There’s a good piece here by Brenda Cronin on some of the lessons that the U.S. might learn from Sweden’s response to an early 1990s banking crisis:

In Sweden, authorities took a hardline policy intended to weed out failing banks. Early in the crisis, the country made substantial capital injections, purchased troubled assets and temporarily nationalised some surviving banks. Sweden disposed of the bad loans briskly, liquidating them by 1997 so they couldn’t linger as a drag on the economy. Stockholm’s strategy succeeded in part because policy-makers were clear about their goals and demanded transparency in banks’ accounting, to identify and contain weak spots. An economist at the Federal Reserve Bank of Cleveland, O. Emre Ergungor, said: “The goal in Sweden was to rehabilitate the system quickly by creating a smaller number of viable institutions out of many ailing ones.” In 1988, before the crisis, there were 525 banks in Sweden; in 2000, there were 124.

The whole piece is well worth reading, but it sidesteps at least one issue. Some degree of consolidation of the U.S. banking system is inevitable and, indeed, desirable (although whether banks should be spending their shiny new taxpayer dollars to that end is, I think, rather more questionable), but how far should it go? Do we really want to see the creation of even more behemoths that are “too big to fail,” and if we do, how should they be regulated? On the latter point the Prudent Bear’s Martin Hutchinson has some ideas that are worth pondering:

The first problem to be solved is what to do with institutions that are “too large to fail.” Clearly they must not be permitted to leverage themselves as did the banks and investment banks of the bubble years, nor must they be allowed to do “fat tail” high-risk principal trading, nor to invest more than modestly in private equity and other illiquid and risky securities. Equally, there is a place for institutions on which the public can unconditionally rely in taking deposits, making loans and underwriting low and moderate-risk securities. The large banks will respond that through their sophisticated risk management systems they can protect themselves and the taxpaying public against loss. They should not be believed. The current crisis has shown that not only did the Value At Risk risk management system pathetically fail, there is no risk management system that is capable of controlling complex instruments in a turbulent market. While the market remains calm as it did from 1995-2007, these securities’ behavior remains apparently under control, obeying the VAR risk limits in most cases and deviating from them only modestly in the 1% of cases they fall outside their VAR limits. However in turbulent markets, as we entered for mortgage securities in July 2007 and for all securities in September 2008 there is no limit as to where these securities may trade. The problem is exacerbated by “mark to market” accounting, which forces entities to mark exotic securities to their value in a thin secondary market, no matter what their likely long term risk characteristics. Hence “too big to fail” institutions should not be allowed to have more than a modest portion of their capital (say 1/3, an amount they can afford to lose and survive) in risky or highly illiquid instruments. In return, “mark to market” accounting should be abolished for these institutions. There are essentially public utilities, like the local water company, and should be regulated and controlled as such. They will do big deals, and will have a limited underwriting capability, but they will not be centers of either risk or innovation.

How to get to that point without adding still further to the miseries of the current credit contraction is, of course, another topic altogether.