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Bill Gross: What the Fed really wants to do is to create inflation

China to subsize car purchase in rural area

This will help domestic consumption, will also help GM. Let’s see how many trucks/pickups Chinese farmers can buy…

Lessons from Swedish model

Swedish model and its lessons offered to the current global financial crisis. A must read.

by Lars Jonung

Sweden’s fix of its banks in the early 1990s is considered a model for today’s policymakers. This column reviews the main features of the Swedish approach and discusses its applicability to today’s banking problems. Policy must be carried out swiftly and openly, aiming at saving banks, not their owners or managers.

The Swedish banking crisis was part of a major financial crisis that hit the Swedish economy in 1991-93. Its origin should be traced to financial liberalisation in the mid-1980s that triggered a rapid lending boom. The pegged exchange rate for the krona prevented monetary policy from mitigating the boom by means of interest rate increases. The boom turned into bust and crisis around 1990, threatening a meltdown of the banking sector. The response of policymakers developed into the Swedish model for bank resolution. It comprises the following seven key features.

The Swedish model for bank resolution

Political unity

A central feature was the political unity across party lines which underlay the bank resolution policy from the very start. The Centre-Right government and the political opposition – the Social Democrats – joined forces and avoided making the banking crisis into a partisan political issue. This unity, initially forged by the determination of the major political parties to defend the pegged exchange rate of the krona, lasted throughout the crisis. Political unity guaranteed the passage through the Swedish parliament, the Riksdag, of measures to support the financial system. It also created policy trust amongst voters.

Blanket guarantee of bank deposits and liabilities

The Swedish government, in cooperation with the opposition, announced in a press release on 24 September 1992 – a critical month when currency pegs in several European countries were successfully attacked – that depositors and other counterparties of Swedish commercial banks were to be fully protected from any future losses on their claims. The guarantee was successful in the sense that foreign confidence in the solvency of the Swedish commercial banks remained intact.

In addition, this measure proved highly beneficial, as it expanded the options for the Riksbank to support commercial banks regardless of their financial position. The government guarantee of bank liabilities gave the Riksbank the option to lend to any commercial bank operating in Sweden, even to those that were on the brink of insolvency.

Swift policy action

Once it was fully understood that a serious financial crisis was in the making, the government, the Riksdag, and the Riksbank responded by taking decisive steps to support the financial system, in particular to help banks in distress. In this way, the confidence of depositors and counterparties in the financial system was strengthened at an early stage of the financial crisis by swift and determined action. Throughout the resolution of the crisis, confidence could then be maintained at a relatively low political cost.

An adequate legal framework based on open-ended funding

In December 1992, the Riksdag, passed legislation by an overwhelming majority to establish a Bank Support Authority, Bankstödsnämnd, as envisaged in the press release of 24 September 1992. The parliament approved open-ended funding for the Bankstödsnämnd, rather than settling for a predetermined fixed budget. This was a deliberate choice in order to avoid the risk that the Bankstödsnämnd would be forced to go back to the Riksdag to ask for additional funding at a later stage. The open-ended funding underpinned the credibility of the bank resolution policy.

The Bankstödsnämnd was set up as an independent agency at arm’s length distance from the government, the Riksbank, and the Finansinspektion (the financial supervisory authority) to underline its independence. This construction fostered credibility and trust in its operations. The opposition was given full insight into its activities. The agency was staffed by professionals, and it began operation in the spring of 1993, shortly after being established.

Full information disclosure

Banks that turned to the Bankstödsnämnd with requests for support were obliged to give disclosure of all their financial positions, opening their books completely to scrutiny. This requirement facilitated the resolution policy and made it acceptable in the eyes of the public.

Differentiated resolution policy to maintain the banking system and prevent moral hazard

Banks that turned to the Bankstödsnämnd were dealt with in a way that minimised moral hazard. The policy priority was to save the banks, not the owners of banks or the bank managers. Banks in trouble were first asked to obtain capital from their shareholders. If they were not able to do so, present owners would have to surrender control and ownership before public support was given. Faced with this threat, private banks in Sweden made great efforts to raise capital from their owners. One bank, the SEB, decided to withdraw its request for government support. Banks that were in temporary difficulties could ask for government guarantees.

Out of six major banks, two were not expected to be profitable in the long run. They were taken over by the government with the aim of being re-privatised. Their assets were split into a good bank and a bad bank, the “toxic” assets of the latter being dealt with by asset-management companies set up by the Bankstödsnämnd, which focused solely on the task of disposing of them. When transferring assets from the banks to the asset-management companies, the government applied cautious market values, thus putting a floor under the valuation of such assets, mostly real estate. This restored demand and liquidity, and thus put a break on falling asset prices. The “good” assets of the two failed banks were transferred to a new bank that eventually emerged as Nordea, now one of the major Nordic banks.

The role of macroeconomic policies in ending the crisis

The bank resolution was facilitated by monetary and fiscal policy. The fall of the pegged exchange rate of the krona on November 19, 1992, following heavy speculative attacks, was an important move towards recovery. Once the krona was floating, it depreciated sharply, encouraging a rapid growth in exports. The ensuing fall in interest rates eased the pressure on the banking system. In July 1996, the crisis legislation and the blanket guarantee were abolished. The government allowed huge budget deficits to build up during the crisis, mainly as a result of the workings of automatic stabilisers, peaking at around 12% of GDP in 1993.

A successful bank resolution

The Swedish bank resolution was successful. Sweden’s banking system remained intact. It continued to function with no bank runs and hardly any signs of a credit crunch. It remained largely privately owned and became profitable shortly after the crisis.

In the long run, the net fiscal cost – the ‘cost to the taxpayer’ – turned out to be very low, close to zero. Figure 1, displaying the net fiscal costs for 39 systemic banking crises in 1970-2007, demonstrates Sweden’s favourable ranking with a net fiscal cost of almost zero. The gross fiscal cost for the bank support policy amounted to around 4% of GDP initially.

Figure 1. Net fiscal costs from systemic banking crises, 1970-2007, per cent of GDP.

Source: Jonung (2009). click to enlarge.

Can the Swedish model be exported?

Answering this question requires comparing the Swedish crisis of the early 1990s with the present global crisis. On a very general level, the similarities are striking. The two crises are both financial crises driven by identical forces – a boom fuelled by lax monetary policy and negligent financial oversight, later turning into a bust.

On the other hand, there are considerable differences. 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. Being a small open economy, Sweden was able to abandon its pegged rate and obtain a significant and lasting depreciation of its currency that contributed to strong recovery. This option is hardly open to an individual country today because the present crisis is global.

The small size of the Swedish financial system in the 1990s facilitated the bank resolution policy. Policy-makers dealt with a limited number of banks – only six major banks – in an overall environment of trust in the banking system. This is in sharp contrast to the current situation in the US, for example, with thousands of banks of different types and many non-bank financial actors, and where public trust in the financial system and its actors (“Wall Street”) is extremely low.

The Swedish bank resolution policy was faced with a financial system that was much less sophisticated and much less globalised than the financial systems of today. There were no structured products, no sophisticated derivatives, hardly any hedge funds, less securitisation, and so on. Indeed, the ongoing crisis has been difficult for the authorities to manage, in part, because some traditional central banking tools – especially in the UK 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.

In addition, Sweden has a tradition of substantial public confidence in its domestic institutions, political system, and elected representatives. Such social capital made it easy for the government and opposition to reach swift and stable agreements on policy actions.

Lessons for today

In spite of the differences between Sweden in the early 1990s and the world today, the Swedish experience holds lessons. A policy to support the financial system benefits from political unity and from being carried out swiftly and openly. The aim should be to save banks in distress, not their owners or managers. This minimizes moral hazard. The resolution policy should be implemented within a consistent and all-encompassing strategy, having a legal framework in which the administration of the support is left to experts acting at arm’s length from the government, the central bank, and the financial supervisory authority. The support benefits from being financially open-ended to ensure the solvency of the financial system. The support should also be designed in a way that the public perceives as fair and just.

The Swedish case illustrates that the task of government during a financial crisis, or – in popular terms – the task of the taxpayer, is to serve as the capitalist or investor of last resort by recapitalising the financial system, thus dampening the effects of the financial breakdown on the real economy.

The Swedish formula cannot be fully imported by other countries due to institutional differences. Still, its guiding principles are applicable outside Sweden today, most prominently in four areas. First, the Swedish experience demonstrates that the threat of public receivership or nationalisation should be a real one as it forces the private sector to find private solutions. Second, the Swedish record suggests that banks in distress, nationalised as well as in private hands, should be split into a good and a bad bank, in order to get the financial system swiftly working again – more precisely, bad assets should be taken off the balance sheets of banks to prevent them from becoming “zombie” banks. Third, the bank resolution policy credibility is significantly enhanced by an open-ended financial commitment by the government. Fourth and finally, policy action should be swift and decisive to arrest the negative feedback loops arising during a financial crisis.

To sum up, the Swedish model of bank resolution should be used as a general template for countries facing financial crisis, but these countries will need to adapt the details of the implementation to their own circumstances.


Jonung, L., (2009) “The Swedish model for resolving the banking crisis of 1991-93. Seven reasons why it was successful.” European Economy, Economic papers 360, European Commission, February 2009, Brussels.

Migration in the US: Why people move less

The economic theory goes: if people buy house rather than rent, they tend to move less; during the current housing crisis, a lot of people bought the house at the peak, in may cases, their mortgages are also under water, which provides even less incentives for people to move.

But America needs a more dynamic mobile workforce in the competitive global economy — These are all unintended consequences of a historical housing bubble.

source: WSJ

Migration around the U.S. slowed to a crawl last year, especially for this decade’s boom towns, as a weak housing market and job insecurity forced many Americans to stay put.

Demographers say the dropoff in migration, shown in Census data to be released Thursday, is among the sharpest since the Great Depression. It marks the end of what Brookings Institution demographer William Frey calls a “migration bubble.”

As asset values rose fairly steadily in the past decade, Americans young and old moved around the country in search of jobs or better weather. In many cases, people living in higher-cost housing markets such as San Francisco and New York cashed in their real-estate winnings and moved to outlying counties, or to states like Florida and Nevada, hoping to find a cheaper house and pocket the difference. Now, “people are hanging tight; they’re too scared to do anything,” said Mr. Frey.

The data, covering the one-year period until July 1, 2008, show this effect across U.S. counties and metropolitan areas — another sign of how this recession has spared few industries or regions.

Migration typically slows during recessions. But in past downturns, the slowdown has been more regional in scope, with workers fleeing weaker job markets for places where companies were still hiring. In the deep 1980s recession, for instance, laid-off auto workers fled the industrial Midwest for energy-rich states in the South with more plentiful jobs.

What’s unique this time is migration has slowed almost everywhere. The sharpest year-to-year changes were among what demographers call “domestic migrants,” people who moved within the U.S. That doesn’t count population changes that result from births, deaths or immigration.

Older metro areas such as New York and San Francisco, which have seen residents move to faster-growing areas, are now losing fewer people. Cities in the formerly hot housing markets such as Nevada and Florida are seeing fewer arrivals and, in some cases, more people moving out than in.

At the local level, more people are staying in the city and postponing their move to the suburbs. In 2005-06, metropolitan areas with one million or more people saw a net 688,000 people leave their core counties. In 2007-08, a net 336,000 left, according to an analysis of Census data by Kenneth Johnson, senior demographer at the University of New Hampshire’s Carsey Institute.

“Fewer people are leaving the urban cores to go to the suburbs,” said Mr. Johnson.

International migration slowed moderately, according to the Census data. In 2005-06, the country absorbed a net of about one million immigrants. In 2007-08, that fell to a net gain of 890,000. The slowdown in international migration was sharpest in outer suburban areas, where the housing market has in general been worse than in core cities or closer-in suburbs.

The slumping economy, as well as depressed prices of just about every kind of asset, is behind many of these decisions to stay put. Jeff Fallon, a managing partner at a private-equity firm in Cleveland, made two trips to Florida last year looking to buy a home in the Sarasota area. But with the stock market down and real-estate prices still falling, Mr. Fallon decided to hold off for a bit.

“I was looking at a substantial amount of our personal wealth disappear as the stock market spiraled down,” he said. “It certainly had a lot of bearing on whether or not I was willing to invest in a second home.”

[Las Vegas strip]

If the migration slump continues, it could slow down economic recovery in depressed housing markets such as Las Vegas.

Decisions like his help explain why a net 15,000 people left the Cleveland area for somewhere else in the U.S. in 2007-2008, compared with a net of 21,000 between 2005 and 2006. Sarasota, meanwhile, saw a net increase of 2,500 residents from inside the U.S., compared with as many as 20,000 during the boom years.

The Census data show that the biggest falloffs were in the worst housing markets. In 2007-2008, the Phoenix area gained a net 51,000 domestic migrants, about half as many as two years ago.

Las Vegas increased by a net 14,000 domestic migrants, two-thirds fewer than two years ago. California’s Riverside-San Bernardino metro area, a once-booming market that has been hammered by foreclosures and job losses, lost domestic migrants for the first time since 1995-1996.

The migration slowdown, if it persists, could further delay the economic recovery in depressed housing markets such as Phoenix and Las Vegas. These places generally have a larger amount of unsold homes, and a disproportionate share of the economy is dependent on construction and other real estate-related trades.

Economists say the housing-centric economies will need to reduce their stock of unsold homes before any meaningful economic recovery takes place. That’s hard to do when fewer people are moving there.

Hedge Fund Performance

(source: Bloomberg)

report from FT:

Hedge fund liquidations hit a record high last year as poor performance and funding pressure, amid dire market conditions, forced almost 1500 funds, or 15 per cent of the industry, out of business.

Most of the damage was done in the second half of the year, according to latest figures from Hedge Fund Research, the data provider.

Investors withdrew a record $150bn from hedge funds in the fourth quarter alone and, 778 funds liquidated during that period, more than doubling the previous quarterly record of 344, set in the third quarter last year.

The total number of liquidations last year was 1,471, an increase of more than 70 per cent from the previous full year record set in 2005.

The fourth quarter also saw a sharp drop in the number of new funds launched, with just 56 launches versus 117 in the third quarter. In spite of the market conditions, more than 650 funds began operations over the course of the year.

On a net basis, the total number of hedge funds declined by about 8 per cent to 9,284.

The funds of hedge funds industry also suffered, with more than 275 funds of hedge funds liquidated last year, another record.

A separate survey by Absolute Return magazine, an industry publication, found that more than 200 hedge funds or fund families in the Americas shuttered or began to liquidate in 2008. At the height of their success, these funds managed combined assets of $84bn.

Three of the top 10 funds that closed last year were Madoff feeder funds, including Fairfield Greenwich Group’s Fairfield Sentry Fund, the biggest casualty of 2008 with an estimated $6.9bn in losses.

Gabriel Capital Group and Ascot Partners, two funds controlled by hedge fund manager Ezra Merkin, represented an estimated $3.3bn in assets connected to Madoff. Tremont Group’s Rye family of funds, which included more than 10 vehicles, may have lost more than $3.1bn, according to Absolute Return. Other vehicles that got caught up in the Madoff scheme include Kingate Management’s Kingate Global fund, with a reported $2.7bn affected, and Maxam Capital’s Absolute Return fund, which has $280m with Madoff.

The research also notes that the number of closed or liquidating funds would likely have been far higher had so many hedge funds had not suspended redemptions or placed loss-making or illiquid positions in side pockets or special vehicles.