A good article in tonight’s Financial Times gives useful detail about the Swedish response to its early 1990s banking crisis. As readers may know, Sweden (along with the less touted Norway) is considered to have been particularly effective in mopping up a banking crisis.
We and others have observed that the US is engaging in ad hoc measures and for the most part, taking the path of least resistance, which is putting us on the same path as Japan, of propping up zombie banks rather than making banks write down bad assets to realistic values. Indeed, an IMF study of 124 banking crises said regulatory forbearance (econ speak for regulators letting banks get by with little to no equity in the hope they will somehow muddle through) is associated with slower recovery from financial crises. Our method for letting banks off easy is giving them a break on accounting. The FASB is under great pressure to relax mark to market accounting, and letting banks carry assets at higher prices will, voila, increase their equity. Nothing fundamentally has improved, but suddenly the books look nicer. That is supposed to improve confidence in banks. Cynics think it will do the reverse.
Consider some of the findings from the IMF paper that have been ignored. For instance, bank and borrower bailouts are not such a hot idea:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
History also suggests that keeping insolvent banks is not such a hot idea:
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
The Financial Times article is worth reading in its entirety. Often, the Swedes point out what they did right, and the US is doing the exact opposite.
The one bit of good news is Sweden dithered for a couple of years before it decided it needed to tackle its banking mess head on. In theory, it is not too late for America to get religion, but I see no recognition on the part of anyone in authority that we are on the wrong path.
Key bits from the Financial Times article:
“It was never the intention of the government and the Bank Support Authority to sort of take over as many banks as possible,” says Mr [Stefan] Ingves [head of the Bank Support Authority in the early 1990s]. “The issue was to be ready to sort out the mess in the system. To do so we needed a process that made it possible for us to evaluate whether a bank was actually OK, had a small problem or a huge problem.”
Yves here. Don’t kid yourself that the stress tests are even remotely adequate to do the job. Back to excerpts:
Arne Berggren, the finance ministry official responsible for bank restructuring, is blunt about the approach he took. It was clear from the outset that the government would act as a commercial investor, demanding equity stakes in return for capital. “We were a no-bullshit investor – we were very brutal,” he says. The authorities also insisted on control. “You take command. If you put in equity, you have to get into the management of the business, [otherwise] management is focused on saving the skins of the [remaining private] shareholders.”….
Private banks were also encouraged to place their bad loans in separate entities. However, in contrast with the recent debate in the US, the authorities never contemplated removing bad assets from those banks. “We refused to buy assets from privately owned banks because it would have been impossible for us to agree on the price and we were never in the business of giving privately held banks subsidies,” says Mr Ingves.
It is remarkable that the Swedish will discuss economic realities as if they are obvious (which they are) while the US government and media seems constitutionally incapable of seeing what is right in front of their noses.
The Swedish story also contains a cautionary tale:
Having tackled the crisis, the authorities conspicuously failed to put in place longer-term reforms to help avert similar problems in the future. “The regulatory framework we put in place in the early ’90s had sunset clauses. So the sun set and that was it,” says Mr Ingves. “The politicians felt, ‘that won’t happen again’,” says Staffan Viotti, an adviser to Mr Ingves and adjunct professor at the Stockholm School of Economics.
Some of the Swedish banks have gotten in over their heads lending to the Baltics, and the unwinding is sure to be ugly.