The Nordic option

Ambrose Evans-Pritchard:

The Fed has been criticised for its rescue of Bear Stearns, which critics say has degenerated into a taxpayer gift to rich bankers.

A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region’s economy to its knees.

It is understood that Fed vice-chairman Don Kohn remains very concerned by the depth of the US crisis and is eyeing the Nordic approach for contingency options.

Scandinavia’s bank rescue proved successful and is now a model for central bankers, unlike Japan’s drawn-out response, where ailing banks were propped up in a half-public limbo for years.

While the responses varied in each Nordic country, there a was major effort to avoid the sort of “moral hazard” that has bedevilled efforts by the Fed and the Bank of England in trying to stabilise their banking systems.

Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country’s top four banks – Christiania Bank and Fokus – were seized by force majeure.

“We were determined not to get caught in the game we’ve seen with Bear Stearns where shareholders make money out of the rescue,” said one Norwegian adviser.

“The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial,” he said.

Stefan Ingves, governor of Sweden’s Riksbank, said his country passed an act so it could seize banks where the capital adequacy ratio had fallen below 2pc. Efforts were also made to protect against “blackmail” by shareholders.

Mr Ingves said there were parallels with the US crisis, citing the use of off-balance sheet vehicles to speculate on property. All the Nordic banks were nursed back to health and refloated or merged.

The tough policies contrast with the Fed’s bail-out of Bear Stearns, where shareholders forced JP Morgan to increase its Fed-led rescue offer from $2 to $10 a share. Christopher Wood, chief strategist at brokers CLSA, says the Fed’s piecemeal approach has led to “appalling moral hazard”.

“Shareholders have been able to lobby for a higher share price only because the Fed took over the credit risk on $30bn of the investment bank’s dubious paper. The whole affair also amounts to a colossal subsidy for JP Morgan,” he said.

Any taxpayer bailout of the system needs to be combined with a massive purge of those not footing the bill for their own mistakes — banking management — and the complete slaughter of banking shareholders.

At the moment, Washington Mutual, Citigroup, and Countrywide are just three of the best-known “banks” whose debt to Uncle Sam — mostly to the Federal Home Loan Banks — exceeds their net assets. They are effectively the property of the US government.

A price must be paid. Under the free market ideal that never happens in real life, the banks fail, everyone freaks out for six months, and the economy experiences torrid growth afterwards.

In the real world, the future individuals of the (banking) institutions are forced to pay for the mistakes of the current institutional occupants. Future Wall Streeters will pay for the mistakes of today’s Wall Street by paying billions more in homage to stupid regulations, oversight that isn’t, and market share lost to more competitive, less cosseted overseas competitors.

The three regulatory options are as follows:

1) Do nothing; reward the bankers for their naked pursuit of risk without reward.

2) The aforementioned Nordic route.

3) A massive patchwork of new regulations and controls, which almost-exclusively subsidizes the institutional malfeasance of the past nine months at the cost of choking future Wall Street vibrancy.

The Nordic option is by far the most attractive of the three. It allocates responsibility, discourages future bad behavior, and punishes prior bad behavior. It keeps the system relatively healthy — assuming the banks are returned to private ownership within less than four years.