In the early 1990's, Sweden had a banking crisis that was remarkably similar to the current US problem. It was an era of easy credit and inflated housing prices, and it ended badly. According to the New York Times, "the country was so far in the hole in 1992 — after years of imprudent regulation, short-sighted economic policy and the end of its property boom — that its banking system was, for all practical purposes, insolvent." You can see its impact in the chart, above left, of the Stockholm 30 Index. So what, exactly, happened and how did Sweden resolve its crisis? What can we learn from it?
First of all, you need to know that Sweden's currency (the krona) was semi-pegged at the time; it floated within a range against a basket of currencies that included, significantly, the German mark. Here's what happened:
1980 - Inflation is high and the economy slow, so to encourage exports, Sweden devalues its currency.
1982 - the economy needs more stimulation so banking regulations are loosened to boost domestic lending.
1985 - credit markets are further deregulated and interest rates liberalized. Ceilings are lifted on bank loans. Interest on consumer debt is tax deductible.
1986- Banks now compete to expand and they over-lend, creating easy credit. A real estate price boom ensues. Consumers are borrowing and spending heavily and the personal savings rate turns negative. Foreign banks with a cheaper cost of funds enter the market and worsen the problem.
1989 - tax deductions of interest on consumer debt are disallowed, a disincentive to borrowing
1990 - Germany's reunification of east and west causes a swift rise in its interest rates. Sweden is forced to raise rates because the currencies are tied. The krona becomes overvalued and borrowing more expensive, making the bubble unsustainable.
1991 - Home prices have doubled over the last decade, but higher interest rates start to trigger defaults. Property values begin a rapid decline. The value of commercial paper also drops and soon, two major banks are unable to meet their capital requirements of 8%.
1992 - Property prices continue their sharp decline and a 3rd major bank fails. The government announces its plan of action. It takes ownership of the failed bank and announces a guarantee of the entire banking system. The currency is floated and a subsequent run on the krona results in sharply higher interest rates, worsening the crisis.
1993 - Central Bank Chairman Bäckström says of this time: "between the summers of 1990 and 1993, GDP dropped by a total of 6%. Aggregate unemployment shot up from 3 to 12%."
1995 - Home prices have now dropped by one-fourth and commercial property prices are down by nearly half. Reports show that non-performing loans exceed 12% of Sweden's's GDP, greater than the capital of the banks.
How was the crisis resolved? For banks in trouble, the government insisted they write down losses and value assets at realistic levels. Banks were told to first try covering losses with capital from shareholders. If this did not work and they needed taxpayer funds, they had to issue blocks of shares to the government in exchange for cash, diluting or cutting off existing shareholders. This tough choice meant that banks tried to resolve their problems by raising private equity, thereby avoiding nationalization. Some were able to do this; some were not. Eventually, the government owned over 20% of all banks.
The government allowed recapitalized banks to continue normal operations by dividing each bank into good and bad assets. The bad loans were placed in independent asset management corporations (AMCs) in 1993, "bad banks" if you will, which had some similarities to the Resolution Trust Corporation in the US. The AMCs were heavily capitalized by the government and given free reign to re-work debt, take over assets and sell them as needed. The bad assets they controlled were assigned new, realistic values, and they were allowed a decade, if needed, to resolve the problems. The taxpayers would be paid back through the sale of assets.
The AMCs resolved all the problem assets on their books by 1997. During the crisis, Sweden spent almost $12 billion to rescue its banks. More than half of this was repaid through the sale of "bad" assets and the sale of bank shares that the government received. Even today, the government still holds shares in one bank. As you can see from the chart above, the stock market did recover, however some studies have shown that the crisis created a permanent decline in output for the country.
