Ebook Resolving the financial crisis: Are the lessons from the Nordics being heeded?
History indicates that how financial crises are managed and resolved can deeply influence subsequent economic performance. The response can affect the length of the slump, the speed and strength of the subsequent recovery, and in all probability also subsequent long-term growth. The way the Nordic countries dealt with their banking crises in the late 1980s-early 1990s has been held up as an example of best practice.
The response was swift, comprehensive and in-depth, helping to re-establish the basis for sustainable growth. While the resolution of the current crisis is still unfolding, it is now two years since the turbulence first broke out. This seems a good time to make a preliminary evaluation based on the Nordic precedent: it is still too early for a full post-mortem, but early enough to help inform current policies.
We address the following questions. How does the management of the current crisis compare with that of the Nordic countries and the corresponding best practice principles? To the extent that it differs, what are the main reasons, and what might be the possible consequences?
Our analysis indicates that current policies have followed best practice in some respects, but have fallen short in others, arguably more important ones. If anything, the authorities have intervened even earlier than in the Nordic precedent. In the current episode, the down-leg of the financial cycle had not proceeded as far and banks were further away from the point of technical insolvency. However, the underlying weakness in balance sheets has not been recognised as fully. Efforts to write down assets and induce underlying adjustment in the sector have not been as extensive.
Impaired assets have been kept on balance sheets at highly uncertain, and possibly inflated, values. The conditions attached to financial support have not been as strict with respect to asset and cost reductions; if anything, they have been designed with an eye to sustaining lending. The objective of reabsorbing excess capacity in the sector has taken a back seat. All this has tended to slow down resolution.
A number of factors partly explain this basic difference. First, the crisis has been much more international in nature. Large cross-border operations have complicated resolution considerably. They have also heightened incentives to extend support to domestic institutions to avoid putting them at a competitive disadvantage. Second, the products at the heart of the initial stages of the current crisis have been more complex. It has proved harder to price and deal with structured securities than with the plain vanilla loans involved in the Nordic crises. Finally, mustering public support for the necessary in-depth measures through the political process has been more difficult.
contents
Introduction
I. Crisis management and resolution: best practice principles
- Principle 1: Early recognition and intervention
Principle 2: Comprehensive and in-depth intervention
Principle 3: Balancing systemic costs with moral hazard
II. The Nordic crises and today’s: comparing the response
- Principle 1: Early recognition and intervention
Principle 2: Comprehensive and in-depth intervention
Principle 3: Balancing systemic costs with moral hazard
III. The Nordic crises and today’s: why did the responses differ?
- Macroeconomic conditions
The international dimension of the crisis
The complexity of the assets involved
Mark-to-market vs accrual losses and the dynamics of the crisis
Overall assessment and possible implications
Conclusion
References
Main tables and graphs
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