SWEDEN IN CRISIS a drama in four acts brian darsow | saloni kantaria | thomas haley | cathy hwang

2

Swedish Financial Crisis CLIMATE CRISIS! LESSONS TRIGGERS

CLIMATE

The Good Old Days Managed Great Depression with ease Post-WWII Plan: Large, centralized institutions to achieve benefits from economies of scale – Result: few large institutions that received government support. – 1980s: 7 Swedish banks = over 90% of Swedish banking

The Twin Crises: Banking and Currency MAJOR FACTORS: – Deregulation of Banking Industry in 1985 – Collapse of Bretton Woods international currency system in 1971 Sweden attempts to maintain fixed currency exchange regime until 1992

Deregulation in 1985 Pre 1985: Banks required to have 25% of assets in bonds. 1985: Regulations dropped. Result: Financial supervisory authority couldn’t deal with the new market conditions

Monetary Policy 1970s: High inflation rates maybe undermined economic expansion. 1980s: Expansionist monetary policy, increased money supply – Lowers inflation rates – Increases borrowing – Increases inflation – (Banking deregulation also leads to increases in money supply.)

Political Factors Tax schedules made borrowing attractive. Political pressure encouraged banks to hold mortgages originating from government housing programs

The Late 1980s : Real estate prices more than double Banks hold much short-term foreign- denominated debt Low interest rates and high inflation

Putting on the Brakes 1989: Government noticed things were moving too fast. – Too much shifting in the markets – Too much foreign money made Sweden more prone to outside shocks – Gov’t tries to reign in securities trading and housing through new taxes on financial transactions

Increase in interest rates Fixed exchange rate abandoned Reduced demand for Real Estate Nyckeln (“The Key”) folded 13 Financial Crisis!

14 1.German reunification  Bundesbank raised German interest rates  European interest rates rise. 2.Domestic macroeconomic policies (inflation) 3.Tax reform in 1991 (savings)

Reduced Demand For Real Estate 15

Real Estate Data : Investment in real estate - average 88% above Autumn 1989: First indications that commercial property market reaching peak Late 1990: Real estate index fell 52% from peak

Fixed Exchange Rate Abandoned September 1992: European currency unrest Swedish government abandoned fixed exchange rate Considerable depreciation of Sweden’s currency Result: Many private sector loans become non-performing

Folding of Nyckeln Fast-growing Swedish financial firm Financed by several Swedish banks Rapid growth by specializing in commercial real estate financing New commercial paper Default left two Swedish banks unable to meet capital regulatory requirements

CRISIS!

How Bad Did It Get? GDP down 6% Unemployment up 9% Five of the largest banks insolvent Loan losses equal to 12% of GDP

What to do? Early stages: ad hoc solutions Currency defense Crisis spread to entire financial system Need for large- scale response

Key Goals Maintain liquidity Reduce inflation Restore confidence Mitigate moral hazard

Nationalize it! Guaranteed entire bank system – Left out shareholders – Forced banks to write down losses Floated currency Bailout money in exchange for equity Transferred bad debts to state-run companies which sold assets

Bank Grading

Asset Management Companies Government-run: – Securum (Nordbanken) – Retriva (Gota Bank) Bank-run: – Diligentia (S-E-Banken) – Nackebro (Handelsbanken) Ensured political/financial independence

Long-term Provided avenue for taxpayers to regain money Mitigated moral hazard problems Total government outlay: 4% of GDP – Recouped most by selling stakes and assets

LESSONS

Lesson #1: Nationalization Taxpayers and government may get profit when markets stabilize More public support Taxpayers = Happy

Lesson #2: Repairing Confidence Goal: Re-establish creditor and depositor confidence How? Controversial: – Maintain market discipline by letting investors suffer loss (Ergungor & Thomson) – Blanket guarantee to avoid runs and allow restructuring (The Economist) Et voila! Confidence!

Lesson #3: Let an Independent Agency Take the Reins Sweden established bad banks (AMCs) to take over assets of good banks – Good banks continue under original name – Deliberate over-capitalization in bad banks so bad banks can salvage independently Key: Political, financial independence

Lesson #4: Transparency Preserves market confidence Garner public support Transparency is cool. Like this transparent toaster.

But Beware! Sweden’s schemes may not work for the United States…

WHY NOT?! Localized financial distress then; int’l financial distress now Favorable int’l economy then Sheer size of US economy Political structure