Topic 8: Japan and Scandinavian Financial Crises Flashcards
what happened to credit/gdp in 1980s and 90s
rose sharply in 19802 and shrank during part of 90s
what happened to asset prices in japan during 1980s and 90s
Land and stock prices rose sharply during the boom. Returns 1980-1990:
Commercial real estate: 600%.
Residential and industrial real estate: 200%.
Stock market: 400%.
Prices dropped sharply during the 1990s. Returns 1990-2000:
Commercial real estate: -85%.
Residential and industrial real estate: -60%.
Stock market: -50%.
what happened to asset prices in sweden during 80s and 90s
Land and stock prices rose sharply during the 1980s.
Office prices in central Stockholm: 250% in real terms during 1981-1990.
Stock market: 200% for broad index (AFGX), 350% for real estate companies,
during 1984-1990.
Dropped sharply during the early 1990s.
Close to pre-boom levels by 1993.
what were the two forces driving the boom
financial liberalization
macroeconomic policies
what was regulation like in sweden pre boom
Credit provision was regulated tightly by the state.
Prudential regulation of banks (standard):
Banks’ capital ≥ fraction of total risk-weighted assets.
8% for corporate loans, 1-4% for mortgages depending on loan-to-value ratio.
Additional regulations:
Banks’ holdings of government and mortgage-backed bonds ≥ fraction of
assets.
Bank lending could not exceed a ceiling.
Excluding residential construction and some forms of business investment.
Ceilings were bank-specific and depended on last year’s lending.
Bank lending rates and deposit rates were capped.
Firms needed special permits to issue bonds.
Limits on international inflows and outflows.
what were the costs of regulation in sweden
Lending ceilings → Some positive NPV investments are not undertaken.
Lending ceilings → Banks have no incentives to raise their market share and
design better products.
New institutional arrangements are created to circumvent the regulations.
Money-market instruments and government bonds offer higher rates than
deposits → Pressure to abolish cap on deposit rates.
Non-regulated lenders have an advantage over regulated ones → Pressure to
abolish lending ceilings.
what was the financial liberalization in sweden
Deposit-rate caps were abolished in 1978.
Liquidity ratios were abolished in 1983.
Lending ceilings and lending-rate caps were abolished in 1985.
Limits on international flows were abolished in 1989
what was the effect on financial liberalization on bank assets and liabilities (sweden)
Annual credit growth rose from 8-13% in 1980-1985 to 16% in 1985-1990.
Bank employment rose by 20% from 1985 to 1990.
Banks became more reliant on wholesale funding.
Deposits (retail funding) decreased from 67% of assets in 1980 to 58% in
1985 and 40% in 1990.
Interbank loans (wholesale funding) rose from 23% of assets in 1980 to 28% in
1985 and 43% in 1990.
An increasing fraction of wholesale funding came from abroad: 44% in 1990
what is wholesale funding
funding by other banks
what were the incentives to lend post liberalization and implications (sweden)
Banks expanded lending rapidly without sufficient regard for borrower quality.
Employment in banks’ marketing departments rose by 25% from 1985 to 1990.
Employment in internal auditing departments dropped by 22%.
Short-termism: Loans yield interest income in the short term, but default
risk appears in the longer term.
Strong incentives to raise market share.
Over-optimism: Lenders assume that the economy and asset values will
keep growing, and are confident that borrowers will repay.
what were the macroeconomic policies in sweden in 1980s
Pegged but adjustable exchange rate.
Inflation (9% between 1970-1980) and occasional devaluations.
Central bank defended the peg by keeping the interest rate high.
One-year rate was 1-2.5% higher than international average.
Spread rose when market expected a devaluation.
Fiscal deficits until 1986.
what were the macroeconomic dynamics port-liberalization (sweden)
Increase in credit → Increase in asset prices and other financial accelerator
mechanisms.
Increase in credit → Increase in aggregate demand → Increase in inflation →
Decrease in real rates → Increase in credit.
Increase in inflation → Loss of international competitiveness → Trade deficit.
A flexible exchange rate could cushion some of these effects.
Smaller inflows of foreign capital → Smaller credit expansion
regulation in japan pre boom
Credit provision was regulated tightly by the state.
Prudential regulation of banks.
Bank lending rates and deposit rates were capped.
Firms needed special permits to issue bonds.
Limits on international inflows and outflows
financial liberalization in japan
Deposit-rate caps were gradually abolished, from 1985 to 1993.
Caps for large deposits were abolished first.
Restrictions on bond issuance were gradually abolished, from 1975 to 1996.
Liberalization for borrowers (bond issuers) was faster than for savers
(depositors).
Limits on international flows were gradually abolished during that period
effect of liberalization on bank assets and liabilities in japan
Slow liberalization for savers → Deposits remained a significant source of
banks’ funding.
Faster liberalization for borrowers → Large firms left the banks for the bond
market, and banks had to find other borrowers.
Rise in real estate loans.
what happened to real estate loans in japan
increased sharply late 80s
macro policies and dynamics in japan
Flexible exchange rate.
High US interest rates in early 1980s → Appreciation of USD relative to JPY.
Plaza Accord, Sep 1985 → Agreement between G5 countries (France,
Germany, Japan, UK, US) to let USD depreciate.
Central banks intervened in currency markets.
JPY appreciated relative to USD by 46% between Sep 1985 and Dec 1986.
Japan’s exports and GDP stopped growing in the first half of 1986.
Japanese authorities undertook policies to stimulate the economy.
Bank of Japan lowered interest rate by 3%.
Government provided large fiscal stimulus.
GDP started growing again in 1987.
Increase in credit → Increase in asset prices and other financial accelerator
mechanisms.
similarities in boom between japan and sweden
Financial liberalization generated additional lending.
Japan: Large firms migrated to the bond market. Depositors remained with
banks.
Scandinavia: Pent-up demand by borrowers. Banks met that demand by
borrowing from abroad.
Macroeconomic policies facilitated the credit boom.
Fiscal expansion.
Monetary policies:
Japan: Low interest rate limited the JPY’s appreciation.
Scandinavia: Pegged exchange rate.
crisis triggers and macro dynamics in sweden
Crisis triggers:
Increase in European interest rates because of German unification.
German 3-month rate rose from 3.7% in Dec 1987 to 5.6% in Dec 1988 and to
8.5% in Dec 1989.
Fiscal tightening in response to high inflation.
Decrease in tax benefit of deducting interest payments from 50% to 30%.
Real after-tax interest rate rose from -1% in 1989 to 5% in 1991.
Macroeconomic dynamics:
GDP grew by 0.9% in 1990 and -1.1% in 1991.
Investment grew by 0.8% in 1990 and -9.8% in 1991.
Bank lending grew by 15.3% in 1990 and -6.3% in 1991.
Real crisis started before financial crisis.
Stock market fell by 37% from its peak in Aug 1989 to Dec 1990.
Commercial real estate prices fell by 6% in 1990 and 40% in 1991.
Financial accelerator started running in reverse.
what happened to finance companies (unregulated lenders) in sweden during crisis
Finance companies were the first to face problems.
They relied on wholesale funding.
Bank loans.
Tradeable investment certificates, typically guaranteed by the banks.
As their credit losses increased, investors did not roll-over the investment
certificates.
Half (three) of the finance companies defaulted in late 1990.
The remaining half had to be supported by the banks.
banking crisis in sweden
Two banks needed new capital to meet regulatory requirements in late 1991.
Nordbanken: State owned majority stake pre-crisis. It acquired the bank by
paying 2bn SEK to minority shareholders, and injected 14.2bn of additional
capital (equity) in 1991-1992.
Forsta Sparbanken: Private owners injected new capital and gave an
interest-free loan. State subsidized the loan at a cost of 1bn.
An additional bank needed new capital in early 1992.
Gota: Private owners injected limited new capital, but the bank was insolvent.
State acquired the bank and injected 25.1bn of capital.
State intervention was relatively uncontroversial.
No deposit insurance existed in Sweden.
Emphasis on saving the banks and not their owners
swedish currency crisis
Sep 1992:
Uncertainty about semi-pegged exchange rates in European Exchange Rate
Mechanism (ERM).
UK and Italy exited ERM in 16 and 17 Sep, respectively, devaluing their
currencies.
Speculative attacks on SEK → Swedish central bank raised interest rates.
Overnight rate rose to up to 500%.
Fears that banks may not be able to continue borrowing internationally →
State provided debt guarantee for all banks on 24 Sep.
Nov 1992:
Further speculative attacks on SEK → Central bank did not raise interest rate
→ SEK devalued by 9% immediately and by 20% by year-end.
Links from currency crisis to banking crisis:
High interest rates made banking crisis worse.
Devaluation hurt Swedish firms borrowing in foreign currency. Yet, Sweden’s
net international investment position was ≈ 0.
swedish debt guarantee
Debt guarantee in Sep 1992 was systemic (concerned all banks).
Goal: Ensure that banks could continue borrowing and avoid runs.
Conditions:
Guarantee available only to solvent banks.
State had to inspect banks.
Banks had to ultimately pay for the costs of the guarantee.
Limited use for the guarantee.
No solvency problems.
Economy started recovering in 1993.
what is a bad bank
Nordbanken set up in 1992 a “bad bank”, Securum.
Securum acquired Nordbanken’s bad loans.
One-third of Nordbanken’s assets.
Paid 50bn to acquire loans with face value 67bn.
Capital of 24bn provided by the state.
