“Us old guys are really being dusted off at the moment,” jokes one architect of Sweden’s successful bank bail-out in the early 1990s. Maybe so, but policymakers, particularly in America, are still taking an age to learn their Swedish lessons. The country took a comprehensive approach to its crisis, not only guaranteeing debts and injecting government cash into banks that could not raise private capital, but also setting up “bad banks” to manage institutions’ toxic assets. The Citigroup rescue edged in this direction; UBS is setting up a bad bank with Swiss government money. But there is further to go.
The idea of a bad bank, a separate entity which takes ownership of non-performing assets and then manages them in order to maximise their value, is simple enough. The Swedes set up two bad banks (with the reassuringly solid names of “Securum” and “Retriva”) to handle the crummier assets of Nordbanken and Gota Bank, two nationalised institutions. And very effective they were (indeed, some borrowers complained they were too ruthless). Their efforts to restructure and sell distressed loans helped Sweden to keep the eventual cost of its bail-out below 2 percent of GDP.
One advantage of the bad-bank structure is neatness. Taking toxic assets off the balance-sheet leaves behind a cleaner bank which should find it easier to raise capital or attract buyers. Another is specialisation. According to Jonathan Macey, a professor at Yale University, the genius of the Swedish scheme was that it allowed people who were good at restructuring bad loans to focus on that job, and those who were better at running banks to concentrate their efforts there.
Things are more difficult today. The Swedish loans were much less complex than modern securitised assets. Pricing the assets was also easier because taxpayers were on both sides of the deal, owning both the nationalised good banks and the bad banks. Nor was the rescue a panacea: Swedish bank lending to the private sector contracted for years after the intervention. But ugly as they sound, bad banks are a good idea.