"Lessons from Sweden’s Bank Nationalization
Talk about nationalizing some of the nation’s biggest banks is all the rage these days. Shares of major financial institutions tumbled further Friday as the chatter continued. The White House’s statement of support for private ownership — “a privately held banking system regulated by the government is what this country should have,” Obama’s spokesman put it — helped a bit, but not enough.
The government taking over a bank presents plenty of problems. Among the challenges, Federal Reserve Chairman Ben Bernanke said this week, is “that you tend to lose the franchise value, that the counterparties and others don’t want to deal with you because they don’t know your future.”
But if it’s necessary, how should it be done? Sweden is often seen as a model of bank nationalization that worked following its boom in real estate and consumer debt. Of course, the concept is always easier when you only have a few banks to worry about, rather than the 8,400 in the U.S. to sort through. (The count is 25 if you just consider the giant banks to probe, as U.S. regulators are preparing to do now.)
The Federal Reserve Bank of Cleveland has assessed the Swedish experience, in a 2007 paper and a commentary this month by two of the bank’s economists.
“Most of the criticisms that can be leveled at the Swedish crisis resolution are easy to make in hindsight,” write researchers O. Emre Ergungor and Kent Cherny. “Facing the prospect of imminent systemic collapse, incentive-skewing actions like blanket guarantees and liquidity provision can seem like surefire ways to restore confidence and avoid meltdown.”
(Blanket guarantees? Extensive liquidity provision? “Oops,” the American people might say after the U.S. government’s moves on that front last fall.)
The Cleveland Fed staffers, in a commentary this month, walk through the Swedish experience of the early 1990s and cite four key principles necessary in resolving troubled financial institutions:
1. Transparency. Fully disclosing banks’ losses “clears the uncertainty surrounding the institutions and makes it possible for the viable institutions to raise new funds.”
For the U.S., of course, the extent of banks’ losses is the big mystery. The government at least appears headed down that road, for its own analysis, by starting stress-testing of major banks to assess how they would fare in a weakening economy.
2. Political and financial independence. “If a government agency holds the purse strings, it can dictate policy and can also impede the process if emergency funding is needed,” they write.
Here, escaping political involvement entirely is a lost cause at this point. The Federal Reserve — an independent agency — oversees the major banks and is intimately involved, but the Obama administration is running the show
3. Maintenance of market discipline Investors must pay the price for missing signs of trouble, they say. “As past historical examples demonstrate, the stability of financial markets after crises largely depends on the incentive framework that is left in place.”
This is where the “blanket guarantees of uninsured depositors” comes into play to skew market discipline. It’s a form of the moral hazard argument — one that’s very much being discussed amid the U.S. response, though moral hazard of course has taken a back seat at times.
4. Restoration of credit flows Getting credit moving through the economy again, they acknowledge, is “a difficult task, given that the economic fallout from a crisis (such as rising unemployment) actually erodes credit quality further.”
With all the talk in Washington about getting banks to lend, that problem surely will stay front and center. But it’s likely to take years to work out.
Read the Cleveland Fed’s full commentary here. — Sudeep Reddy"
Me:
So, let’s see. So far, with TARP:
1) No. No one’s quite sure what the plan is or has been.
2) No. Plenty of effective industry lobbying.
3) No. Real moral hazard, taking the big banks over, is the one option not being considered.
4) No. We gave money to people who had no intention of getting credit moving through the economy, or were even competent to do so.
How are we doing so far?