The Swedish Financial Crisis

1. The experiences , questions & lessons taken from Sweden. The Swedish Financial Crisis

2. OUTLINE • The Swedish Economic Background (1970s-1980’s) • 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, 1970’s to 1980’s

6. Swedish Economic Background & Roots to the Crisis Source: Englund, Peter (1999), "The Swedish Banking Crisis: Roots and Consequences", Oxford Review vol 15 n°3, Swedish Statisitics pp 82

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 • 1980’s • 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 Capital inflows • Upward pressures on the exchange rate • Contributed to the overheating of the economy.

11. Roots of the crisis: Credit Expansion Source: Englund, Peter (1999), "The Swedish Banking Crisis: Roots and Consequences", Oxford Review vol 15 n°3, 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 n°3, 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 it’s 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 1980’s to 1992 non performing bank loans mushroomed from 0.2% to 5%. • From 1991 to 1993 Sweden’s 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 1982:1 – 1999:9 Source: Englund, Peter (1999), "The Swedish Banking Crisis: Roots and Consequences", Oxford Review vol 15 n°3, 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 n°3, 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

21. 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) AMC’s (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.

24. 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. • ErgungorE. (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 n°3, 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 it’s Banking Crisis” September, 2008. Data: • Swedish central bank: http://www.riksbank.com/