Tue Mar 18th, 2008 at 05:31:56 AM EST
The current US financial crisis is often compared to the Japanese one, but one might argue that a better comparison is the Swedish crisis of the early 90's, which by the way was the worst one we had since the depression which isn't little considering the constant crisis we had during the 70's.
It was so bad it probably crossed the line from recession and went into depression territory. For example, GDP fell by 6 %, housing prices fell by a quarter and several banks were nationalised.
Promoted by Colman, with a little reformatting.
On a more personal level, I had just started school back then and remember how they cut the milk from school lunches - only water was available.
I'm apparently not the only to have seen this connection. So has Justin Fox of Time:
While the econoscribes of the U.S. (me included) were writing Thursday about what the President's Working Group on Financial Markets had to say about the current financial crisis, a guy who may know more about dealing with financial disaster than anybody in Washington was giving a speech on "kriser i det finansiella systemet" to the Swedish Economics Association in Stockholm.
I'm talking about Stefan Ingves, who is currently Governor of the Bank of Sweden (the country's central bank) but was more importantly one of the chief engineers of the most successful financial bailout and restructuring of the 20th century. This happened in Sweden in the early 1990s, when Ingves was Under-Secretary and Head of the Financial Markets Department at the Ministry of Finance. What befell Sweden between 1990 and 1993 was a full-fledged depression: Housing prices fell 20-25%, real GDP dropped 6%. But by quickly taking over and recapitalizing insolvent banks, Swedish authorities kept it from becoming a long, dragged-out affair like the Great Depression in the U.S. or Japan's lost decade in the 1990s.
And Paul Krugman:
Justin Fox suggests that we learn from the way Sweden dealt with its financial crisis at the beginning of the 90s. I'm looking into it.
What Justin doesn't mention, however, is that (according to Reinhart and Rogoff) the resolution of Sweden's financial crisis imposed a fiscal burden -- that is, required a taxpayer-financed bailout -- equal to 6 percent of GDP. That would be $850 billion in America today. Just saying.
What (I think) Krugman doesn't mention here is that the bailout meant that the State became a bank owner, and that the banks were later sold at a profit. But I'm not sure the profits were larger than the costs of the bailout. Looking at the cost of the bailout, it doesn't seem wholly unlikely that the whole thing payed for itself, especially as the State still own shares in one of the banks.
Another person noting the similarites is David Rosenberg of Merril Lynch:
The Japanese credit crisis is usually cited as the benchmark for what not to do. But few cite Sweden's crisis as a template on what might actually work. ... the Swedish authorities realized early on that a banking crisis cannot be resolved until the problem is properly defined. That means assessing who the "bad" and "good" houses of issues are and be willing to allow the "bad houses" to fail (as an aside, "good houses" do not necessarily imply "big" houses).
... Sweden established a Bank Support Authority to undertake "reality testing" on the loan books of Sweden's largest banks and had a "board of valuation" experts go in and value the assets on the books of all the lenders. Call it invasive if you will, but then again, the government was doing the work that market players could not or would not do - value the collateral and do it quickly. This is similar to what Barney Frank is proposing in the US mortgage sector today. ...
It should also be noted that it was Sweden's equivalent of the US Treasury, and not the central bank, that played the primary role in this crisis management stage (though the Riksbank maintained an accommodative monetary stance and lowered interest rates right through to December 1993, more than a year after the markets had bottomed). And, it obviously required the heavy hand of government intervention; there are solid grounds for this when there is market failure in the private sector, in this case, insufficient information regarding the quality of financial sector balance sheets. ...
But the best stuff here probably comes straight from the horse's mouth, in a recent speech on the similarities of the US and Swedish crises, held by Stefan Ingves, Governor of the Bank of Sweden, who back in the days played a crucial role in cleaning up the Swedish banking mess.
There are similarities between today's financial turmoil and the Swedish bank crisis
Some common denominators for the period prior to the outbreak of the crisis include a rapid increase in property and share prices, the fact that the current account deficit was large and growing and that economic growth had declined from an earlier high level. One important difference is that the exchange rate regime has not played a prominent role in the US case.
Too low risk premiums and abstruse risks
But it is also possible to find more specific parallels to the Swedish bank crisis. In both cases lending has increased rapidly at the same time as the banks have underestimated and therefore not taken sufficient payment for the credit risks. In Sweden this was linked to the banks - after decades of credit regulation - lacking a developed strategy for managing and pricing credit risk. When deregulation came in the mid-1980s they were quite simply unused to loan losses. But such tendencies could also be seen prior to the recent market turmoil. For a long time, risk premiums for credit risk-related securities were remarkably low. The uncertainty has led to an increase.
But, there are also other parallels. This includes in particular the arrangements that made the banks' real risk-taking more abstruse. The banks' formal and informal promises of loans to special investment vehicles meant that the problems quickly bounced back into the banks' balance sheets.
The structures were a side-effect of the desire to avoid regulation
It is also interesting that the abstruse structures, which led to the current financial turmoil and the bank crisis in the 1990s, were in both cases partly due to so-called regulatory arbitrage. The most recent wave of securitisation of the banks' credit portfolios was partly propelled by deficiencies in the capital adequacy rules. Through securitisation the banks could easily avoid a lot of expensive capital adequacy. Since 2004 a new capital adequacy regime, Basel II, has applied. This is more finely meshed and does not allow the same possibilities to avoid capital adequacy through securitisation. However, it has not yet been implemented in all countries, such as the United States, for instance.
The Swedish finance companies were in their day the result of regulatory arbitrage. Prior to the abolition of credit regulation in Sweden, the finance companies were often used as a means for the banks to get round the credit restrictions. This "grey" credit market was once substantial and an important source of additional income for the banks.
Credit insurances existed then as now
One can also observe another similarity, namely the occurrence of so-called credit insurances. A company that sold credit insurances to the Swedish banks in the 1980s and 1990s was Svenska Kredit. Many banks bought insurances against losses from their loans to property companies from this company. When the property market crashed, Svenska Kredit was unable to meet all of its obligations and consequently went bankrupt. This in turn fuelled the problems for the banks.
There are parallels between the Swedish credit insurance companies of that time and the current so-called monolines. These are large insurance companies which are specialised in insuring various types of bond loan. Those who have bought the companies' insurances have traditionally been municipalities, federal states and other bond issuers with poorer credit ratings. The insurance has meant that the bond loans have received better credit ratings and it has been possible to sell them at better rates. In July 2007 the outstanding volume of bonds insured by monolines amounted to a value of USD 3,300 billion.
In recent years these monolines have increasingly been used to insure securities issues with a subprime content. This has meant that they have also begun to experience problems. This risks in turn having repercussions for the securities they have insured and ultimately for those who have invested in them.
Of course, there are also some essential differences between the most recent financial turbulence and the Swedish bank crisis. This applies to both the nature and the scope of the crisis. But, as you will note, there are many and striking similarities in the way people have acted. Or as Voltaire is supposed to have said "While history may never repeat itself - man always does!"
Justin Fox adds:
I just got off the phone with the abovementioned Kenneth Rogoff, who is convinced that Congress will end up spending trillions of dollars sloppily bailing out the mortgage business, so an $850 billion price tag attached to a cleanup that resolves most of the current credit problems, wipes out the shareholders of insolvent institutions, and leaves us with a more rational regulatory setup (as the Swedish bailout seems to have done) actually sounds like a pretty good deal to me.