B. Espen Eckbo

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Research Papers in Economics

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BANKING SYSTEM BAILOUT –
SCANDINAVIAN STYLE
B. ESPEN ECKBO*
Introdution
Between 1985 and 2000, close to one hundred coun-
tries experienced severe banking failures.By some es-
timates, at least twenty of these produced tax payer
bailout costs in excess of ten percent of their country’s
gross national product (GNP). Neither a high degree
of economic development nor the implementation of
internationally accepted standards for banking super-
vision have immunized a country from banking sys-
temic fragility. In fact, as observed by Allen and Gale
(1999) as well, events precipitating banking crises are
remarkably similar across countries with substantially
different corporate governance regimes.
The similarities in crisis events notwithstanding,coun-
tries differ substantially in their handling of a crisis.If
you are going to use taxpayer money to prop up the
banking system,what is the best way to do it? Bailout
mechanisms include things like deposit insurance, di-
rect loan guarantees, infusion of new bank capital in
the form of debt or equity instruments,and liquidation
and sale of bank assets and non-performing loans.
There are pros and cons of each of these options,and
they have been used to a varying degree to resolve sys-
temic banking crises across the world.Below,I reflect
on some lessons learned from the crisis resolution ob-
served in Sweden and Norway during the Scandi-
navian banking crisis of the early 1990s.1
Scandinavian crisis development
The Scandinavian financial crisis of the early 1990s
followed a period of financial liberalization policies
in the 1980s.These policies included liberalization of
bank lending volume, removal of interest rate caps,
modernization of bank capital requirements,and the
innovation of new and relatively high-risk financial
products.The liberalization caused a rapid expansion
in the volume of bank loans made available for spec-
ulative investment. Banks, which are in the business
of converting liquid short-term demand deposits to
relatively illiquid long-term investments, became
much more sensitive to creditor default rates. In this
more fragile state,negative economy-wide shocks ex-
posed the illiquidity of the banks’ loan portfolios and
threatened the solvency of the banking system.
After a significant drop in the world oil price in
1985, Norway (a significant oil exporting country)
experienced a shift in its current account from a sur-
plus to a deficit, which in turn triggered a devalua-
tion of the Norwegian krone in 1986 (Norway was
pursuing a fixed exchange rate policy at the time).
Recession began in 1988, which started a financial
crisis among the country’s savings banks, followed
by collapse of major commercial banks and the re-
al estate market in 1990–92. Sweden also experi-
enced a recession,and the country’s largest savings
bank collapsed in 1991, followed by a collapse of
two of the largest commercial banks. Property
prices had dropped and the country experienced a
currency crisis in the fall of 1992. The crisis ended
in 1993 in both countries.
According to calculations by the International Mo-
netary Fund,the cumulative fall in real GDP over the
crisis period was greater for Sweden than for its
neighbor (5.3 percent versus 0.1 percent in Norway).
Loan losses in the peak crisis year was 2.8 percent of
GDP in Norway and 3.8 percent in Sweden, while
non-performing loans added up to 9 percent and 11%
of GDP in each of the two countries, respectively. In
Norway, it took two years for the banking sector to
return to profitability, and four years before bank
lending was back to its pre-crisis level.In Sweden,re-
turn to profitability also took two years,while it took
* Tuck Centennial Professor of Finance and Founding Director of
the Lindenauer Center for Corporate Governance at the Tuck
School of Business at Dartmouth College, USA.
Email:B.Espen.Eckbo@tuck.dartmouth.edu.Some of the ideas pre-
sented here also appear in Eckbo (2009).
1 For a detailed empirical survey of the events and consequences of
the banking crises in the early 1990s across Norway, Sweden and
Finland, see Moe, Solheim and Vale (2004).as much as ten years before bank lending reached its
pre-crisis level.
Norway: the Government Bank Investment Fund
In Norway, the banking industry privately funds two
guarantee companies,the Savings Banks’ Guarantee
Fund and the Commercial Banks’ Guarantee Fund.
These were drawn down during the initial phase of
the crisis (by 1991). In addition, several of the banks
were merged and others were bankrupt and placed
under temporary public administration.
The government initially started to fund the failed
banks through its new Government Bank Insurance
Fund in January of 1991.This insurance fund was an
independent legal entity,with a mandate to provide
liquidity to the two private guarantee funds. The
fund was allowed to impose conditions both on the
private funds and the banks receiving bailout mon-
ey. These conditions included, among other things,
management issues such as hiring and firing of key
personnel,board composition and major investment
decisions.
The Norwegian government also implemented a di-
vision of labor between the Government Bank
Insurance Fund and the Norwegian Central Bank.
The former would channel support to banks that were
largely insolvent, while the latter would provide liq-
uidity in the form of loans to largely solvent banks.In
the fall of 1991, the crisis reached systemic propor-
tions with large losses reported by the three largest
commercial banks.These three banks held about one
half of the total assets in the banking sector.
At this point, the Norwegian parliament created a
second financing vehicle: the Government Bank
Investment Fund (GBIF).While the insurance fund
continued to pour liquidity into insolvent banks,
GBIF began to purchase securities floated by (still)
relatively healthy banks.This included purchases of
“preferred capital”, an equity-like contract which
was convertible into common stock. In preparation
for GBIF’s purchase of this convertible preferred se-
curity, the Norwegian parliament amended the ex-
isting banking law,allowing the government to write
down a bank’s common stock to zero against its loss-
es. The purpose of the amendment was to prevent
equity holders from holding up (forcing bargaining
with) the government as it proceeded to bail out the
banking system.
Subsequent common stock write-downs resulted in
the GBIF becoming the sole owner of two of the
three largest commercial banks and the dominant
owner of the largest (Den Norske Bank or DnB).By
the end of the 1990s, the government had sold most
of its banking shares to private investors,with the ex-
ception of a “negative majority” (34 percent) held in
DnB.The negative majority allows the government to
block a takeover – perhaps a benefit for some local
interests but surely at the cost of reducing interna-
tional competition for Norwegian banking assets.
The Norwegian economy started to recover in 1993
and the banking crisis was essentially over.Research
at the Norwegian Central Bank indicates that, based
largely on direct cash flows,the overall benefit of the
government’s intervention probably exceeded the di-
rect cost (which include direct payments and interest
rate subsidies) – even without accounting for the val-
ue of various loan guarantees that never had to be
called. Moreover, the estimate excludes any positive
externality from having saved the banking system and
any negative incentive effects (in terms of excessive
bank risk taking) given the proven existence of a
lender of last resort.
Sweden: the “good bank/bad bank” model
The crisis in Sweden began with heavy losses report-
ed by the country’s largest savings bank in 1991.Later
that year, the third-largest commercial bank
(Nordbanken) also began reporting large losses. At
the time, the Swedish government owned 71 percent
of the bank’s common stock. The government pro-
ceeded to purchase a new share issue and to buy out
the private shareholders at the equity issue price.This
was in contrast to Norway, where the private equity
was forcibly written down to zero before the govern-
ment proceeded to fund the bank.
In full control of Nordbanken, the government now
split the bank’s assets into two parts:The “good” as-
sets were continued within the bank,while the “bad”
non-performing loans were spun off into a separate
legal entity called Securum,created in 1992.Securum
followed earlier “bad” bank structures in the US in
the 1980s,and was managed much like the Resolution
Trust Company created by the US government in the
late 1980s to liquidate assets held by troubled savings
and loan associations.A bad bank solution was also
created for the fourth largest commercial bank,Gota
Bank, when it failed in early 1992.This time the bad
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assets were transferred to the asset management
company Retriva.The remaining good assets of Gota
Bank were auctioned off, ultimately purchased by
Norbanken in 1993 with no payment to Gota Bank’s
shareholders.
Securum acquired troubled assets from Nordbanken
with a book value of SEK 67 billion.2 Most of these
assets (SEK 60 billion) were in the form of loans to
various financially distressed companies,with the re-
mainder consisting largely of real estate holdings.
Securum paid Nordbanken SEK 50 billion for these
assets,financed through a combination of a loan from
Nordbanken and government equity infusion.
Securum’s mission was to liquidate in an orderly fash-
ion the troubled assets so as to maximize recovery.
The management company was dissolved in 1997 af-
ter liquidating its assets.
It appears that Securum drove a hard but successful
bargain with many of its troubled borrowers. Part of
the loan mass was held by small companies,and it was
not uncommon for the company founder/entrepre-
neur to pledge his own common stockholding in the
company as collateral for the company’s loan.Failing
to service the debt,however,Securum had the right to
seize the pledged collateral,thus effectively acquiring
control of the distressed company without the need
for a formal bankruptcy procedure. In Sweden, the
bankruptcy code mandates a quick auction sale of the
bankrupt firm (piecemeal or as a going concern).3 By
avoiding bankruptcy, Securum also avoided the auc-
tion time pressure, and instead proceeded to develop
the troubled company in preparation for its sale as a
going concern down the line.To support this strategy,
Securum’s management team was deliberately chosen
to have industrial management experience,which un-
doubtedly contributed to its success.
Unlike Norway, Sweden also issued (in the fall of
1992) a blanket guarantee for all bank loans in the
Swedish banking system, effective until July of 1996.
Naturally, this blanket guarantee greatly benefitted
existing bank shareholders. Moreover, the Swedish
Central Bank provided liquidity by depositing large
foreign currency reserves in troubled banks, and by
allowing banks to borrow freely the Swedish curren-
cy (at no risk to the Central Bank given the govern-
ment blanket loan guarantee). Perhaps because of
these additional moves, the Swedish government’s
cash infusion to end the banking crisis was almost en-
tirely limited to Nordbanken and Gota Bank.
In summary, both Sweden and Norway created bank
restructuring agencies to oversee the government’s
cash infusion in troubled banks. Existing sharehold-
ers were largely forced out of the failed banks. Both
countries also established strict guidelines for com-
panies receiving government support, including bal-
ance sheet restructuring targets, risk management
and cost cuts.Moreover,both countries engineered a
public takeover of the largest troubled commercial
banks and promoted private bank mergers.However,
only Sweden implemented a “good bank/bad bank”
model, and perhaps most important, only Sweden is-
sued a blanket creditor guarantee which greatly ben-
efitted existing bank shareholders.The end result was
similar in the two countries: a relatively speedy re-
covery and return to robust economic growth. The
macroeconomic impacts of these banking crises were
relatively short-lived.
Relevance for the US bailout strategy
Given that financial crises tend to a have common
origin, why do we see such a bewildering set of dif-
ferent bailout mechanisms across time and across
countries? Shouldn’t there be an optimal response
derived from the objective of maximizing tax-payer
return from bailing out private firms?
When comparing Scandinavia with the US, what
stands out is the role played by government owner-
ship of the failed banks in Scandinavia.This role was
(and still is) politically acceptable as the government
in these two countries have a long history of partner-
ing with the private business sector.Moreover,nepo-
tism and corruption is a minimal problem in these
highly successful societies.
In contrast,in the US debate,government acquisition
of controlling equity ownership positions in failed
banks remains highly controversial. This issue ap-
pears to touch a raw nerve with many confessed lib-
ertarians and free-market economists.The concept of
“socialism” is rearing its ugly head – exposing a
deeply rooted skepticism towards government own-
ership of private enterprise.Nevertheless,even those
opposed to outright government control of banks ap-
pear to demand tax-payer bailout money. If the ob-
jective is to maximize taxpayer return from the
2 See also Bergstrom, Englund and Thorell (2002) and Jonung
(2009).
3 See Eckbo and Thorburn (2008) for an economic description and
empirical analysis of the Swedish bankruptcy system.bailout, the approach ought to be pragmatic: as the
Scandinavian experience suggests, a controlling gov-
ernment equity stakes in the bailed out companies
may be optimal in the short run and should be care-
fully considered.It’s a zero-sum game:if the tax-pay-
er doesn’t insist on the best possible deal, another
party to the bailout will reap the benefits at the tax-
payer’s expense.
A clear case in point is the eight dollar per share
windfall to shareholders of Bear Sterns, when the
government debt guarantee of that firm caused
JPMorgan to raise its takeover bid from two to ten
dollars.This type of shareholder windfall,which we al-
so saw in Sweden as the stock market responded to
the government’s blanket debt guarantee,would have
been avoided had the government taken an equity
stake in the bailed-out bank.
As of February this year, the central element of the
US government’s financial stability plan has been its
$100 billion public-private investment program
(PPIP). Under the PPIP, the US Treasury partners
with private investors such as mutual funds, private-
equity firms and pension funds on an equal-dollar ba-
sis when these investors purchase toxic bank assets.
Moreover,the equity is levered up with non-recourse
government debt guaranteed or provided by the
Federal Deposit Insurance Corp.,Treasury or Federal
Reserve (depending on the program). As an impor-
tant incentive mechanism, the government absorbs
more than its share of any future losses realized on
the asset while receiving only its proportionate (one-
half) share of any gains.
It was initially thought that the PPIP would succeed
in removing more than two trillion dollars of the
banking system’s toxic assets that have yet to be ful-
ly written down on banks’ balance sheets.This has not
happened and the PPIP was recently curtailed dras-
tically.Part of the reason the PPIP has not worked as
expected is the improved financial climate, which al-
lows banks to raise capital through other means. A
second reason is that banks have been reluctant to
put toxic assets up for sale because, under current
“marking to market” accounting rules, revealing the
market value of one asset may trigger a downwards
reassessment of the bank’s entire loan portfolio –
lowering capital adequacy ratios.
A third reason why the PPIP has stalled is concern
among private investors of possible political ramifica-
tions of partnering with the government. The fear in-
cludes things like curbs on executive compensation and
forced investment decisions favoring political rather
than purely economic objectives. There is a message
here to the US government as well as their private part-
ners: management of taxpayer-funded bailouts de-
mands adherence to sound economic principles with a
minimal of political interference.In other words – bank
bailouts should be run Scandinavian style.
References
Allen, F. and D. Gale (1999),“Bubbles, Crises, and Policy”, Oxford
Review of Economic Policy 15 (2), 9–18.
Bergstrom,C.,P.Englund and P.Thorell (2002),“Securum och Vagen
ut ur Bankkrisen”[Securum and the Road out of the Banking Crisis],
SNS, Stockholm.
Eckbo, B. E. (2009), “Ghosts of Crises Past”, Financial Times
Mastering Management Series, (January 23), 6–8.
Eckbo, B. E. and K. S. Thorburn (2008), “Automatic Bankruptcy
Auctions and Fire-Sales”, Journal of Financial Economics 89,
404–22.
Jonung, L. (2009), “The Swedish Model for Resolving the Banking
Crisis of 1991–1993: Seven Reasons why it was Successful”, Euro-
pean Economy – Economic Papers 360, European Commission.
Moe,T.G.,J.A.Solheim and B.Vale (2004),The Norwegian Banking
Crisis, Norges Banks Skriftserie/Occasional Papers No. 33, Oslo.
CESifo DICE Report 3/2009 12
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Automatic Bankruptcy Auctions and Fire-Sales”,

B.Vale (2004),The Norwegian Banking Crisis, Norges Banks Skriftserie/Occasional Papers No.

Crises, and Policy”,

Ghosts of Crises Past”, Financial Times Mastering Management Series,

P.Thorell (2002),“Securum och Vagen ut ur Bankkrisen”[Securum and the Road out of the Banking Crisis],

The Swedish Model for Resolving the Banking Crisis of 1991–1993: Seven Reasons why it was Successful”, European Economy – Economic Papers 360, European Commission.

Banking System Bailout- Scandinavian Style

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Banking System Bailout- Scandinavian Style

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