Swedish banking crisis

In the late 1980s and early 1990s, the Scandinavian countries underwent their most severe financial crisis of the postwar period. In Sweden, high inflation made the fixed-exchange-rate policy untenable, so the krona was devalued several times. When consumer price inflation hit 15 percent in 1980, the government decided to break the inflationary spiral (i.e., inflation expectations) and promote economic growth through a series of financial reforms throughout the 1980s.

The real estate market experienced a speculative boom parallel to the rapid growth in credit. Home prices more than doubled between 1981 and 1991. From 1990 to 1995, residential real estate prices dropped 25 percent and commercial real estate prices dropped 42 percent (inflation-adjusted rates). Banks’ nonperforming loans mushroomed from 0.2 percent–0.5 percent of total loans in the 1980s to 5 percent in 1992.

As a result, Sweden had to nationalize several of its largest banks.

Background
Even in the early 1950s, Sweden was one of the freest economies in the world. But between 1950 and 1976, Sweden experienced an expansion in government spending unprecedented during a period of peace, with government spending to GDP rising from about 20% in 1950 to more than 50% in 1975. Virtually every year, taxes were increased while the welfare state expanded, both in the form of a sharp increase in the number of government employees and ever more transfer payment benefits. (The share of public sector employees out of total employment grew from 20 percent in 1965 to 30 percent in 1975 and 38 percent in 1985 )

During the first 20 years, this relentless government expansion took place seemingly without ill effect, as Sweden benefited from rapid global growth — although Sweden's growth had already started to slip in relative terms, from well above average to just average. This changed in the 1970, with rapidly increasing anti-business regulations and sharply increased payroll taxes.

The payroll-tax increases, along with increasing wage demands from unions, made Swedish businesses highly uncompetitive on the global markets, something which was to be solved by devaluing the Swedish krona. As a result, price inflation rose sharply, leading to repeated devaluations.

After Palme was killed by an unknown assassin in February 1986, pragmatist Ingvar Carlsson became prime minister. Worried that Swedish growth had trailed most other countries, Carlsson's government implemented a number of free-market reforms. Among these were the lifting of all currency controls in 1989 and a tax reform that dramatically reduced marginal tax rates. Although these reforms have arguably contributed to improving the long-term economic performance of Sweden, they would contribute to precipitating the deep economic downturn in the early 1990s.

Meanwhile, as the economy started slowing significantly in 1990 after a series of tightening measures, consumer price inflation slowed. With the combination of continued high nominal interest rates, reduced capital gains taxation (and with that, reduced deductions for interest payments) and falling price inflation, real interest rates started rising significantly, helping to end the asset price bubbles. On top of all of this came the oil price shock following Saddam Hussein's invasion of Kuwait and an economic downturn in key trading partners such as the United States, the United Kingdom, and Finland. The end result was that Sweden slipped into a recession in late 1990.

In the collapse in November 1992, the dramatic increase in interest rates (up to astronomical 500% ) and the deep recession had at the same time created a large amount of bad loans, making almost all major banks in effect bankrupt. Only after the Swedish government pledged they would bail out the banks with whatever money they needed was a widespread banking collapse averted.

The recession became Sweden's deepest by far since the Great Depression, with GDP in 1993 being 5% lower than in 1990, with employment falling more than 10%, and the budget deficit rising to more than 10% of GDP. By then Sweden had fallen to between 15th and 20th place in international income comparisons, a decline from which it has never since recovered. After this deep downturn, a number of free market reforms and budget cuts were implemented and Sweden underwent a recovery.

The jobless rate was traditionally very low in Sweden, averaging about two percent. Over the following two decades, however, the official unemployment rate has more than tripled, and the official numbers almost certainly undercounted the true rate of unemployment. The McKinsey Global Institute estimated that the real unemployment rate was around 15 percent (as of 2004). Other estimates usually put total Swedish unemployment, including the so called hidden unemployment, at somewhere between 15 and 20 percent, about three times above the official unemployment figures.

Links

 * Swedish banking crisis on Wikipedia