The Swedish Crisis

8 Items to Learn About Banks and Bailouts #6

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?

So begins a New York Times article from last year about the Swedish banking crisis of the 1990s and their response. In 1992, the Swedish banking system was for all purposes insolvent. They pulled themselves out of it. So, what exactly happened in Sweden and what can we learn from it?

Sweden got into their mess in a manner not unlike the mess we find ourselves in. They went through a period of deregulation in the mid 1980s that resulted in a "frenzy of real estate lending". A bubble developed. The Swedish banks did not do enough to prepare for the possibility that the value of the collateral on their books would decline. Unfortunately, that is what would happen.

How did the Swedish solve their crisis? Nationalization. Here's how it worked:

• The Swedish government guaranteed all deposits held at Swedish banks. (We, of course, already do something similar through the FDIC.) They also guaranteed the creditors.
• A "Bad Bank" was created to hold troubled assets. Any bank whose assets were placed in the bad bank were forced to write down losses. 
• These banks were also required to give the government a large ownership stake in common stock. Existing stockholders were wiped out. (This was a very important step.)
  
• A "Bank Support Authority" was formed to supervise those institutions that the government supported.
• Eventually, the troubled assets were sold off with the money going into the government's coffers, essentially paying back much of the money to the tax payers.
• Additionally, the government would make money selling its ownership stake in the banks back onto the market. (This is why many Americans prefer to call the process pre-privitization to nationalization.)

Ultimately, the cost to Swedish tax payers has been less than 2% of GDP. Their nationalization program was a huge success and the Swedish have travelled the work evangelizing about their program. Have Americans listened? Of course not.

We'll explore the current mess that is the American program in a post early next week, but know that many prominent American economists, most notably Brad DeLong and Paul Krugman, believe that the Swedish solution is the best option we have for getting out of this mess. It may go against the first instincts of most free market Americans, but I think anyone who studies up on the Swedish repsonse would have no choice but to agree that it worked for them and it will work for us.

(Source, Source, Source, Source)