Way to survive in Denmark - 1

"Too big to fail".

"Too big to fail" is the expression that is connected to US financial crisis.

In 2010 Federal Reserve Chair Ben Bernanke introduced the term and defined is "A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences

 

He continued that: "Governments provide support to too-big-to-fail firms in a crisis not out of favouritism or particular concern for the management, owners, or creditors of the firm, but because they recognize that the consequences for the broader economy of allowing a disorderly failure greatly outweigh the costs of avoiding the failure in some way. Common means of avoiding failure include facilitating a merger, providing credit, or injecting government capital, all of which protect at least some creditors who otherwise would have suffered losses...If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved."

"Interest-only loan"

In 2003 a new form of loan was introduced in Denmark, an interest-only loan. And interest-only loan is a loan in which, for a set term, typically 10 years, the borrower pays only the interest on the principal balance, with the principal balance unchanged.

While buying a property in Denmark the common practice is to get a loan over 30 years. The loan is usually 80% of the total price of the property and it is expected to have 20% in cash. Many do not posses such an amount so there comes the bank loan on a much higher interest rate. While introducing an interest-only loan, the intentions were absolutely right. To allow, especially the new buyers to take the loan, save up the money from the principal balance and use them to repay the more expensive loan, such as bank loan and the, after the set term had ended, start paying a higher rate than normal because you now effectively have a 20 year regular mortgage.

But... what did really happen?

"Luxury trap"

The idea behind an interest-only loan is absolutely great and the intentions were right. But what did consumers really do with that money? Statistics has shown the consumption of flat-screen television, stereo, cars, vacations, steaks had increased dramatically. So why is that?

Back in Denmark, one of the shows that I absolutely loved watching was "Luxury trap". Not only because this show made me feel good (which I will not deny, it did) but also I tried to understand why and how people get into the bankruptcy situation and how to avoid the same fate.

But the major theme from one program to the other was the "misunderstanding" of the concept of the loans. Of course, if you get that kind of the advice

"Misunderstanding"?

"Misunderstanding"? The human nature is to consume and not safe. So what happens when people get more money between their hands? They start using them... I doubt that people were actually looking that far ahead and planning to pay all those borrowed money back.

And then I thought.... Wait a minute, what will happen if a critical mass of people in Denmark will get into the same situation of being on the edge of bankruptcy?

The social-democratic government will never allow the country to fail! In the beginning of the 21 century a major reforms on unemployment have been done and a stable economic development has been initiated.

So if a critical mass of people will get into trouble the government will kick in.

2014 will be an interesting year. This is the year were the first 10 year rate-only loans will end and I expect a massive change in a mortgage / bank systems. And I am sure social-democratic government will kick in one way or the other and save the day.

Unless... there is "Dancing with the stars" on the blue screens.