Lessons from Sweden

Over at Credit Writedowns, Edward Harrison has been having email discussions with Lars Jonung, the chief economic adviser to Prime Minister Carl Bildt in 1992-94 when the Swedish solution was implemented.

Jonung has disagreed with Alan Blinder and others who seem more focused on shoring up confidence than repairing the financial sector.

Here’s an excerpt:

“When Sweden was hit by a financial crisis in 1991-93, its response comprised a unique combination of seven distinctive features: 1) swift policy action, 2) political unity, 3) a blanket government guarantee of all bank liabilities (including deposits but excluding shareholder capital), 4) an appropriate legal framework based on open-ended government funding, 5) complete information disclosure by banks asking for government support, 6) a differentiated resolution policy by which banks were classified according to their financial strength and treated accordingly, and 7) an overall monetary and fiscal policy that facilitated the bank resolution policy.

Two major banks were taken over by the government. Their assets were split into a good bank and a bad bank, the “toxic” assets of the latter being dealt with by asset-management companies (AMCs) which focused solely on the task of disposing of them. When transferring assets from the banks to the AMCs, cautious market values were applied, thus putting a floor under the valuation of such assets, mostly real estate. This restored demand and liquidity, and thus put a break on falling asset prices.

The Swedish model proved successful. The banking system was kept intact. It continued to function, swiftly emerged from the crisis and remained mainly in private hands. Taxpayers did not lose out in the long run. The net fiscal cost of the bank resolution 15 years after the crisis is close to zero. The policy priority of saving the banks, not the owners of the banks, kept moral hazard at bay.”

Go read the full piece . . .


Lessons from Swedish bank resolution policy
Posted by on 11 March 2009 at 11:12 am

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