The bills are alive

THE alpine hamlets and valleys of Vorarlberg, Austria's westernmost province, rarely attract much attention, even at home. Yet the region was the source of an idea for cheaper borrowing that has spread risk not just throughout Austria but into many of its neighbours, too—and is now complicating efforts by the European Union and the International Monetary Fund to rescue Latvia's teetering economy.

It all started innocuously enough in the late 1980s. Many of Vorarlberg's residents worked in neighbouring Switzerland and earned Swiss francs. So it seemed sensible enough to borrow in the same currency; Swiss interest rates were, after all, lower than those in Austria. Once the idea took off it spread fast and far. By the end of 2007 almost one-third of Austrian household borrowing was denominated in foreign currencies with low rates.

This rapid take-up was repeated and exceeded as Austrian and other Western banks moved into central and eastern Europe. The IMF reckons that Polish households took on mortgages denominated in Swiss francs that were worth about 12% of GDP in 2008. In Estonia foreign-currency mortgages accounted for about 80% of household borrowing last year (see chart); in Hungary almost 85% of new mortgages were in Swiss francs in recent years.

This borrowing primed a bomb that still threatens some emerging-market economies and their bankers. The most exposed of all is Latvia, where more than 80% of all household borrowing is denominated in foreign currencies, mainly euros. That seemed to pose little danger as long as Latvia could credibly keep its currency pegged to the euro. But with its economy mired in a deep recession and the country dependent on outside lenders' money, there are increasing doubts about Latvia's ability to maintain the peg. Devaluation might help exports but would also make it harder for households to pay back their foreign loans. On October 6th the Latvian government said it was drafting a law limiting the liability of mortgage borrowers to the (reduced) value of their homes, not the value of the original loan, a move that would make devaluation less painful and that would saddle banks such as Swedbank and SEB of Sweden with big losses.

Consumers and lenders in other countries are also at risk. According to Hans-Joachim Dübel of Finpolconsult, a consultancy, Hungarian consumers who took out loans in January 2007 may now be paying as much as 70% more than they did then because of the forint's depreciation and higher risk premiums. Keeping the lid on this explosive situation has been possible only because of the Swiss central bank's interventions to prevent its currency from appreciating and its offer, along with a similar one by the European Central Bank, of generous currency swaps to neighbouring central banks. These arrangements were renewed again last month.

There are other ways of blunting the dangers of foreign-currency mortgages. Austria's financial regulators wrote rules in 2003 to protect consumers from huge currency swings (by, for instance, forcing the loans to convert into local currency if the value of the foreign debt rose above a certain threshold). In Poland, where mortgages denominated in Swiss francs were directly tied to interest rates in Switzerland, the worst-hit households are paying only about 20% more to service their mortgages, according to Mr Dübel. Hungary's central bank has proposed stricter limits on loan-to-value ratios for mortgages denominated in foreign currencies.

Even so, some regulators may prefer to eliminate the dangers of these loans altogether rather than just limit them. Last month Joaquín Almunia, the EU's commissioner for economic affairs, highlighted foreign-currency mortgages as the sort of danger that the newly formed European Systemic Risk Board would be looking for. More succinct is the verdict of a senior official at Austria's financial regulator: “We don't want millions of people acting like little hedge funds.”