Sweden did not nationalize its entire banking system

I hadn’t intended to write this post, but I caught the back end of a lot of chatter about the Swedish banking crisis response and needed to set the record straight on what actually happened in Sweden.

Andrew Ross Sorkin wrote what I would consider to be a full-throated defense of the Geithner-Obama bailouts earlier today in a post called "Imagine the Bailouts Are Working."

He says:

You may recall that during the most perilous months of 2008 and early 2009, there was a vigorous debate about how the government should fix the financial system. Some economists, including Nouriel Roubini of New York University and The Times’s own Paul Krugman, declared that we should follow the example of the Swedes by nationalizing the entire banking system.

Now I happen to believe this is like declaring victory at halftime, but that’s neither here nor there. What is pertinent, however, is

1. we understand that no serious economic pundit was talking of nationalizing the entire US banking system ever.
2. we realize in making comparisons to Sweden that Sweden did not nationalize its banking system at all.

Here’s what actually happened in Sweden:

Sweden had no aggregator bad bank and the bad banks were not nationalized. Each big bank set up its own bad bank. They were given illustrious names such as Securum, Retriva, Nackebro and Diligentia. Securum was the biggest bad bank belonging to the already state-owned bank, Nordbanken, and it became a separate state company. The private bad banks, however, remained the property of the private banks from which they were removed.

Nobody traded toxic waste at the height of the crisis in Sweden. Such trade is an unnecessary complication. A bad bank is not a bank but a private equity fund, which does not need much capital or recapitalization. Its task is to isolate the rotten apples so that they do not contaminate the good loans in the cleansed banks.

The bad banks sold off their assets at a leisurely pace over several years to maximize their value, avoiding excessive depreciation of assets through fire sales. Any gain was to the benefit of its owners. In this way, Sweden avoided the problem of trading undervalued assets. In the end, even Securum made a small profit.

There is no reason to merge bad banks, because asset sales require plenty of management capacity. A major concentration of assets in an aggregator bank would only aggravate the functioning of asset markets.

The Swedish emergency bank authority divided the banks into three groups. One group consisted of two obviously bankrupt banks, the private Gota Banken and the state Nordbanken. They were merged into state-owned Nordbanken, eventually becoming Nordea, a thriving bank that has been gradually privatized. A second group of private banks, Swedbank and SEB, had too little capital but could be revived. After long negotiations with the state, their shareholders decided to recapitalize them at their own expense, and these farsighted shareholders gained handsomely, although their old capital had been consumed. A third group consisted of private banks in rude health, primarily Handelsbanken, which continued to thrive, but it also set up a bad bank, Nackebro.

Thus, the common American idea that the Swedish bank resolution involved major nationalization is a sheer misunderstanding. Only one failing private bank, Gota Banken, was merged with an equally bankrupt state bank. Sweden avoided private-public partnerships, of which Fannie Mae and Freddie Mac are the most telling and repulsive example, because, as Larry Summers so memorably has stated, public-private partnerships usually means that profits are privatized and losses nationalized.

In sum, in Sweden bad debts were not taken over by the state or transferred to any aggregator state bank; but each bank, private or state-owned, established its own bad bank. The Swedish model avoided the trading of depressed assets in the midst of the crisis, while they were internally valued at their low market value. If nobody can assess the value of an asset, it is probably not worth much. Only one bankrupt bank was nationalized.

–Lessons for the US from the Swedish Bank Crisis – Anders Åslund, Peterson Institute

So, I hope that makes it clear: Sweden did not nationalize its banking system. Given this context, it should be plain that no one was ever talking about Hugo Chavez-style nationalization and expropriation. Presenting it as such was a canard used by fear-mongerers who were clearly interested parties. Those who glommed on to this meme were either disingenuous or foolish. And it angers me greatly.

More correctly, we were advocating pre-privatization of one bank (Citi – and maybe BofA), which is what Sweden did with Nordbanken. The only reason no one named Citigroup by name back then is out of fear for its viability as a going concern (that was certainly my reason). Åslund does mention that Norway did nationalize its major banks during the same Nordic banking crisis. So, to the degree you want to discuss a larger nationalization regime or thought one was needed, Norway is a more-appropriate model to reference.

I was the first blogger to mention the Swedish response as a model in August 2008 in my post The Swedish banking crisis response – a model for the future? and I wasn’t talking about some sort of expropriation of solvent companies like Goldman or JPMorgan Chase. What Sweden did that is admirable is the following:

1. fashion a workout scheme that had bi-partisan political support
2. resisted  the moral hazard of unfairly rewarding shareholders of a bankrupt institution
3. separated regulatory and workout roles so as to reduce conflicts of interest
4. quickly wrote down valuations and liquidated the bad debts as opposed to dragging the process out

This is what we actually wanted – not the caricatured full-scale banking nationalization that Andrew Ross Sorkin writes about.

What the U.S. has done is more akin to what the Japanese did (see Lessons from Japan’s Bank Crisis from Aug 2008) and we know how that ended. I do hope it ends differently in the U.S. but I suspect it will not. But, for all of the pundits declaring victory at halftime, you may regret this when fulltime comes.