Is a Financial Crisis in Sweden and the Baltics in the Cards?

This topic is and yet isn’t a bit afield from the normal beat of this blog.

A reader sent links to some recent posts at Bronte Capital, a blog by John Hempton, which is reportedly read by top financial executives in Sweden and has a following among some of the more savvy analysts in London.

He makes a bold call:

But otherwise enjoy a post that breaks all the rules. I am loudly calling the likely collapse of a politically sensitive country. Its one of those circumstances when shouting fire can cause the tragedy. To some extent I take comfort in my low readers…

Hempton then goes through what he calls the “fixed currency model of bank collapse” which on a quick reading seems sound (and note Hempton has made quite a study of this area and has several posts on banking crises, per here and here, so he does have a basis for his views).

Back to the post:

Past currency crises have been associated with bank collapses. In Thailand (which was precisely to this model) the finance companies actually collapsed and the banks almost collapsed. In Korea both the banks and currency collapsed.

But you need to be really careful of countries with fixed exchange rates and huge, unsustainable current account deficits.

Never much fun shorting the banks in such countries

If you had picked the collapse of the Thai Banks you might have cleverly shorted the stocks. It would not have helped much. Suppose you shorted $100 worth of a Thai bank. It collapsed down 95%. So you had $95 in profit. The only problem is that you have the profit in the pre-crisis exchange rate. The currency also dropped almost 90%. So you were left with about $10 profit. That is fine-and-dandy but it is not much reward for effort of picking a system that is about to collapse.

You would of course be much better just shorting the currency – or shorting the ADRs of the target stock (the ADRs being priced in a hard currency).

The real exception is that if you find a bank in a hard currency that is totally exposed to the debacle country you can make a fortune. You can guess now that Swedbank is my bank. It is not the only one – but is very spectacular.

Hampton then goes into a lengthy discussion of the very vulnerable Eastern European currencies, in particular Latvia, Estonia, and Lithuania, to which good old Swedbank is heavily exposed. We get to a bottom line:

Swedbank funds the Latvian current account deficit. It funds it in Euro.

So what happens next?

Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.

If the Lati doesn’t devalue its only because people (ie Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can’t be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.

This is a very big problem for Swedbank. Swedbank’s equity is 68 billion SEK – but 20 billion is intangibles. Swedbank is probably solvent at the end of this – but only just. Swedbank will (at best) lose its independence. Swedbank is in turn wholesale funded – and the chance of it becoming Swedish Government property is not low.

Having lent that much to a country with a phoney fixed exchange rate in a currency they can’t print – Swedbank management deserve it. Bad things happen to bad banks and this is a bad bank.


I wrote this post before SwedBank’s great looking 2Q results. They made it all work – by lending even more to the Baltics. Latvian deposits are actually falling despite high inflation and rapid (but declining) loan growth.

I used to think Swedbank would probably survive. I now think it probably goes to zero.

Now this appears to be a judgement call as to how bad things will get for Swedbank, but the point it is that it is plausible that they could get sufficiently bad that the bank is nationalized.

I may not be as plugged in as I sometimes like to fancy myself (we Americans can be pretty insular), but I suspect very few people here or in the UK expect a financial crisis to erupt in Sweden and the Baltics. How destabilizing could that be? Swedbank has roughly $280 billion in assets, so it isn’t a small fry. The bigger cause for pause might be political instability in the Baltics, which is something I am in no position to assess, or the impact of a flight to quality in currencies.

I’d be curious to get readers’ take on this one, both the bank’s vulnerability and the larger consequences if the situation devolves as Hempton suggests.

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  1. Anonymous

    I’m from Finland and believe that this will happen. The balts had a huge debt based orgy – in particular in real estate. Think of L.A. or Arizona. And, yes, Swedes were the ones financing it, largely at least. With no real economy, not even gambling as in L.A., the balts will not be able to pay it back. Hence, they and their Swedish financiers will tank with 100 per ecent certanity. Then again, they also deserve it. The balts with cope with the meltdown by immigrating elsewhere in even higher numbers, unpatriotic as they are…

  2. jonesf

    The Sutuation in the Baltics has been pretty much anticipated from the Swedish banks. They’ve been talking about this scenario for some two years now. No doubt it will be hitting their future earnings but a crash is pretty unlikely. And 30 billion SEK? That’s no money. As long as the bank is solvent the central bank would lend that money with ease.

    On the other hand, since Sweden had a bank crisis not long ago, the policital climate is not favourable to a bank that screws up. They really have no excuses if it goes down the drain.

  3. Fiuman

    One aspect of thi, is that when (i would gladly write if, but i fear its way past that) the baltic Real Estate market starts going down, we might see less financing for RE elsewhere in Eastern Europe. And that will hurt German, Austrian and Italian banks (Reiffeisen, Unicredit, Erste…) – and in turn they will close the spigot for corporate loans, so Eastern Europe is upfor some tough reawakening after about 10 years of easy credit.

  4. Abe, NYC

    Rubini has forecast a major crisis in Eastern Europe for some time, and said the Baltic countries will be the hardest hit. I think it’s fairly easy to imagine what will happen to the Baltic countries because they are going to have a currency crisis, which we have seen over and over again. Things will get real ugly in high deficit countries. I’m more curious about what will happen to surplus countries such as Russia or Kazakhstan.

  5. Paul

    Wow, here’s a post (and comments) to give the lie to the idea of calm, rational, fact-based Scandis.

    1) the Thai baht did not drop 90%. With the exception of a couple of weeks around the turn of 97-98 the drop was more like 40%.

    2) Intangibles are not an equity item. They’re assets. “Savvy analysts in London” are usually more demanding about this sort of thing.

    3) $5bn of gross exposure, without allowing for Hansa equity, deposits or recovery rates is pretty manageable in the context of a $280bn balance sheet. (that’s assuming that the poster’s SEK30bn figure for Swedbank exposure to Hansa is right, not something i’d take on trust).

    4) (from the original post) Stag parties are not a key part of the Latvian economy. Nor is Prague cheaper than Riga. Nor, for that matter, is Shannon anywhere near Birmingham.

    5) Swedbank heavily dependent on wholesale funding? Yes clearly a key issue but this is to do with how Swedish mortgages generally are financed and has absolutely zip to do with the Balts.

    6) Certainly the scandi banks are going to take a nasty bath in the Balts. But the Scandi banks are big relative to the size of their Baltic subsidiaries and the Baltic numbers (current accounts, real estate, funding, fdi) are far worse than those in the rest of CEE, even the Balkans.

    This banking setback will be nasty enough without getting hysterical.

  6. John Hempton

    I ought to reply. Yes – I got the extent of the Thai Baht collapse wrong. I conflated with the Indonesial Rupiah which was between 80 and 90.


    The exposure of Swedbank to the Lats is well over half the equity.

    The recovery rates will be very poor indeed. You only need to look at the extent of negative equity in the Estonian mortgage market to convince yourself of that. Besides the Baltic deposits will rank ahead of the Swedbank unsecured in the Hansa Bank funding.

    A current account deficit of 20% of GDP is a wapping big imbalance. It has to be funded somewhere. Watch that place.

    Funny – senior bankers at competitor banks are moderately worried.

    And as for someone who is a panic merchant about the banking crisis – I own WaMu sub debt. I prefer it to Swedbank debt!


  7. Paul

    sorry tone of my comment was a little snotty…but i should qualify:

    The post referred to suggests Swedbank equity could go to zero on the back of a Latvian crisis. I’m not disputing that Latvia could blow a nasty hole in Swedbank’s equity – just suggesting that the
    impact should be manageable – more SocGen than Northern Rock. The Latvian sovereign stepping in to help Hansa rather than the Swedish to help Swed for example.

    That said, I am genuinely fascinated by Mr Hempton’s willingness to hold WaMu sub – surely recovery rates on US HELoC’s likely to be a fraction of worst-case assumption of Latvian recovery rates?

  8. jonesf

    As a subsidiary Hansa is, afaik, Swedens responsibility in case of liquidity issues and also for the oversight of their financial stability. Any central bank intervention would however be coordinated and cleared among the national central banks.

  9. Anonymous

    Hmmmmm, well, I am a Latvian and a professional investor, and located in Baltics …. so to say – having first hand experience.

    There will be “some kind of” crises for sure (it may be full scale blow-out, including political), however, it is premature to quantify the casualties .. The Scandi (and also other foreign/local) banks appear to be well aware of challenges to be handled in the near future, but nobody speaks loud. It is quite curious that none has publicly declared that e.g. Latvia is in technical recession … It appears that the tactics at the moment is to let it run … as long it goes. The governments in Estonia and Latvia appear to be raising “crisis funds” silently, also in Asia… I am not sure what will be the actions, when the “big meltdown” starts …. however, there are no signs of panic, at least yet. And the credit losses for the banks are not comparable to the ones in the U.S., at least yet, again … The worst is yet to come, I expect the freezing pain to start around Christmas for the Latvians, but Lithuania is still running real retail sales growth (y-o-y) in double digits, they are some 12 to 18 months lagging vs Estonia, and Latvia lags Estonia some 4-6 months, but may be closing the gap …

    The imbalances have been extreme, but mainly due to real estate … so the major adjustments are expected to be there, but the exports are beginning to falter too. Of course, people have borrowed against their anticipated earnings in the future. So, at the end (if also Europe is slipping into recession, and it appears very likely at the moment)Baltics may experience broad based “ice age” with dramatic adjustments, e.g., real GDP growth may be NEGATIVE in the range of 5-10% for couple of years, squeezing out imports, etc …

    I may spend more time tomorrow during European time, if there is any interest …

  10. Mara

    As another Latvian, living in the states but helping support family over there, I could see for some time that the real estate prices were totally psycho. I don’t even know any local latvians who own real estate, except for rather modest little apartments that were paid in cash (which was the norm since independence in 1992).
    My 2 cents is that the Swedes will get a lot of defaults. My sense is that Mrs.Vikes-Freiberga’s govt won’t be able to do a lot. And given the unpopularity of rich foreigners coming in to buy up gaudy houses and condos [and raising locals’ prices for everything], there’s not going to be a lot of sympathy to their plight.
    Considering its rather grim history, the latvians can weather the economic “ice age” that will come. As for Russian interests, and the implication of aggression in the face of economic weakness— I’d say there’s no greater chance of them suddenly invading than there would be at any other time. Let’s be honest, we don’t have one of those great ‘super weapons’ like in the movie “The Mouse that Roared” (but it would be cool if we did!).

  11. Anonymous

    OK, some more info on the background:

    1. Swedish central bank is and has been aware of the situation, and for some time, as this MoU between Riksbank and central banks in Baltics may suggest

    2. The people will survive, e.g., as the majority of Latvians (in worst case via relatives) have access to the farmland, so they will have some food …

  12. Anonymous

    This scenario implies that the latvian and estonian currencies become devalued. So we have to look at how probable that would be.

    As i understand, outside speculators/shocks cannot cause the currency to become devalued, because there are no instruments to use. Internally there is no political power who might be capable or willing to devalue the currency.

  13. Anonymous

    well, Latvia beats Spain today … and prints a stunning 8.3% y-o-y drop (real/comparable prices, seasonaly adjusted) in retail sales … it should be a miracle to avoid a negative real GDP growth figure in 2nd quarter in y-o-y terms.

    I would say that Baltics in some instances have been running a more dangerous exercise than Iceland … heck, but Scandi central banks found some common language to stabilize the "Icelandic dream" with swap facility arrangements, see … What about small Baltics? Probably not only Sweden, but Scandi problem too?

  14. Anonymous

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  15. Anonymous

    I do not see really how it should happen, it is really too early to speak about mass of negative equity in Estonia or Latvia. We see some price drops from the peak last year but that’s only the peak of the iceberg. Swedbank will hold alright.

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