Sunday, November 30, 2008
Sweden's Path, Not Japan's, Can Guide Cleanup
In tackling the national economic downturn, President-elect Barack Obama and his newly appointed economic team might want to study how Japan and Sweden weathered similar storms during the 1990s. Sweden's response to its crisis is widely considered a model. The Swedish government and central bank in 1992 quickly stabilized the krona and reversed contractions in gross domestic product and a rising unemployment rate by allowing some banks to fail, recapitalizing others and isolating bad assets. In two years, the country's economy was growing again. Tokyo's piecemeal steps, meanwhile, ushered in a "lost decade." The economy stagnated until zombie banks propped up by the government finally succumbed. The Japanese economy took almost a decade to right itself, and while most of the country's major banks have shed nonperforming loans dating from the crisis, their profitability today hovers around levels of 10 years ago. The paramount lessons for nations battered by financial crises are: Act quickly, consolidate the financial sector and pursue the right balance of recapitalizing banks and isolating troubled assets. Sweden did all three and Japan arguably did none, taking timid and unsuccessful measures for years before a new government forced sweeping action in 1998. "Some say the Japanese government did nothing for 10 years, but that's not really the case. They tried things and they failed," said Takeo Hoshi, a professor of economics at the University of California, San Diego. Among the failed ideas was establishing asset-management companies that didn't buy enough distressed assets and held on to those they did acquire instead of restructuring and selling them. In Sweden, authorities took a hard-line policy intended to weed out failing banks. Early in the crisis, the country made substantial capital injections, purchased troubled assets and temporarily nationalized 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. "The goal in Sweden was to rehabilitate the system quickly by creating a smaller number of viable institutions out of many ailing ones," said O. Emre Ergungor, an economist at the Federal Reserve Bank of Cleveland. In 1988, before the crisis, there were 525 banks in Sweden; in 2000, there were 124. That the Swedish government proceeded with the same transparency it exacted from banks also was crucial. "The key here was not to play games with investors or taxpayers," Mr. Ergungor said. When Sweden began to sell the distressed assets, "the market didn't think, 'What is the government trying to hide now?' " In Japan, officials loath to recognize that banks were failing didn't craft a sweeping coordinated plan as circumstances got worse. The government resisted capitalization measures because using public funds to prop up tottering institutions was hugely unpopular with taxpayers. Tokyo's indulgence ceased abruptly after a major bank and a securities house collapsed in 1997. The next year, political leaders backed capital injections and determined that the financial sector's survival depended on consolidation. The nation went from having roughly 20 big banks in 1990 to half a dozen today. In taking on the crisis, the U.S. has advantages that Japan and Sweden didn't, including a strong currency and a low inflation rate. The U.S. also faces liabilities that weren't factors in the 1990s, and that could complicate solutions to today's crisis. Any recovery will have to unfold amid recessionary conditions that began at home and spread around the globe. The U.S. has acted swiftly but erratically, executing "crisis management on the fly," said Gerald P. O'Driscoll Jr., a senior fellow at the conservative Cato Institute and a former vice president at the Federal Reserve Bank of Dallas. After an initial stumble, the Treasury Department pushed a $700 billion rescue plan through Congress, establishing the Troubled Asset Relief Program to buy toxic assets through a reverse auction. Shortly thereafter, Treasury changed its focus to capital injections, which U.S. officials argue shows flexibility -- but which markets may interpret as indecision. In mid-November, Treasury Secretary Henry Paulson scrapped the plan to buy troubled assets from financial institutions. Mr. Paulson said the government planned to continue capital injections and start assisting consumers through programs such as stepping up student loans and preventing foreclosures. Last week, Mr. Paulson followed through on that plan, announcing $800 billion in assistance -- largely from the Federal Reserve -- to credit markets. Mr. Paulson and Fed Chairman Ben Bernanke have "sowed uncertainty repeatedly and serially," Mr. O'Driscoll said. "No one knows if they're going to get bailed out or not." Many banks are wondering whether the institutions that received capital injections will use the public funds to resume lending or to acquire smaller rivals. The U.S. also hasn't followed Sweden -- and ultimately Japan -- in taking the politically charged step of forcing comprehensive consolidation in the financial-services industry. "If we all agree that there was a credit bubble, then there has to be a contraction in credit," said Adam Posen, deputy director of the Peterson Institute for International Economics. Pursuing a policy of consolidation is "a genuinely difficult thing to do. That's why the Swedish political class in '92 and '93 and the Japanese political leadership in 2002 deserve credit." Thus far, the U.S. crisis has claimed few high-profile casualties, such as Lehman Brothers Holdings, which sought bankruptcy protection in September. Government intervention preserved insurer American International Group, put mortgage giants Fannie Mae and Freddie Mac into conservatorship and blessed J.P. Morgan Chase's takeovers of Bear Stearns and Washington Mutual. At the end of November, the government gave ailing Citigroup a reprieve through a patchwork of remedies, including injecting $20 billion in capital and guaranteeing some troubled assets. Treasury has said its priority is righting the banking system, not consolidating it, although federal rescue efforts may lead to some thinning of the ranks. Just as members of Congress rejected the first draft of the TARP legislation, they are likely to resist bank closings or takeovers. Mr. Obama has an opportunity to take a step that may exact a short-term political cost and yield a long-term economic gain.