The Effect of a Financial Crisis on Household Finances: A Case Study of Iceland's Financial Crisis

Iceland experienced a financial crisis in 2008-2009 when its banking system collapsed, the currency lost half its value, most businesses became technically insolvent, house prices fell, and household debt increased due to indexation to foreign currencies or the price level. This paper tells the story of the crisis and maps the losses to households using a dataset from tax returns that includes all taxpayers in the country and contains the value of housing, mortgage debt, disposable income, and net worth. For relative losses in net worth, the results show that families with children, especially those with parents aged between 24 and 45 years, suffered the largest proportional losses in net worth. The losses were also greater in urban areas. The fall in net worth, measured in local currency, correlated with income and education level as well as the number of children and the urban area. Real disposable income fell by one third or more for a large fraction of the population, causing a further increase in the burden of debt, which increased most for the high-income groups before falling due to rising income and mortgage relief. Urban areas, where banks are located, experienced a boom-bust cycle, while the rural areas experienced this cycle to a much lesser extent. We find that net worth took many years to recover but that by 2019, net worth had recovered for all age groups.