Sweden's credit crunch lessons

By Nigel Cassidy
Business correspondent, BBC News

It is recognised as one of the oldest central banks in the world.

Yet it seems that Sweden's Riksbank could even teach America's Federal Reserve a thing or two about recovering from the current debt crisis.

As the IMF becomes the latest body to call on governments for concerted global action to calm troubled markets, policymakers are studying how Sweden managed to rescue four of its biggest banks when its own credit boom turned to bust in the early 1990s.

House prices had slumped, the currency was out of control, and unemployment and bankruptcies were rising rapidly.

Rescue plan

If the Riksbank had failed to act rapidly and chosen not to inject capital into its major banks, the entire financial system of the country might well have collapsed.

You do have to act swiftly. You can't say this is a banks' problem, because it is also your problem Lars Heikensten, former governor, Swedish Riksbank

At a cost of some $11bn (£5.5bn), Sweden guaranteed repayment of depositors and creditors at all of its stricken banks.

But the state aid was skilfully targeted, so none of the cash went to the bank's shareholders.

Indeed, most of the money was regained by the Swedish government as the national economy recovered.

Moral hazard

Sweden's affluent economy could have been threatened

Perhaps without even fully realising it at the time, the Swedes had identified what was to become known as 'moral hazard' - the risk that the state might bail out private investors who risked their money on the stock market.

One man with a ringside seat at the time of the Swedish crisis was the Riksbank's Lars Heikensten, who subsequently served a term as central bank governor.

"One of the questions we had to ask was quite simple. Will this bank be solvent or not?

"If the government was to step in with taxpayers money to deal with solvency problems, it was made clear that the owners would have to give up all their rights. That was important for political reasons - and for moral hazard reasons."

Working with the banks

Against the clock, Sweden had managed to do what the Federal Reserve and other central banks are still grappling with.

It worked closely and transparently with lenders to get all the bad news out quickly, rather than allow institutions to keep announcing new write-offs over time.

Sweden had recognised that bank assets could only be resold or returned to the private sector once all the bad loans were disentangled from the good.

Mr Heikensten is at pains to stress that although Sweden's situation was very grave for the country, the central bank's task was more clear-cut than the current crisis facing his opposite numbers in world financial centres today.

Lessons learned?

But he and other central bankers, past and present, have already been meeting in the United States.

"I'm sure they are learning from all available experience," he says.

"There is more knowledge than there was 15 years ago, but there are certainly no quick fixes.

"But you do have to act swiftly. You can't say this is a banks' problem, because it is also your problem. So you do have to act swiftly."

As a country where state involvement in the economy remains strong, Sweden's bank rescue was less controversial than any such move would be in the United States.

Consider for example the furore over the JP Morgan takeover of Bear Stearns, where shareholders held out for more cash.

But the Swedish experience does illustrate that in exchange for rescue cash, banks will have to open their books fully to public scrutiny.

And in return, it is unlikely that shareholders can expect any compensation.