The Nordic crisis, including the countries of Norway, Sweden, and Finland, became apparent in the early 1990s. In general, there was a lack of regulation in the financial sector with numerous Non-Performing Loans (NPLs) resulting. Investments, denominated in foreign currencies were prolific, and in the case of Sweden, accounted for half of total bank lending (Moe, Solheim & Vale 2004). Interest rates were low, which led to demand-driven inflation and a real estate bubble. The impacts of speculative attacks on local currencies, as a result of being part of the European Exchange Rate Mechanism (ERM), severely hampered the ability to pay-back loans. The government’s actions were swift, in that they began a systemic approach to the crisis with various financial remedies in the form of either capital injection, forced mergers and in some cases liquidation or nationalization. There were several factors that led to the crisis, some common to the three countries, others were country specific. In general terms, the problem was derived from credit bubbles, though there were some differences in asset classes leading to the bursting of the bubble. Norway experienced the crisis before the other two, in large part due to export decline driven by oil prices. During the heavy run up prior to the late 1980s, Norway enjoyed a robust current account, however when the price declined in 1986, that had a tremendous effect on exports and cash in-flows (Moe, Solheim & Vale 2004). Norway experienced a major reversal in 1986, when according to the Norges bank, asset prices came down, the business cycle reversed, inflation hit 8%, and the current account reversed by 10% (Moe, Solheim & Vale 2004). The Norwegian crisis pre-empted the other two countries as a result, which was felt throughout the system in the form of unemployment and stagnant growth. Finland felt the sting from the break-up of the former Soviet Union, which impacted its exports. In addition, Finland had a much higher per capita concentration of banking staff and banks than the other two countries, so shocks to the banking sector impacted them more. Bank profitability decreased for both commercial and savings banks alike of all three Nordic countries, but commercial banks were hit harder in Norway, especially in 1990-92, while savings banks profitability in Finland was -10% (Moe, Solheim & Vale 2004). Sweden experienced a greater run-up of real estate than the others prior to the crisis.
ERM Effects The European Exchange Rate Mechanism (ERM) formed in the late 1970s amongst great controversy with the many players involved, while others were added later. The idea was that the exchange rate between the various currencies could not fluctuate by more than 6%. Following the fall of the Berlin wall in 1989 and German Re-unification, their fiscal expansion led to higher interest rates. Most of Europe had to follow suit if it wanted to continue a fixed exchange rate, pegged to the German Deutsche-Mark. The Nordic countries, along with several others, had currencies trading close to the bottom of their ERM bands due to foreign exchange traders. On 16 Sep, 1992, dubbed “Black Wednesday”, the speculative attacks began. England, for example, had to raise rates from 10 to 12% and then threaten 15% all in one day, while spending billions of foreign currency reserves to buy up speculative sales of the Pound. The speculators were selling pounds, convinced that the government would not meet its promise of increased rates, nor be able to maintain the narrow exchange rate band. Each European country faced a losing battle; either raise rates to maintain the currency exchange or maintain rates, which would lead to depreciation of their sovereign currency in the short run, making it difficult to repay foreign loans. Krugman (1999) and others, describe this as a currency exchange crisis or “Second-generation crisis model”. In the case of the Nordic countries, the ERM particularly affected them since most of their loans were denominated in foreign currencies. Other countries, such as Italy, had to extend their band’s range, adjust the central parity between the Mark and their currency, or allow the currency to float. The ERM was abandoned by the countries of Norway and Sweden in 1992 for many reasons. Recession followed for those countries that continued to peg their currency to the Mark. There are many benefits for countries to take themselves off a fixed rate, such as not having to spend to prop up a devaluing currency; it’s almost impossible for a government to have more reserves than the currency market. Also, the devalued currency means more exports, which will improve the real economy, reference Fig 2 below, which shows exports for Sweden increasing starting in 1992. In general, all three shared the same characteristics of the crisis, in the form of bank failures and problems with insolvency. First, small banks failed, and/or merged with larger industry partners. Then larger banks began to show signs of trouble, which led to an equities decline. As described by the Norges bank, which detailed each of the countries’ experience below, the five largest banks in Finland, the four largest banks in Norway, and three large banks in Sweden all required liquidity or some other form of government support (Moe, Solheim & Vale 2004). Kaminsky & Reinhart (2009) describe the high number of indicators of a financial crisis prevalent in the Nordic crisis, which for all three countries included: M2 Multiplier, M2 Reserves, bank deposits, exports, terms of trade, reserves, real interest rate differential, output, stock prices, and deficit/GDP ratio. Unique to Finland and Sweden was the real exchange rate, while only Norway and Sweden shared the lending-deposit rate ratio indicator. Norway Norway preceded the other Nordic countries’ crises, kicking off in 1986, but seriously getting underway in 1988 and ending at about the same time as Finland and Sweden. It experienced the smallest drop in real GDP and fall in bank lending, though the crisis lasted for about five years. The many years of lucrative oil exports were the main thrust behind its sizzling economy. It did not have as many loans denominated in foreign currencies, so when the ERM was attacked, Norway was already at the end of its crisis and didn’t feel the pinch as much as other European countries, though it was one of the first to remove itself from the ERM. After the fall of oil prices and resulting NPLs hitting the books, there was a wave of loan losses from the largest commercial banks. The first sign of trouble was the Sunnmorsbanken, which was later merged with Christiania Bank in 1988. In ’89 more banks failed and began to merge with larger banks, while the Central Bank made fund guarantees from the Commercial Banks Guarantee Fund (CBGF) that were quickly dried up. Eventually, the government formed the Government Bank Insurance Fund, which managed the private guarantee funds and would essentially manage insolvent banks, while Norges Bank continued to provide liquidity to solvent institutions. In ’91 three of the largest banks representing 54% of total Norwegian banking assets, Christiania Bank, Fokus Bank, and Den Norske Bank, required support. They received it, but were required to write-down shareholders assets to or near zero, while management was replaced. As a result of these interventions the government came to own an 87.5% stake in the largest commercial bank (Den Norske Bank) and became the sole owner of the second (Christiana Bank & Kreditkassen) and sixth (Fokus Bank) largest commercial banks. The objective of official support during this period was to restore capital ratios to at least 8 percent. Profitability was restored to pre-crisis levels and operating expenses were reduced by about a third (Allen & Gale 1999). When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares. Finland The crisis in Finland lasted approximately two years, starting in 1991 with a cumulative loss of GDP just over 10%. Non-performing loans were the key ingredient leading to a fall in bank lending of 35.5%, and it would last until 2000 when lending returned to pre-crisis levels. According to Hoggarth, Reidhill & Sinclair (2004), Finland’s bank credit to GDP ratio was well above the other two, standing at approximately 80% at the start of the crisis in 1991, though four years later it had dropped to about 60%, more in line with Norway and Sweden’s bank credit to GDP ratios. They show that Finland achieved the highest commercial bank profitability after the crisis, due in large part to its restructuring efforts. As discussed, Finland was affected by the ERM speculative attacks at about the same time as the collapse of the former Soviet Union. The first Finnish bank to approach insolvency was Shopbank, a commercial bank, though unlike most of the bail-outs to follow, the shareholders were not bled out, since the Bank of Finland chose instead to inject approximately USD $3.6 B to the bank. At first, the government responded by providing a capital injection into the banks to avoid a credit crunch, though the liquidity was provided in the form of preferred stock, convertible to common voting stock should other conditions not be met. There were conditions set on the capital support, which in Finland included: balance sheet restructuring, cost cutting, management changes and improvements in internal controls (Moe, Solheim & Vale 2004). The Government Guarantee Fund (GGF) was established to provide this direct support and manage the crisis. The GGF acquired and managed the Shopbank, starting in ’92, and at the same time provided support to 41 savings banks, which merged into the Savings Bank of Finland. The GGF managed the NPLs of STS-Bank, which was a commercial bank turned savings bank, and lacking the experience to be profitable as such. This is one of the many incidents where the GGF managed a “bad bank” which held all NPLs, and often times the balance sheets of other banks merged with it. In addition, the Finnish government provided a blanket creditor guarantee in ‘92, though equity holders were not protected; a guarantee that would last approximately six years. The GGF also guaranteed funds to the KOP commercial bank, the Union Bank of Finland, and several co-operative banks. Sweden Sweden, like Finland, experienced its banking crisis from ’91-’93, and was greatly affected by the ERM due to the fact that a large number of loans were foreign denominated. Financial de-regulation in the 1980s and low interest rates led to a frenzy of real estate lending, more-so than in the neighboring countries, and when property prices imploded, the number of NPLs sky-rocketed. It experienced a drop in bank lending of about 26.4% and it took approximately ten years before pre-crisis level of lending was restored. Five of six of Sweden’s largest banks, accounting for over 70 percent of banking system assets, experienced difficulties (Reinhart & Rogoff 2008). The first bank to go was Forsta Sparbanken, the largest savings bank, in late ’91, for which the government provided a loan, and when that didn’t fix the problem, it was merged with a few smaller banks into the new Sparbanken Sverige. The third largest commercial bank, Nordbanken, required assistance as well, though its shareholders received full compensation for their equity; in part due to the fact that approximately 71% of it was previously owned by the government, which felt responsible for its failure. In contrast, several months later, the government reversed its stance and the private shareholders received nothing for their shares, such as the case with Gota Bank, the fourth largest commercial bank. Once the ERM attacks occurred late ’92, all of the seven largest banks, representing 90% of total banking assets, were hit with severe losses from NPLs. Bad assets for all these banks were transferred and handled by separate asset management companies, either Securum or Retriva. The government announced a guarantee for all bank deposits and creditors for the nation’s 114 banks, starting autumn ’92 and lasting four years. The Central Bank, Riksbanken, used a large portion of its foreign currency reserves as liquidity support for the banks with foreign loans. Similar to Finland, Sweden set conditions on liquidity injections, such as reducing risky loans, improvement of internal controls and cost-cutting. Towards the end of the crisis, a crisis resolution agency, Bankstodsnamnden, was created to use public funds to support all banks (Moe, Solheim & Vale 2004). Nordic Resolution…Legacy As for handling of the crisis, most experts would argue that the Nordic countries should receive high marks, overall, due to swift action. Relative to other financial crises, the Nordic episode was short, with long term benefits derived from new regulations. The report by Ergungor (2007) of the Federal Reserve of Cleveland reports that, “…Sweden did particularly well in terms of recognizing the magnitude of the losses, assigning realistic values to seized collateral, and giving markets a clear picture of how the crisis was being managed…They moved quickly; making equity injections to revitalize borrowers who were damaged but still viable, and acquiring a majority of their shares in most cases…The efficiency of Sweden’s legal infrastructure was a critical factor in the country’s speedy resolution process.” The various tools used, were true to tax-payers’ interests, and the governments were able to minimize losses, even turn a profit in some cases after re-incorporating the nationalized banks into the private sector. These tools could be classified as emergency measures or restructuring measures. The emergency tools included: a blanket guarantee, Lender of Last Resort loans, a separate bank restructuring agency, and asset management companies. Restructuring included: mergers, deposit insurance funds, liquidation, government open assistance (i.e. consultants), nationalization (temporary), management changes, accounting targets and process changes. These tools will be discussed in the general response plan here-in. There was little political jockeying going on, which helped unify the countries. There was support by both parties in each of the Nordic countries’ legislatures, which lent credibility to any law passed as financiers knew that the measures would not disappear with any change of government (Moe, Solheim & Vale 2004). They enacted “bad banks” to help the credit crunch while tackling NPLs. Being the first out the gate of developed countries to experience a banking crisis, makes the Nordic crisis resolution, while imperfect, a model for decades to come. Other countries should heed the lessons learned from the Nordic crisis. “The Bush administration’s handling of the financial crisis is in part inspired by a successful Swedish bank rescue in the 1990s, but one crucial deviation could cost US taxpayers dearly…[Sweden] introduced a guarantee for all creditors but not for stock holders. That guarantee made it possible for everyone to do business with the banks without risk” (Lundgren 2008). The Nordic recovery was effective. Reinhart & Rogoff (2008) report that current sovereign ratings for these countries are at 94.9, 95.9, and 94.8 for Finland, Norway, and Sweden respectively. The only problem is that the structural changes instituted by these countries did not make them immune to global recession in 2008. Lessons from the Japanese Crisis The crisis in Japan was preceded by financial liberalization in the 1980s and asset bubbles in the form of stock prices and high land values. When the Governor of the Bank of Japan noticed a bubble formation and changed policy, with interest rates increasing from just over 2% to 6% in a year, the asset classes burst. Stocks began to fall in 1990, and again in 1997 following mass failures, however real estate prices continue to drop, falling approximately 40% since 1992. All told, 7 banks were nationalized, 61 financial institutions closed, and 28 merged. As a result, the luster of the Japanese resurgence culminating in the 1980s saw an Institutional Investor rating of 91.4 with a drop of almost 6 points since 1979 (Reinhart & Rogoff 2008). Japan began experiencing failures of several smaller financial institutions in 1990-91, and it is believed that this was due in large part to NPLs. These loans, which were damaging the Japanese banks’ balance sheets, were estimated in ‘95 at between USD $469B to $1 Trillion and 10-25% GDP (Reinhart & Rogoff 2008). Credit was readily available; the bank credit/GDP ratio was 1 to almost 1.2 throughout the 1990s and commercial banks’ profits steadily declined since crisis (Hoggarth, Reidhill & Sinclair 2004). Another debilitating factor in the financial sector was the jusen problem. Jusen or housing loan corporations were founded by banks with private real estate experience, but when they shifted to the commercial sector, their lack of expertise led to losses of about 6.5 Billion yen. Stock prices began to fall moderately, but we didn’t see the main volatility in the Nikkei until 1997 with the failure of several large banks. There was significant pressure on the Governor of the Bank of Japan to respond. In 1994, Governor Yasushi Mieno said, “It is not the business of the central bank to save all financial institutions from failure. On the contrary, failure of an institution that has reasons to fail is even necessary from the viewpoint of nurturing a sound financial system” (Nakaso 2001).
A couple months after the governor’s statements, the failures began. Two urban credit cooperatives, Tokyo Kyowa and Anzen failed, for which a new bank, Tokyo Kyoudou Bank, was formed to assume the failed assets, for which the Bank of Japan initially funded and the Deposit Insurance Corporation (DIC) guaranteed the deposits. The TKB later received capital injections and low interest loans by private institutions, in what became known as the hougachou approach. This term comes from a typical way of raising money from communities through a traditional festival (Nakaso 2001). Being politically more popular than a Central Bank bail-out, this approach shored up the lack of funds by the DIC, though later we see that it would not work during a system wide-failure. Other major failures, such as the Cosmo Credit Cooperative, Kizu Credit Coop, Hyogo Bank, Daiwa Bank (with losses primarily overseas), Taiheiyou Bank, Hanwa Bank, Kyoto Kyoei Bank, Sanyo Securities, and Tokuyo City Bank, soon followed. Those that didn’t fail were restructured or merged, such as NCB, while Hokkaido Takushoku Bank and Hokkaido Bank merged; same with Fukutoku bank and Naniwa Bank. The government and population woke up after major failures in 1997, and a new phase in government response followed. Failures of the Hokkaido Takushoku Bank, Sanyo Securities, Yamaichi Securities, Nippon Credit Bank and Long Term Credit Bank led to a reconsideration of the government’s stance (Allen & Gale 1999). The Amendment to the Deposit Insurance Law in 1996 addressed some issues, such as removal of a payoff cost limit to financial institutions, the raising of insurance premiums from 0.012% to 0.084%, and a Chief Executive Director of the DIC (separate from the Bank of Japan) was appointed. This wasn’t enough to save two of the larger banks, Nippon Credit Bank, Hokkaido Takushoku Bank, and Yamaichi Securities (one of largest securities/insurance houses), from a bail-out. By February 1998, the public opinion had changed too, and supported introduction of public funds for capital injection, to the tune of $230B in special government bonds or guaranteed credit lines. This calmed the markets down somewhat, but a new problem reared its head; derivatives sank the Long Term Credit Bank (LTCB) of Japan (with assets of $240B USD). It seemed capital injections and restructuring wasn’t enough, so the government created the Law Concerning Emergency Measures for the Reconstruction of the Functions of the Financial System, which allowed for the temporary nationalization of troubled institutions. Once LTCB was nationalized in Oct 1998, the Bank of Japan was forced to deal with its derivative issue, discussed in the causes of financial crisis below. Besides the Financial Reconstruction Law (nationalization) the LTCB case was instrumental in passing of the Financial Function Early Strengthening Law for dealing with failed financial institutions. The process of systematically dealing with failed institutions was outlined, reference Figure 3 below, a reproduction of Figure 2 found in Nakaso (2001). In addition, several fiscal stimulus measures introduced. “Before 2007, explicit stimulus measures were a part of the policy response only in the Japanese crisis…in emerging markets, fiscal stimulus packages were not an option, because governments were shut out of access to international capital markets” (Reinhart & Rogoff 2008). Another crisis was brewing regionally, the Asian crisis. That crisis erupted in July in Thailand and its neighboring countries, and then spread to Korea in the autumn. The two regional crises fed off each other (Nakaso 2001). There were several spill-over effects from these crises, especially in the form of capital flows. When capital inflows decline, this will affect the balance sheets of domestic entrepreneurs, which can’t borrow to pay back loans or create new products or markets. Their demise in-turn further reduces capital inflows.” (Krugman 1999) The Japanese experience was considered by many as the “Lost Decade”. Japan was/is fortunate enough being a large economy and able to borrow from foreign governments, besides being more immune to speculative attacks, however the lack of urgency at the beginning of the crisis coupled with a Japanese consumer characterized by frugality and an unwillingness to spend contributed to it lasting 12 years and in some industries it is on-going. Even today, Japan’s sovereign rating isn’t as high as other developed countries. S&P lists their sovereign currency rating (Long Term/Outlook/Short Term) at AA/Negative/A-1+, while all three of the Nordic countries received a rating of AAA/Stable/A-1+ (Cavenaugh 2009). To compare the crises, Allen & Gale (1999) state, “A comparison of the policies followed in Norway and Japan underlines the importance of this aspect of government intervention. In Norway, a prompt recapitalization of the banks allowed them to resume lending, the recession soon ended, and economic growth returned. In Japan, the presumption was that economic growth would return and this would solve the banking problems.”
