Is the Swedish model useful today?

To what extent can the Swedish model be applied to other countries currently suffering from financial tensions and severe banking problems? To answer this question, the Swedish crisis of the early 1990s has to be compared to the present global crisis.

Some similarities are striking. The causes of the two crises are similar. The impulse driving the boom that preceded the crisis can be traced to financial liberalization and financial innovations, setting off a credit boom that fuelled rapid increases in asset prices, particularly house prices. The boom was supported by lax monetary and fiscal policies. The private sector, households, firms and financial institutions ended up overindebted. Financial supervision and regulations were inadequate to prevent the boom and the emergence of large financial imbalances.

Eventually, boom turned into bust—with a declining volume of credit, deleveraging, falling asset prices, and distress in the financial system bringing the threat of bankruptcy of major financial institutions, and triggering heavy government intervention to support the banking system. The financial crisis impacted on the real economy, initiating a deep recession.

On the other hand, there are also considerable differences between the Swedish crisis of the 1990s and the current global financial crisis. Most important, the initial conditions for Sweden compared to those of most other countries today are significantly different. The Swedish crisis of the early 1990s was primarily a local phenomenon, or—more accurately—a Nordic one, as Finland and Norway also went into crisis at roughly the same time as Sweden.

Sweden, being a small open economy with a pegged exchange rate when the crisis peaked, was able to abandon the pegged rate in November 1992, thus obtaining a lasting depreciation of its currency that contributed to a prolonged recovery. This option of an export-oriented growth strategy out of the crisis is currently not open to the world, because the present crisis is a global one. An individual country can no longer rely on the rest of the world to maintain aggregate demand for its exports, as Sweden was able to do in the 1990s.

The small size of the Swedish financial system in the 1990s facilitated the bank resolution policy. Policymakers had to deal with a limited number of banks—only six major banks, in fact—in a global environment of trust in the banking system and in financial markets (except for the Nordics). The Swedish system was also bank-based, with few major financial actors outside the banking system. This is in sharp contrast to the US today, for example, where there are a large number of banks of different types and many nonbank financial actors and where public trust in the financial system and its actors (“Wall Street”) is extremely low.³³

The Swedish bank resolution policy was also confronted by a financial system that was much less sophisticated and much less globalized than the financial system of today. There were essentially no structured products, no sophisticated derivatives, hardly any hedge funds, a more limited supply of financial instruments, and less securization, among other differences. Structured products were not traded in local and global markets, repackaged with increased leverage to create other securities, and then traded again.

In short, the Swedish financial system was much more transparent than is currently the case in most countries. Now, the lack of transparency has prevented the rise of a properly functioning interbank market, giving rise to large interbank spreads and a liquidity crisis, in spite of various government guarantees in several countries. A liquidity crisis of this type did not emerge in Sweden in the early 1990s, because the banking system remained transparent. The ongoing global crisis is a banking crisis as well as a financial market crisis, in contrast with the Swedish crisis, which was primarily a banking crisis, and only later became a currency crisis. In particular, both local and global systemically important markets serving the short-term liquidity and funding needs for a wide range of financial institutions and hybrid financial/nonfinancial companies have been under severe stress—and at times not functioning at all—since the advent of the US subprime crisis in the summer of 2007.

Indeed, on this score, the ongoing crisis has been difficult for the authorities to manage, in part because some traditional central banking tools—particularly in the United Kingdom and the US—are not well suited, either legally or architecturally, to provide liquidity for the institutions most in need, including investment banks and insurance companies. By contrast, the Swedish blanket guarantee of September 1992 immediately created trust; one reason for this was the comparatively simple set of instruments available compared to the present case.

In addition, Sweden has a long tradition of confidence in its domestic institutions, in its political system and in its elected representatives.³⁴ With this large social capital, it is easier for the government and the opposition to reach agreement on public policy actions that are stable and lasting. The tradition of open public debate makes it easier for policymakers to explain difficult and costly decisions to the public and to be trusted. Trust contributed to the belief that the Bankstödsnämnd was going to carry out its duties in a fair and correct way without favoring any of the parties involved. It may be difficult for other countries to mobilize the same type of social capital that was needed in order to make the Swedish approach successful.

Today, as a result of the global financial crisis, there is much more genuine uncertainty about the international financial architecture, about the regulation of the financial system and about the proper strategy for central banking than was the case in the early 1990s. The Swedish policymakers of yesterday designed their bank resolution policies in a more stable macroeconomic and financial global setting.

The above account of the differences between Sweden in the early 1990s and the global situation today suggests that it was far easier for policymakers to deal with a local financial crisis in a small open economy, like Sweden's, in the past than it is today to manage a global crisis characterized by strong and sophisticated financial and economic cross-border links. The international financial linkages suggest a need for international cooperation. Although policymakers trying to support the financial system today are facing greater challenges, the Swedish model of bank resolution can nevertheless serve as a source of inspiration—indeed as a benchmark or template—for countries facing financial crisis.

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