The Swedish Financial Crisis

1
The Swedish Financial Crisis

• The experiences , questions lessons taken from
  Sweden.

2
OUTLINE

• The Swedish Economic Background (1970s-1980s)
• Role of Deregulation (1985)
• Credit expansion the housing bubble
• The Crisis (1989 1992)
• Extent of the crisis
• Crisis Management
• Lessons and policy implications from the crisis
• Conclusion

3
Questions to keep in mind.

• What caused this crisis? Deregulation? Fixed
  exchange rate? Bad policies?
• How was the Swedish Crisis resolved so quickly?
  Good policy or global economic growth?
• What are the policies we can adopt and the
  lessons we can take from this crisis today?

4
Swedish Economic Background and Roots to the
Crisis. (1970s-1980s)
5
Swedish Economic Background Roots to the Crisis

• Sweden, 1970s to 1980s

6
Swedish Economic Background Roots to the Crisis
7
Swedish Economic Background Roots to the Crisis
Source Steigum, E (2008). Monetary instability,
financial deregulation and crisis Some Nordic
lessons. Norweign School of Management.
8
The role of Deregulation (1985-1990)
9
Roots to the Crisis Deregulation

• 1980s
• High regulation of banks and insurance
  companies.
• Lending ceilings placement requirements.
• 1983-1985
• Theses regulations were progressively lifted.
• 1989
• Regulation on international transactions were
  finally lifted.

10
Roots of the Crisis Deregulation

• 1. Financial sector weaknesses
• Lack of expertise
• Difficulty adapting to the change from a
  sheltered environment to a much more open
  competitive situation.
• Increased risk-taking
• High leveraging
• High-risk concentration in certain economic
  sectors
• Primarily real estate (60 of all loan losses)
• Presumed no exchange rate risk
• Banks as borrowers themselves insisted on loans
  denominated in foreign currency
• Believed not to have hedged against this risk.
• Government no longer borrowing in foreign
  currency
• Borrow from banks that borrow abroad
• Government transferred the exchange rate risk to
  domestic banks.
• 2. Fixed exchange rate with free capital
  movements

11
Roots of the crisis Credit Expansion
Source Englund, Peter (1999), "The Swedish
Banking Crisis Roots and Consequences", Oxford
Review vol 15 n3, Wallendar(1994) pp 84
12
Roots to the Crisis The Bubble
Source Steigum, E (2008). Monetary instability,
financial deregulation and crisis Some Nordic
lessons. Norweign School of Management.
13
Roots of the Crisis The Bubble
Source Englund, Peter (1999), "The Swedish
Banking Crisis Roots and Consequences", Oxford
Review vol 15 n3, Wallendar(1994) pp 87
14
The Crisis.(1989 1992)
15
The Crisis

• 1989 triggers the crisis!
• 1. Internal factors.
• Bad timing on new saving policies
• Tax reform on interest payments
• Inflation focused macroeconomic policy
• 2. External factors .
• German unification
• Global Economic slowdown
• ERM break down- float of the krona
• 3. Commercial property reached its peak.
• Instant reaction by the stock market
• 52 fall in the real estate index
• Foreign credit lines withdrawn

16
Extent of the Crisis

• 1990 bubble burst and the residential real estate
  prices dropped 25 .
• From the late 1980s to 1992 non performing bank
  loans mushroomed from 0.2 to 5.
• From 1991 to 1993 Swedens GDP fell by a total of
  around 6.
• Unemployment shot up from 3 to 12.
• Public sector deficit worsened to as much as 12
  of GDP.

17
Stockholm Stock Exchange Indices Monthly
Averages 19821 19999
Source Englund, Peter (1999), "The Swedish
Banking Crisis Roots and Consequences", Oxford
Review vol 15 n3, Wallendar(1994) pp 87
18
Bank Profits and Credit Losses 1990-1991 (Billion
SEK, 12 month moving average)
Source Englund, Peter (1999), "The Swedish
Banking Crisis Roots and Consequences", Oxford
Review vol 15 n3, Wallendar(1994) pp 90
19
Crisis Management
20
Crisis Management

• Financial Measures
• Restore confidence
• Government issued an unlimited guarantee to all
  depositors.
• The banking liquidation or reconstruction
  strategy was explained to the public.
• A new agency, Bank Support Authority
• Losses were announced
• Method establish to decide exactly which banks
  need to be liquidated.
• Strict Valuation Rules
• Banks were marked-to-market
• Bleed the Shareholders bankers

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Crisis Management (2)

• Financial Measures (cont.) AMCs
• How do they work?
• Splitting the ailing bank into a good bank and
  bad bank
• bad assets go to the AMC at carefully assessed
  market values
• Regrouping and improvement of assets
• Wait for a reasonable price
• Time consuming but better than a fire sale
• Allowed bank to get back to more important
  strategies

22
Crisis Management (3)

• AMCs (cont.)
• High degree of independence from political and
  regulatory constraints.
• They were deliberately over capitalised (SEK 24
  billion, an amount equal to the Swedish defence
  budget)
• Enabled the AMCs to carry out their salvage
  operations autonomously and did not have to
  request funding from legislature which might have
  tried to influence their decisions
• Exempt from regulation on the timing of
  collateral liquidation (estimated it would take a
  decade)

23
Crisis Management (4)

• Fiscal Policy
• Not much it could do as it was already extremely
  deficitary.
• Monetary Policy
• Dual role
• Stimulating the economy and ease burden on
  borrowers.
• Ensure capital flows need to rebuild depleted
  foreign currency reserves.

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Was the quick recovery due to global improvements
or good policies?

• Growth of the Swedish economy paralleled the
  global economic boom of the 1990s.
• Foreign demand for Swedish goods and services
  rose from 0.89 of GDP in 1990 to 1.2 of GDP in
  1995.
• Liquidations were completed by 1997 at a smaller
  cost than tax payers had anticipated
• AMC return 1.8 billion dollars in 1997 of its 4.5
  billion (in depreciated kronas)
• Did sensible policies pay off or did the rising
  tide lift all boats? (Ergungor, 2007)

25
Was the quick recovery due to global improvements
or good policies?

• No proof to answer this question directly.
• Can only evaluate the resolution strategy from
  previous crises (Ergungor et al, 2006)
• confidence needs to be restored quickly
• The process must be transparent
• Maintenance of market discipline
• A plan to jump start credit flows in the
  financial system by repairing the damaged
• political consensus and independence

26
Conclusion

• What caused this crisis? Deregulation? Fixed
  exchange rate? Bad policies?
• How was the Swedish Crisis resolved so quickly?
  Good policy or global economic growth?
• What are the policies we can adopt and the
  lessons we can take from this crisis today?

27
Bibliography

• Articles
• Calomiris, Klingebiel, Laeven. (2004) Taxonomy
  of the financial crisis resolution mechanisms
  cross country experience. World Bank policy
  research papers.
• Ergungor E. (2007) On the Resolution of the
  Financial Crises The Swedish Experience. Policy
  Discussion Papers. Federal Reserve Bank of
  Cleveland.
• Englund, Peter (1999), "The Swedish Banking
  Crisis Roots and Consequences", Oxford Review on
  Economic Policy vol 15 n3, pp 80-97
• Heikensten, Lars (1998), Financial Crisis,
  experiences from Sweden, mimeo
• Jackson J. (2008) The US Financial Crisis
  lessons from Sweden. Congressional Research
  Service Library of Congress. CRS report for
  Congress.
• Steigum, E (2008). Monetary instability,
  financial deregulation and crisis Some Nordic
  lessons. Norweign School of Management
• The New York Times. How Sweden Solved its
  Banking Crisis September, 2008.
• Data
• Swedish central bank http//www.riksbank.com/