ProFinance.Ru (Site news), April, 25, 2008

WILL ECONOMIC SITUATION IN SWEDEN SERVE AS A LESSON FOR THE US?

American government is looking for a way out of the situation that many economists call the most serious financial crisis since the times of Depression. In any case, they may quite learn a lesson from another painful banking crisis that cost big losses. A big real estate bubble broke in Sweden at the beginning of the 1990s and brought turmoil to Scandinavian economy leaving behind the broken financial companies, collapsed organizations and crowds of unemployed. This was the first systemic banking crisis in a developed country since the 1930s. As a result of which, the economy of Sweden was falling for three years in succession, which did not happen in the US since the moment of quick demobilization after the end of World War II. The Swedish and the American crises have many common traits. Both countries experienced time of financial deregulation and in both countries banks that grew bolder again found ways to collect unacceptable amounts of the debt. Fortunately, despite the economic conditions that were much worse than in the US today unlike the similar case in Japan Sweden got restored quickly.

However, the measures taken in Sweden would be very ambiguous in the United States. Sweden used large amounts of taxpayers’ money for restoration of the suffered banks. David Rosenberg, economist of investment bank Merrill Lynch, comments, "In case of Sweden the solution was finally found with assistance of the state balance… As a result, the government carried out recapitalization of the system." "Here is a lesson." Successful experience of Sweden in climbing out of the crisis may be useful for the US too. However, liquidation of this crisis cost Sweden dearly. According to estimates, it cost 6% of the annual volume of production. An equivalent bill for the US would amount to $850 billion today. The government of Sweden could manage the money so freely only because it received broad approval among politicians, which would be difficult to imagine in the guerilla atmosphere in the US in the year of presidential elections. Peter Inglund from the Stockholm School of Economics says, "There was a tradition of cooperation between political lines of the party in Sweden… The crisis was so obvious that everyone was scared."

A familiar story

To anyone who paid attention to the financial situation in the US growing worse the case of Sweden would seem very familiar. At first, there were long years of economic expansion: revenues were growing and it seemed that good times would never end. Along with this, the seeds of the future Swedish crisis were sowed during the period of prosperity. Comprehensive deregulation of the credit markets in 1985 acquainted bankers with new clients, products and markets that neither bankers nor legislators understood fully. Urban Backstrom, former official of the Finance Ministry, wrote, "The supervisory agencies were not ready for the new conditions that appeared after deregulation of the credit market. This meant that throughout the 1980s credits could be issued on shady and sometimes absolutely unreliable grounds without interference of controlling agencies." The major part of the flow of new loans fell on the overheated real estate market where prices of commercial real estate fell more than twofold in the second half of the 1980s. The first problems appeared among the financial organizations that possessed a big volume of such investments. In September of 1990, company called Nyckeln known as "The Key" ceased to exist after it failed to restart its financing.

Majority of financial companies was in the hands of large banks occupying dominating position in the Swedish economy. Such companies as Nyckeln financed their operations on account of securities of a new type – commercial securities called marknadsbevis, which possessed a banking guarantee. When Nyckeln went broke the market for such securities suddenly collapsed and losses were reflected in the balance reports of banks as repercussions in a way similar to the way in which American banks suffered now from losses from derivative financial tools that they removed from their balances. Stephan Viotti, chief advisor to the head of the Central Bank of Sweden, says, "There is a striking similarity to what is happening now." In 1991, economy started declining for the first time in ten years and kept falling in 1992 and in 1993. Unemployment grew dramatically from 1.6% in 1990 to 12% in 1993. Being afraid that collapse of the banking sector would harm the entire economy, in September of 1992 the Swedish government issued a general guarantee of all banking liabilities. Depositors, creditors and trading partners – everyone – had to be protected from losses. However, shareholders had to suffer to avoid a tempting financial risk in the future. In exchange for the state money the government received stakes in equity of the banks, whereas stakes of existing owners decreased.

Dirt-cheap

Decisive actions of the government resulted in a situation when restoration was as dramatic as the crisis that preceded it. In 1994 and in 1995, the annual growth of economy amounted almost to 4%. The emergency banking guarantee was liquidated in 1996 and substituted with the deposit insurance system similar to Federal Deposit Insurance Corp. in the US. Successful resolving of the crisis in Sweden caused a storm of applause of economists including Alan Greenspan, Chair of the Federal Reserve System (FRS) of that time who said in 1991 that "immediate resolving has a positive effect." There are differences between the Swedish and American situations. After all, Sweden is a small country. The annual productivity of the entire economy is equalized to the ten-day activity in the US. Problems of Sweden were also exaggerated by peculiarities of the taxation system and unwise protection of the fixed currency exchanged rate. This resulted in a situation when authorities increased overnight interest rates quickly to a level of 500% killing for the commercial sector. The current financial problems of the US are also unprecedented in their difficulty. The current crisis is not confined to commercial banks and traditional crediting practices. Today, the main role is played by investment banks and tools that did not exist at the beginning of the 1990s, namely swaps for defaults on credits, bonds secured by debt liabilities and structural investment tools. At any rate, some observers register existence of the signs showing that the US is already using the lessons learned by Sweden. Anders Aslund, Swedish economist of Peterson Institute for International Economics in Washington, mentions sale of investment bank Bear Stearns to JPMorgan Chase as the main example. The deal supported by the FRS helped avoidance of the risk that bankruptcy of Bear Stearns might involve other financial institutions.

Payment

He says, "Situation regarding Bear Stearns looks as if it has been taken from pages of the textbook about the way Sweden has coped with the banking crisis." Edward Kane, professor of finance from Boston College, stated that decision of FRS to help sale of Bear Stearns became the first sign that the government was taking over the financial system. Kane who worked as consultant for FRS, IMF and foreign central banks added, "They unconditionally issued guarantees to such companies in any quantities. This process is called nationalization. It is not obvious and not recognized." Such guarantee makes the government a co-owner of the largest financial institutions of the country. For example, during the peak of crisis in Sweden the government managed 22% of the entire banking system. When the crisis decreased and banks started bringing revenues again Swedish taxpayers shared the profit. Kane says that American government should use the example of Sweden and issue an official guarantee of financial institutions of the country for taxpayers to be able to receive benefit from restoration. Despite that economy restarted its growth Sweden kept paying for its former squandering. In the 1990s, unemployment remained on the levels before the crisis and the Swedish government that managed surplus in the 1980s experienced budget deficit for seven years in succession. The relatively high living standards of Sweden suffered too. In 1970, Sweden had the third place according to per capita income in the Organization of European Community and Development (consisting of 30 countries) being inferior only to the US and Switzerland. By 1991, it well to the 14th place where it remained now. Kenneth Rogoff, professor of the Harvard University, says that the price of regulation of problems in the financial system in the US will be as high as in Sweden and possibly even higher.

According to reports of The USA TODAY