Sweden’s response to a systemic banking crisis

Governments should avoid the onset of a systemic financial sector crisis in the first place but, of course, avoidance is never optional! It is merely an aspiration!

When a crisis does occur it is the unequivocal responsibility of government to maintain liquidity so as to avoid a credit crunch; to restore confidence when this has been undermined and to ensure that the capital base or capital reserves of the national banking system is adequate following a period of excess lending. These are the views of Bo Lungdren, currently Head of the Swedish National Debt Office and formerly Sweden’s Deputy Minister for Finance when the Swedish banking crisis unfolded in the early 1990’s. He spoke at a lunch meeting of the Institute of International and European Affairs in Dublin on Tuesday, July 7^th.

Lungdren succeeded Carl Bildt, the former Prime Minster of Sweden and current Foreign Minister, as Leader of the Moderate Party from 1999 to 2003. But when he was a member of the Swedish Government confronted with the banking crisis his party was one of four parties in a minority coalition government.

The Swedish crisis bears some resemblance to that currently occurring Ireland but the similarities. The Swedish financial system had been deregulated in 1985 and the inflationary period which ensured between 1985 and 1990 caused a property boom which evolved into a property bubble. Private sector credit in Sweden increased from 85% to 135% of GDP in the five years prior to the bubble bursting.

The crisis in Sweden was of a more moderate scale than that in Ireland. It cost €6.5 billion to repair the damage (4% of GDP), of which €2 billion was recouped within five years. Two of the seven mid-sized Swedish banks were nationalised (Nordenbankenn now known as Nordea and Gota Bank) and one of the seven did not participate in the government support programme. Ireland has already injected €11 billion (7% of Ireland’s GDP) in three banks – the recently nationalised Anglo Irish Bank, Bank of Ireland and AIB Bank.

The difference in scale is illustrated by the amount of credit outstanding at the time of crisis in both countries. Private sector credit in Ireland has increased from 136% to 216% of GDP in the five years (2003 to 2008) prior to the collapse of the banking system here. Household debt in Ireland, according to the most recent Quarterly Bulletin from the Central Bank of Ireland indicates that household debt outstanding in Ireland is €148 billion – a figure that is in excess of 80% of current GDP.

The Swedish crisis was regional in nature – impacting the financial systems of Norway and Finland to some extent. Its resolution was expedited by a currency devaluation. The complexity of the current crisis aggravated as it is by the asset securitisation phenomena has uncovered a scale of loss that had not been anticipated.

The Swedish approach was to guarantee the depositors and creditors of the financial system – but not the shareholders. The incidence of moral hazard was curtailed by exacting accountability among those who caused the crisis. directors, management and shareholders. The Swedish Government decided to what extent it would support banks’ in difficulty. They did not determine or directly influence this matter.

Lungdren was discreet enough not to offer public advice to the Irish Government although he did share his opinions with the Oireachtas Committee on Finance and the Public Service.

Sweden did not establish a bad bank, an equivalent to Ireland’s National Asset Management Agency and he cautioned against discounting the price of assets taken on by a bad bank on the grounds that the capital vacuum created had to be filled. Assets should be valued on the basis of ‘mark to market’ if a quick recovery of the financial system is to be achieved. He also emphasised the importance of transparency if the credibility and integrity of a rescue initiative is to be maintained. Stress tests are merely base-line scenarios and must be treated accordingly.

Swedish banks incurred losses of €25 billion during that crisis. Credit losses in Ireland have been estimated by the IMF to potentially be €35 billion and the Irish economy is about half the size of the Swedish economy.

Some Swedish banks are apparently experiencing fresh difficulties as a consequence of exposure to the economic crisis in Baltic countries, especially Latvia and Estonia.

Moral hazard of nationalising Anglo Irish Bank

The response of many prominent Fianna Fáil politicians to the result of the elections last Friday was to plead for more effective communication of Government actions. The saga of Anglo Irish Bank must provide a specimen illustration of ineffective communication.

It was nationalised on January 15^th, less than a month after the abrupt resignation of former Chairman, Seán FitzPatrick, fellow director, Lar Bradshaw who has been the Government appointed director of the Dublin Docklands Development Authority, David Drumm former Group Chief Executive, William McAteer, Group Financial Director and Chief Risk Officer, to mention but a few. McAteer is a former partner of PricewaterhouseCoopers. The current chairman of the nationalised bank was managing partner of that firm for a number of years. But the Government has failed to educate and convince the public that maintaining Anglo is in the national interest.

John McManus, has written a very compelling article in today’s edition of The Irish Times that argues the time has come to shut Anglo Irish Bank for good and the argument that it is too costly to close it is false.

No State money was invested since nationalisation but the begging bowl is out now. When the 6-month report to 31 March was issued on 29 May there was an immediate demand for €4 billion of additional capital. It was also signalled that further losses of €3.5 billion are anticipated. Anglo had assets of €101 million when it was nationalised. But the results at 31 Mar have diminished to €88.5 billion in a matter of 75 days since nationalisation.

The nation's capacity to bail out zombie banks is not infinite, nor is there much faith in their capacity to redeem themselves without extensive changes at the top. The National Pension Reserve Fund was valued at €15.5 billion on 31 March, having lost 30.4% of its value in the previous year. €7 billion of this has been invested in AIB and Bank of Ireland and if €4 billion is to be immediately committed to Anglo and a further demand for €3.5 billion is lurking in the shadows, the nation's sovereign wealth will amount to a mere €500 million.

The incidence of moral hazard is never far away when a fairy grandmother emerges to bail out an errant entity, and the former discipline of the stock market no longer prevails. It has emerged that Anglo made loans of €175 million to 10 directors and that €31 million of these are impaired. Would this impairment arise if the State was not involved and the stock market had to be impressed by the prowess of the business?

Apart from FitzPatrick who owes €106 million, Bradshaw, Drumm and McAteer the former directors were Tom Browne, Fintan Drury, Noel Harwerth, Anne Heraty, Michael Jacob, Gary McGann, Ned Sullivan, Declan Quilligan and Pat Whelan.  The former board received emoluments of €11.5 million in 2008, a slight reduction on the €12.9 million doled out in 2007.  But these far-sighted people decided that, had they remained, fees for non-executive directors would have been reduced by 20%!

This success of nationalisation is predicated on maximising the collection of outstanding liabilities. What signal is conveyed by a high incidence of impairment in the directors' loan account? There should be no directors loans whatsoever outstanding in a nationalised company.

The immediate call on State support of €4 billion immediately, is apparently to be made before the investigation of the Garda Fraud Squad and Office of the Director of Corporate Enforcement is completed. Impaired loans amount to €10.7 billion and a further €12.9 billion are deemed, at this stage, to be 'past due, but not impaired'. But they could be against this background. Loans of over €300 million, provide by Anglo to its own customers to buy Anglo shares, are now impaired and await the pleasure of the Irish taxpayer.

The cost of running Anglo Irish Bank, now a State enterprise is exorbitant. The average salary for the 1,753 employees for six months was €48,488 (equivalent to €96,976 per annum). A comparison with those public entities that engage with Anglo reveals that the average salary at the Department of Finance in 2009 will be €58,601, while the average salary of staff in the Office of the Director of Public Prosecutions is anticipated to be €64,946.

The Minister for Finance advised that nationalisation would mean "drawing a line under past activities". As the Minister is the only shareholder, why was it even necessary to engage a public relations firm in connection with the publication of the first interim statement since nationalisation? If the intention is to signal the drawing of a boundary with life under the ancient regime, why would the new board of directors and not be bold enough to 'go for change' rather than choose Drury Communications, a public relations firm established by Fintan Drury?  Drury was a former director of Anglo Irish Bank until June 27 2008. He was paid €85,000 in 2008 as a retainer to attend 4 board meetings and 6 meetings of the Anglo Risk and Compliance Committee and 2 meetings of the Nomination and Succession Committee.  Surely there is some due out of a staff of 1,753 that could coherently articulate what is happening, or have all those with these qualities already resigned?

The Government has not done enough to convince the public of the systemic importance of either Anglo Irish Bank or Irish Nationwide Building Society. The McManus article suggests that since it is most unlikely to redeem its reputation. Customer funding has dropped from €47.8 billion on 30 September to €34.1 billion on 31 March – driven by “a market wide aversion to risk”. But is also reflects the decrease of €7.3 billion of customer deposits received from Bowler’s Irish Life Assurance Company that was designed to hoodwink stakeholder at the end of the last financial year – 30 September 2008. 

Customer lending, to existing customers, increased fractionally from €71 million to €72.3 million and €700 million of this concerned capitalised interest and the roll-up of other interest outstanding.  Basically it is a matter of endemic stagnation combined with a ruined reputation and an open-ended drain on public funds.

Ireland’s credit rating was reduced on June 8th to AA negative by Standard & Poor’s on account of the fiscal cost of weakening bank sector asset quality.

Banks' bailout: Is the Irish taxpayer blinded by optimism?

Now that the National Asset Management Agency (NAMA) has been inaugurated, is the taxpayer being asked to approach the resolution of the banking crisis on the basis of a blind act of faith? The challenge is admittedly both complex and enormous, with many uncertainties although the idea of taking over portfolios’ of loans, good and bad, is an encouraging feature. The cornerstone of success is dependent on property development borrowers repaying loans in full, over an agreed time or by forcing the sale of their mortgaged collateral property assets at a time and on a basis that yields the State a profit above the loan balance due.

There have been references to the approach of the Swedish Government to their real estate induced financial crisis in 1992. But there are important differences to that currently prevailing in Ireland with respect to the scale of the problem and the level of national indebtedness.

Private sector borrowing in Sweden increased from 85% to 135% of GDP in the five years prior 1992. Private sector borrowing in Ireland has increased from 136% to 214% of GDP between 2004 and 2008. The Swedish Government was obliged to commit a sum equivalent to 4% of GDP (around €14 billion) towards the rescue with a net cost equivalent to 2% of GDP when the crisis abated and profit on the sale of assets realised. The estimated toxic loans arising in Ireland remains uncertain but if they are €90 billion, this is equivalent to 50% of our shrinking GDP.

The Minister for Finance, Brian Lenihan TD, intends to visit the financial centres of Europe as a confidence boosting measure and confidence needs to be restored rapidly of credibility is to be reinstated. His audience will seek explicit answers. Our profligate banks increased private sector credit by 97% to €393 billion since 2004 on terms that no competent Financial Regulator or Government ought to have tolerated. Current economic conditions and the confiscation of substantially more income in the form of taxes and levies following the Budget, aggravate the prospect of timely repayments being made on loans that should have never been approved.

Will the Minister be able to tell his audience that an orderly and complete change in the board of directors’ of each of the supported banks will commence not later than the 2009 annual general meeting of that bank? Will be able to demonstrate confidence in the risk management competency and procedures of these banks against a background where the risk process at Irish Life & Permanent did not escalate details of the €7.5 billion investment in Anglo Irish Bank to the board before this transaction was executed? How will the Minister be able to convince these audiences’ of Ireland’s capacity to recover its prosperity and solvency because, unlike Sweden, we do not have an abundance natural resources or an equivalent indigenous industrial base?

If some of the supported banks or building societies, following a downward revaluation of the assets held as collateral for loans are not likely to return to profitability in the medium-term, will they be closed or merged sooner rather than later?

There must be transparency if the taxpayer is to repose trust in these measures and those who brought about this crisis must bear the cost of their malevolence promptly.