As the debate sharpens in the U.S. Congress over Treasury Secretary Henry Paulson's proposed $700 billion bailout package, Washington policymakers would be wise to lift their gaze beyond the Beltway and take a look at Sweden. That country has already been in this particular policy hell, during a banking crisis of its own in the early 1990s. "The basic conditions are the same," says Bo Lundgren, Sweden's Finance Minister at the time. "There was the same anxiety and the same need for confidence." He's one of a number of Swedish financial types who have been shuttling in and out of Washington and New York in recent months with a compelling message: there is a way to shore up ailing financial institutions without saddling taxpayers with the entire bill.
Under the current plan being hawked by Paulson and the Bush administration, that astronomical sum would be used to buy up bad debt from ailing institutions in order to clean up their balance sheets. The criticisms of the plan are legion, but one irksome feature is that the banks that made the worst mistakes are in line to get the most help, providing little incentive for future managers to mend their ways. And all taxpayers would get for their rescue money is a mountain of toxic loans of highly dubious value.
The Swedish example offers one way to minimize such "moral hazard" and potentially recoup some of the funds taxpayers are being asked to spend to help get the credit markets rolling again. The idea, says Lundgren, is not to just give money, but "to get some ownership (in return), and eventually be able to get some revenue back." By taking a stake in its enfeebled banks, Sweden was able to minimize the taxpayers' burden in the long run.
Sweden's financial crisis in the early 1990s stemmed from a 1985 deregulation of credit markets, which set the stage for overexpansion and bubbles in the real estate and finance markets. When those bubbles burst in the early 1990s, Sweden's currency crumbled and interest rates spiked to 500% overnight. Of the country's seven biggest banks, five needed either government bailouts or big injections of money from shareholders. The value of the country's real estate market plunged 50-60% in 18 months. "The whole Swedish banking system was off-balance," Lundgren recalls.
The government tried several stop-gap measures to no effect and in late 1992 opted for a complete re-booting of Sweden's financial system. Conservative Prime Minister Carl Bildt's administration sat down with the center-left opposition and came up with a bipartisan, multi-tiered approach. The government issued blanket insurance for a period of four years to creditors in all the country's 114 banks. It established an agency to oversee all banks that needed recapitalization and told them to immediately write down their losses.
Most importantly, the government stipulated that in order to become eligible for government funding, banks would have to give up something namely equity in return. In the case of one leading bank, the mere prospect of the government taking a stake was enough to persuade shareholders to dig deeper and raise money on their own. For the rest, the government was able, once the markets rebounded, to sell off the stakes it had acquired, making a profit that was effectively returned to taxpayers' coffers. At one point the government controlled more than 20% of the entire banking system.
The cash that Sweden poured into its banks at the time amounted to about 4% of the country's Gross Domestic Product. The comparable share of the U.S. GDP would be about $850 billion, or not much more than what Paulson has recently proposed . But in Sweden's case at least one half of that money, and possibly more, depending on the source, was recouped by subsequent equity sales.
One of the attractions of this Swedish model is that it reduces so-called "moral hazard" effectively rewarding poor or reckless risk assessment by forcing financial institutions that took the highest risks to pay towards their own rescue. And it allows the state to recoup the money that it expends to buy up the bad debt at the core of the problem.
Paulson's current plan exacts no such a price from the financial institutions it proposes to bail out; the idea has not been publicly discussed by either the Congress of the Bush Administration. But it ought not be considered ideologically beyond the pale, since the U.S. government did get equity stakes when it bailed out mortgage giants Fannie Mae and Freddie Mac, as it did last week for AIG, the world's largest insurance company.
Swedish experts caution that the Swedish financial system is relatively small compared to the U.S. In 1992 most leading government officials knew the bank chiefs on a first name basis. Still, the Swedish experience could hold other lessons, says Robert Bergquist, chief analyst at SEB, one of Sweden's largest banks. "The Swedish success depended on four factors," he explains. Stockholm acted quickly, in open acknowledgement of the problems, and under a broad political agreement across the party spectrum. "Running parallel with these three factors," he says, "a new economic policy new goals for inflation and the budget was developed after the crisis."
In Sweden's case, he adds, the crisis eventually had silver lining. "It acted as an alarm about Swedish economic policy, which was expanding too much. There was too much focus on defending the currency. The tax system encouraged indebtedness and real estate speculation through cheap loans. The crisis exposed shortcomings, and we had to change tack."
Within several years, Sweden succeeded in getting its economy back on course. Growth has been as robust as in any country in western Europe in recent years and its banks have helped finance the economic boom in the Baltics and points east. Whether its approach could work in the far larger and more complicated U.S. market isn't clear. Certainly the captains of Wall Street would bray over the mere hint of nationalization. But with hundreds of billions of dollars at stake, it might be worth, at the very least, a hard look.
With reporting by Lotta Narvehed / Stockholm