A good article in tonight’s Financial Times gives useful detail about the Swedish response to its early 1990s banking crisis. As readers may know, Sweden (along with the less touted Norway) is considered to have been particularly effective in mopping up a banking crisis.
We and others have observed that the US is engaging in ad hoc measures and for the most part, taking the path of least resistance, which is putting us on the same path as Japan, of propping up zombie banks rather than making banks write down bad assets to realistic values. Indeed, an IMF study of 124 banking crises said regulatory forbearance (econ speak for regulators letting banks get by with little to no equity in the hope they will somehow muddle through) is associated with slower recovery from financial crises. Our method for letting banks off easy is giving them a break on accounting. The FASB is under great pressure to relax mark to market accounting, and letting banks carry assets at higher prices will, voila, increase their equity. Nothing fundamentally has improved, but suddenly the books look nicer. That is supposed to improve confidence in banks. Cynics think it will do the reverse.
Consider some of the findings from the IMF paper that have been ignored. For instance, bank and borrower bailouts are not such a hot idea:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
History also suggests that keeping insolvent banks is not such a hot idea:
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
The Financial Times article is worth reading in its entirety. Often, the Swedes point out what they did right, and the US is doing the exact opposite.
The one bit of good news is Sweden dithered for a couple of years before it decided it needed to tackle its banking mess head on. In theory, it is not too late for America to get religion, but I see no recognition on the part of anyone in authority that we are on the wrong path.
Key bits from the Financial Times article:
“It was never the intention of the government and the Bank Support Authority to sort of take over as many banks as possible,” says Mr [Stefan] Ingves [head of the Bank Support Authority in the early 1990s]. “The issue was to be ready to sort out the mess in the system. To do so we needed a process that made it possible for us to evaluate whether a bank was actually OK, had a small problem or a huge problem.”
Yves here. Don’t kid yourself that the stress tests are even remotely adequate to do the job. Back to excerpts:
Arne Berggren, the finance ministry official responsible for bank restructuring, is blunt about the approach he took. It was clear from the outset that the government would act as a commercial investor, demanding equity stakes in return for capital. “We were a no-bullshit investor – we were very brutal,” he says. The authorities also insisted on control. “You take command. If you put in equity, you have to get into the management of the business, [otherwise] management is focused on saving the skins of the [remaining private] shareholders.”….
Private banks were also encouraged to place their bad loans in separate entities. However, in contrast with the recent debate in the US, the authorities never contemplated removing bad assets from those banks. “We refused to buy assets from privately owned banks because it would have been impossible for us to agree on the price and we were never in the business of giving privately held banks subsidies,” says Mr Ingves.
It is remarkable that the Swedish will discuss economic realities as if they are obvious (which they are) while the US government and media seems constitutionally incapable of seeing what is right in front of their noses.
The Swedish story also contains a cautionary tale:
Having tackled the crisis, the authorities conspicuously failed to put in place longer-term reforms to help avert similar problems in the future. “The regulatory framework we put in place in the early ’90s had sunset clauses. So the sun set and that was it,” says Mr Ingves. “The politicians felt, ‘that won’t happen again’,” says Staffan Viotti, an adviser to Mr Ingves and adjunct professor at the Stockholm School of Economics.
Some of the Swedish banks have gotten in over their heads lending to the Baltics, and the unwinding is sure to be ugly.
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I wasn’t aware we’d ever adhered to Swedish norms….
I’m just waiting for Geithner’s cranium to split open and some alien creature to jump out!
I didn’t like hearing that Obama and Dodd are the largest recipients of AIG investment folks political contributions.
Obama looked like he had so much promise. I expect he will be much better than the alternative but fascist lite is not what we need.
psychohistorian
It is remarkable that the Swedish will discuss economic realities as if they are obvious (which they are) while the US government and media seems constitutionally incapable of seeing what is right in front of their noses.
Some things are obvious to most Swedes. Like if you run a bank into the ground you should be summarily fired. Common sense….totally lacking in America.
Good stuff from last week: Time for Geithner and Bernanke to Go
The problem is not simply that securitization has blown up, but that Geithner and pal Bernanke are determined to sift through through the rubble to see if they can fit the pieces together again. It’s Humpty Dumpty redux.
“The Fed needs to lure investors back into the market for these asset-backed securities, or ABS, where new issuance has almost disappeared This has led to a contraction in lending to consumers, deepening the recession. In the fourth quarter of 2008, there wasn’t any issuance of U.S. credit-card ABS, compared with $23 billion a year before, according to Dealogic…
The entire US establishment is still in the state of denial about fixing the banks. They are sticking with he notion, if we pump money enough time will sort everything out.
I for one seriously doubt that approach will work. Because the assumption of that approach is that US domestic economy is large and isolated enough that pouring money into every aspect of the national economy will create large enough growth to cure everything.
I don’t think so.
1. housing and baby boomer demographic.
2. consumer debt and changing of spending lifestyle. People will be more cautious about piling up long term debt.
3. The biggest one: if China and Asia start growing fast by late ’09 early ’10, and they experience inflation,… watch out. They have to raise interest rate. And with that US interest rate will have to follow less we want to see galactic size liquidity drain. (some of the sign are already here, money flow start to gently move eastward.)
4. Energy price will remain unstable. (Iraq, israel, Iran, Afghanistan, Saudi, Egypt) All these are predicted to have some turmoil in the next 2 years. Fluctuation of $20-$30/barrel is not unimaginable.
5. Major global banking rule change. No more crazy easy money tricks. (subprime, CDS, CDO, currency derivatives) all will be very muted and regulated.
Basically, the power that be think if they can hold on little longer, things will be back to 2005-2006 growth and everything will be fine.
I doubt it.
But this time araound, unfortunately, Sweden has acted differently, more attuned to bank lobbyists, and issued a blanket guarantee to insolvent banks.
It is also a myth that the first bank rescue saved the tax payers, it is widely accepted that tax payers and customer paid for 80% of the losses, only 20% by s/h.
Another good summary of the Swedish experience that hopefully will help destroying the canards that are still circulating. A few comments in relation to the article:
• The bailout was system wide, as mentioned in the article, which helped prevent messy and outdrawn case by case soap operas AIG and Citi style.
• Market value was consistently applied and was a key to success. People in Sweden would back then have laughed at the idea to creating a new, artificial, floor for asset values through state purchases or private/public initiatives. It is ironic that the U.S. believes so much more in social engineering than Sweden does.
• Banks considering state support had to strip entirely naked for inspection. There were no room for secrets, whether they were bonuses or SIVs. The state was, as it says in the article, very brutal in its approach. Bank CEOs with huge ego problems were unceremoniously thrown out, all in the interest of the taxpayer.
• Today’s financial products are vastly more complicated than the assets Sweden had to value. This is true. But if a financial product is so opaque that no one understands it, the only way to determine a value is to see what the market is prepared to pay for it. Apply market value. Full stop. Troubled assets during the Swedish crisis could consist of a polluted industrial site in Eastern Germany or a half finished ghost golf course in Spain. Those days, European markets were empty on buyers during an 18-24 month period. It was not easier then to determine a market value than it is for today’s flawed financial products, really.
• Sweden is a small economy while the U.S. banking system’s problems are global. Sure, but Sweden was essentially on its own to handle the problems. EU membership came only a few years later, so support from EU partners was not possible. The extent of the crisis was such that the country truly faced ruin but it managed to pull itself up by the bootstraps. I do not buy the argument that the Swedish solution is too small and isolated to be relevant to the current global crisis.
• Sweden has created a bit of a mess for itself again. In addition to a mindless Baltic expansion, there is a private equity bubble that currently is imploding in Sweden. Those two factors may together force the state to intervene with full blown bailouts again.
Of course the US is the politicians are bought and paid for by the banking industry and wall street.
And?
Why assume that the people making the decisions really care about doing whatever is best for the country instead of doing what is best for themselves, their friends, and their family members?
And why assume that there are no under-the-table deals or other corrupt practices going on right now that we do not know about influencing these people’s actions?
To me all benefit of the doubt left the room some time ago when it comes to the political and business leadership class in this country.
It’s quite surprising to continue to talk about the Swedish model when that is neither applicable nor replicable for own admission also of Swedish economists. If you want to scare Americans about nationalization, just quote the Swedish model when actually nationalization is not even needed.
Its like super duper califragilistic irony – the supposedly “socialist” Swedes understand and practice capitalism …O, about a (insert number that is equal to the current trillions used in the bailout) times better than the supposedly rough and tumble, market dicipline, mythological wild cowboy American capitalists. The Americans refuse to accept that capitalism is a profit and LOSS system. (o yeah, the taxpayers take the losses, because the bankers are too…nobel…sensitive…delicate???)
Obama should get Jim Baker to come run Treasury for a year. Pros: Baker knows the job; he recognizes we face a solvency crisis and need to put failed banks into receivership; and since he’s a Republican, he’d give Obama political cover from cries of socialism.
http://hedgedbet.blogspot.com/2009/03/modest-proposal-jim-baker-to-treasury.html
I don’t get this. Yves is trumpeting the virtues of the Swedish model, and also saying bailouts are a mistake. And at different points, she’s said we need to impose massive haircuts on the banks’ creditors when we nationalize. But this is exactly what the Swedes didn’t do. They guaranteed all of the liabilities of the Swedish banks: no one took a haircut at all.
It makes no sense to hold up the Swedish experience as a model to follow and then discard one of the key elements of that model: blanket guarantees for creditors. If you want to advocate nationalization with serious haircuts, fine. But don’t cite Sweden as evidence that it can work.
The main virtues of the Swedish plan were transparency and trust, in my opinion. The plan was (relatively) transparent, the rules were not complex, and everyone that wanted to get access to the cash had to agree to the financial exam. In return for that transparency (and the cash), the government put the trust of its citizens behind the bank.
Now, the situation in the US is different, but those parts can still be applied… at least for new deals.
What the politicians in the US needs to understand is that transparency and honesty (at least about big things like the financial health of their country) is important if there is to be a good end. Also, while the US *can* indeed muddle through the current events, the end result will not be pretty. The representatives of both parties would do a joint press conference, stating that they had a plan (and, you know, actually brought some sort of plan with them) and said “We are going to do this, because we need to save our country. Please help us” they would still get an overwhelming positive response.
People WANT someone to take action – people accept that there are some sacrifices to be made – but what people really, truly can’t stand is the opacity, the not-knowing. It is one way of making the country start to get over the Depression jitters. It is far from the only one, but it has as advantage that it works with the current system and attempts to pre-empt large scale populism from overwhelming good sense.
Piling on more and more debt to resuscitate the previous and now discredited securitized global financial system is a no-win strategy. What is required is debt forgiveness/reorganization as part of receivership, starting with zombie financial institution such as Citi, BofA and AIG. A piecemeal approach to propping up failed institutions, hoping that the market will revive and asset values will return to full valuations, is a policy of desperation that is only good for the insolvent banks’ directors, executives, stockholders and bondholders but terrible for the US. The credit crisis bank bailout policy of Obama/Geithner/Summers/Bernanke will put the US into a no/slow growth economy for 20 years, like the Japanese (1989-2009), and result in an S&P 500 Index value of 321 in the year 2029, like the Japanese (Nikkei Index ’89 top of 38,916; ’09 currently at 7,972: down 80%).