The Corner

Iceland-on-Thames–And What the Swedes Did

Another day, another bank bailout. This time it’s in the UK, and judging by this report from the Daily Mail (admittedly no supporter of the Labour goverrnment), some of Gordon Brown’s supporters are growing alarmed about what this could mean for Britain’s (dire) finances:

“The starkest warning came from one of the Prime Minister’s own allies, Will Hutton, who heads up the Work Foundation think tank. He warned that the scale of the liability for taxpayers,as well as overall borrowing, was so enormous that the International Monetary Fund may have to be called in. ‘With the amount of red ink in the UK budget deficit next year, together with the amount of new liabilities the taxpayer is having to underwrite, we look like Iceland-on-Thames. ‘The open question is whether we can get through this without a loan from the IMF,’ he said ominously. ”

Images of Iceland conjure up thoughts of Sweden, which went through its own banking crisis in the early 1990s–and emerged in good shape (if not without considerable pain). The discussion here by Steve Waldman at Interfluidity of what was (or was not) done in Sweden is well worth reading (follow the links too). In particular, note these comments by Urban Backstrom some years after the crisis had passed (Backstrom, a member of Sweden’s (vaguely) right-of-center Moderate party had been in government at the time of the crisis and later became governor of the Swedish central bank).

In September 1992 the Government and the Opposition jointly announced a general guarantee for the whole of the banking system… The bank guarantee provided protection from losses for all creditors except share-holders… The decision was of course troublesome and far-reaching. Besides involving difficult considerations to do, for example, with the cost to the public sector, it raised such questions as the risk of moral hazard… One way of limiting moral hazard problems was to engage in tough negotiations with the banks that needed support and to enforce the principle that losses were to be covered in the first place with the capital provided by shareholders…

Mr. Waldman adds:

Why did the Swedes nationalize? Not because they wanted to, but because the (sound) principles under which they provided capital demanded it: They required aggressive write-downs prior to the provision of public capital, and they demanded that shareholders take losses before taxpayers. Nordbanken was insolvent. The value of shareholders’ equity was negative. The first dollar krona of public capital bought the bank.

Hmmmm.

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