This come-out occurs after a recent article by in Nouriel Roubini and Matthew Richardson in the Washington Post entitled “Nationalise the banks! We are all Swedes now!” which says:
“Nationalizing banks is not without precedent. In 1992, the Swedish government took over its insolvent banks, cleaned them up and reprivatized them.”
To which our Director here at ECIPE, Fredrik Erixon, a Swede, responded in an e-mail to us:
“Sweden nationalized one small, regional bank during the 1990s crisis – the big bank that had to be bailed out directly with government subsidies was already owned by the government. “
But what is it exactly about Sweden that seems so attractive? Christopher Wood, in an article in the FT last month was more explicit about the so-called Swedish model of cleaning up banks:
“Under this model banks were nationalised, fully aligning the interests of the institution with that of the taxpayer, while the depositor was fully protected. In the process shareholders were in effect wiped out, as they should be, and incumbent management was replaced, as it should be. This left none of the massive conflicts of interest, as well as perverse unintended consequences, caused by the present anomalous situation in the west where too many banks are being rewarded for failure – leading, incidentally, to a massive competitive disadvantage for those banks that managed their affairs more prudently.
A crucial principle of the Swedish model is that banks were forced to write down their assets to market and take the hit to their equity before the recapitalisation began. This is of course precisely what has not happened in either the US or Britain, where too many policy measures seek to delay asset price clearing and only add public sector debt on top of existing private sector debt. This is why the current approach in the west to the banking crisis can be compared more accurately with Japanese policy in the 1990s, and that clearly did not work. The outcome, as then, is increasingly zombie-like banks.
The ultimate endgame in countries such as the US and Britain is still likely to be full-scale nationalisation of most of the banking system, as the logic of such action finally becomes overwhelming. But it would be much better if this were done proactively rather than reactively, since it would accelerate resolution of the financial crisis. This is why nationalising the banks would also be bullish for stock markets, if not for the specific bank stocks themselves – although, obviously, there are powerful vested interests wanting to prevent such an ultimate course of action.
Another point about nationalisation, as in the Swedish model, is that it allows the government to separate the bad assets from banks’ balance sheets and place them in one big “bad bank”. This should enable whatever is left of the smaller “good” bank, which should be managed by old-fashioned commercial bankers, to become a viable private sector operator again more quickly. Another more technical, albeit important, point is that, given that many of the bad assets in this cycle will be derivative- related in some form or other, where two nationalised banks have been counterparties to the same transaction the derivative deal could be in effect terminated or cancelled because the government would be the owner of both entities. In this respect the limited number of counterparties in the $55,000bn* credit default swap market could suddenly become a positive and not, as now, a systemic negative.”
The question is really, given the size and complexity of the US’ financial sector, if the government will be able to manage all this complex mess top-down?
The policy choices that are crystallizing regarding the rescue of the banking system are very roughly the following ones:
On the one hand, the need to wipe off the bank’s bad assets, with the risk of having some banks fail. A radical solution such as proposed by Anne Schwartz however is not possible, for the systemic risk posed by potential massive bank bankruptcies. Without banks, no modern economy, basically. However, as some countries such as Germany or the US are coming up with the idea of setting up a “bad bank” to buy off the toxic assets, this core idea is now resurfacing. CEPS’ Daniel Gros explained very well what are the stakes and how a bad bank would work best.
On the other hand, there is a great aversion to let banks fail. That’s why nationalisation is a big topic right now. Given that the Lehman collapse last year only seems to have accelerated the crisis and shaken confidence even further, there is fear of an even deeper crisis if after an asset clean-up some important banks are allowed to close down. But the big risks of course are of a classic political-economy nature: moral hazard (risky behaviour by banks in the future will be encouraged, since they will act with the idea in mind that they will be bailed out anyway), and potentially a drift into some forms corruption, collusion between bankers and policy-makers, and politicisation of banking sector policies and activities. The US government will probably have the will to re-privatize banks to avert that problem. But how much damage will be done in the meantime?
The initial policy response has been the rush to save banks after the Lehman collapse. This means all forms of support to bank and bank lending, subsidies, and nationalizations. The UK has stuck out its head very strongly on those fronts. But it doesn’t seem to really be working. The more risky but in the long-term more effective policy option of cleaning up the banks themselves to have them work more effectively in the future is only resurfacing now after Hank Paulson’s (in)famous and probably not completely ripe “TARP” was drowned in the bailout package discussions.
Curious to see what will be the next episode in this decidedly epic global banking crisis.