Lessons for the US from the Swedish Bank Crisis
Having lived through the Swedish banking crisis in the 1990s, I am struck by how poorly the American public understands what really was a successful cure that remains relevant to the current situation. In fact, the Swedish example would probably provide the best, most capitalist, solution for the United States.
All indications are that the Obama administration has not decided what to do about the banks. The delays in clarifying its plans raise the danger of the United States tumbling into Japan's trap in the 1990s, with an unresolved banking crisis lasting for a decade. Thus the Obama administration needs to think again and act fast. It must quickly identify, write off, and remove the bad debts from the normal banks, which are assessed at no less than $1 trillion, or about 7 percent of US GDP. Select "stress tests," as discussed in Treasury Secretary Timothy Geithner's speech in early February, are not enough.
Substantial bad debts are like a worm in an apple. If you leave it alone, it will devour the whole apple. Nonperforming loans keep nonperforming enterprises alive, but they should be sold off or put into bankruptcy. Until they are written off, they will attract more good money, which will be wasted. It is sheer waste to try to recapitalize a damaged bank, as the US government has done with Citibank and others.
Intellectually, the case is evident, but to force banks to write off $1 trillion requires a lot of political courage.
Sweden did not nationalize its banks. It was Norway that did so, which is an alternative model. In Sweden, a temporary emergency bank authority was set up on the model of the US Federal Deposit Insurance Corporation. It had outside, mainly foreign, consultants to scrutinize all bank debts and establish objectively which were nonperforming. The banks were forced to write off their bad debts and transfer them to bad banks.
Sweden had no aggregator bad bank and the bad banks were not nationalized. Each big bank set up its own bad bank. They were given illustrious names such as Securum, Retriva, Nackebro and Diligentia. Securum was the biggest bad bank belonging to the already state-owned bank, Nordbanken, and it became a separate state company. The private bad banks, however, remained the property of the private banks from which they were removed.
Nobody traded toxic waste at the height of the crisis in Sweden. Such trade is an unnecessary complication. A bad bank is not a bank but a private equity fund, which does not need much capital or recapitalization. Its task is to isolate the rotten apples so that they do not contaminate the good loans in the cleansed banks.
The bad banks sold off their assets at a leisurely pace over several years to maximize their value, avoiding excessive depreciation of assets through fire sales. Any gain was to the benefit of its owners. In this way, Sweden avoided the problem of trading undervalued assets. In the end, even Securum made a small profit.
There is no reason to merge bad banks, because asset sales require plenty of management capacity. A major concentration of assets in an aggregator bank would only aggravate the functioning of asset markets.
The Swedish emergency bank authority divided the banks into three groups. One group consisted of two obviously bankrupt banks, the private Gota Banken and the state Nordbanken. They were merged into state-owned Nordbanken, eventually becoming Nordea, a thriving bank that has been gradually privatized. A second group of private banks, Swedbank and SEB, had too little capital but could be revived. After long negotiations with the state, their shareholders decided to recapitalize them at their own expense, and these farsighted shareholders gained handsomely, although their old capital had been consumed. A third group consisted of private banks in rude health, primarily Handelsbanken, which continued to thrive, but it also set up a bad bank, Nackebro.
Thus, the common American idea that the Swedish bank resolution involved major nationalization is a sheer misunderstanding. Only one failing private bank, Gota Banken, was merged with an equally bankrupt state bank. Sweden avoided private-public partnerships, of which Fannie Mae and Freddie Mac are the most telling and repulsive example, because, as Larry Summers so memorably has stated, public-private partnerships usually means that profits are privatized and losses nationalized.
In sum, in Sweden bad debts were not taken over by the state or transferred to any aggregator state bank; but each bank, private or state-owned, established its own bad bank. The Swedish model avoided the trading of depressed assets in the midst of the crisis, while they were internally valued at their low market value. If nobody can assess the value of an asset, it is probably not worth much. Only one bankrupt bank was nationalized.