A Tale of Two Crises: Learning from Sweden and Japan

Sweden and Japan are the two crises being cited as case studies for resolving the current U.S. banking problems. Both crises were caused by the liberalization of lending rules and excessive risk taking. Both created asset bubbles. But their resolutions were quite different.

Sweden, from 1990 problems to 1997 resolution took seven years.

Sweden's economy started to wobble in 1990 and by 1991, many banks were having trouble meeting capital requirements; some were on the brink of failure. The government acted quickly and announced a plan in 1992. First it guaranteed all deposits. Next, it insisted banks write down losses and value assets at realistic levels. Banks were told to first try covering losses with capital from shareholders. If this did not work and they needed taxpayer funds, they had to issue warrants to the government in exchange for cash, eventually diluting or (in some cases) cutting off existing shareholders. As bank shares were somewhat narrowly held in Sweden, this tough approach meant that banks tried to resolve their problems by raising private equity, avoiding nationalization. Some were able to do this; some were not. Eventually, the government owned over 20% of all banks.

As most people now know, Sweden's plan also divided the troubled banks into good and bad assets. The bad loans were placed in independent asset management corporations [AMCs] in 1993, or "bad banks." The AMCs were heavily capitalized by the government, but privately run, and given free reign to re-work debts, take over assets and sell them as needed. The bad assets they controlled were assigned new, more realistic values. They were allowed years, if needed, to resolve the problems and the taxpayers would be paid back through the sale of assets. The AMCs resolved all the problem assets on their books by 1997, and to date, Sweden's taxpayers have gotten back more than $0.50 on the dollar, with more money expected to come from the sale of government-owned bank shares.

Japan, from 1990 problems to 2003 resolution (?) took 13 years.

The stock market peaked in 1989, then collapsed in 1990, dropping some 43%. This was followed by years of declining asset prices, creating under capitalized banks. In 1992, the home loan companies became a concern for the Ministry of Finance, which tried to restructure them. In 1993, facing rising defaults, traditional banks collaborated to establish the CCPC,Cooperative Credit Purchasing Program, to take bad loans off their balance sheets. The banks lent CCPC the money to buy their problem assets, and deducted the losses from their taxes. Still, conditions deteriorated and in 1997 a life insurer, two securities firms and a major bank suspended operations.

1997: Government Plan Part One - The government creates a stress test for banks; they must revalue their assets realistically and valuations can be audited. Capital ratio thresholds are specified at which the government can require dividend reductions or operation cuts. This did not turn the tide and in 1998, the crisis peaked. The government then authorized "almost unlimited" public funds to shore up capital, and after billions in bailouts, a credit crunch ensued as banks tried to cash.

1998: Plan Part Two: Many banks still needed significant capital injections. Japan's Deposit Insurance Corporation granted these through the purchase of preferred shares or subordinated debt, but each bank had to submit a restructuring plan. If the plan was not progressing, the government could convert these obligations to common voting stock, to have leverage over management. During this round of audits, the government found that the "stress tests" had not worked; many banks were still valuing assets at unrealistic levels. Part Three: Finally, some tough measures. Government audits of banks became harsh and write-downs are forced. One bank needs $17 billion, some banks are nationalized and some are allowed to fail. By this time, the stock market was down 79% from its 1989 peak.

Comments

[mgcolin:]

Interesting analysis...very insightful in my opinion, Thank You.

The day to buy will be the 2 days after Obama announces nationalization - if he does.

US Gov't may recognize this and just be waiting for right time to nationalize (Sweden approach). They can alter the "stress test" criteria to get whatever answer they want and have cover of 'data' to try to prove they made the right call. My guess is they nationalize.

It's looking like Obama is trying to make us into Sweden anyway...

Anything is better than the status quo...it's the uncertainty (half the market thinking Japan, half thinking sweden) that's killing the market and the economy.

Mar 06 12:54 PM