How Sweden solved its banking crisis
A banking system in crisis after the bursting of a real estate bubble. An economy in the throes of jobs. A market oriented government struggling to stem the panic. Seems familiar?
This is the case for Sweden. Was the country so far in the hole in 1992 ?? after years of reckless regulation, short-sighted economic policy and the end of its housing boom ?? that its banking system was, for all intents and purposes, insolvent.
But Sweden has taken a different route from that currently offered by the US Treasury. And Swedish officials say there are lessons from their own nightmare that Washington might miss.
Sweden did not just bail out its financial institutions by letting the government take over bad debts. He extracted kilos of flesh from the bank’s shareholders before issuing checks. The banks had to write down losses and issue money orders to the government.
This strategy held the banks to account and turned government into owner. When troubled assets were sold, the profits flowed back to taxpayers and the government was able to recover more money later by selling its shares in the companies as well.
“If I go to a bank,” said Bo Lundgren, who was then Swedish Minister for Fiscal and Financial Affairs, “I would rather get equity capital so that there is a benefit to the taxpayer.”
Sweden spent 4% of its gross domestic product, or 65 billion crowns, the equivalent of $ 11.7 billion then, or $ 18.3 billion today, to rescue ailing banks . This is slightly less, in proportion to the national economy, than the $ 700 billion, or about 5% of gross domestic product, that the Bush administration estimates its own initiative will cost the United States.
But the final cost to Sweden ended up being less than 2% of its GDP. Some officials say they think it was closer to zero, depending on how certain rates of return are calculated.
The tumultuous events of the past few weeks have produced many nods in Stockholm. Mr Lundgren even toured New York in early September, explaining what the country did in the early 1990s.
A few American commentators have proposed that the United States government withdraw capital from the banks as a price for their bailout. But that doesn’t appear to be seriously considered by the Bush administration or Congress yet.
The reason is not entirely clear. The government has already traded its sovereign guarantee for shares of Fannie Mae and Freddie Mac, mortgage finance institutions, and the American International Group, the global insurance giant.
Charging taxpayers with nothing in return could be a mistake, said Urban Backstrom, a senior official in Sweden’s finance ministry at the time. âThe public will not support a plan if you leave anything to the old shareholders,â he said.
The Swedish crisis had surprisingly similar origins to the American crisis, and its neighbors, Norway and Finland, were hampered to the point of needing a government bailout to escape the quagmire as well.
The financial deregulation of the 1980s fueled a mortgage frenzy by Swedish banks, which weren’t sufficiently concerned about whether the value of their collateral risked evaporating in times of crisis.
Real estate prices have imploded. The bubble quickly deflated in 1991 and 1992. A futile effort to defend the Swedish currency, the krona, drove overnight interest rates to 500%. The Swedish economy has contracted for two consecutive years after a long expansion, and unemployment, at 3% in 1990, has quadrupled in three years.
After a series of bank failures and ad hoc solutions, the moment of truth arrived in September 1992, when the government of Prime Minister Carl Bildt decided it was time to clean up.
Alongside the center-left opposition, Mr Bildt’s Conservative government announced that the Swedish state would guarantee all bank deposits and creditors of the country’s 114 banks. Sweden created a new agency to oversee institutions that needed recapitalization, and another that sold off assets, mostly real estate, that banks held as collateral.
Sweden asked its banks to write off their losses quickly before asking the state to recapitalize. Faced with its own problem later in the decade, Japan made the mistake of dragging out this process, delaying a solution for years.
Then came the imperative to bleed the shareholders first. Mr Lundgren remembers a conversation with Peter Wallenberg, then chairman of SEB, Sweden’s largest bank. Mr Wallenberg, a descendant of the country’s most famous family and steward of much of its economy, has heard that there will be no sacred cows.
The Wallenbergs turned around and staged a recapitalization themselves, avoiding the need for a bailout. SEB made a profit the following year, 1993.
âFor every crown we bank, we wanted the same influence,â Lundgren said. “It ensured that we didn’t have to go into some banks at all.”
By the end of the crisis, the Swedish government had taken over much of the banking sector, and the agency had largely fulfilled its relentless mandate of draining social capital before injecting liquidity. When the markets stabilized, the Swedish state then profited by reintroducing the banks to the stock market.
More money can still go into official coffers. The government still owns 19.9% ââof Nordea, a Stockholm bank that has been fully nationalized and is now a popular giant in Scandinavia and the Baltic Sea region.
Sweden’s crisis management policy was equally harsh, although much calmer.
Shortly after the plan was announced, the Swedish government found that international confidence had returned faster than expected, easing pressure on its currency and bringing money back to the country. The center-left opposition, while fearing the government would still let the banks get away with it, argued it was penalizing shareholders in private.
“The only thing that held back an avalanche was the hope the system held,” said Leif Pagrotzky, a senior opposition member at the time. “In public, we stuck together 100%, but we fought backstage.”