Submitted by Swedish Lex, who helped unwind Sweden’s imploded banks in the 1990s:
The U.S. Secretary of the Treasury appears to be close to proposing a Faustian bargain that, seemingly, will involve considerable Government subsidies towards a limited number of economic operators. In return for the sacrifice – the creation of massive moral hazard – Geithner would be able to sustain the mirage of the financial system’s strength.
This guest post will provide a few, brief, observations on the present situation and, in particular, on some of the underlying differences between Europe and the U.S. that are shaping the respective responses to the crisis.
Congress’s financial watchdog, the Congressional Oversight Panel, on 19 March organised a hearing “Learning from the Past — Lessons from the Banking Crises of the 20th Century” (video soon available). Tim Geithner declined the COP’s invitation but if he had attended, he would have had an opportunity to listen to Bo Lundgren, Director General of the Swedish National Debt Office and Former Swedish Minister of Financial and Fiscal Affairs, laying out his conclusions from the Swedish bank bailout in the early 90s.
One is tempted to think that the U.S. could have been spared a lot if only Geithner had found a slot in his agenda to attend the COP hearing. From Lundgren’s testimony:
The other main conclusions that I believe you can draw from my experiences of the Swedish banking crisis are that:
Government intervention is unavoidable if you are facing a systemic crisis.
Prompt action is important. A comprehensive approach is better than a piecemeal strategy.
Transparency enhances confidence and promotes the public legitimacy of the measures that have to be taken.
Broad political consensus and resolute political actions taken by the political system are probably more important than any of the technical aspects on how to deal with the crisis. This also enhances confidence, not least internationally, in our ability to deal with the crisis.
In order to limit moral hazard and get public support, it is important to have a stronger approach and deal with the banks firmly, enforcing the principle that losses are to be covered in the first place by the capital provided by the shareholders. If that means that banks must be nationalised, then so be it. They can be privatised again at a later stage.
Lundgren’s conclusions are intended to be of general nature and are not only applicable to lilliputian Sweden. The Swedish approach, as summarised by Lundgren, leaves no room for Faustian bargains à la Geithner. The Swedish Government during the financial crisis intervened comprehensively, not to socialise, but to solve the problem while avoiding moral hazard. All in the general interest. This point was reinforced during the Q/A session at the COP hearing when Lundgren was asked how the Swedish Government managed to avoid corrupt management of nationalised banks and of the other financial institutions that effectively were under Government tutelage for a certain period. The response was in essence that it was obvious, and never in doubt, that the Government, and its appointed agents, would act to protect the general interest.
Lundgren also said that
Lundgren’s response to the COP’s question revealed a degree of mutual incomprehension that may express a major cultural divide. That virtual barrier may render the Swedish bailout solution inapplicable to the U.S., despite its substantive merits.
Furthermore, the notion of the general interest is enshrined in EU Law and guides the actions of the EU and its institutions, including when addressing the financial crisis. The EU Treaty stipulates that “The Commission [the EU’s executive] shall promote the general interest of the Union and take appropriate initiatives to that end”. The roots of the notion of the general interest can be traced from Jean-Jacques Rousseau (“the general will”) through the French Revolution to our times where it thus constitutes integral part of the EU’s political and legal arsenal.
So, how does a fuzzy principle with roots dating from the Enlightenment impact the Realpolitik of the current financial crisis? Well, consider the recent and unilateral decision by France to subsidise its car manufacturing Industry, provided however that the state funds would “protect” French jobs and not those in other European states. Sarkozy’s blatant protectionism enraged European partners but no peer pressure, including from Germany, could however make de Gaulle’s political heir change his mind. What the French however forgot (yet again) was that the EU Treaty forbids state subsidies within the EU that distort competition. The EU Commission has to vet, and approve, any measure by the Member States that risk tilting the EU playing field that is (supposedly) level.
A couple of days ago, the Financial Times reported that the French Government was backing down from its initial proposal in order to make it compatible with the conditions imposed by the EU Commission as required by the EU Treaty. The French know that by ignoring the EU bureaucrats in Brussels, they would eventually have been defeated in the European Court of Justice. A handful of EU career bureaucrats in Brussels thus wield more power when they act to uphold the general interest than the combined EU Governments, minus France.
The EU Institutions and the Member States are currently working on a major overhaul of all financial regulation, the guiding principle being that of the general interest.
Jean-Jacques Rousseau is quoted among the philosophers that influenced what would become the U.S. Constitution. The U.S. Constitution states in its preamble that one of its purposes is to “promote the general welfare” (see “general will” according to Rousseau). The preamble however seems to be of limited nature and practical influence (readers’ comments welcomed). Consequently, where the EU (and Sweden) puts the general interest at the core of its action, the U.S. Institutions appear to lack a similar principle to protect against special interests and to promote sensible policies.
Naked Capitalism has been one of the most efficient and fastest forums for analysis and critical scrutiny of governments’ handling of the financial crisis. Otherwise insightful NC commentators however often seem disarmed when confronted with the invisible concrete wall of special interests that stands in the way of devising appropriate policy responses.
To conclude, Geithner’s new plan will be closely scrutinized in capitals across the globe and will influence stakeholders’ view on the capacity, or inability, of the U.S. to address the financial crisis and to reform its institutions. The world is much in demand for competent leadership after a year of costly, improvised and inefficient bailouts. If Geithner’s plan receives a hostile welcome domestically, the ambition of the U.S. to lead again internationally, beginning at G 20, will suffer an instant blow. If the Obama Administration and Congress are unable to govern in the general interest at home, their influence abroad will thus dwindle accordingly.