How the rise of the Swiss franc could destabilize Europe
My breakfast companion looked gloomy.
He’d flown into Washington from Vienna the day before. When he deplaned, he found a shocking email waiting for him: a demand from his banker for immediate payment of €12,000. Although a resident of Austria, he had taken a home mortgage in Swiss francs, which carried a lower interest rate than mortgages in euros. But 48 hours before he had arrived in the United States, the Swiss franc had surged by 20 percent against the euro. That currency appreciation had wiped out his equity in the house. His frightened banker wanted a new infusion of cash to replace the vanished equity.
In the second half of January, hundreds of thousands of homeowners across Europe—and especially across Central and Eastern Europe—have been jolted in similar ways. Their distress is contributing to a political and financial crisis in a region already shadowed by economic anxiety and Russian aggression.
First, some background: In small European countries, especially those that don’t use the euro, local banking markets are not very competitive and often dominated by foreign banks. These foreign banks, which typically borrow in euros, worry about the risk of lending in the local currency. If that currency depreciates, the lending bank could suffer severe losses. Bankers being bankers, they look instead for ways to offload that currency risk onto their customers.
Enter mortgages denominated in Swiss francs. Interest rates in Switzerland have historically ranked among the lowest in the world. (You can get a Swiss mortgage today for a fixed rate as low as 1.5 percent .) During the real-estate bubble of 2005-2007, mortgage rates in Central and Eastern Europe could cost in the double digits. Many homeowners were tempted to borrow in Swiss francs instead.
Europe’s austerity moments is ended
The temptation was especially acute because it was invisible. As a paper published by the Swiss central bank explained, Swiss-franc mortgages “rarely involve cash flows in Swiss francs. All loans are disbursed and all installments are paid in [local currency]. It is merely the value of the installments due and the value of the outstanding loan which are indexed to the [Swiss franc].” Typically, the lending institution was not a Swiss bank either, but the same retail bank where the customer made deposits and wrote checks. The loans looked extra cheap because local currencies in Central and Eastern Europe were gaining value during the real-estate bubble, as investors anticipated Poland and Hungary joining the eurozone in short order.
In those years, cheap Swiss-denominated debt spread across Europe. In Western Europe, however, franc borrowers were concentrated in the business and financial sectors, where (one hopes) they understood the risks they were incurring—and could, if they wished, hedge against them. In Central and Eastern Europe, however, Swiss debt flowed into the household sector: Roughly go percent of all Swiss-franc debt in Poland was loaned to households.
Altogether about 566000 Polish households, 150000 romanian households, and 60000 Cro households bought Swiss-franc mortgages. Most astonishing of all was the Hungarian case: half of all households in Hungary contracted foreign-currency debt, almost always in the form of Swiss francs.
Foreign-currency mortgage holders suffered badly during the financial crisis of 2008. In a crisis, investors turn to the familiar and the seemingly secure—and few financial assets on earth are as familiar and secure as the Swiss franc. The value of Central and Eastern European currencies relative to the franc tumbled, as the monthly payments on mortgages linked to the franc proportionally spiked. Governments desperately scrambled to relieve debtors. Poland banned new Swiss-franc lending; Hungary experimented with postponing interest payments and adding them to the principal ultimately due.
Then, in 2011, an unexpected respite arrived. The euro crisis of 2010 presented Switzerland with a nasty dilemma. The same search for safety that devalued the Polish zloty and Hungarian forint in 2008 now devalued the euro against the franc, sending the cost of doing business in Switzerland soaring. In 2011, the European Union’s statistical agency rated Switzerland’s consumer costs as the continent’s highest. Swiss exporters and service providers were in danger of being priced out of business. Responding to their complaints, the Swiss central bank pegged the franc against the euro in September 2011 at a rate of 1.2 francs to the euro.
Currency pegs usually end badly, but that’s because countries typically peg in the face of downward pressure on their currency: a central bank says that one Ruritanian dinar is worth one U.S. dollar, the markets test that claim by selling dinars back in exchange for dollars, and the Ruritanian central bank eventually runs out of dollars and has to give up. But the situation is very different when a central bank is pegging against upward pressure. If the markets think the Swiss franc is worth more than 1.2 to the euro, they’ll keep selling euros to buy Swiss francs. The Swiss central bank, in turn, will never run out of Swiss francs. There seemed every reason to believe that the Swiss franc-euro peg would hold forever—or, at least, for as long as Geneva hotel owners wished to remain in the international conference business.
Everywhere in Europe, traditional modes of leadership and established institutions are unraveling.
Then, without warning, Switzerland changed its mind. On January 15, 2015, the Swiss central bankended the peg—and the franc almost instantly rocketed up 20 percent against the euro, and even more against the currencies of Central and Eastern Europe. Imagine having your mortgage indexed to the price of gasoline during a gas-price spike, and you’ll have some idea of the shock that greeted people like my breakfast companion.
It’s not clear exactly why Switzerland did this. (The most plausible theory is that as the euro declined against the dollar, Americans with money in Swiss accounts began to complain that their investments were being devalued.) Whatever the motive, what matters here are the consequences for Central and Eastern Europe: an even deeper plunge into a mortgage crisis, and further destabilization of already troubled democracies.
Croatia has announced that it will peg its currency, the kuna, to the Swiss franc for a year to protect mortgage holders. It’s a desperate measure, one that could cost Croatia at least 30 percent of its currency reserves as skeptical investors sell kuna to buy francs. Arguably even more dangerously, if the peg to the franc does somehow hold, and if the franc continues to rise against the euro, Croatian goods and services could seem more and more expensive to German, French, and Italian customers. But Croatia’s already unpopular Social Democratic government is terrified, and terrified politicians make reckless decisions. The Romanian parliament is debating a similar move. Poland’s populist Law and Justice party is demanded that the government freeze Polish Swiss-franc mortgages at the January 14 exchange rate, but the government is hesitating to go that far. Instead, it’s trying to negociate a “pain-sharing” agreement with national banks and threatening them with “social pressure” if they do not comply.
Ominously, one regional government has gained a huge boost of prestige as a result of the crisis: Viktor Orban’s in Hungary. After all its other debt-relief measures failed, Orban’s regime in the fall of 2014 ordered all mortgage lenders in Hungary to convert their Swiss-franc loans into Hungarian forints. This high-handed measure imposed heavy losses on the banks, which Orban shrugged off. Hungary’s banking sector is heavily foreign-owned, and the ultra-nationalist leader has little sympathy for foreign business, especially financial business. Orban’s central bank chief sent a blunt message to the Austrian, Italian, and Belgian banks that dominate the local market: We have too many banks here anyway. Orban explicitly rejects the idea of “liberal democracy,” identifying Russia, Turkey, and China as more successful models for ambitious nations. After the events of January, his example may look more creditable to Europeans in search of escape from seemingly unending financial and economic crisis.
Everywhere in Europe, traditional modes of leadership and established institutions are unraveling. Last weekend, Greece elected a government that rejects EU-imposed austerity (a neo-Nazi party finished third). Marine Le Pen of the far-right, anti-EU National Front leads the polls in French presidential matchups. If the polls are accurate, almost half of all Italian voters support parties that are skeptical of or outright opposed to the European Union.
The last thing Europe needs is one more shove toward the ideological extremes. But thanks to its mortgage bankers, and the unintended consequences of Swiss monetary policy, it may have just received another.
