2010. A parliamentary subcommittee was set up to establish the responsibilities. On the other hand, the government also aimed to alleviate the burdens for households with foreign currency loans. A first step was to introduce a temporary moratorium on the repossession of real estate whose owners were lagging behind with their mortgage payments. This moratorium was several times extended. Until the time of writing, banks are limited to designate only a tiny fraction of homes in their non performing loans (NPL) portfolio for sale. Some of these homes are taken over by the National Asset Manager. In this case, former owners then can stay in their houses as renters. The government also forged an 31

agreement with banks to convert non-performing foreign exchange loans into Hungarian Forint. Another agreement concerned an exchange rate protection scheme, under which foreign currency loans are calculated at a discounted fixed exchange rate. As a consequence of all of these policy measures, the ultimate risk of indebted households to lose their home has been significantly mitigated. Repossessions are limited, the debt burden of many debtors is renegotiated, and evictions happen only in the rarest of cases. In spring 2012, evictions amounted to roughly 0.2% of the total stock of delinquent loans. Banks meanwhile are sitting on more than 100.000 homes in their NPL portfolio (Realdeal 2012a and b, Calmfors et al. 2012). In addition, the government also passed a special piece of legislation for more affluent indebted households. For those who could afford to repay their forex loan by a one-off payment could do so at an exchange rate fixed at 20 percent below market rates. It is banks who had to cover the differences between the discounted exchange rate and the market rate. According to the MNB, by the closing end of the program in February 2012, 24 percent of FX borrowers have participated in the program, using their financial savings, or taking out HUF debt instead. Despite these measures, however, in value terms, the number of outstanding mortgages is now again at the level where it was in 2008, that is all the program was able to do is to compensate for the weakening of the HUF (Portfolio 2012). All in all, the Fidesz government used “emergency power policies” - a term coined by Vanhuysse (2009, 9) to denote the strategic elements in the construction of emergency welfare – to redesign central elements of the Hungarian welfare state in the context of a deep economic and political crisis and arguably also a regime change. Fidesz emergency power 32

policies have revolved around two pillars. First, its overtly nationalistic and anti finance-capital discourse aims at pitting vulnerable households against foreign banks, this way generating support for its interventionist policies among all strata of society even if the most important program came to the rescue of the affluent households rather than the distressed borrowers, who are concentrated in lower income segments (IMF 2011). Second, the government pursues an active reversal of the risk shift by its interventionist policies and its strategy of pushing the costs of the various support schemes on banks rather than tax payers and individuals.14 Also, the establishment of an asset management company can serve the aim of a partial renationalization of home ownership. Arguably, therefore, the recent policies aimed at solving a major mortgage crisis have added another layer of emergency measures to the Hungarian welfare state, which are bound to have longer lasting legacies. At the same time, the policies’ dismal macroeconomic consequences will most likely in some near future call for another round of welfare state retrenchment and privatization of risks.

4. 2 Estonia: the crisis that never was15 In contrast to Hungary, the governments under Prime Minister Andrus Ansip mostly focused on the macroeconomic dimensions of the crisis. Two issues stand out: the defense of the currency board, and a strong commitment to austerity. In addition, in the words of Rainer Kattel and Ringa Raudla, Estonia “outsourced” some of its problems to international actors and the EU (Kattel and Raudla 2012). As indicated above, it was due to Estonia’s currency board that the banks’ foreign currency exposure presented less of a risk to the country. It was therefore crucial for the government to 33

defend the currency board and the pegged exchange rate at all cost. At times, this was not an easy task. Given how hard all Baltic countries were hit by the crisis, it was assumed in a number of international and even some domestic policy circles that devaluation of their currencies was only a matter of time. In 2008, the currency of neighboring country Latvia, which had a similar restrictive exchange rate regime as Estonia, came under strong pressure, and according to a number of sources, members of an IMF delegation were in favor of a devaluation of the lats in order to allow the country restore its competitiveness. The discussions in Latvia set off strong fears of contagion in neighboring Estonia. In the final account, the Latvian government resisted the pressures. In its defense of the lats the government was supported by the EU, the Swedish Central Bank, and Estonian authorities (e.g. Lütz and Kranke forthcoming, Baltic Course, 2009, author’s personnel communication with Rainer Kattel and Wolfgang Drechsler). Instead of external devaluation, which would have put the burden of adjustment on the indebted middle classes and Estonian consumers, the Ansip administration prescribed the country steep austerity, large public and private sector wage cuts and lay-offs and retrenchment of welfare programs. These measures affected disproportionally people depending on social welfare, lower skilled workers, and the manufacturing industry. While among these social groups mortgage borrowing was marginal, they picked up a disproportionately high share of the housing bust (OECD 2009, 89 fn9, Masso and Krillo 2011). Within a single year, Estonia cut its public sector expenses by the equivalent of more than 9 percent of its GDP. Public sector wages declined by 7.6 percent, and average wages by 4.6 percent. The combined effects of a steep recession and austerity hit the population almost unmitigated. Estonian labor markets are flexible – and have become more so during the crisis, 34

as the government decided to only partially implement a new employment contract act which had just been agreed upon in tripartite negotiations prior to the crisis. Within a single year, unemployment increased from 5.5 to almost 14%, and emigration increased significantly. The Estonian welfare state with its meager unemployment benefits and short benefit periods did not offer much in terms of compensation (Masso and Krillo 2011, Kattel and Raudla 2012). Despite the fact that defending the currency peg inflicted a lot of immediate pain on the population, there was little debate about the course of action. This is for a number of reasons. As argued in section 2, the county’s party system is not well suited to bringing about policy alternatives. The currency board was also one of Estonia’s most important symbols of national independence, and in the popular as well as the elites’ minds, it had served the country well. Defending the currency saved the heavily indebted middle class, and transnational banks, both of which would have suffered big losses in case of devaluation. External actors, including the Swedish government and the EU, also expressed their strong interest in the country keeping the peg. Arguably the most important reason was that it allowed the country to solve the problem of its foreign currency exposure by adopting the euro. Indeed, in May 2010, the EU Commission recommended Estonia’s eurozone entry on January 1, 2011. The exit into the euro was not the only instance in which Estonia relied on international rather than domestic actors and institutions to solve its problems. Its currency board arrangement also limited its ability to provide liquidity support to banks. This became an acute problem in the fall of 2008, when worries about Swedbank’s exposure to the Baltic economies spilled back to Estonia, resulting in a deposit outflow. As the problem case was a foreign-owned bank however, providing liquidity and bailing out the banks could conveniently be “outsourced” to 35

the Swedish Central Bank, which had to take out a loan from the European Central Bank to help its banks (Kattel and Raudla 2012). The exit into the eurozone did much to eliminate two major risks for the indebted Estonian population – that of higher and volatile interest rates and that of a change in the exchange rate. Interest rates in fact decreased, alleviating the debt burden of households. The government and banks also tackled the issue of NPLs. In an act from November 2010, the government introduced a new individual debt restructuring procedure, which provided an alternative for overindebted individuals to declaring personal bankruptcy. Whereas the existing bankruptcy regime came with very harsh and inflexible conditions, the new procedure makes it possible for individuals to negotiate an in increase in the deadline for repaying the debt, a payment in installments, or reduction of obligations. A few months later, the government also legislated in support of out of court restructuring of individual debt (OECD 2011, Liu and Rosenberg 2013). Banks also did theirs to help debt restructuring. Thus, for instance Swedbank reacted to the crisis by creating a team of specialists on overdue loans (author’s correspondence with a communication specialist at Swedbank). The major Estonian banks also wrote off a significant number of bad loans. All these measures are likely to have made the life of indebted individuals easier. NPL decreased since 2008, but on the other hand, foreclosures have been on the rise ever since 2007, with 1300 people losing their real estate in 2012, a 56% rise from 2011 (Postimees 2013). Overall, incumbent Estonian government relied primarily on a market based approach to cope with the fallout of the crisis. Although the housing boom and bust stood at the center of the Estonian crisis, few policy measures have directly targeted issues of privatized housing, the 36

mortgage credit boom or the risks of overindebtedness. Instead, austerity policies which allowed the exit into the eurozone took care of much of the risk.

5. Discussion and extension of the argument This being an explorative study, this section extends the findings to the other East Central European OECD countries – that is the Czech and Slovak Republics, Poland and Slovenia - to see whether a more general argument on the interplay between transnational finance, welfare states, politics and the privatization of risks can be made. My first finding is that despite the fact that Hungary and Estonia have different welfare state traditions and social policy preferences, both countries went through a similar process of fast privatization of housing and of mortgage lending booms. This suggests – very much in line with existing literature – that common factors such as fiscal pressures and a commitment to introducing a market economy at the beginning of the transformation, and the thorough transnationalization of the financial system in the runup to the EU accession explain much of this outcome. A quick glance through the region confirms this. With the exception of the Czech Republic, all East Central European OECD countries have a very high share of homeownership (Andrews, Caldera Sánchez and Johansson 2011, 17). According to Palacine and Shelburne (2005, 6), however, the Czech Republic “has a de facto high rate of homeownership, as cooperative members have transfer rights equivalent to homeowners.” It is particular interesting to note that Slovenia, a country with a significant welfare state legacy and ruled by left wing governments throughout the 1990s and the early noughties has among the highest homeownership in the region. Household and mortgage lending booms also occurred in all countries. In the Czech Republic, Slovakia and Poland, credit to households grew 26 and 28 % annually between 2003-08, and 37

between two to three times faster than the rate of credit growth to corporations (Mitra, Selowski and Zalduendo 2010, 50). These rates are comparable to the Hungarian, and significantly lower than the Estonian, indicating that in countries with a welfarist commitment lending booms are less spectacular than in neoliberal countries. An interesting difference can be observed between the Slovene credit boom and that of the rest. In Slovenia, credit expansion was driven by corporate rather than mortgage lending. While there was a construction boom, too, this was triggered by investment in public infrastructure (European Commission 2012, 16). The similarities of rapid credit growth and the difference in lending patterns between Slovenia and the rest of East Central Europe prompts two suggestions. First, all financial systems in the region profited from the combination of the economic catching up process with the liberalization of capital movements, and convergence with the institutional and regulative standards of the European financial system during a time when global credit was abundant. Second, the divergent lending pattern might be due to the ownership structure of Slovenia’s banks. As Slovenia is the only country in the region that kept a largely domestically owned banking sector, lending to corporations continued to play a major role. In contrast, foreign banks were mostly drawn to the region because of high returns, and housing and consumer lending was a most profitable market segment. This could further imply that foreign bank ownership – as well as a high penetration of FDI in the productive sector - is likely to be much less conducive to the emergence of a bank based financial system than a domestically controlled bank and productive sector. Second, I found that welfare state legacies and domestic politics, most importantly the nature of party competition, mattered for the concrete risks that were shifted onto house owners, and 38

for crisis management. Through an extension of this argument to the other countries, this finding can be put into sharper relief. What is interesting to note that none of the other East Central European countries have exposed their populations to so big risks as Hungary and Estonia. For instance, in the Czech Republic mortgage lending occurred at fixed rather than variable interest rates, and equity withdrawal was impossible. The Czech Republic also was the only country where foreign currency lending never took off. In Slovakia and Slovenia, foreign currency lending mattered in the early years of the boom, but the exchange rate risk was eliminated by these countries switchover to the euro. In Poland, foreign currency lending played an important role, but never took the gigantic proportions of Hungary or Estonia. If that observation is correct, then it suggests that we need to disentangle further the relative significance of welfare tradition and party competition in the risk shift. While all East Central European OECD countries bar Estonia share an (emergency) welfare state legacy kept by and large intact also during post communism, party competition over welfare differs. As shown by Kitschelt et al (1999, see also Makszin 2010), it is only in Hungary that the major parties do not differ from each other in their position on welfare. Competition therefore results in a politics of outbidding, where it becomes suicidal for any party to retrench welfare. This has dire macroeconomic consequences, which could only be bridged by relying increasingly on markets and shifting major risks onto the population. In contrast, in the other countries, parties have distinct socio-economic positions. Arguably, party competition is therefore better able to keep welfare, fiscal and monetary excesses at bay.16 This claim can be supported by the example of the Czech Republic, where prudent monetary and fiscal policies have allowed for low domestic interest rates, which made foreign currency borrowing simply unattractive. In 39

Slovenia, where foreign currency borrowing played a significant role, the corporatist system – unique in the region – allowed to deliver fiscal restraint, predictable monetary policy, and ultimately EMU entry. In Slovakia, the same result came about by a right-wing government retrenching welfare, this way paving the way for EMU entry.

6. Conclusion This paper has analyzed the risk shift that has taken place through the privatization of home ownership, which has exposed households to the uncertainties stemming from an increasingly deregulated financial market in two East European countries, Hungary and Estonia. I also extended the core findings to other countries in the region to see whether a more general argument on the interplay between transnational finance, welfare states, politics and the privatization of risks can be made. This has allowed me to identify three paths of risk shifting in East European housing and mortgage markets. While fiscal problems and the “Europeanization” of the financial systems have led to high house ownership and mortgage booms everywhere, the risk associated with this have been mediated by the existence of welfarist concerns, and the nature of party competition. In Estonia, where policy makers enthusiastically endorsed the neoliberal ideology of privatization, deregulation, and a limited role of the state, and where the party system and major institutions were geared towards locking the neoliberal path in, governments have exposed the population to major risks associated with the magnitude of the lending boom, danger of overindebtedness, and foreign currency borrowing. Once credit markets dried up, adjustment to the new situation happened almost unmitigated. The government stepped up its neoliberal policies to save the banking 40

sector and protect the euro-indebted middle class. It pursued policies of internal devaluation, prescribed economic hardship which mostly affected poorer, public welfare dependent and unskilled strata of the population; and outsourced parts of the problem solving to European actors. In Hungary a risk shift of similar proportion has taken place for different reasons. Here, it is the specific combination of an emergency welfarist legacy and a highly destructive form of party competition which can explain the risk shift. Hungary’s politics of outbidding has led to a severe derailment of public finances, and repeatedly led governments to clash with the central bank. Against this background relying on markets and shifting risks to the population has been the way out. After the outbreak of the crisis, we however see a return to the country’s emergency welfarist orientation. The current government strongly interferes in exchange rate management, debt restructuring and tries to push the costs towards (foreign) market actors. While these interventions might have been helpful in the short run, their dire macroeconomic effects are likely to unclench another round of risk shifting in the long run. The paper thus has dealt with two extreme paths towards risk shifting. The extension of the argument suggests that those countries with welfarist legacies and party systems that are polarized on socio-economic issues have also been able to generate welfare and prudent fiscal and monetary policies simultaneously. It is these countries that have exposed their populations to a comparatively minor risk shift only. Clearly, more research is needed to establish whether this is the causal mechanism at work indeed. All in all, the findings of this paper however support arguments developed in similar research for Western countries – whereas the risk shift is ubiquitous, and strongly linked the deregulation of finance, welfare states, partisan politics 41

and public policies matter for the distribution of social hardship and for mitigating the damages caused by the global financial crisis.

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Appendix: Tables and Figures

Table 1: Growth and composition of household lending in Hungary and Estonia Average

Ratios

of

Share

growth of

lending

to

credits to

Share of forex

Household

Nominal

Mortgage

housing loans

loans

within

debt/GDP

growth of

loans with

households to

in

the

banks’

(%)

house

adjustable

household

lending

household

household

prices

interest

(annually,

households

lending (%)

loans (%)

(annual

rates

%)

and

growth in

(% of all

Corporations

%)

housing

to

of

total

(%) (2003-

2003

loans) 2008

2003

2008

2003

2008

2008

2008)

2002-

2006

2006

Hungary 21

35

49

64

51

5.0

70.2

29

11.9

74

39

45

51

78

81

66.6

82.4

48.9

36.4

70

Estonia

Sources: Column 1 and 2 Mitra, Selowsky and Zalduendo (2010, 50); Column 3 and 4 National Bank of Hungary (2009, figure 2/17), Column 5 Tiongson et al. (2010, 25); Column 6 Égert and Mihaljek (2007, 4); Colum 7 row 1: Lamine (2009, 3); row 2: Tiongson et al. (2010, 29).

Table 2: Indicators of household vulnerabilities in the wake of the crisis (2009) Household

Default

debt

Rate

(%

Exchange rate Household interest burden

of

income)

income) 71

Foreclosures

house

and

(% of disposable prices

disposable

Hungary

Nominal

forced

sales

(annual % change)

7.6

Floating

4

- 6.3

71.683* 663 (0.1% of mortgages)

Estonia

105

4

Fixed

4

-35.9

1329 869 (0.5% of mortgages)

* Most likely, this number refers to the number of renegotiated foreclosures. See OECD 2010: 97 Colum 1: Debt of households and non-profit institutions serving households, as % of gross disposable income. Source: OECD 2013, p. 73. Column 2 Outstanding Residential mortgage loans in default to the total volume of outstanding mortgage loans Dec. 2009. Source: European Commission 2011, p. 13. Column 3 data for Hungary Calmfors et al. 2011, Colum 4: Data for Hungary OECD 2010: 86, for Estonia Estonian Central Bank 2012, p. 23, Colum 5 EMF 2012, p. 87. Colum 6 European Commission 2011, p. 15. Calculation of forced sales for Hungary based on mortgage data of the Hungarian National Bank, for Estonia based on mortgage data of OECD (2011).

54

Figure 1: Housing loans in foreign currency (Hungary)

Source: Molnár (2010: 10)

Figure 2: Estonia: New housing loans by currency

Source: Estonian Central Bank (2009: 34)

55

Figure 3: Hungary: Interest rates on forint and fx housing loans

Source: Molnár (2010: 11)

Figure 4: Estonia Interest rates on kroon and euro housing loans

Source: Estonian Central Bank (2009: 35).

56

2

Until November 2011, it depreciated even 66% relative to the Swiss franc. Since then, the forint has rallied

somewhat, but the exchange rate has been very volatile. 3

The Visegrád countries are Hungary, Poland, and the Czech and Slovak Republics

4

János Kádár was communist leader and General Secretary of the Hungarian Socialist Workers' Party from 1956

until 1988. 5

While housing could be purchased as early as 1969 in Hungary, many restrictions made it unattractive to do so

(Hegedüs and Szemzö 2010). 8

MDF (Hungarian Democratic Forum) was FIDESZ junior partner.

9

In Hungary, the role of commercial and other special banks are distinct. Mortgage banks underlie strict control,

but they also have access to special privileges. There are three mortgage banks: OTP Jelzálogbank, then FHB which was set up by the government, and the Unicredit mortgage bank (Molnár 2010: 14-17). 10

For Hungary, a study finds that: “Between 2001 and 2007, households’ exchange rate exposure changed by

almost 10% of GDP, as they assumed the majority of the foreign exchange exposure arising from the growth in external debt. In fact, they are the real foreign currency risk-takers.”(Király et al. 2008, 230). 11

From 2001 - 2008, Hungary pegged its currency with a flexible band to the euro. After that, it turned to a floating

exchange rate regime. 12

For instance, while Prime Minister Férenc Gyurcsány already back in 2005 issued a warning on his blog that it

would not be good if foreign currency lending increased because of the exchange risk attached to it, opposition leader Viktor Orbán announced in the public TV in 2006 that while it is true that there are risks attached to foreign currency lending, he thinks this should not be of concern for the government, as it was a decision made by the Hungarian people (Free Hungary 2011). 13

This interpretation is offered by the parliamentary subcommittee on the causes of indebtedness (Committee… of

the Hungarian Parliament 2012).

57

14

It is interesting to see that after transnational banks, Orbán has now declared war on transnational energy

providers. In January 2013, his cabinet implemented a 10% reduction in energy prices. When a court revoked part of this bill, Orbán declared that he has no intention whatsover to accept this “scandalous ruling”. It is probably not by chance that the government focuses on energy prices. According to a recent study by Tarki (2011), households are much more likely to be in arrears with the payment of utility bills than with mortgages. 15

I borrow this title from Kattel and Raudla (2012).

16

This argument runs somewhat against the influential thesis of Timothy Frye that party polarization on the left-

right space hinders economic reforms (Frye 2011). Further research is needed to establish whether my argument indeed holds in the area of macroeconomic and welfare policies.

58