Given the turbulent events of re-cent months in the money markets and with a stable world economy fast becoming but a memory, forecasters and governments around the world are expecting long-lasting consequences of the credit crunch.
The UK government and the Bank of England have made commitments to inject large sums of money into the financial system, interest rates have been cut substantially and inter-bank small business and export lending has been guaranteed.
Nevertheless, the banking system is in no shape to return to pre-crunch lending levels, and it is widely believed that the economy has not seen the worst of things yet.
Of the five big financial crises in the post-war era, three have taken place in the Nordic region. From 1987 to 1991 Norway, Finland and Sweden all experienced serious economic downturns and subsequent swift interventions by the state.
Such crises are recurring events and each has its own causes and triggers. However, the precedents set are worthy of examination prior to making recommendations on how the UK market might be put on the track to recovery.
One of the key problems in the lead-up to one financial crisis in the Nordic region was deregulation.
“Credit market deregulation in 1985, necessary in itself, meant that monetary conditions became more expansionary,” Sweden’s central bank chair- man explained to a symposium in 1997. “Moreover, this coincided with a rising level of activity, relatively high inflation expectations, a tax system that favoured borrowing and exchange controls that restrained investment in foreign assets.”
After the liberalisation of interest rates in the Nordic countries a credit boom ensued, resulting in both house and commercial real estate prices escalating. The cost of borrowing rose and the market eventually crashed.
This was compounded by a global economic slowdown following the reunification of Germany and Iraq’s invasion of Kuwait.
Due to the bursting credit bubble the US helped create and that now threatens to bring down the global financial system, the US is facing a real prospect of a decade of little or no economic growth.
The response in Sweden was far swifter. Most notably, the state intervened to rescue three of the largest financial institutions in the region – Forsta Sparbanken, Nordbanken and Gota Bank. In particular the state took over Nordbanken and Gota Bank, while guaranteeing a loan for Forsta.
The Swedish government issued an unlimited guarantee stating that no depositors or other counterparties to Swedish credit institutions would suffer any losses.
“This was a fundamental measure in order to restore confidence in Swedish banks among domestic and foreign depositors and other counterparties,” said the deputy governor of the country’s central bank in 1998. We can detect echoes of this approach in the US and UK interventions of the past year. We saw UK chancellor Alistair Darling increase the threshold for bank deposit protection to £50,000 from £35,000 while Irish banks increased guarantees to 100% for all customer deposits – a move which immediately triggered flows of cash from the UK to Irish banks.
A recent Financial Insights report suggests the European Central Bank might take on the role of single regulator, overseeing all European financial sectors, and UK Prime Minister Gordon Brown is an influential voice in favour of holistic macro-regulation.
During the financial crisis in Sweden the government put in place measures to determine which banks should benefit from such support and which should be liquidated. In particular, the guarantee did not extend to the banks’ shareholders so there was an incentive for the institutions to seek help only if there was no alternative.
Once bad loans were written down support would only be offered if it was deemed possible the bank concerned could achieve profitability in the medi-um term. If this was not the case the bank would be merged or closed.
The key to managing a crisis successfully seems to involve three common factors. The first is swift response, as we have already seen in the case of Sweden. By quickly moving to protect all deposits and creditors while taking responsibility for bad loans it is arguable that the government averted economic meltdown.
The second factor is bipartisanship. The Conservative and Social Democrat parties worked together in Sweden to resolve the situation in the early 1990s.
In a 2008 article in the US National Journal entitled ‘What we can learn from Sweden’ Bruce Stokes notes that “Swedes credit their bipartisanship for the rapid restoration of investor faith in the country’s financial system”.
The third element is transparency. In Sweden, the government chose to be honest with its citizens and its market.
Any recovery process must go through several phases before remedial measures bear fruit. Transparency allowed the government to communicate its ideas efficiently and receive constructive feedback. It also helped ordinary people and the market to plan ahead, so limiting shocks.
Given US lawmakers’ initial rejection of plans to stabilise the economy, it remains to be seen whether the crisis there can be curbed and if action was taken swiftly enough during the initial phase.
However, with uncertainty about the whole question of lending continuing, banks would do well to review their protective measures and overhaul their best practices.
The next few months will undoubtedly reveal whether banks and governments were in a position to act more swiftly than they did to prevent a financial and economic meltdown.