Friday, September 26, 2008

What Bernanke and Paulson Can Learn From Sweden's Financial Crash

"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. The country was so far in the hole in 1992 — after years of imprudent regulation, short-sighted economic policy and the end of its property boom — that its banking system was, for all practical purposes, insolvent."


I came across this article by Carter Dougherty in the New York Times on Tuesday, and found it very interesting.

But before we go on to the rest of the article:

Last night, I attended an debate at Washington State University. One of the speakers in The Great Election Debate was writer and activist Cliff Kincaid, who said more than once that the 700 billion-dollar plan proposed by Treasury Secretary Henry Paulson, Fed Chairmen Ben Bernanke and the Bush White House is not a bailout , but socialism.

Socialism is widely understood to mean state or collective ownership and administration of the means of production and distribution of goods, including banks.

I grew up in a country that some have called labeled a socialist democracy. In Singapore, the government does own some banks and the like, including a very successful investment company, called Temasek Holdings. With a multinational staff of more than 300 people, it manages a portfolio of about S$185 billion, or more than US$127 billion, focused primarily in Asia. It is an active shareholder and investor in such sectors as banking & financial services, real estate, transportation & logistics, infrastructure, telecommunications & media, bioscience & healthcare, education, consumer & lifestyle, engineering & technology, as well as energy & resources. In 2008, The Economist reported that Morgan Stanley had estimated the fund's assets at US$159.2 billion. Late last year Temasek threw a 5 billion-dollar lifeline to Merrill Lynch.

All right - back to the NYT aritcle. Here's where the Swedish experience does include socialist principles.

Dougherty writes:

"Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

"That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.


'“If I go into a bank,” said Bo Lundgren, who was Sweden’s finance minister at the time, “I’d rather get equity so that there is some upside for the taxpayer.”

"Sweden spent 4 percent of its gross domestic product, or 65 billion kronor, the equivalent of $11.7 billion at the time, or $18.3 billion in today’s dollars, to rescue ailing banks. That is slightly less, proportionate to the national economy, than the $700 billion, or roughly 5 percent of gross domestic product, that the Bush administration estimates its own move will cost in the United States.

"But the final cost to Sweden ended up being less than 2 percent of its G.D.P. Some officials say they believe it was closer to zero, depending on how certain rates of return are calculated.

"The tumultuous events of the last few weeks have produced a lot of tight-lipped nods in Stockholm. Mr. 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 United States government extract equity from banks as a price for their rescue. But it does not seem to be under serious consideration yet in the Bush administration or Congress.

"The reason is not quite clear. The government has already swapped its sovereign guarantee for equity in Fannie Mae and Freddie Mac, the mortgage finance institutions, and the American International Group, the global insurance giant.

"Putting taxpayers on the hook without 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 if you leave the former shareholders with anything,” he said.

"The Swedish crisis had strikingly similar origins to the American one, and its neighbors, Norway and Finland, were hobbled to the point of needing a government bailout to escape the morass as well.

"Financial deregulation in the 1980s fed a frenzy of real estate lending by Sweden’s banks, which did not worry enough about whether the value of their collateral might evaporate in tougher times.

"Property prices imploded. The bubble deflated fast in 1991 and 1992. A vain effort to defend Sweden’s currency, the krona, caused overnight interest rates to spike at one point to 500 percent. The Swedish economy contracted for two consecutive years after a long expansion, and unemployment, at 3 percent in 1990, 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 clear the decks.

"Standing shoulder-to-shoulder with the opposition center-left, Mr. Bildt’s conservative government announced that the Swedish state would guarantee all bank deposits and creditors of the nation’s 114 banks. Sweden formed a new 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. Facing its own problem later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years.

"Then came the imperative to bleed shareholders first. Mr. Lundgren recalls a conversation with Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank. Mr. Wallenberg, the scion of the country’s most famous family and steward of large chunks of its economy, heard that there would be no sacred cows.

"The Wallenbergs turned around and arranged a recapitalization on their own, obviating the need for a bailout. SEB turned a profit the following year, 1993.

“For every krona we put into the bank, we wanted the same influence,” Mr. 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 a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.

"More money may yet 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. The center-left opposition, while 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.”'

Here's a link to Dougherty's article in the New York Times.