March 17, 2008 1:35

Merrill's David Rosenberg joins me in getting all Swedish about the financial crisis

See, I'm not the only one pushing the Swedish solution! From Merrill Lynch North American economist David Rosenberg's Morning Call Notes today:

The Japanese credit crisis is usually cited as the benchmark for what not to do. But few cite Sweden's crisis as a template on what might actually work. ... the Swedish authorities realized early on that a banking crisis cannot be resolved until the problem is properly defined. That means assessing who the "bad" and "good" houses of issues are and be willing to allow the "bad houses" to fail (as an aside, "good houses” do not necessarily imply "big" houses).

... Sweden established a Bank Support Authority to undertake "reality testing" on the loan books of Sweden's largest banks and had a "board of valuation” experts go in and value the assets on the books of all the lenders. Call it invasive if you will, but then again, the government was doing the work that market players could not or would not do – value the collateral and do it quickly. This is similar to what Barney Frank is proposing in the US mortgage sector today. ...

It should also be noted that it was Sweden's equivalent of the US Treasury, and not the central bank, that played the primary role in this crisis management stage (though the Riksbank maintained an accommodative monetary stance and lowered interest rates right through to December 1993, more than a year after the markets had bottomed). And, it obviously required the heavy hand of government intervention; there are solid grounds for this when there is market failure in the private sector, in this case, insufficient information regarding the quality of financial sector balance sheets. ...

Rosenberg also offers some recommended reading: Stockholm School of Economics finance prof Peter Englund's article "The Swedish banking crisis: Roots and consequences," and a 2002 Business Week interview with Sweden's former Minister for Fiscal and Financial Affairs, Bo Lundgren. An excerpt from the latter:

"Broad political consensus and resolute political actions taken by the political system are probably more important than any of the technical aspects on how to deal with the crisis." In Sweden's case, Lundgren's nonsocialist coalition government worked very closely with the Social Democrats in the opposition.

In the end, they came up with a three-pronged approach based on the major Swedish banks' real level of need to avoid a systemic collapse that would have completely blindsided the economy. Some banks received state support. Others had to fend for themselves. The state-owned Nordbanken was overhauled by the government and merged with smaller banks, Lundgren points out.

Update: Barry Ritholtz says he tried to comment on this post, but was thwarted by the nasty registration process, so let me just link to his summing up of Reinhart's and Rogoff's paper on five big financial crises of the post-war era (Spain '77, Norway '87, Finland '91, Sweden '91, Japan '92). The money quote:

Reinhart and Rogoff draw parallels between the current U.S. financial woes and five previous financial crises. All five of these were “associated with major declines in economic performance over an extended period."