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Magazine / ISSUES & IDEAS

What We Can Learn From Sweden

As Washington watches Wall Street’s slow-motion meltdown, Stockholm may have much to teach the next president about weathering banking tsunamis.

June 21, 2008

STOCKHOLM--In the early 1990s, Sweden experienced the worst financial crisis suffered by any industrial country since the Depression. The Swedish banking collapse wiped out fortunes, cost taxpayers a staggering amount of money, and may have permanently reduced the country's standard of living.

"Our crisis was more serious than what we have seen so far in the United States," observed Hans Soderstrom, an adjunct professor of economics at the Stockholm School of Economics, referring to America's subprime mortgage mess. Thus, as Washington watches Wall Street's slow-motion meltdown, Stockholm may have much to teach the next president about weathering banking tsunamis.

Sweden's response to its banking problems was bipartisan, transparent, massive, and, above all, fast. And the principal lesson, according to Stefan Ingves, head of the Swedish Central Bank, was: "You cannot rely on the private sector or markets alone to solve systemic banking problems." During the crisis, Ingves ran the Swedish Bank Support Authority, which was charged with resolving many of the bad loans.


As with the U.S. savings and loan crisis in the 1980s and today's subprime mortgage fiasco, Sweden's banking problems were triggered by desirable but poorly managed deregulation. The loosening of financial-sector rules led to a rapid expansion of credit followed by a boom in real estate prices that eventually crashed.

In the 1960s and '70s, Swedish interest rates were effectively negative, after adjusting for inflation, and there were limits on lending. But in 1985, seeing how financial deregulation was energizing business in Britain and the United States, Sweden liberalized its interest rates and credit ceilings. Credit-hungry companies and households rushed to borrow. Seeing an opportunity to boost revenues, bank managers took new risks. A credit boom ensued.

Home prices more than doubled between 1981 and 1991. Commercial real estate followed suit. But a change in the tax laws in the late 1980s meant that consumers could no longer deduct interest payments on debt, effectively increasing the cost of mortgages. Thanks to rising inflation and no interest-rate regulation, the cost of borrowing in Sweden skyrocketed.

The bottom eventually fell out of the real estate market. From 1990 to 1995, commercial real estate prices fell 42 per cent in real terms and residential prices dropped 25 percent. People who had used real estate as collateral for loans became insolvent overnight. And banks' portfolios of nonperforming loans mushroomed.

External events compounded Sweden's domestic problems. A global economic slowdown sparked by Germany's reunification and the oil shock after Iraq's invasion of Kuwait caused Sweden to slide into recession in late 1990. As the economy weakened, speculators began to bet against the Swedish krona. To maintain the fixed exchange rate, the government kept raising interest rates, which, in a recession, was counterproductive. Eventually the krona had to be devalued. This posed an added challenge for Swedish banks and corporations that had borrowed extensively in foreign currencies and now had to repay those loans with a depreciated krona.

The first victims of this financial perfect storm were Forsta Sparbanken and Nordbanken, two of the six largest financial institutions in Sweden. By the fall of 1991 neither had adequate capital. To keep them operating, the state was forced to guarantee a loan for Forsta and take over Nordbanken. Within a year, a third major institution, Gota Bank, went under and was also taken over by the government. At that point, the state owned 22 percent of the nation's banking system assets.

"If the state had not intervened," Soderstrom said, "the banking crisis would have brought down the economy."

The government also offered guarantees to all depositors and creditors in the core banking system, but not to bank stockholders. "The guarantees ensured there would not be a run on the system," he said.

The state then identified the good and bad assets held by Gota Bank and Nordbanken and set up separate entities to manage them. The portfolio of good loans was eventually consolidated into what is now Nordea bank, which was privatized. The government companies overseeing the bad loans provided equity to troubled borrowers and, in some cases, hired new management.

"We made them solvent and eligible for loans again," said Bo Lundgren, who was the minister of fiscal and financial affairs during the crisis.

The government rapidly sold off assets as they became business-worthy again, although it retains 20 percent of Nordea.

The cost was staggering. Swedish taxpayers initially shelled out 4 percent of gross domestic product to cover the bad loans. (By comparison, the savings and loan crisis cost 2.6 percent of U.S. GDP.) But the government eventually turned a profit by privatizing the assets it had acquired. Nevertheless, Soderstrom estimates that the crisis wiped 1 trillion krona off household and corporate balance sheets, an amount equal to two-thirds of the Swedish economy at the time. The country endured a three-year recession, and the economy has never regained its relative rank among other industrial societies.

A 2007 study by the Federal Reserve Bank of Cleveland saw lessons in Sweden's experience. "Any number of events can lead to crises," the report concluded, "but the general principles for resolving crises successfully are universal."

Bipartisanship: Political backbiting impedes problem-solving. The conservatives who governed Sweden in the early 1990s worked closely with the opposition Social Democrats, who had every reason to cooperate because they had been in power when the seeds of the crisis were sown. Swedes credit their bipartisanship for the rapid restoration of investor faith in the country's financial system. Such coordination is easier to pull off in a small, homogeneous society. Nevertheless, the cost of partisanship was only too evident in Japan in the 1990s, where factional bickering prolonged banking difficulties.

Transparency: Stockholm concealed neither the extent nor the nature of its banking problems, even though such openness risked fanning public fears of the magnitude of the crisis. Bad loans were priced at their current market value. Such marking to market has its downsides. It punishes those who took risk and rewards those who didn't. Business leaders--such as investor Erik Penser, who owned Nobel Industries--lost nearly everything because they were not given time to make good on their debt.

Expediency: The Swedish government moved rapidly to guarantee all depositors and creditors while taking over failing banks and bad loans. "If you try to muddle through," Lundgren said, "you will only prolong the crisis." But Swedish officials admit that it is not easy to determine what is a regular bank, who is a depositor, and who bears the ultimate risk.

Overcapitalization: The government promised to spend what it would take to resolve the crisis both because the cost was unknown and because there was fear that asking for too little and subsequently needing more would panic financial markets. This open-ended commitment also minimized day-to-day legislative interference in bank restructuring. "It was a very large confidence measure," recalled Johan Schuck, finance columnist at the Stockholm daily Dagens Nyheter.

Control: The state demanded control over bank assets equivalent to the risk it assumed in taking on bad debts. The government eventually reaped the benefits when it sold those assets. This principle--the socialization of control equal to the socialization of risk--ensured that only financial institutions in dire straits accepted the money.

Preparation: Sweden had no legal framework to deal with banking crises. It even lacked deposit insurance. Extraordinary powers should be put in place before they are needed, Swedish officials advise. "All involved with today's problems should be studying the U.S. banking crisis of 1933," Lundgren said.

Flexibility: And, most important, every crisis is different. "You have to improvise at all points," Soderstrom said.

In the end, Lundgren noted, "Swedish banks have all learned a lesson: be more cautious." The next U.S. president can only hope that American financial institutions can learn the same lesson without the economic trauma that Sweden experienced.

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