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Scandinavian Debt Crisis Waiting to Happen Puzzles Krugman

By Peter Levring
January 14, 2014 6:50 AM EST 82 Comments
Nobel Prize-winning Economist Paul Krugman.
Photographer: Scott Eells/Bloomberg
Nobel Prize-winning Economist Paul Krugman.

Scandinavia, which attracted investors during Europe’s sovereign debt crisis, is now coming under international scrutiny on concern that record household debt levels from Denmark to Sweden aren’t sustainable.

“You wonder if that’s a crisis waiting to happen,” Nobel Laureate Paul Krugman said in a Jan. 9 interview in Copenhagen. “I’m not sure, but it’s nervous-making.”

Sweden and Denmark boast public debt loads that are less than half the euro-zone average. Norway’s $820 billion sovereign wealth fund means its government has no net debt. Yet in all three nations, stable AAA ratings have driven down borrowing costs and fed consumer borrowing sprees that the International Monetary Fund and Organization for Economic Cooperation and Development argue pose a threat to stability.

“You’d think that if you survived the financial crisis without major damage you’re okay, but you’re not,” Krugman said.

In Denmark, consumers owe their creditors 321 percent of disposable incomes, a world record that the Paris-based OECD said in November demands a policy response. In Sweden, debt by that measure is close to 180 percent, a level the government and central bank say can’t be allowed to rise. Norway’s central bank has struggled to find a policy mix that addresses its 200 percent private debt burden.

Savings Buffer

Household debts in Scandinavia are backed by pension savings and home equity, a buffer policy makers argue mitigates the risks. Yet Krugman cautions against relying too much on such assets to balance borrowing.

“Pensions are problematic,” he said. “You can make excuses, let’s put it that way.” The region has no choice but to cut its consumer debt load to reduce risk, he said.

Scandinavia’s plight underlines the distortions spurred by lax monetary policies in Washington and Frankfurt which have anchored borrowing rates across much of the rest of the globe. For the world’s richest economies, the mix has wreaked havoc with their credit and real estate markets.

“There’s a whole class of countries -- Canada is in the same boat -- that have stable banking systems and managed to avoid the worst of the financial crisis,” Krugman said. “But now in the global low-interest environment, they’ve seen house prices rising, even as they were falling in the U.S., and have high levels of household debt.”

Housing Bubbles

All three Scandinavian nations have grappled with overheated housing markets since the global financial crisis started more than half a decade ago. In Denmark, a property boom that peaked in 2007 burst a year later. In Norway, the housing market is showing signs of deflating after prices doubled over the past decade. In Sweden, apartment prices have almost tripled nationwide since 2002, while house prices have more than doubled and are still rising.

“You look at high debt ratios and high house prices in the Nordic area and people say ‘well, that’s different from high house prices elsewhere,’” Krugman said. “It’s a warning phrase. When you hear that, you should get very worried.”

So far investors aren’t. Credit default swaps on debt sold out of the Nordic region are the lowest in the world, signaling creditors and derivative traders see negligible risks on debt repayment, according to data compiled by Bloomberg.

Borrowing Curbs

Gross domestic product in all three nations will exceed the average for both the 18-member euro area and the 28-nation European Union this year, the European Commission said in November.

Denmark, where the central bank estimates indebtedness is hurting household demand, growth will be slowest at 1.7 percent, versus 2.8 percent in Sweden. The mainland economy of Norway, which is outside the EU, will expand 3 percent, the OECD estimates.

Danish consumers are still “hard hit” by the financial crisis and there isn’t much “convincing evidence” suggesting that will change this year, Peter Bojsen Jakobsen, an economist at Sydbank A/S, said today in a note.

According to Andreas Hakansson, an analyst at Exane BNP Paribas in Stockholm, “there is a real need for deleveraging in Denmark.” And as consumers cut back, “bank earnings and GDP will grow slowly over the next few years, which is the main reason for our cautious view on Danish banks,” he said today in an e-mail.

Lending Crackdown

While authorities in Norway and Sweden are exploring ways to limit borrowing, Denmark’s central bank Governor Lars Rohde and Finance Minister Bjarne Corydon said last week indebtedness isn’t a threat because households can tap pensions and home equity if they get into trouble. The savings are equivalent to almost 1 1/2 times gross domestic product, central bank data show.

Still, the Financial Supervisory Authority in Copenhagen is considering measures to crack down on mortgage lending policies in an effort to tackle record debt levels, Ulrik Noedgaard, director general at the watchdog, said in an interview.

Rohde, whose mandate requires him to adjust interest rates to defend the krone’s peg to the euro, said households can survive a sudden jump in borrowing costs thanks to their high savings rates. In Norway, Prime Minister Erna Solberg said in an interview last week the economy can withstand a decline in its housing market, which she predicted won’t be “very large.”

Though the central banks of Norway and Sweden, which both have independent monetary regimes, have said debt burdens in isolation warrant higher rates, Krugman argues that tightening at this point in the economic cycle would do more harm than good.

“I would not raise interest rates. The question is what other avenues are there: financial regulation? This is a really bad time to do it.” Krugman said. “It’s a dilemma and I don’t have the answer.”

To contact the reporter on this story: Peter Levring in Copenhagen at plevring1@bloomberg.net

To contact the editor responsible for this story: Jonas Bergman at jbergman@bloomberg.net

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