Swedish Lessons

Carl Bildt is foreign minister of Sweden. As leader of the conservative Moderate Party, he was prime minister in the 1990s when Sweden had a financial meltdown similar to the United States today.

Stockholm—As prime minister of Sweden in the early 1990s, when the country went through a banking crisis similar to the one in the US, I can easily imagine the strong pressure everyone who has been involved in processing the rescue plan feels. A financial meltdown of such a scale as we see today is dangerous not only for the US and its citizens but also an emergency situation for the global economy as a whole.

However, our experience in dealing with an even worse situation—though in regard to a far smaller economy—is that there are perfectly sound and adequate tools at hand if you want to stabilize the situation and regain confidence in the markets.

Between 1990 and 1993, Sweden's GDP dropped by 6 percent, aggregate unemployment went up from 3 percent to 12 percent and the public deficit exploded to 12 percent of GDP. The economic downturn led to a massive wave of bankruptcies and falling asset prices. The loan losses in the bank sectors skyrocketed, and the banks had to make provisions for losses equivalent to 12 percent of GDP.

In the fall of 1992, the situation had almost spun out of control. Five out of seven of Sweden's largest banks, covering 90 percent of the market, were de facto insolvent, and we had to face the fact that all earlier measures had been insufficient. The non-performing loans exceeded by far the banking sector's total equity capital, and it was obvious that even more decisive actions were necessary.

To establish a firm base for further measures, the government, backed by the opposition, issued a bank guarantee that provided protection from losses for all creditors except shareholders. There was no specified sum mentioned in the parliament's legislation, and the government got a wide mandate to act in other respects as well.

A special authority was set up to administer the bank guarantee and manage the banks facing insolvency. The Central Bank supplied liquidity but was not directly involved in managing the banks or the non-performing loans. The bad loans were assigned realistic values and put aside in a special company—Securum—whose mission was to regain as much as possible of the public money when the real estate market was stabilized.

The direct outlays were equivalent to 4 percent of GDP, and most of it would later be recovered. Adding the revenues from the privatization of the banks, which were temporarily in public hands, meant that the taxpayers actually made a slight profit.

Parallel with the direct measures to counter the effects of the credit crunch, strong actions were taken to stabilize the macroeconomic situation. This was necessary because the macroeconomic imbalances reinforced the banking crisis just as the banking failures threatened the overall stabilization process.

There were certainly many lessons to be learned from the financial tsunami in Sweden in the early '90s.

Lesson one was that bad macroeconomic management is costly. My government was prepared for a severe blow because of two decades of mismanagement of public spending and price stability. The Swedish economy was structurally in very bad shape when we were elected in the fall of 1991. My government had to do the bailing out when things got untenable.

Lesson two was the importance of maintaining liquidity in the banking system. It is necessary in order to prevent a collapse of the financial system and limit the consequences for the real economy.

Lesson three was the necessity of swiftness and transparency in dealing with the banking sector problems. There is always a risk for moral hazard when you bail out the losses. The best way to avoid this is, of course, to gear the terms of recapitalization in such a way that the shareholders, which often should include the management, will have to pay for their mistakes.

Lesson four was that economic policy in a small economy—such as Sweden's—must find a delicate balance between stimulating investments and consumption while maintaining a credible inflationary target. If the currency weakens and interest rates go up, you will not get the necessary growth and you risk being mired in stagflation.

What was clear in Sweden—and what worries me about the US—is that a rescue plan is not possible without achieving bipartisan consensus. That is in itself indispensable for regaining confidence in the markets.

We were able to achieve this in Sweden. Consensus lasted throughout the whole process of restructuring the banking system. We never faced any demands for going back to the heavily regulated markets of the past or for permanent state involvement in managing the financial sector. On the contrary, due to an organized and well-managed restructuring, it was possible to preserve the advantages of the deregulation of the '80s and, when the market conditions made it possible, privatize the banks as well as the credit stocks.