Sweden’s Financial Bailout Plan: What the U.S. Can Learn From It

By G.L.C., on October 17th, 2008

In recent history, governments have nationalized banks when the pressures of internationalized financial markets and international competition have made it difficult for them to control and stabilize their finances and currency. During the last couple of decades, countries as different as Mexico, France, Sweden, and Japan carried out partial or more or less complete bank nationalizations to regain control of the financial situation.

In an attempt to overcome the present credit crisis, the U.S. government is using taxpayer’s money to bail out large corporations. The government has already swapped its sovereign guarantee for equity in Fannie Mae and Freddie Mac, the mortgage finance institutions, and American International Group, the insurance giant.

Sweden faced a similar crisis in the early 1990s – a banking system in crisis after the collapse of a housing bubble, an economy hemorrhaging jobs, and a market-oriented government struggling to stem the panic.

Sweden was able to overcome the crisis. How did they do it? Can the United States learn something from the Swedish crisis?

Financial deregulation in the 1980s fed a frenzy of real estate lending by Sweden’s banks, which did not worry enough about whether the value of their collateral might evaporate in tougher times. Property prices imploded. The bubble deflated fast in 1991 and 1992. In 1992, years of imprudent regulation and shortsighted macroeconomic policy left its banking system almost insolvent. The Swedish government not only rescued the banks and financial companies by taking over the bad debts, it successfully extracted equity from the stock holders before writing the rescue checks in an attempt to keep the banks and financial institutions on the hook while returning profits to taxpayers from the sale of distressed assets by granting warrants that turned the government into an owner. The government took a hands-on approach, pumping cash into the banks deemed to only have temporary problems and letting the ones believed to have no prospect of viability go under. Two banks were taken completely over by the state, which in turn offered a blanket guarantee for all creditors, but not for share holders.

Once the crisis was over, the Swedish government sold off nearly all of the nationalized bank investments, getting back most of the money that had been pumped in to rescue the banks.

The Swedish government took over insecure loans during the crisis worth around $9.9 billion of taxpayer money, but eventually got most of it back through dividends and later reselling the nationalized bank assets.

There were proposals in the United States that the government extract equity from the bank for the bailout they receive. But the proposals did not get any serious consideration.

By extracting equity from the banks and financial institutions for the bailout packages, the government could swing the public opinion in its favor. Using taxpayer’s money for bailing out large corporations without offering anything in return is not likely to find much public support. The bailout package appears to favor stock holders without much prospect of the tax payer’s money ever being reimbursed. If the banks survive, the stock holders’ holdings will still be there but the tax payers will have to foot the bill.



Leave a comment   Politics and Government   , , ,  

Credit Crunch Forcing Entrepreneurs to Turn to Online Communities for Funding

By Cheryl Grey, on October 17th, 2008

Traditional global credit markets have frozen, and they’re proving difficult to unstick. Under-capitalized banks are not keen to lend out what’s left on their balance sheets—not even and sometimes especially not to each other—and the value of the U.S. currency has risen steeply relative to those of other nations as banks around the world hoard greenbacks to shore up their reserves.

Few consumers are yet being hit hard enough to hurt except those who let the euphoria of easy credit tempt them too far. But the largest danger for the national economy lies in the companies large and small that provide employment, many of which depend upon short-term credit to fund their day-to-day operations.

Corporations that would normally issue commercial paper to finance their capital needs have been disappointed lately, as the market for such short-term debt fell by 11% over the past four weeks, according to the Federal Reserve. Granted this is a volatile data series; however, a fall of U.S. $22 billion in one month is still painful. Research conducted by Greenwich Associates reports that 45% of large corporations and 67% of medium-sized ones have located fewer buyers for their CP, while companies which have been able to sell their debt report that the cost of doing so has risen, in some instances significantly, to further increase the already steepening cost of doing business. Whether the Fed’s plan to bulwark the CP market will bear success remains to be seen.

The Fed’s most recent survey of senior lending officers reported that 65% of domestic banks have raised their lending standards for business loans in all categories, while a recent survey by the National Small Business Association claims that 67% of U.S. small businesses have been affected by the credit crunch, up from 55% in April.

So if the banks aren’t lending, what’s an established small business with the opportunity and desire to expand supposed to do? For that matter, what about the entrepreneur with a great idea? That other “business loan” traditionally employed, the owner’s credit cards, is looking increasingly problematical even if the owner can convince the loan officer to raise the credit limit.

Enter Alternative Financing

Americans are amazingly adept at finding new ways of financing their businesses. Two of the newer methods available are business cash advances and peer-to-peer lending via the Internet.

Unsecured business cash advances drawn on future credit card sales are becoming increasingly popular among small businesses. The funds are generally available within days rather than the weeks required for banks to sort through their paperwork, and because the funds are based on “plastic” sales to be made in the future, not on credit utilized in the past, no credit check is required. Think of them as payday loans for businesses.

Peer-to-peer lending can include loans from friends and relatives but it’s growing fast on the Internet. Of course, angels and venture capitalists have been around for a long time, but for much of that time they’ve limited the amount of exposure they’ve offered to the general business-owning public for fear of an avalanche of funding requests. However, the advent of the Internet has created social networking for entrepreneurs and investors, in the form of bulletin-board websites where those seeking capital can post their business plans and qualifications, and those with capital can locate ideas and teams that interest them.

With the credit crunch freezing traditional funding avenues, one such bulletin board, RaiseCapital.com, reported a “dramatic increase over the last few months” in the number of users on their site. “Both the registered users looking for capital and investors looking for opportunities have increased,” wrote Alyssa Miller, vice president of 5W Public Relations, in an email exchange discussing RaiseCapital.com.

Another online lending service, Angelsoft.com, displayed live statistics indicating 24,478 requests for funding currently submitted, up from 16,030 through the second quarter of 2008, a surge of 52.7%. However, the number of investors only rose from 9,416 to 12,336 in the same time period, a growth rate of 31%.

RaiseCapital.com is a free service, while Angelsoft.com charges a fee to both investors and entrepreneurs to weed out tire-kickers. Even with such entry hurdles to overcome, only 1.32% of all ideas submitted to Angelsoft.com receive funding, but whether that’s an indication of tightness in the market or lack of preparation among the entrepreneurs was not immediately obvious.



Leave a comment   Citizen Economists   , ,  

Did the Community Reinvestment Act Lead to the Present Financial Crisis?

By Evelyn Black, on October 17th, 2008

With the U.S. credit crunch gone global and the $700 billion bailout package now looking like a small drop of water in a tidal wave of woe, the question of blame is now all over the media.

Who caused this mess?

If you read the Wall Street Journal you could easily come away thinking that the whole problem started when Jimmy Carter decided to sell houses to minorities.

Jimmy Carter did sign legislation that required retail banks to make an effort to make loans to minority groups. The Community Reinvestment Act or CRA was passed in 1977 under Carter’s watch and was a bipartisan attempt to address the real and serious issue of housing discrimination based on racial or ethnic heritage.

The policies initiated under Carter in the CRA were supported by both Bill Clinton and George W. Bush, as pointed out in a recent Floyd Norris column in the New York Times entitled “Who’s to Blame?”

Norris quotes a speech given by Bush not long before the housing bubble burst, in which the president underscores the government’s policy of aggressively lending to minority groups and other Americans who could not formerly afford home ownership. This policy even had a name under the Bush Administration: “The Ownership Society,” the idea being that a person who owns something has more of a stake in supporting the free enterprise system than a person who feels left out of the loop.

The Republican embrace of Bush’s “Ownership Society,” itself an outgrowth of the Carter and Clinton years and the CRA, was taken to extremes never imagined by the authors of the original legislation. In an excellent Newsweek feature entitled “Subprime Suspects” reporter Daniel Gross explains that the CRA only applied to retail deposit banks and said nothing about forcing these institutions to provide subprime lending; it only stated that lending had to be fair and had to include reasonable attempts to lend to all groups regardless of race or ehtnicity.

Gross points out that the while some major retail banks did make subprime loans to minorities in an attempt to satisfy the requirements of the CRA, the problem didn’t become truly cancerous until unregulated financial firms like Argent and American Home Mortgage began to sell “creative financing” to subprime borrowers, many of whom were actually professional people with shaky credit, real estate speculators, and middle class buyers in “bubble” states like California and Florida who were looking to purchase homes priced well beyond their means, egged on by real estate agents who were on a roll.

Gross goes on to say that

…lending money to poor people and minorities isn’t inherently risky. There’s plenty of evidence that in fact it’s not that risky at all. That’s what we’ve learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. And as the New York Times recently reported, Nehemiah Homes, a long-running initiative to build homes and sell them to the working poor in subprime areas of New York’s outer boroughs, has a repayment rate that lenders in Greenwich, Conn., would envy. In 27 years, there have been fewer than 10 defaults on the project’s 3,900 homes. That’s a rate of 0.25 percent.

On the other hand, Gross remarks,

…lending money recklessly to obscenely rich white guys, such as Richard Fuld of Lehman Brothers, or Jimmy Cayne of Bear Stearns, can be really risky. In fact, it’s even more risky, since they have a lot more borrowing capacity. And, here, again, it’s difficult to imagine how Jimmy Carter could be responsible for the supremely poor decision-making seen in the financial system. I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33:1, that instructed Bear Stearns hedge-fund managers to blow up hundreds of millions of their clients money, and that required its septuagenarian CEO to play bridge while his company ran into trouble.

Poor regulation and oversight and the repeal of interstate banking laws that enabled fly-by-night mortgage brokers and retail banks to sell bad loans immediately to investment banks who then chopped these loans up into creatively-conceived investment vehicles which were then sold and resold and resold again with leveraged money – none of these issues have anything to do with poor people buying houses.

It appears that there is plenty of blame to go around, but the blame ultimately rests not with the understandable and noble desire for home ownership, but rather with the very human tendency towards greed during boom times. The refusal of the government to enforce existing regulations or to maintain proper oversight fed this greed. Many financial firms in turn completely ditched any voluntary adherence to fiduciary responsibility, overthrowing such archaic notions easily and quickly when faced with the promise of enormous profits. Stockholders were loathe to stop this runaway train while their returns were still spiking, and soon they came to expect these consistently ridiculously-high returns no matter what the market conditions.

What was so terrible about the boring old days when lending institutions had to stand by the mortgages they wrote? Wells Fargo, one of the few big subprime lenders that actually kept and serviced its own mortgages, is still in fairly decent shape. Underwriting a mortgage you have to keep on your books is bound to be a more serious process than underwriting one you intend to sell to a glorified gambler minutes after closing the loan. This makes such simple sense it is hard to believe today that it was overlooked.

But that’s what happens when people catch boom fever. Reason goes right out the window.

Right now, one out of six American homeowners is upside down on their mortgage, with no end in sight to the downward spiral. Blame Jimmy Carter if you must. But don’t expect any of those homeowners, many of whom probably live right on your block, to take you seriously.



13 comments   U.S. Economics   , , , , , ,