September 23, 2008 by Philip Dru
A banking system in crisis after the collapse of a housing bubble. An economy hemorrhaging jobs. A market-oriented government struggling to stem the panic. Sound familiar?
It does to Sweden, which was so far in the hole in 1992 – after years of imprudent regulation, shortsighted macroeconomic policy and the end of its property boom – that its banking system was, for all practical purposes, insolvent.
But unlike the United States, whose Treasury has made a proposal to deal with a similar situation, Sweden did not just bail out its financial institutions by having the government take over the bad debts. It also clawed its way back by pugnaciously extracting equity from bank shareholders before the state started writing checks.
That strategy kept banks on the hook while returning profits to taxpayers from the sale of distressed assets by granting warrants that turned the government into an owner. Even the chairman of Sweden’s largest bank got a stern answer to the question of whether the state would really nationalize his bank: Yes, we will.
“If I go into a bank,” Bo Lundgren, Sweden’s finance minister at the time, said, “I’d rather get equity so that there is some upside for the taxpayer.”
The tumultuous events of the last few weeks have produced a lot of tight-lipped nods in Stockholm. And for all the differences between Sweden and the United States, Swedish officials say there are lessons to be learned from their own nightmare that Washington may be missing. Lundgren even made the rounds in New York in early September, explaining what the country did in the early 1990s.
A few American commentators have proposed that the U.S. government extract equity from banks as a price for the bailout they are likely to receive, as Sweden did. But it does not seem to be under serious consideration yet in the Bush administration or in Congress.
That’s despite the fact that the U.S. government has already swapped its sovereign guarantee for equity in Fannie Mae and Freddie Mac, the mortgage finance institutions, and American International Group, the insurance giant.
Putting taxpayers on the hook without offering anything in return could be a mistake, said Urban Backstrom, a senior Swedish Finance Ministry official at the time. “The public will not support a plan,” he said, “if you leave the former shareholders with anything.”
The Swedish crisis had strikingly similar origins to the American one. Norway and Finland went through related experiences, and they also turned to a government bailout to escape the morass that bad policy had created.
Financial deregulation in the 1980s fed a frenzy of real estate lending by Swedish banks, which spent too little time worrying whether the value of collateral might evaporate in tougher times. Property prices exploded.
The bubble deflated fast in 1991 and 1992. A vain effort to defend Sweden’s currency, the krona, resulted in an incredible spike in overnight interest rates at one point to 500 percent. The Swedish economy contracted for two years straight after a long expansion, and unemployment, at 3 percent in 1990, quadrupled in three years.
After a series of bank failures led to ad hoc solutions, the moment of truth arrived in September 1992, when the government of Prime Minister Carl Bildt opted for a clear-the-decks solution.
With the full support of the opposition center-left, Bildt’s conservative government announced that the Swedish state would guarantee all bank deposits and creditors of the nation’s 114 banks. Sweden formed an agency to supervise institutions that needed recapitalization, and another that sold off the assets, mainly real estate, that the banks held as collateral.
Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. In a similar situation later in the decade, Japan made the mistake of dragging the process out, officials in Sweden and elsewhere note, delaying a solution for years.
Then came the imperative to bleed shareholders first.
Lundgren, the former finance minister, recalls a conversation with Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank. Wallenberg, the scion of the country’s most famous family and steward of large chunks of its economy, heard from the finance minister that there would be no sacred cows.
The Wallenbergs turned around and arranged a private recapitalization, obviating the need for a bailout at all. SEB turned a profit the next year, 1993.
“For every krona we put into the bank, we wanted the same influence,” Lundgren said. “That ensured that we did not have to go into certain banks at all.”
By the end of the crisis, the Swedish government had seized vast swaths of the banking sector, and the agency had mostly fulfilled its tough mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.
Indeed, more money may come into official coffers. The government still owns 19.9 percent of Nordea, a Stockholm bank that was fully nationalized and is now a highly regarded giant in Scandinavia and the Baltic Sea region.
The politics of Sweden’s crisis management were similarly tough-minded, though much quieter.
Soon after the plan was announced, the Swedish government found that international confidence returned more quickly than expected, easing pressure on its currency and bringing money back into the country. A serious credit crunch was avoided. So the center-left opposition, though wary that the government might yet let the banks off the hook, made its points about penalizing shareholders privately.
“The only thing that held back an avalanche was the hope that the system was holding,” said Leif Pagrotzky, a senior member of the opposition at the time. “In public we stuck together 100 percent but we fought behind the scenes.”
Sweden eventually shelled out 4 percent of its gross domestic product, 65 billion krona, or $10 billion, to rescue ailing banks. That is slightly less, in terms of the national economy, than the minimum of $700 billion, or about 5 percent of GDP, that the Bush administration estimates a similar move would cost in the United States.
But enough was recouped through sales of distressed assets and bank shares that were sold later, that the cost ended up being less than 2 percent of GDP. Some officials believe it was closer to zero, depending on how certain rates of return are calculated.
Looking back, Swedish official say the tough approach toward the banks paved the way for success. It eliminated “moral hazard,” the problem of relieving investors of bad decisions. And, much as it might be a shock in the United States, the demise of shareholders also underpinned the political consensus that help restore stability to financial markets even before the bailout was truly under way.
While government ownership of banks goes against the American grain, Lundgren worries that if the U.S. bailout rests on a thin reed, politically speaking, then it could fail.
The U.S. Treasury is now planning to purchase the distressed assets outright, without demanding equity. If it wants to restore the banking system’s creditworthiness, it would have to err on the side of paying too much money to the banks that caused the crisis, Lundgren said.
“If the valuation is bad, from the taxpayer’s point of view, you lose,” he said. “And that decreases the legitimacy of the plan.”
IHT | Carter Dougherty | Monday, September 22, 2008