Borrowers in Hungary Learn Tough Lessons

Viktor Orban, the Hungarian prime minister, last month.

For many people in Central and Eastern Europe, a new experience began a quarter-century ago. Communist governments collapsed, and the wide world of private ownership, democracy and free markets opened up suddenly.

It was not always a happy transition. This month, even as Germans were celebrating the anniversary of the fall of the Berlin Wall, the Hungarian government was passing laws and issuing edicts aimed at helping a large proportion of the populace recover from the mistake of buying houses with loans denominated in Swiss francs.

The story of how Hungarians wound up deeply in debt in Swiss francs — a currency many of them had never possessed and none of them earned at their jobs — is partly a story of European overconfidence during the boom that preceded the credit crisis. But it is also a story of how poor regulation of banks can be disastrous — at first for the customers and then for the banks.

The fascination with borrowing in foreign currencies spread through several countries in Central and Eastern Europe early in the current century. The benefits were obvious: Because interest rates in other currencies were much lower than those in local currencies, monthly payments on a mortgage denominated in euros or Swiss francs would be lower.

The risks were also clear: If the local currency fell relative to the foreign currency, monthly payments would rise, perhaps precipitously.

But at the time, that risk seemed manageable. Capital was flowing into the countries as they joined the European Union and began preparations to adopt the euro. Local currencies were strong and were expected to remain so.

Hungarians were perhaps the most eager to borrow in foreign currency, particularly after the government cut back on a previous program to subsidize mortgage loans made in the local currency, the forint.

Credit...Akos Stiller for The New York Times

“Starting in 2004, people forgot the government-backed mortgages,” said Zoltan Torok, an economist for the Hungarian unit of Raiffeisen, an Austrian bank.

The government says half the households in the country ended up with foreign currency loans. And the situation was made worse by a lack of effective bank regulation. That enabled the banks to make a lot of money — until the disaster left them weak and the public furious.

Some of the loans were denominated in euros, which seemed to make sense at the time because it was widely — but wrongly — expected that Hungary would switch to the euro by 2009, five years after it joined the European Union. So someone who took out a 25-year mortgage in euros would have currency risk for only a few years.

But most of the loans were denominated in Swiss francs, simply because interest rates — and therefore initial monthly payments — were lower. When the Swiss franc appreciated relative to the euro after the financial crisis began in 2008, those borrowers were in even more trouble than those who borrowed in euros.

In nearby Poland, the government imposed some regulations. Foreign currency borrowers had to be better off than many borrowers and therefore better able to withstand the risk. The banks were limited in their discretion in choosing exchange rates and had to follow market interest rates in making adjustments — something that has helped tremendously. Polish borrowers have still suffered, but nothing like those in Hungary.

There, it turned out, only the banks were paying close attention to the details of the loan agreements people were signing. They gave the banks considerable discretion in determining the exchange rates they would follow and the interest rates that would be charged. The banks used that discretion to their own benefit.

Viktor Orban, the populist who has been Hungary’s prime minister since 2010, has tried a variety of measures to reduce the pain for the borrowers, including a moratorium on evictions of destitute homeowners and a scheme that reduced monthly payments but increased the amount owed. The government has imposed taxes on banks based on their assets, not their profits, of which there are not many.

The authoritarian tendencies of the Orban government have drawn criticism in other European capitals, but its promise to hold the banks accountable has not hurt its popularity at home.

In July, the government ordered the banks to pay compensation to borrowers who had been damaged by what the government viewed as unfair contracts. This week, Hungary’s constitutional court upheld that law, saying that fairness was always required, meaning the new law did not amount to retroactive legislation. The payments are expected to be made early in 2015.

“The amount the banks will have to pay back could be as much as 900 billion forints,” said Yves Lemay, the managing director of banking and sovereigns at Moody’s Investors Service in London, adding that amount, equal to about $3.5 billion, was “about 32 percent of the capital buffer of the entire system.”

The government announced this week terms of a conversion of outstanding foreign currency mortgage loans into forints. The banks were relieved that the government chose market rates and that it agreed to provide euros to banks, which had taken on euro obligations to hedge their risks on the mortgage loans.

But forcing conversion only assures there will not be more losses from future currency depreciation. It does nothing to offset the earlier depreciation. And the required compensation will not come close to making borrowers whole.

Susanne Urogdi Kocsis, a 57-year-old Budapest resident, says she borrowed the equivalent of 7.4 million forints, or around $42,000, in 2007 to buy a larger apartment for her family. She says she has already paid back 4.5 million forints, “but the bank is asking for 11 million.” She thinks converting the loan to forints, as the government is forcing banks to do, will be of little help. “A lot of people won’t be able to pay back, and we will never be able to get new loans,” she said this week.

Before the crisis, and the plunge in the forint, Hungary’s banking system appeared to be profitable and well capitalized. Now none of the banks have investment grade ratings. Moody’s, the credit rating firm, rates the only large Hungarian-owned bank, OTP Bank, at Ba1, the highest junk bond rating. Other banks, most of them controlled by Western European banks, have lower ratings. Several have needed capital infusions from corporate parents.

The forint is now worth about 36 percent less in Swiss francs than it was when Hungary joined the European Union in 2004. Hungary’s economy grew at an annual rate of 4.1 percent from 1999 to 2006. Seven years later, it was smaller than it had been in 2006, although it did grow 1.1 percent in 2013.

The banks have suffered huge losses, said Mr. Torok, the bank economist, mentioning both the economic slump and the government actions. “But it is not like somebody is winning. Everybody is losing. The households are losing. The government is not winning.”

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