The Swedes did nationalize

Of Sweden’s banking crisis in the early 1990s, Kevin Drum writes (ht Tyler Cowen, Mark Thoma):

A lot of the sentiment in favor of nationalization appears to be driven by admiration for Sweden’s “quick and decisive” action to clean up its own banking mess in the early 90s, so let’s take a look at what Sweden did and didn’t do. First off, here’s what they didn’t do:

  • They didn’t act all that quickly. The real estate crash and the resulting credit losses began in late 1990, solvency problems started to become acute in late 1991, and a variety of treasury guarantees and capital injections were tried for another year after that. (Sound familiar?) It wasn’t until late 1992 that the Swedish government finally took serious, systemic action.

  • They didn’t nationalize the banking system. Only one bank, Gota, was taken over, and that happened only after it had collapsed. And aside from Gota, only one bank received a substantial amount of capital injection: the state bank, Nordbanken, which had much bigger problems than most of the private banks.

  • Generally speaking, they didn’t fire existing bank management.

So what did the Swedes do? The main thing was simple: in late 1992 the Swedish government guaranteed all bank obligations throughout the system…

What else? Not too much, actually. An agency was formed to dig into the portfolios of nearly every major bank, and this resulted in a capital requirement guarantee for one bank that was never used. In addition, the shareholders of Gota and Nordbanken were mostly wiped out.

So what are the lessons for us? First, we don’t necessarily need to nationalize. If we have to, then we have to, but with the exception of Gota that’s not what the Swedes did.

Second, we could consider a systemwide guarantee of all bank obligations, instead of the one-offs we’ve (partially) applied to Citi and BofA.

Third, we still have to take care of the toxic assets clogging up bank balance sheets. The Swedes did this for Nordbanken and Gota by hiving off “bad banks” to handle the valuation and eventual sale of their bad assets.

I’ve a great deal of respect for Kevin Drum. He’s a trustworthy guy. And there’s murkiness in the definition of what it means for a bank to be nationalized. (Has AIG been nationalized in the US? How about Fannie Mae?)

But substantively, Drum is just wrong here. The state took full ownership and control over Nordbanken in 1992, actively cleaned it up, and eventually reprivatized it. During the crisis, Nordbanken purchased Gota, effectively nationalizing the smaller bank. It is true that only these two banks were nationalized, and a Swedish government description of the crisis is careful to note that, as a matter of policy “the state would not endeavour to become an owner of banks or other institutions.” But Nordbanken alone had an asset base of 23% of GDP. To put that in perspective, in US terms that’s almost as large as Citi and Bank of America. (Citi and Bank of America together had an asset base of 26% of US GDP at the end of 2007.) Nordbanken was not just some little bank. (I don’t think it’s fair to characterize Nordbanken prior to the crisis as “the state bank” either, as Drum does. Nordbanken was a product of mergers, and one of its parents was a large state-owned postal bank. Other parents were private. Nordbanken was a listed public company, and was not actively controlled by the state prior to the nationalization. I do not know how much of the firm was owned by the government prior to the banking crisis. [Update 23-Jan-2009: 77% state-owned — thanks Kevin! — see here for more.])

Other banks were not nationalized for the simple reason that only Nordbanken and Gota required significant recapitalization by the state. Other banks faced a liquidity crisis, which was resolved by a blanket guarantee and central bank lending. But Nordbanken and Gota were insolvent, were unable to raise private capital, and were nationalized. (A third bank did receive a very small amount of public capital without being nationalized.)

Again, nationalization was never a grand policy. It was the natural result of the principles that defined the Swedish response to the crisis. From a 1997 speech at Jackson Hole by Swedish cental bank governor Urban Backstrom:

In September 1992 the Government and the Opposition jointly announced a general guarantee for the whole of the banking system… The bank guarantee provided protection from losses for all creditors except share-holders… The decision was of course troublesome and far-reaching. Besides involving difficult considerations to do, for example, with the cost to the public sector, it raised such questions as the risk of moral hazard… One way of limiting moral hazard problems was to engage in tough negotiations with the banks that needed support and to enforce the principle that losses were to be covered in the first place with the capital provided by shareholders

Banks applying for support had their assets valued by the Bank Support Authority, using uniform criteria… 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 write-down of the loss making assets. One advantage of this method is that it helps to avoid the bank 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 materialise. The handling of problems among savings and loan institution 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. This can lead, for instance, to borrowers in temporary difficulties being forced to accept harsher terms, which in turn can result in payments being suspended.

The Swedish authorities opted for the second method: disclose expected loan losses and assign realistic values to real estate and other assets. This method was consistent with other basic principles for the bank support, such as the need to restore confidence. Looking back, it can be said that in general the level of valuation was realistic. [bold mine, italics original]

Why did the Swedes nationalize? Not because they wanted to, but because the (sound) principles under which they provided capital demanded it: They required aggressive write-downs prior to the provision of public capital, and they demanded that shareholders take losses before taxpayers. Nordbanken was insolvent. The value of shareholders’ equity was negative. The first dollar krona of public capital bought the bank.

Drum also points out that during the Swedish crisis, existing bank management was not generally shown the door. But Nordbanken’s management was replaced. Whether or not the Swedes insisted on management changes as a policy matter, in practice they did defenestrate the managers of their largest bank. The neighboring Norweigians made changing the board and senior management of failed banks an explicit condition of state support during their contemporaneous crisis. The Norweigians didn’t issue a blanket guarantee to bank creditors. (Norway, like Sweden, is viewed as having responded to its banking crisis effectively and successfully. Rather than the “Swedish model”, people sometimes refer to the “Nordic model”. Both Sweden and Norway forced exhaustive write-downs and wrote off shareholders prior to committing public capital, effectively nationalizing the recapitalized banks.)

Anyway, I’ll show you mine if you show me yours. My sources are below. (I’ve no special expertise on this — Drum’s post challenged conventional wisdom that I had accepted, so I decided to have a look around.)

Update: Added the bit about Nordbanken’s prior state affiliation (postal bank was a parent), and the replacement of Nordbanken’s management.

Update History:
  • 18-Jan-2009, 3:30 p.m. EST: Added information about Nordbanken’s previous state affiliation and replacement of Nordbanken’s management.
  • 18-Jan-2009, 3:30 p.m. EST: Corrected my dyslexic multiple spellings of Nordbanken.
  • 18-Jan-2009, 3:30 p.m. EST: Changed dollar to krona…
  • 18-Jan-2009, 7:30 p.m. EST: Removed an “also”, and also “myself”.
  • 23-Jan-2009, 5:15 a.m. EST: Added update with info from Kevin Drum on Nordbanken’s prenationalization share of public ownership [77%].

8 Responses to “The Swedes did nationalize”

  1. Martin writes:

    Thank you for the article. Kevin Drum is wrong and I was dumbstruck when I first read it.

    First off, the Swedes did give a non-recourse loans with around 70% of the stock as collateral to one of the largest bank thrusts (Sparbanken). It would essentially had meant nationalization if they failed to pay.

    When it comes to Nordbanken, the government actually bought out the private owners prior to the restructuring. In the case of Gota it was not until their owner filed for bankruptcy that the government stepped in and protected the liabilities and effectively nationalized it.

  2. RueTheDay writes:

    Steve – I think you’ve hit on all of the key points:

    –Writedown of assets to realistic levels

    –Wipeout of existing equity

    –Replacement of top management

    Whether it’s called nationalization or not is largely irrelevant (though I agree with you that in the Swedish case it was nationalization).

    The three things listed above need to happen before any recapitalization with public funds can be effective. Unfortunately, the US authorities still seem to be hell bent on trying to fix the problem WITHOUT doing those three things. If anything, their actions seem to be trying to deliberately avoid them.

  3. Another good model for temporary nationalization is the S&L crisis in the U.S. in the late 80s, as Krugman notes in his column today.

  4. RueTheDay writes:

    RHS – The RTC model from the S&L Crisis is a good model, but it may have limited applicability here. Back then, the main issue was commercial real estate. It was much easier to deal with than the largely residential (at least for now) problem of today because 1. there were fewer properties to dispose of and 2. no one was living in most of them. Of course with the CRE market heading off a cliff now, we just may have to resurrect the RTC anyway, in addition to whatever else.

  5. I know that most people do not like him, but…

    Read the 10 Planks of The Communist Manifesto written by Karl Marx in 1848

    Plank N° 5. Centralization of credit in the hands of the state, by means of a national bank with State capital and an exclusive monopoly.

    Perhaps we can discuss centralization and exclusive monopoly levels…but it appears that Marx was eventually right…

    M.G. in Progress

  6. Lyndon Comstock writes:

    How about using stock warrants as a form of contingent nationalization? Have the government take warrants to cover it’s potential downside for the purchase or guarantee of problem bank assets.

    If it overestimated the downside it could even revoke some of the warrants later.

    Yes, it could involve a lot of warrants but, under the circumstances…

    If seizing control of the board is the issue, the government is in a position to do that whether or not it guarantees problem assets.

  7. falanke writes:

    Thank you for the informative and excellent post! I have a question… when you say that equity shareholders were wiped out, do you mean just the common share holders? What about preferred share holders?

  8. Thanks for an informative post with lots of useful references, Steve.