"The Sweden Example
Ryan Avent beats me to the punch by pointing out the most important part of today’s Times’ story on Tim Geithner, namely that in the summer of 2008, after the collapse of Bear Stearns but before the meltdown of Lehman Brothers, Geithner proposed having the government guarantee the debts of all U.S. banks. The plan was shot down as politically untenable, but, as Ryan points out, had it been put into effect, we would most likely not have seen Lehman go under or had to deal with the incredibly negative consequences of that failure. More important, perhaps, by reducing the threat of panicked runs on bank debt (since those debts would have been guaranteed), such a guarantee would also have made it easier for regulators and banks to deal in a transparent fashion with the toxic-asset problem. That’s why the very first step in Sweden’s much-admired solution to its banking crisis in the early nineteen-nineties, was, yes, a guarantee of all bank debt. As one of the regulators involved in that effort put it, the guarantee “was provided in order to restore confidence and to ease the immediate pressure on banks,” by ensuring “the stability of the payment system and to safeguard the supply of credit.”
Given all this, Ryan is perplexed that Yves Smith, in her post today on the Times article, dismisses Geithner’s proposal as just another attempt to give Wall Street a handout. In part, this could be because Smith thinks that, in the absence of a systematic plan to deal with toxic assets (which we don’t know if Geithner had), guaranteeing all bank debt would have allowed banks to engage in more risky behavior, knowing that taxpayers would foot the bill. But I think what’s really driving Smith’s attack on Geithner’s proposal is her conviction that any plan to deal with the banking system has to require bank bondholders to take a major hit. In other words, for Smith, the Swedish solution is not the right one. Nationalizing the banks, and wiping out the shareholders, isn’t enough: you have to impose significant pain on the banks’ debtholders, too.
Lots of nationalization advocates believe that a debt guarantee is a bad idea. But one of the things that’s made the debate over nationalization confusing is that many of these same people, while arguing that bank debtholders should take a hit, also say that what the U.S. should do is emulate Sweden. Henry Blodget, for instance, has argued that that we should follow “a tried and true way of fixing banks: The Swedish Model,” and yet he also insists that we should stop bailing out bank bondholders. And Barry Ritholtz has written that when it comes to dealing with the banks we should “Go Swedish. Wipe out shareholders, bond holders, and all the bad debt and junk paper these firms hold.”
Needless to say, this doesn’t make any sense. At the heart of the Swedish solution was the guarantee of all bank debt, ensuring that bondholders would not take a hit. And the Swedes, at least, thought that guarantee was essential to making their plan work. In the U.S. context, maybe we should follow a different approach, but nationalization supporters should be clear: if they want to cram down the debtholders, then they don’t want the U.S. to follow the Swedish model. You cannot “Go Swedish” and “wipe out bond holders” at the same time.
There are nationalization advocates who really do want the U.S. to emulate Sweden, including most notably Paul Krugman, who’s said, “Sweden guaranteed all [bank liabilities]. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership.” But many supporters of nationalization are just invoking Sweden in order to prove that there’s a historical precedent for successful nationalization, while at the same time arguing that the U.S. should reject a crucial part of what made that precedent work. So the news that Geithner wanted the U.S. to take a first step on the Swedish path is unlikely to change their view of him. If anything, it’ll just confirm their assumption that he’s not willing to do what’s necessary.