IF THIS BE SOCIALISM, MORE, FASTER, PLEASE:

Sweden's credit crunch lessons (Nigel Cassidy, 4/09/08, BBC News)

[P]olicymakers are studying how Sweden managed to rescue four of its biggest banks when its own credit boom turned to bust in the early 1990s.

House prices had slumped, the currency was out of control, and unemployment and bankruptcies were rising rapidly.

If the Riksbank had failed to act rapidly and chosen not to inject capital into its major banks, the entire financial system of the country might well have collapsed.

At a cost of some $11bn (£5.5bn), Sweden guaranteed repayment of depositors and creditors at all of its stricken banks.

But the state aid was skilfully targeted, so none of the cash went to the bank's shareholders.

Indeed, most of the money was regained by the Swedish government as the national economy recovered. [...]

Against the clock, Sweden had managed to do what the Federal Reserve and other central banks are still grappling with.

It worked closely and transparently with lenders to get all the bad news out quickly, rather than allow institutions to keep announcing new write-offs over time.

Sweden had recognised that bank assets could only be resold or returned to the private sector once all the bad loans were disentangled from the good.

Mr Heikensten is at pains to stress that although Sweden's situation was very grave for the country, the central bank's task was more clear-cut than the current crisis facing his opposite numbers in world financial centres today.

But he and other central bankers, past and present, have already been meeting in the United States.

"I'm sure they are learning from all available experience," he says.

Sweden's turn from socialism (Josiah R. Baker , 6/16/07, Washington Times)

The Swedish government still spends more money than any other government in the world, relative to gross domestic product (GDP). But changes are afoot. Finance Minister Anders Borg recently produced a comprehensive plan, "Reconstructing the Swedish Model: Challenges and Priorities" that illustrates the new administration's sincerity for reform.

To Sweden's credit, some of its economic reforms have already surpassed the United States. Its social security is partially privatized, the inheritance tax is eliminated, and most people no longer pay any primary residential property tax.

"Social security, and the combined three levels of income taxes can still reach as high as 85 percent," says Swedish attorney and entrepreneur, Ulf Sandstrom.

The Heritage Foundation's Freedom Index gives Sweden surprisingly high marks because of its overall political and societal stability. Outside investors have largely agreed with the perception that Sweden is a safe, long-term bet.

Foreign capital is digging in. Many Swedish industries have merged and/or been bought with foreign capital. Volvo, Ericsson, Saab, ABB and Telia (the former State telecom) are no longer entirely Swedish-owned. On May 25, the Nasdaq Stock Market Inc. agreed to buy the Swedish stock exchange OMX for $3.7 billion to form NASDAQ OMX Group.

Despite direct investments, more than 80 percent of new jobs come from small businesses, not the traditional corporations.

MORE:
Japan Credit Perspectives: Responding to Financial Crises: Lessons to Learn from Japan’s Experience (Koyo Ozeki, August 2008, PIMCO)

Japan’s financial crisis persisted for nearly 14 years, from the burst of the economic bubble in 1991 until around 2004, but throughout that timeline there were transitions in the state of the markets and the nature of the crisis. Broadly speaking, we can divide the progression into four phases (Chart 1).

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Phase 1 (1991–94): The real estate bubble collapsed, triggering an economic shock. The government responded typically with economic stimulus packages, such as public works projects.

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Phase 2 (1995–96): Signs of instability appeared in the financial system. Even as banks failed due to financial difficulties, the government failed to come up with a comprehensive policy package that would address financial system issues.

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Phase 3 (1997–99): The bankruptcy of major banks triggered a financial emergency. Through establishment of new laws and budgetary measures, the government nationalized failed banks and injected taxpayer money into large financial institutions. Even so, it was unable to resolve the situation.

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Phase 4 (2000–04): The system again reached a crisis point due to the massive volume of excess debt held by corporations. The Financial Revitalization Program (“Takenaka Plan”) promoted the disposal of non-performing loans, and the government supplied public funds to tottering Resona Bank. These measures finally helped bring the crisis to an end. [...]

Q: Why did it take so long to resolve the crisis?

A: It took nearly 14 years from the burst of the Japanese bubble economy in 1991 until the financial crisis finally came to an end. There are several reasons for this unusually long timeframe.

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Hopes for a turnaround in property prices: From the collapse of the bubble economy until the mid-1990s, most people assumed that real estate prices would eventually turn upward again. Policy makers were also focused on encouraging an economic and market recovery through fiscal stimulus measures such as public works projects.

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Existence of colossal latent stock profits: At the start of the 1990s, Japanese banks had stock portfolios with unrealized profits amounting to nearly twice their net worth. This acted as a buffer for loss write-offs, encouraging a complacent stance that they could hold out until the real estate market made its comeback. The plunge in the stock prices in 2000 severely eroded these latent profits, and appraisal losses began to have a negative impact on profits. Banks and financial authorities gradually came to recognize the risks regarding the shares in their portfolios, and proceeded to trim their holdings.

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Massive scale of the problem: Japan’s cumulative bad debt totaled an estimated 25–30% of GDP, while the value actually written off by financial institutions amounted to nearly 100 trillion yen (US$910 billion) or 20% of GDP. The large banks alone accounted for 75 trillion yen (US$680 billion) of this total (Chart 10). This exceeds the combined value of their net worth of 20 trillion yen (US$180 billion) and 14 years worth of net operating profits at 50 trillion yen (US$450 billion). They realized profits from their share holdings to supplement the portion that could not be covered by net operating profits. Though this conclusion is made in hindsight, it is clear that banks simply did not have the financial strength to dispose of these vast losses in a short period, and they had no choice but to take their time to write off debt using their annual earnings and unrealized profits. [...]

Q: Is rapid disposal really the key to early resolution of problem?

A: In responding to a crisis, authorities must 1) rapidly analyze the nature of the problem, 2) evaluate its scale, and 3) devise necessary measures. It is difficult to identify the precise causal relationship between financial system measures and a bottoming out in asset prices, but one lesson that can be learned from Japan’s financial crisis is that the delay in recognizing the problem during Phases 1 and 2 (1991–96) made the subsequent fallout even worse, and an underestimation of the situation’s severity and the authorities’ trial-and-error approach in Phase 3 (1997–99) caused the delay in settling the problem. [...]

Differences between U.S. Subprime Crisis and Japan’s Crisis
Both the subprime loan turmoil in the U.S. and the financial crisis in Japan resulted from a bubble created by the presence of surplus liquidity. However, there are several differences.

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Complex structure of U.S. bubble: Whereas Japan’s bad debt problem stemmed from commercial real estate and excess corporate debt, the U.S. subprime problem involves a more complicated mixture of bubbles related to the housing market, financial institution business models and financial products for investors.

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Speed of valuations: Japan’s bad debt was mostly bank lending, and valuations took some time as regulators conducted asset inspections. In contrast, the subprime loan problem involved securitized products, so market valuations were completed relatively quickly. The valuation of housing loans by commercial banks in the U.S. could take longer than securitized products, though, so we should keep a close eye on future developments.

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Creditor nation vs. debtor nation: Japan is a creditor nation and does not rely on overseas financing, so its bad debt situation was an internal problem. The U.S. is a debtor nation, which complicates the matter. Also, U.S. housing loans and other securitized products are widely held by overseas investors, so the risk can easily spread to global markets. This will naturally impact how the government responds to the problem.

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Scale of the problem: Japan’s bad debt problem on a cumulative basis amounted to a whopping 25–30% of the nation’s GDP (Chart 14), whereas the subprime problem is an estimated 5–10% of U.S. GDP. The difference in scale will likely affect the cost and speed of resolving the situation.

Posted by Orrin Judd at October 4, 2008 12:13 PM