The Swedish model as a solution to the bank crisis, as proposed in
the Financial Times.
Ann
The Swedish model is the best hope for western banks
By Christopher Wood
Published: January 20 2009 02:00 | Last updated: January 20 2009 02:00
As newspaper headlines are full of stories about more forced capital
injections by governments into leading American and British banks, it
has surely become time to end the present ad hoc approach to the
intensifying banking crisis.
In the US and Britain most of the big banks have now become a weird
hybrid of public and private sector, given growing government equity
stakes in these banks. This raises the issue of the deeply flawed
policy response to the crisis. This is that if the authorities are
not prepared to let insolvent financial institutions go bust, which
would be the quickest, most effective way to correct excesses, as the
Lehman precedent demonstrates, the next best way is to nationalise
the, in effect bust, banks outright. This remains the opposite of
what is happening in the US and the other country most vulnerable to
an imploding financial services sector, namely Britain. Rather, what
is happening is nationalisation by stealth.
This approach reached its ludicrous extreme in the November bail-out
of Citigroup, where the US government put more money in than the
entire market capitalisation of the company on the day the deal was
announced. But the taxpayer ended up with only a 7.8 per cent equity
stake while incumbent management was left in place! Yet now, just two
months later, still more taxpayer money looks as if it is about to be
poured into Citigroup, while a similar sweetheart deal has been done
with Bank of America.
This approach is a recipe for gross conflicts of interest. It means
the institutions receiving taxpayer money are encouraged to continue
to avoid ultimately necessary writedowns because of the hope of yet
more bail-outs. Yet the reality is that there is an established
template for what to do in banking crises if governments remain
determined, as they do, not to allow bank failures. That is the
Swedish model of the early 1990s.
Under this model banks were nationalised, fully aligning the
interests of the institution with that of the taxpayer, while the
depositor was fully protected. In the process shareholders were in
effect wiped out, as they should be, and incumbent management was
replaced, as it should be. This left none of the massive conflicts of
interest, as well as perverse unintended consequences, caused by the
present anomalous situation in the west where too many banks are
being rewarded for failure - leading, incidentally, to a massive
competitive disadvantage for those banks that managed their affairs
more prudently.
A crucial principle of the Swedish model is that banks were forced to
write down their assets to market and take the hit to their equity
before the recapitalisation began. This is of course precisely what
has not happened in either the US or Britain, where too many policy
measures seek to delay asset price clearing and only add public
sector debt on top of existing private sector debt. This is why the
current approach in the west to the banking crisis can be compared
more accurately with Japanese policy in the 1990s, and that clearly
did not work. The outcome, as then, is increasingly zombie-like banks.
The ultimate endgame in countries such as the US and Britain is still
likely to be full-scale nationalisation of most of the banking
system, as the logic of such action finally becomes overwhelming. But
it would be much better if this were done proactively rather than
reactively, since it would accelerate resolution of the financial
crisis. This is why nationalising the banks would also be bullish for
stock markets, if not for the specific bank stocks themselves -
although, obviously, there are powerful vested interests wanting to
prevent such an ultimate course of action.
Another point about nationalisation, as in the Swedish model, is that
it allows the government to separate the bad assets from banks'
balance sheets and place them in one big "bad bank". This should
enable whatever is left of the smaller "good" bank, which should be
managed by old-fashioned commercial bankers, to become a viable
private sector operator again more quickly. Another more technical,
albeit important, point is that, given that many of the bad assets in
this cycle will be derivative- related in some form or other, where
two nationalised banks have been counterparties to the same
transaction the derivative deal could be in effect terminated or
cancelled because the government would be the owner of both entities.
In this respect the limited number of counterparties in the $55,000bn
(as estimated by the International Swaps and Derivatives Association
in mid-2008) credit default swap market could suddenly become a
positive and not, as now, a
systemic negative.
It is true the Swedish model is not a pain-free panacea. It would
just mean the beginning of an orderly work out. Unfortunately, the
deflationary pain is inevitable because of the scale of the credit
boom of recent years, the excesses of which were ignored for so long
by the relevant central bankers.
Christopher Wood, equity strategist for CLSA Ltd, in Hong Kong, is
the author of The Bubble Economy (first published by Atlantic Monthly
Press, 1992)
Copyright The Financial Times Limited 2009
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