- The Swedish case makes an interesting case study for several reasons. First, the Swedish crisis management in the early 1990s is currently attracting international attention. It is regarded as a model for countries facing collapsing financial systems. Sweden is a well-developed welfare state with a large public sector, a tradition of good governance, and a high gross domestic product (GDP) per capita. The lessons from a financial crisis in such a society are likely to be of interest to other rich countries hit by the present global financial crisis
-Â A large part of the expanding volume of credit was channeled into property and share markets. House prices increased rapidly (Figure 2). The private sector utilized the rising value of real assets as collateral for additional borrowing. The process was fuelled by a rising rate of inflation, which peaked in 1990 (Figure 3). Inflation expectations followed the rise in the inflation rate. The real after-tax interest rate was negative for many investors due to the combination of high actual inflation, high inflation expectations and the rules of the tax system (Figure 4).
-Â The result was the creation of a financial bubble in the Swedish economy, built on excessive indebtedness within the private sector, and a corresponding overlending within the financial system. The credit boom was reflected within the real sector as well. Consumption became the driving force behind the overheating of the economy (Table 1). During the most intense part of the boom, households consumed more than their disposable income. Real income grew rapidly (Figure 5). Government finances improved during the overheating, since the sharp growth in consumption and income resulted in growing tax revenues from value added taxes (Figure 6). The budget showed a small surplus in the late 1980s, leading to a decline in the debt-to-GDP ratio. REF. Table 1
-Â Swedish real interest rates were forced upwards by international factors, in particular the reunification of Germany, which led the Bundesbank to raise German, and thus European, interest rates. The krona was subject to several speculative attacks due to the falling credibility of the policy of a pegged krona rate. The Riksbank had to defend the krona rate by raising interest rates in Sweden by more than rates in the rest of Europe.
- When the real rate of interest rose, the price of assets declined in a downward spiral. The fall in asset prices meant a reduction in wealth, since these had been financed through loans whose nominal value remained unchanged (Figure 2). The downturn was fuelled by expectations that asset prices would continue to fall.8 The number of bankruptcies increased dramatically. The massive loss in the balance sheet of the private sector created by the increase in the real rate of interest can be calculated in various ways. Söderström (1996: 174â79) estimated that the value of tangible assets in Sweden declined by about 30%. He also showed that the private sector tried to counteract this loss of wealth by increasing its financial savings by making repayments on its loans and thereby trying to rebuild its equity.9 Households adjusted their portfolios by increasing savings and by reducing consumption, primarily of durable consumer goods. The savings ratio rose from a negative level at the end of the 1980s to about 8% in 1993.10 This change in private savings was a significant feature of the crisis.
-Â At this point, it became apparent that the many years of regulated low interest rates had resulted in considerable overinvestment. The rise in the real rate of interest revealed excessive holdings of assets, mainly in the form of housing, at the beginning of the 1990s. Then this asset bubble burst. The revaluation of property and other assets brought with it an abrupt freeze in investment within the housing sectorâa sector that had previously been considered a major engine of the Swedish economy.
-Â Domestic developmentsâa growing financial crisis, falling industrial output and rising unemploymentâundermined the credibility of the pegged krona rate. The authorities were trapped in a situation where external conditions (the currency crisis) required contractionary measures, while domestic considerations (the banking crisis) demanded an expansionary policy. The more the Riksbank tried to defend the pegged krona rate by raising interest rates, the deeper the domestic crisis became. With the European currency markets facing unrest in September 1992, the Riksbank defended the krona by significantly raising its overnight rates. For a very short period, the marginal interest rateâthe overnight rateâwas 500%. The government and the opposition party, the Social Democrats, agreed in September to jointly back two austerity packages to avoid a devaluation of the krona. However, the defense of the krona broke down in November 1992 when it came under massive speculative attack. A floating exchange rate was introduced on 19 November 1992, amounting to a considerable depreciation of the Swedish currency (Figure 8).
-Â The depreciation of the krona in November 1992 marked the culmination of the crisis and the beginning of the recovery in Sweden. Because the krona was floating, interest rates were gradually lowered. The turnaround and the recovery started in 1993. Economic growth turned positive in 1993 and remained strong throughout the rest of the 1990s, apart from a short downturn in 1996/97 (Figure 5). Almost all indicators of economic activity showed positive numbers after 1993â94. Exports were the major driving force behind the recovery, increasing as a share of GDP. Exports for 1992 amounted to 28% of GDP. By the end of the decade the number was over 45% (Figure 9)âa remarkable development within less than a decade.
-Â Several factors contributed to this sharp expansion in exports. First, the large and persistent depreciation of the krona after November 1992 increased the competitiveness of Swedish goods. Wage moderation and improvements in productivity facilitated the growth of exports. Exports were also favorably affected by Sweden's entry into the European Union in 1995, which fostered trade both directly and indirectly by promoting foreign direct investment, not least in the rapidly growing information communication technology sector. The rise in domestic demand during the recovery phase was markedly lower. Both private and public consumption grew more slowly than GDP in the years following the crisis. At the same time, the household savings rate remained at a higher level than before the crisis, indicating a continued improvement of the balance sheets of the private sector.
-Â The effects of the crisis on employment were more prolonged. Unemployment rates in the 1990s never dropped back to the level that prevailed during the 1980s. Open unemployment began to decline from the high level of around 8â10% by the end of 1997 (Figure 7). The high and persistent rate of unemployment contributed to wage moderation in the 1990s and well into the new century.
- Differentiated resolution policy - The general strategy was to divide the banks into three categories, depending on whether the statutory capital adequacy ratio would be breached and, if so, whether this breach was temporary. The first category included those banks that might deteriorate towards the capital adequacy limit, but would subsequently be able to achieve enhanced solvency on their own; the second category covered those that might fall below the limit for a time, but would eventually recover; and the third category was for those that were expected not to recover. Each of these three categories was treated differently by the BankstödsnÀmnd. Two bank asset management corporations (AMC) were set up to manage the bad debt (nonperforming loans) of two financial institutions, Securum as AMC for Nordbanken and Retriva as AMC for Gotabanken, as part of the resolution policy, as had been the case in other countries. A novel approach was adopted which involved splitting the assets of an ailing bank into "good" and "bad" assets, and then transferring the "bad" assets to the AMC, principally to Securum.22 In addition, when assets were placed under the administration of Securum and Retriva, they were assigned low market values in the due diligence process, effectively setting a floor for asset values. Because market participants did not expect prices to fall below this level, trading was maintained
-Â Sweden, being a small open economy with a pegged exchange rate when the crisis peaked, was able to abandon the pegged rate in November 1992, thus obtaining a lasting depreciation of its currency that contributed to a prolonged recovery. This option of an export-oriented growth strategy out of the crisis is currently not open to the world, because the present crisis is a global one. An individual country can no longer rely on the rest of the world to maintain aggregate demand for its exports, as Sweden was able to do in the 1990s. The small size of the Swedish financial system in the 1990s facilitated the bank resolution policy. Policymakers had to deal with a limited number of banksâonly six major banks, in factâin a global environment of trust in the banking system and in financial markets (except for the Nordics). The Swedish system was also bank-based, with few major financial actors outside the banking system. This is in sharp contrast to the US today, for example, where there are a large number of banks of different types and many nonbank financial actors and where public trust in the financial system and its actors (âWall Streetâ) is extremely low.33 The Swedish bank resolution policy was also confronted by a financial system that was much less sophisticated and much less globalized than the financial system of today.
-Â Indeed, on this score, the ongoing crisis has been difficult for the authorities to manage, in part because some traditional central banking toolsâparticularly in the United Kingdom and the USâare not well suited, either legally or architecturally, to provide liquidity for the institutions most in need, including investment banks and insurance companies. By contrast, the Swedish blanket guarantee of September 1992 immediately created trust; one reason for this was the comparatively simple set of instruments available compared to the present case.
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