Lessons from Sweden’s Banking crisis of 1992

There is a lot of comparison of the crisis with Sweden’s 1992 crisis. For a primer on the Swede crisis and lessons learnt see this. It is a speech by Urban Bäckström, then state secretary at Sweden’s Finance Ministry. The speech is given at Kansas City Fed Symposium -1997. There is some literature here as well.

Sweden’s Banks also had taken huge exposure to real estate and housing markets. The markets had just been deregulated as well. This led to higher debt and speculative bubbles. The outcome was higher inflation and the cycle turned. The banks assets became Non performing and there was a banking crisis.

What did Sweden do? They recapitalised banks and set up a guarantee fund to provide liquidity and assurance over banks. Bäckström says there are two approaches to a crisis management:

The Swedish Bank Support Authority had to choose between two alternative strategies.  The first method involves deferring the reporting of losses for as long as is legally possible and using the bank’s current income for a gradual writedown of the loss-making assets. One advantage of this method is that it helps to avoid the bank’s being forced to massive sales of assets at prices below long-run market values. A serious disadvantage is that the method presupposes that the bank problems can be resolved relatively quickly; otherwise the difficulties compound, leading to much greater problems when they ultimately materialize. The handling of problems among savings and loan institutions in the United States in the 1980s is a case in point.

With the other method , an open account of all expected losses and writedowns is presented at an early stage. This clarifies the extent of the problems and the support that is required. Provided the authorities and the banks make it credible that no additional problems have been concealed, this procedure also promotes confidence. It entails a risk of creating an exaggerated perception of the magnitude of the problems, for instance, if real estate that has been taken over at unduly cautiously estimated values in a market that is temporarily depressed.

And which method did Sweden follow?

The Swedish authorities opted for the second method: disclose expected loan losses and assign realistic values to real estate and other assets.

And which approach has US been following? Clearly, the first. no wonder markets collapse each time there is a policy measure. There is no credibility in the statements and markets expect worse is to follow.

Bernanke says TARP will cost much lesser than USD 700 billion. However, recent IMF estimates say total looses from US based assets alone is USD 1.4 trillion and further USD 675 billion of capital would be needed. So, clearly we have a big disparity and Markets are not going to believe policy actions. Mint rightly says these number don’t matter anymore. 

Time to acknowledge the problems. Otherwise, we are going to see more collpases going forward.