Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Origins and Resolution of Financial
Crises: Lessons from the Current and
Northern European Crises*
Finn Østrup
Copenhagen Business School
Solbjergvej 3, 2000
Frederiksberg, Dinamarca
fo.ckk@cbs.dk
Lars Oxelheim
Lund University
Lund and Institute for
Economic Research
P.O. Box 7080, S-220 07
Suecia
lars.oxelheim@fek.lu.se
y
The Research Institute of
Industrial Economics
P.O. Box 55665
102 15 Stockholm
Suecia
Clas Wihlborg
Chapman University
One University Drive
Orange, California 92866
EE.UU
y
Copenhagen Business School
Department of Finance
Solbjerg Plads 3
DK-2000 Frederiksberg
Dinamarca
wihlborg@chapman.edu
Abstracto
Since July 2007, the world economy has experienced a severe fi-
nancial crisis that originated in the U.S. housing market. Subse-
frecuentemente, the crisis has spread to financial sectors in European and
Asian economies and led to a severe worldwide recession. El
existing literature on financial crises rarely distinguishes between
factors that create the original strain on the financial sector and
factors that explain why these strains lead to system-wide conta-
gion and a possible credit crunch. Most of the literature on finan-
cial crises refers to factors that cause an original disruption in the
financial system. We argue that a financial crisis with its contagion
within the system is caused by failures of legal, regulatory, and po-
litical institutions
One policy implication of our view is that various forms of finan-
cial rescue would be reduced in times of crisis if appropriate con-
trols and safeguards were already in place. We draw on
experiences from the financial crises in the Nordic countries at
the end of the 1980s and the beginning of the 1990s. En particular,
the Swedish model for crisis resolution, which has received atten-
tion during the current crisis, is discussed to illustrate the prob-
lems policymakers face in a financial crisis without appropriate in-
stitutions. We discuss European Union approaches to the current
crisis before turning to policy implications from an emerging mar-
ket perspective in the current crisis.
1. Introducción
In mid 2007, a major ªnancial crisis hit the economies of
the advanced industrial countries. The March 2009 crisis
Financial support from the Marianne and Marcus Wallenberg
Foundation for Lars Oxelheim is gratefully acknowledged.
* We are grateful for comments on the draft presented at Asia
Economic Panel meeting in Jakarta 23 Marzo 2009.
Asian Economic Papers 8:3
© 2009 The Earth Institute at Columbia University and the Massachusetts
Institute of Technology
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
has spread worldwide. The crisis had its immediate origin in the markets for so-
called sub-prime mortgages in the United States, though in the current debate it is
sometimes traced back to expansionary policies in the United States after the burst-
ing of the IT bubble in 2001 and to Asia and the undervaluation of the Chinese
yuan. The crisis affected European ªnancial ªrms with large exposures to U.S. mort-
gage-related securities at an early stage. The crisis in ªnancial markets triggered a
severe recession that worsened through 2008 and the beginning of 2009. At ªrst, el
Asian economies seemed to escape the crisis relatively unscathed, but during the
second half of 2008, the Asian economies experienced large-scale capital outºows
and declining growth rates. Stock prices in the emerging economies fell more than
in the advanced industrial economies during the “crash” of October 2008.
In March 2009, the ªnancial crisis developed into a worldwide deep recession and
there are widespread fears that economic activity will remain depressed for years.
En este momento, it is not clear to what extent the decline in real activity originates in the
weak ªnancial sector or whether it depends on a shift in consumption-savings be-
havior in Europe and the United States, En particular. In the ªrst case, the large de-
cline in real activity in many countries would be explained by a decline in the sup-
ply of credit while, in the second case, the decline in real activity would explain a
declining demand for credit. Disagreements among economists about the appropri-
ate response to the crisis reºect differences in opinion about the main source of cur-
rent problems and the need for adjustment.
en este documento, we focus on causes of ªnancial crises and the policy responses to
a ellos. In our terminology, to qualify as a ªnancial crisis an event affecting a part of
the ªnancial system must spread throughout the ªnancial system as a whole
through contagion effects and the crisis in the ªnancial system must have real conse-
quences through, Por ejemplo, a credit crunch. En general, a ªnancial crisis requires
both developments outside the ªnancial sector leading to ªnancial disruption and
contagion within the ªnancial sector from the original disruption. Once a crisis is
underway, real activity is declining the factors outside, and inside the ªnancial sec-
tor can interact in complicated ways. The appropriate policy response to a crisis
would depend on the weight of the different factors as sources of decline in real ac-
actividad.
The existing literature on ªnancial crises rarely distinguishes between factors that
create the original strain on the ªnancial sector and factors that explain why these
strains lead to system-wide contagion and a possible credit crunch. To clarify this
distinction we discuss common explanations of ªnancial crises in the literature and
the policy debate. Although most of the literature on ªnancial crises refers to devel-
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
opments that cause disruptions in the ªnancial system, we argue that a ªnancial cri-
sis with its contagion within the system is caused by failures of legal, regulatory,
and political institutions.
One policy implication of our view is that various forms of ªnancial rescue would
be reduced in times of crisis if appropriate controls and safeguards were already in
lugar. We discuss institutional reform such as legally binding bank insolvency pro-
cedures. Without this type of reform, institutions lack the appropriate controls to
avoid contagion within the ªnancial system and a potential credit crunch, and as a
resultado, ªnancial crisis management by governments is required. We draw on experi-
ences from the ªnancial crises in the Nordic countries at the end of the 1980s and the
beginning of the 1990s to illustrate the problems policymakers face in ªnancial cri-
ses without appropriate institutional controls. We discuss the Swedish model for cri-
sis resolution and current regulatory initiatives in the European Union (EU) in re-
sponse to the current crisis.
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Finalmente, we turn to policy implications from an emerging market perspective. Nosotros
conclude that legal and regulatory institutions can contribute to reducing the likeli-
hood that shocks to the system cause ªnancial crises. Macroeconomic policy includ-
ing exchange rate arrangements can be conducted to minimize the impact of shocks.
Crisis resolution procedures are required once a large part of the ªnancial system is
distressed.
En la sección 2, the paper proceeds with a summary of the evolution of the current cri-
sis in the United States and Europe. Common explanations of ªnancial crises are
discutido en la Sección 3, with examples from European crises in particular. Después de eso,
we present our view of ªnancial crises as the result of institutional failures in Sec-
ción 4. The so-called Swedish Model for crisis resolution is discussed in Section 5
and current regulatory initiatives in the EU are reviewed in Section 6. We present
conclusions in Section 7 and outline implications for policy and institutional reform
from an emerging market perspective.
2. The current crisis in the United States and Europe
Prior to 2007, A NOSOTROS. housing prices had risen to unprecedented heights relative to
long-term levels, and were fuelled by a long period of low interest rates and an ex-
panding credit supply. En 2007, a growing sense of uncertainty about mortgage-
related investments was ampliªed by high levels of leverage and by the lack of
transparency in structured ªnancial products, in particular credit debt obligations,
(CDOs), which had been issued with backing in mortgage loans. The perception of
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
uncertainty came to a head in June 2007 when two hedge funds managed by Bear
Stearns, the ªfth-largest U.S. investment bank, ran into trouble and had to be un-
wound. The uncertainty regarding real estate prices caused investors to adjust their
appraisal of risk in the summer of 2007. Credit risk premiums increased and there
was a big decline in prices on mortgage-backed securities. The upward adjustment
of risk premiums spread to the short-term market for wholesale ªnance.
The ªnancial crisis had an early impact on European economies through two chan-
nels. Primero, the crisis spread to Europe through the direct exposure of European
ªnancial ªrms to U.S. mortgage-related ªnancial products. According to one esti-
compañero, one-third of U.S. mortgage-backed securities had moved offshore and to Eu-
rope in particular.1 In August 2007, two German banks—IKB and Landesbank
Sachsen—collapsed due to losses on mortgage exposures in the U.S. market. Among
the large European banks, the Union Bank of Switzerland (UBS) suffered particu-
larly large losses.
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Segundo, European ªnancial markets were affected by the same rise in risk premiums
and the same demand for liquidity as the U.S. markets. The rush to liquidity be-
cause of insolvency fears caused ªnancing difªculties for a number of European
banks. en septiembre 2007, depositors started massive withdrawals from the British
bank Northern Rock, which had relied on the wholesale ªnancing market.2
The European Central Bank reacted early to the difªculties in the wholesale ªnanc-
ing markets by suspending a rise in its policy rate, which was expected to take place
in September 2007. Además, the European Central Bank reacted through a large
increase in its lending facilities for banks. Also in September 2007, the Bank of Eng-
land and several other central banks decided to lower their policy rates. In Decem-
ber 2007, further cuts in policy rates were implemented. Estados Unidos. Federal Reserve
(Fed) introduced similar measures in the United States.
In March 2008, Bear Stearns collapsed due to losses on mortgage-related assets and
was taken over by JP Morgan Chase with support from the U.S. Treasury. Criticism
followed the U.S. government’s decision to support the bailout of Bear Sterns. El
crisis entered a new phase when the U.S. government in mid September 2008 de-
cided not to intervene to save Lehman Brothers, the fourth largest U.S. investment
1 Blundall-Wignall (2008).
2 The British government intervened by guaranteeing all claims on Northern Rock. Sin embargo,
it was taken over by the British government in February 2008 as no buyers were interested
in its acquisition.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
bank, from bankruptcy. For the ªrst time since the beginning of the 1930s, ªnancial
authorities in a major economy allowed a large ªnancial institution to ªle for bank-
ruptcy. Widespread turbulence in ªnancial markets followed. Financing through
several important markets came to a virtual standstill. The commercial paper mar-
ket and interbank lending came to a halt. Growth prospects declined as reºected in
the steep 30–50 percent fall in share prices in October 2008.
Also in mid September 2008, several large European ªnancial ªrms had to be sup-
ported through the injection of capital from governments. One of the largest Euro-
pean ªnancial groups, Fortis, was taken over by the Benelux governments. Dexia
was taken over by the governments in Belgium, Francia, and Luxembourg. In Great
Bretaña, the government acquired controlling stakes in three of the eight largest
banks. In Germany, the government stepped in to save the mortgage lender Hypo
Real Estate and, in January 2009, it acquired 25 percent of the equity in Commerz-
bank, the second-largest German bank. In Iceland, three major banks with interna-
tional operations were taken over by the government. In December 2008, the Irish
government took over one of the largest banks. In Denmark, seven smaller banks
collapsed in the autumn of 2008. In Sweden, the government took control of a
medium-sized investment bank.
European governments reacted to the ªnancial crisis through rescue packages for
banks and other ªnancial institutions. The ªrst package was implemented in Ireland
where all claims on the six largest Irish-owned banks became guaranteed in Septem-
ber 2008. To a varying extent, the European rescue packages included government
guarantees for debt obligations; government purchases of bad or “toxic” assets from
banks; government injection of capital to banks in return for direct share holdings;
lending facilities for the purchase of commercial papers; and direct government pur-
chases of assets, such as mortgage-backed securities.
During 2008 y 2009, European banks were hit increasingly by losses originating in
Europa, and this trend is expected to continue. Primero, in many European countries,
real estate prices had risen to levels that appeared incompatible with long-term
equilibrium already in 2007. Mesa 1 shows that housing price increases in, for exam-
por ejemplo, the United Kingdom (Reino Unido), España, and the Nordic countries have been even
steeper than in the United States. Segundo, losses of bank-subsidiaries in Eastern Eu-
rope are expected to increase.3 Third, a number of large European corporations have
been the target of private equity funds and, thereby have become highly leveraged.
3 In December 2008, Lithuania had to be bailed out through loans from the IMF, the EU, y
the Nordic countries.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Mesa 1. The increase in residential real estate prices relative to income
Increase in price-to-income ratio (por ciento)
Canada
Dinamarca
Finland
Francia
Alemania
Irlanda
Italia
Japón
Países Bajos
Norway
España
Suecia
Suiza
Reino Unido
United States
1997–2007
(cid:2)31.4
(cid:2)63.6
—
(cid:2)69.1
(cid:2)24.3
(cid:2)86.1
(cid:2)47.6
(cid:2)28.4
(cid:2)54.3
(cid:2)54.3
(cid:2)67.3
(cid:2)61.6
(cid:2)6.9
(cid:2)93.9
(cid:2)23.4
2002–07
(cid:2)30.8
(cid:2)38.2
(cid:2)15.0
(cid:2)47.5
(cid:2)13.0
(cid:2)20.2
(cid:2)24.9
(cid:2)22.2
(cid:2)15.7
(cid:2)26.4
(cid:2)38.3
(cid:2)34.5
(cid:2)5.7
(cid:2)39.5
(cid:2)14.7
Fuente: OECD, Economic Outlook, Statistical Appendix.
Finalmente, a bubble in commercial real estate appears to have developed in several Eu-
ropean countries. En 2007, prices on commercial real estate had risen to record levels
in Denmark and Ireland. Francia, Los países bajos, and Spain have also experienced
big price increases on commercial real estate.4
Mesa 2 shows that credit to the private non-ªnancial sector over the 5-year period
2002–07 rose sharply in several advanced industrial economies. The pattern remains
when the horizon is extended to the 10-year period 1997–2007. The largest expan-
sion of credit took place in Spain where the debt of the private non-ªnancial sector
relative to gross domestic product rose 77.5 percentage points over the 5-year period
2002–07. Other countries with considerable increases in private non-ªnancial sector
debt over the 2002–07 period are Denmark, Finland, Francia, Italia, the United States,
and the UK. There is no obvious correlation between credit growth and the severity
of the crisis, sin embargo. The United States, the UK, and Denmark are among the coun-
tries that have been hardest hit but, hasta hace poco, Spain had not been affected as
strongly as many other countries. Cifra 1 indicates a positive correlation between
the increase in debt incurred by households over the period from 2000 a 2007 y
the increase in residential real estate prices relative to their long-term level for 15 anuncio-
vanced industrial economies.
3. Common explanations of ªnancial crises
En esta sección, we review ªve commonly referred to explanations of ªnancial crises
and illustrate them with historical events. The explanations are not mutually exclu-
4 BIS (2008).
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Mesa 2. The increase in credit to the private non-ªnancial sector (percentage points of GDP)
Austria
Bélgica
Dinamarca
Finland
Francia
Alemania
Irlanda
Italia
Japón
Países Bajos
Norway
España
Suecia
Suiza
Reino Unido
United States
Fuente: OECD, National Accounts.
Nota: a. 1997–2006 period. b. 2002–06 period.
1997–2007
24.4
49.6
73.4
39.5
49.3
13.3
43.8
(cid:2)44.4a
60.5a
143.7
87.7a
59.2
2002–07
(cid:2)7.6
(cid:2)16.9
(cid:2)52.4
(cid:2)29.5
(cid:2)24.9
(cid:2)10.6
(cid:2)25.7
(cid:2)17.9b
(cid:2)12.0b
(cid:2)77.5
(cid:2)43.3b
(cid:2)22.7
Cifra 1. The relationship between increase in household debt and increase in residential
real estate prices
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Fuente: OECD, Economic Outlook; OECD, Financial Accounts.
Nota: The ªgure shows for 15 advanced industrial countries (Canada, Dinamarca, Finland, Francia, Alemania, Irlanda, Italia, Japón, Nether-
lands, Norway, España, Suecia, Suiza, Reino Unido, y los estados unidos) the relationship between (i) the increase in house-
hold debt relative to gross domestic product (measured in percent) over the 2000–07 period (for Japan, Nertherlands, Suiza, y el
United Kingdom 2000–06, for Ireland 2001–07), y (ii) the increase in household prices relative to their long-term level (measured in per-
centavo) over the same period. House prices relative to long-term levels are found as the price-to-income ratio measured by the OECD.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
sive and several crises appear to be the result of a combination of factors. The expla-
nations of crises discussed here focus on factors that cause and trigger the original
disruption in the ªnancial sector as opposed to factors that cause the systemic ef-
fects of an original disruption. The ªve views we present are:
1) Macroeconomic developments and leverage;
2) Behavioral factors; speculation and optimism;
3) Shift to liquidity and safety;
4) Management failures; y
5) Institutional weaknesses.
3.1 Macroeconomic developments and leverage
According to this view, failures in ªnancial institutions occur because of negative
macroeconomic shocks following a period of credit expansion leading to high lever-
age of households and ªrms. The negative shock to highly leveraged ªrms or house-
holds causes losses in the ªnancial system with the consequence that highly lever-
aged banks risk becoming insolvent.5 According to the “debt-inºation” theory
suggested by Fisher (1933), the level of debt in ªnancial and non-ªnancial enter-
prises is the crucial factor that determines the probability and size of ªnancial crises.
A high level of debt in non-ªnancial enterprises raises the risk of bankruptcy during
economic downturns, causing losses for banks and inducing them to cut down on
their lending. Sucesivamente, a reduction in bank lending reduces the credit and money
supply.
A secondary effect of macroeconomic shocks on asset prices can amplify the original
shock and worsen the impact on the ªnancial sector.6 Similarly, substantial indebt-
edness in foreign currency can amplify the shock if the domestic currency falls in
valor, as is often the case.7 Macroeconomic developments and shocks may explain
why households and ªrms run into debt payment problems. Sin embargo, the insuf-
ªciency of capital in ªnancial ªrms to withstand shocks and the ampliªcation of the
original shock through the ªnancial system must be explained in other ways.
Four Nordic countries (Dinamarca, Finland, Norway, and Sweden) experienced se-
vere ªnancial crises from the mid 1980s to the beginning of the 1990s. En cada caso,
the crisis was characterized by a large prior increase in lending from banks and
5 Ver, Por ejemplo, Mishkin (1991, 1997), which discuss ªve different types of macroeconomic
shocks that may cause ªnancial crises.
6 Ver, Por ejemplo, Bernanke, Gertler, and Gilchrist (1996), Kioytaki and Moore (1997), y
von Peter (2004).
7 Eichengreen and Hausmann (1999).
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
other ªnancial institutions, but the shock that triggered the crises was different.
Large drops in real estate values triggered the Danish, Finnish, and Swedish crises.
También, the Finnish crisis was associated with a large decline in Finnish exports be-
cause of the break-up of the Soviet Union.
The ªnancial crisis in Japan beginning in 1990 followed a pattern that was similar to
the Nordic ªnancial crises. In the second half of the 1980s, Japanese share prices rose
3.2 veces. Real estate values on commercial property, En particular, also rose sharply.
En 1990, Japanese asset prices collapsed and Japanese banks experienced large
losses, especially in real estate (Inaba 2005). The Japanese authorities postponed a
resolution of the crisis in the hope that the economic situation might improve. En el
end of 1997, the Japanese ªnancial system was close to collapse with massive with-
drawals from banks. En noviembre 1997, the Japanese Minister of Finance and the
Governor of the Bank of Japan issued a common statement in which they guaran-
teed all deposits in Japanese banks. En 1998, one of the largest Japanese banks, Largo
Term Credit Bank of Japan (LTCB), collapsed.
The crises that hit several East Asian economies (Indonesia, Korea, Malasia, el
Philippines, y Tailandia) in the 1997–98 Asian ªnancial crisis can be classiªed
within the same category to some extent. Fixed exchange rate regimes contributed
to the crisis because they encouraged borrowing by banks and ªrms in foreign cur-
rency. Domestic bank lending expanded rapidly and grew relative to the GDP. Previo
to the crisis, East Asian countries experienced steep increases in asset prices, en par-
ticular stock prices and prices on commercial real estate. A rising share of bank lend-
ing was used for speculative projects in real estate and for investments in equities.
In July 1997, a sudden change in market perception of risk and the willingness to
bear it took place (Furman and Stiglitz 1998). Como resultado, property prices fell sharply
and triggered banking crises. The Asian crisis cannot be explained by macroeco-
nomic developments alone, sin embargo. Other explanations are offered within the fol-
lowing two categories of crises.
3.2 Behavioral factors; speculation and optimism
A common explanation of ªnancial crises refers to speculation in ªnancial and/or
real assets and excessive optimism during a period leading up to an event triggering
a sharp decline in asset prices. Keynes (1936 [1973]) developed one view of asset
speculation. According to Keynes, expectations of future returns on investments
must be characterized by a large degree of uncertainty and this leaves a large mar-
gin for expectations to be determined by possibly shifty sentiments.8
8 Keynes (1936 [1973]) writes: “The later stages of the boom are characterized by optimistic
expectations as to the future yield of capital goods sufªciently strong to offset their growing
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Minsky (1964) shares a similar view of asset speculation as the origin of ªnancial cri-
ses. Driven by optimism, corporations increase debt levels to ªnance purchases of
assets. At a certain stage, a sudden and sharp fall in asset prices occurs, combined
with a large cutback in lending. Kindleberger (1989) offers a similar explanation of
ªnancial crises.
Related and more recent behavioral explanations have been offered by Bernanke
and Gertler (1999) and Davis and Zhu (2005). The latter see speculation in commer-
cial property as a particularly destabilizing factor as banks may be tempted to in-
crease lending due to the apparent safety of commercial property as collateral. Borio
(2006) and Borio, English and Filardo (2004) argue that a liberalized ªnancial system
is marked by recurrent crises as banks may be tempted to increase lending in peri-
ods with an optimistic valuation of future income prospects.
Historical examples are manifold. En 1907, the United States experienced a severe
ªnancial crisis with the collapse of several important institutions, most notably the
Knickerbocker Trust Company. Stock prices fell by about 40 percent between Sep-
tember 1906 and November 1907. The collapse came after a period with sharp in-
creases in stock prices marked by a speculative sentiment. j. PAG. Morgan Jr., partner in
JP Morgan & Compañía, noted in January 1906: “For the ªrst time in three years the
public—with stocks at their present high prices—have begun to come in heavily
with the result that the so-called market-leaders are no longer in charge, and that the
stock market is running away in a fashion which I must say suggests to me possible
trouble in the future although not in the immediate future.”9
Over the 8-year period from August 1921 to September 1929, stock prices in the
United States rose 6.1 veces. Stock purchases were made possible through lending
from banks. Especially after 1925, bank credit rose steeply relative to the GDP (Higo-
ura 2). Following the crash in October 1929, bank credit relative to the GDP fell
sharply. Un total de 9,096 A NOSOTROS. banks, representing approximately a quarter of total de-
posits, collapsed from 1930 a 1933. The ªnancial crisis spread to several European
countries, especially Austria and Germany, as U.S. investors withdrew their over-
seas investments, as they needed funds in the home market.
abundance and their rising costs of production and, probably, a rise in the rate of interest
también. It is of the nature of organized investment markets, under the inºuence of purchasers
largely ignorant of what they are buying and of speculators who are more concerned with
forecasting the next shift of market sentiment than with a reasonable estimate of the future
yield of capital-assets, eso, when disillusion falls upon an over-optimistic and over-bought
market, it should fall with sudden and even catastrophic force” (páginas. 315–316).
9 Bruner and Carr (2007), pag. 16.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Cifra 2. The evolution of bank lending in the United States 1914–40
PAG
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Fuente: Ofªce of the Census, Statistical Abstracts of the United States.
3.3 Shift to liquidity and safety
Another classic explanation of ªnancial crises is a sudden increase in demand for
liquid and/or low-risk assets. Bagehot (1873 [2007]) discussed how a sudden de-
mand for liquid, safe assets could be caused by a sudden sentiment of fear. The de-
mand shift caused, Por ejemplo, by sudden concerns about the solvency of banks
may trigger bank runs. These runs can hit a large number of solvent as well as insol-
vent banks if the public cannot speciªcally identify the insolvent ones. Friedman
and Schwartz (1963) describe how bank runs contributed to the crisis in the 1930s.
This explanation of ªnancial crises comes closer to addressing issues of contagion
within the ªnancial system while the previous ones focus on explanations of shocks
to the ªnancial system. Keynes, Minsky, and Kindleberger argue that the demand
shift to liquid and safe assets may arise when a speculative bubble bursts, thereby
linking this explanation of crises with the speculative explanation above. As noted
herein, the Asian ªnancial crisis in 1997–98 was characterized both by a prior in-
crease in asset prices based on optimism and speculation and a shift in risk percep-
tions in 1997.
3.4 Management failures
Excessive risk-taking on some level of a ªnancial ªrm is one type of failure in this
categoría. Irvine H. sprague, chair of the Federal Deposit Insurance Corporation
(FDIC) de 1979 a 1986 gave the following account of ªnancial failures: “the greed
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
factor . . . remains the major—often the only—reason for a bank’s failure. Banks fail
in the vast majority of cases because their management seek growth at all cost, reach
for proªts without due regard to risk, give privileged treatment to insiders, or gam-
ble on the future course of interest rates. Some simply have dishonest management
that loots the banks.”10
Referring simply to greed as in the above quote seems simplistic. Corporate gover-
nance that would allow simple greed to rule must be considered as well as incen-
tives of bank managers. We return to these issues in the section on institutional
weaknesses next.
3.5 Institutional weaknesses
This ªfth view of ªnancial crises refers to weak regulatory and contractual institu-
ciones, En particular. Many economic reports, as well as academic papers, refer to de-
regulation as an important cause of ªnancial crises. According to Mishkin (1997),
institutional weaknesses can cause ªnancial crises for a variety of reasons. por ejemplo-
amplio, a weak political structure may cause budgetary deªcits and subsequent
losses in ªnancial institutions, which may be pressured into holding government as-
sets to ªnance the deªcit. The lack of efªcient ªnancial supervision may also be seen
as the consequence of institutional weaknesses. Other writers see weak protection of
creditor rights as raising the risk of withdrawals from ªnancial institutions and thus
of bank failures.11
It is a common view that institutional weaknesses and failures describe the situation
in developing and emerging market economies. Financial crises occur with equal
frequency in developed countries, sin embargo. En la sección 4, we argue that a broader set
of institutional failures should be viewed as the main causes of systemic ªnancial
crises in countries on all levels of development.
The overview of the current crisis in Section 2 indicates that all the explanations of
ªnancial crises discussed here seem to have been at work. Macroeconomic develop-
ments have played a role in that credit was in ample supply since 2001, as shown in
Mesa 2. The availability of credit contributed to speculative activity in residential
real estate, En particular, but probably also in raw materials and equities. A shift in
favor of safety has revealed itself in higher credit risk premiums and lack of liquid-
ity in markets for securities. Management failures in the form of a focus on short-
term earnings and insufªcient attention to risk management seem to have contrib-
10 sprague (1986 [2000]), pag. 233.
11 A review of the literature is found in Breuer (2004). A study by La Porta et al. (1998) shows a
larger risk of ªnancial crises in countries with a weak enforcement of property rights.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
uted. Among institutional factors, many observers have pointed to deregulation but
at the same time, the Basel Capital Adequacy Framework (BCAF) has become
stricter. In the next section, we focus on a range of institutional factors that we sug-
gest have contributed to the severity of the current crisis.
4. Financial crises as institutional failures
4.1 Allocation of value losses
From December 1999 through September 2002, Estados Unidos. stock market lost half of its
valor, reducing household wealth by roughly US$ 10 trillion. From mid 2006 through December 2007 real estate prices fell about 30 percent reducing household wealth about US$ 3 trillion.12 In the ªrst case, the systemic consequences for the ªn-
ancial sector as a whole, as well as for the real economy, were minor. In the second
caso, a major system-wide ªnancial crisis erupted with severe consequences in the
stock market and, En particular, in the real economy. How can the system in one
case allocate US$ 10 trillion dollars worth of losses without severe strains while US$ 3 trillion dollars worth of losses in the second case have severe systemic conse-
quences? In both cases losses had to be allocated to households and individuals one
way or another. One would expect the problem caused by the allocation of losses to
be proportional to their magnitude.
The factor that immediately comes to mind as an explanation for the difference be-
tween the two cases is leverage. Equity investment is leveraged to a much lower de-
gree than real estate investment. The ªnancial ªrms supplying debt are also highly
leveraged. De este modo, in the case of real estate investment, a relatively modest decline in
asset values threatened the solvency of a number of ªnancial ªrms. Leverage cannot
be the fundamental explanation of a systemic ªnancial crisis, however.13
In markets functioning without friction, ªrms’ leverage and insolvency should not
cause a substantial problem. Después de todo, there are contracts specifying how losses are
to be allocated. Once the ªnancial ªrms’ equity is exhausted, the additional losses
should be borne by their creditors. Some of these creditors are households and oth-
ers are other ªnancial ªrms. Insolvency procedures would allocate the losses in ac-
cordance with the pre-speciªed contractual arrangements or in accordance with
12 See Gjerstad and Smith (2009). This article contains an analytical review of events leading
up to the so-called sub-prime mortgage crisis. “Blindsided by the Bubble.” Wall Street Jour-
nal 6 Abril 2009.
13 We are not arguing that the severity of the current crisis is due entirely to the systemic ef-
fects of the sub-prime mortgage problem. It is likely that another important factor is the
desire of households and ªrms to decrease their leverage as a result of increased risk-
premiums as households reduce consumption and ªrms reduce investments.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
rules as speciªed in insolvency law. Assets of the failing ªrms would be purchased
at reduced values by other ªnancial and non-ªnancial ªrms or households. The in-
direct ramiªcations for the real economy should be small.
Most of the traditional explanations for ªnancial crises cannot explain why a
systemic crisis erupted after the US$ 3 trillion worth of losses, but not after the US$ 10 trillion worth of losses, in spite of the much larger initial shock to the ªnan-
cial system in the latter. Por ejemplo, the expansionary, low-interest-rate policies of
the Fed may have contributed to the run-up in housing prices since 2001 but they do
not explain why the system could not handle the decline. También, often cited “short
memories” and other behavioral characteristics of ªnancial market participants may
also have contributed to the development of a pricing bubble, but explanations for
the systemwide effects of the decline in prices must be sought elsewhere.
4.2 Frictions creating systemic risk
Aquí, the task is to identify the sources of frictions that cause great delays in the
loss-allocation and to ask why these frictions exist. The tragedy in a ªnancial crisis is
that frictions cause additional losses in wealth and income. These losses must be al-
located as well. Therein lies the systemic failure with contagion among ªnancial in-
stitutions and the decline in real activity that we are now experiencing.
Six candidates come to mind when examining explanatory factors in ªnancial mar-
kets:
(1) The individuals and ªrms facing and taking losses are reluctant to accept these
losses and may try to cover them up to, Por ejemplo, not lose creditworthiness or
to avoid runs.
(2) The lack of transparency in valuation of assets allows ªnancial ªrms, in particu-
lar, to delay loss recognition.
(3) Uncertainty and asymmetric information about asset values create a liquidity
problem in markets when potential buyers suspect that sellers try to unload rela-
tively low-quality assets (adverse selection).
(4) Insolvency procedures for many ªnancial ªrms are time-consuming and costly in
ellos mismos. The allocation of losses requires assets of ªrms to be valued without
well-functioning markets and exact contractual relationships must be identiªed.
(5) Many potential losers are protected by explicit or implicit insurance schemes cre-
ated by expectations of bailouts in different forms. The coverage of explicit de-
posit insurance schemes and other creditors of banks are often expanded in times
of crises. In the current crisis, creditors of non-bank ªnancial ªrms have also ob-
tained protection. Even shareholders and managers of large entities facing losses
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
obtain a degree of protection when the survival of their ªrms is more or less
guaranteed. The greater the share of the ex ante contractual losers that gain pro-
tection, the greater the losses that are potentially faced by others. In the end,
losses must be borne by someone. The taxpayers are obviously the “loss-takers of
last resort” but in the current crisis taxpayers seem to resist this role.
(6) Political conºicts about the allocation of value losses create uncertainty about the
ªnal allocation of losses. This uncertainty about the political process creates dis-
incentives for those contractually responsible for losses to take private initiatives
to deal with them. Primero, ªrms hold out to see where the political process leads
and they lobby to inºuence the political process with the objective of shifting
losses to others.
These factors contribute not only to delays in the allocation of the original losses but
also potentially to an ampliªcation of the losses, as well as to contagion among
ªnancial institutions and from ªnancial institutions to ªrms. Contagion is created by
lack of liquidity in markets for securities, delays in settlement of claims, posible
runs on banks, and the withholding of new credit.
The reduced availability of ªnancial resources affects activity in the real sectors once
the ªnancial sector is impaired by the process of loss allocation. Frictions in labor
and product markets may be the source of additional output losses and unemploy-
mento. These frictions affect the severity of the systemic effects of a ªnancial crisis.
Product and labor market frictions amplify the effects of households’ and ªrms’ at-
tempts to decrease their leverage as well. En el siguiente, the discussion is re-
stricted to ªnancial sector frictions.
Managers of ªnancial ªrms and investors do not perceive that they live in a world
without market frictions. De este modo, one would expect that the listed frictions and their
potential consequences would be taken into account in the risk analysis of invest-
ments and lending. Por ejemplo, the risk and costs associated with slow insolvency
procedures should be taken into account by creditors as well as ªnancial ªrms, en-
ducing the latter to hold more capital. Similarmente, one would expect that the risk of
declining liquidity of assets under some circumstances and the price effects of de-
clining liquidity should be taken into account by ªnancial ªrms and investors in
various securities.
4.3 Incentives to consider “friction-risk”
A number of factors contribute potentially to relatively weak incentives for investors
and managers of ªnancial ªrms to take into account the risks associated with peri-
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ods of increased friction. They increase the vulnerability of the system to systemic
crises after, Por ejemplo, the bursting of an asset price bubble and they provide the
rationale for much existing regulation and supervision of the ªnancial sector. El
factors that weaken the incentives to take systemic risk and liquidity risk into con-
sideration ex ante are partly the same as the above factors causing friction in the al-
location of losses:
(i) Explicit deposit insurance and implicit protection of various stakeholders in the
ªnancial system in the form of expected bailouts create disincentives for creditors of
banks and other ªnancial ªrms to evaluate risk and to require a risk-premium for
lending. Por ejemplo, expected intervention by central banks in case low liquidity
prevents assets from being sold at “fair values” reduces the incentives to manage li-
quidity risk ex ante.
(ii) The more responsive the political system is to pressures from particular groups
facing losses in times of stress, the greater the implicit protection of these groups is.
Por ejemplo, large ªnancial entities can more easily convince lawmakers and regu-
lators about the dire consequences of their failures. The “too big to fail” argument
for big banks is by now widely accepted. This argument provides creditors of these
institutions with stronger implicit protection and the “too big to fail” ªrms with
lower costs of funding.
(iii) Compensation and remuneration of executives, credit ofªcers, and other risk
decision-makers may bias incentives toward short-term proªt considerations at the
expense of risk.
(iv) Complexity and non-transparency of securities and their value-factors may en-
able originators to take on risk without facing increased funding costs and to sell the
risk at prices that do not include an appropriate risk-premium. In the current crisis,
mortgage-backed securities were created and sold in tranches. With the beneªt of
hindsight it seems that ratings agencies and quantitative risk models were unable to
estimate risks associated with these instruments appropriately. It is obviously hard
to make a clear distinction between the inability to evaluate risk and the lack of in-
centives to evaluate risk appropriately because of factors (i)–(iii).
(v) The supervision and regulation of banks in particular should be mentioned here,
porque, Por ejemplo, capital requirements could substitute for incentives created in
the market place. The BCAF specifies methods and procedures for evaluating the
risk of particular assets. If these methods are inappropriate they divert risk manage-
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
ment resources to risk measures that do not reºect reality or to the gaming and ma-
nipulation of these risk measures. Under Basel I, which was in effect during most of
the period leading up to the current crisis, the methods for risk-evaluation were
crude and provided incentives for so-called risk arbitrage.14 Under Basel II, cual
was implemented in 2007 in Europe, ratings and quantitative modeling became im-
portant for the amount of capital a bank must hold against a particular asset. Ambos
elements of the Basel II framework seem to have failed in the current crisis. Neither
Basel I nor Basel II considers the contribution of a bank to systemic risk when speci-
fying capital requirements.
Factors (i)–(v) contribute to the likelihood that times of friction will occur as a result
of excessive risk-taking in the ªnancial system whereas factors (1)–(6) en la sección 4.2
create frictions in the allocation of losses. These partly overlapping groups of factors
contribute to the severity of systemic effects and both can be linked to legal, regula-
conservador, or political institutions.
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4.4 Frictions, incentives and institutional failures
Legal, regulatory, and political institutional factors are not directly linked to the
listed factors in Sections 4.2 y 4.3, but a speciªc institutional characteristic of a
country can inºuence friction in ªnancial markets as well as ex ante incentives in
varias maneras. Relevant institutions affecting frictions in the allocation of losses are
those inºuencing the incentives of ªrms and individuals to recognize losses, en-
forcement of contracts, liquidity of securities, and transparency of valuation and
transparency of risk factors for securities as well as ªnancial ªrms. Relevant institu-
tions affecting ex ante incentives are those inºuencing risk-taking incentives of
managers of ªnancial ªrms and their incentives and ability to provide relevant in-
formation in the markets for securities including markets for their creditors and
shareholders. The institutions discussed subsequently affect frictions as well as ex
ante incentives in ªnancial markets.
Most of the assets that fell in value after the IT bubble burst were traded in active
markets for equity. Contractual relations for allocating the losses were uncompli-
cated since the assets were relatively simple claims on corporate assets. Más-
más, there were few layers of ªnancial ªrms wherein losses had to be recognized.
Finalmente, the political pressures to protect losses were mild and therefore, weakened
the ability of equity investors to form political pressure groups to delay loss alloca-
14 Under Basel I many asset types with different risk were given the same risk-weights within
each “risk-bucket” providing incentives for banks to lend to relatively risky, high interest
rate lenders within each “risk-bucket.” See Benink and Wihlborg (2002).
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
ción. Ex ante risk-taking incentives of investors in equity markets were not an issue
either because risk-taking decisions were made by those directly exposed to risk.
The situation was obviously different in the markets for real estate and real estate
ªnancing. Layers of ªnancial ªrms and markets for securities were involved in cre-
ating multiple agency relationships. Housing and its affordability is a major policy
issue. The broad range of activities of ªnancial ªrms involved in mortgage ªnancing
implies that one ªrm’s failure may have broad repercussions. The political sensitiv-
ity of the failure of ªnancial ªrms is enhanced by the sheer size and complexity of
some of these ªrms.
Wihlborg (2009) describes a number of reasons that have been put forward in the
debate about causes of the ªnancial crisis and its systemic consequences. Several
reasons for the crisis are mentioned previously including the existence of a real es-
tate price bubble pre-2007 and its bursting. To explain the systemic consequences of
these events, we now focus on institutional characteristics that contribute to the fail-
ures of loss allocation or to the failure of ªnancial ªrms to account properly for the
risk or both. We do not claim to present an exhaustive list but focus on a few key in-
stitutional characteristics: explicit and implicit insurance of stakeholders in ªnancial
institutions, procedures for resolution of insolvency, corporate governance in ªnan-
cial institutions, and uncertainty about the political process in times of crisis.
4.5 Institutions affecting loss allocation and incentives
4.5.1 Explicit and implicit insurance in the ªnancial sector The explicit and im-
plicit insurance of depositors and other creditors of ªnancial ªrms reduce the incen-
tives of these creditors to monitor the risk of ªnancial ªrms. The explicit deposit in-
surance systems in the United States and European countries affected by the crisis
provide only partial coverage for depositors through limits on the size of insured
deposits and—at least until recently in the UK—through co-insurance.15 Non-bank
ªnancial ªrms in the United States in particular do not enjoy the beneªt of deposit
insurance. Como consecuencia, it is unlikely that the explicit deposit insurance systems
were strong enough to remove major creditors’ incentives to monitor ªnancial insti-
tutions. Por eso, the existence of explicit deposit insurance does not appear to have
been a major contributing factor to the failure of market discipline on risk-taking be-
havior of ªnancial institutions.
15 Eisenbeis and Kaufman (2008) argue that the run on Northern Rock in the UK can be ex-
plained by the existence of co-insurance and possibly delays in insurance payments after a
bank failure. They base this argument on the observation that there was no run on any
A NOSOTROS. bank that faced circumstances similar to Northern Rock.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
A more plausible candidate would appear to be the existence of implicit insurance.
One explanation of strong implicit insurance of banks’ creditors is that banks have
special characteristics relative to other ªrms. Primero, banks supply liquidity in the eco-
nomic system as a whole. Large parts of their liabilities are short term and subject to
bank runs if creditors fear non-repayment. Segundo, there are generally substantial
amounts of short-term interbank liabilities that may contribute to contagion among
banks if one bank fails. Tercero, creditors of banks in particular are diverse and many.
De este modo, banks do not generally have one or a few large creditors with a strong interest
in resolving distress. The risk of runs on a bank in distress and contagion implies
that speed of action in distress resolution is essential. Conventional liquidation and
restructuring procedures are too time-consuming to be applied to banks without
modiªcation. Como resultado, governments in most countries tend to intervene to pre-
vent bank failures of some magnitude. The moment the government intervenes, el
allocation of the banks’ losses becomes a political issue.
There is little doubt that the implicit insurance of creditors of banks is strong in most
European countries, and there is strong empirical evidence that implicit insurance
tends to be strong in countries with low explicit deposit insurance coverage (Ang-
kinand and Wihlborg 2008). The strong implicit insurance in Europe may have con-
tributed to the willingness of European ªnancial ªrms to buy more than one-third of
the securities backed by sub-prime mortgages in the United States. The implicit in-
surance of banks’ creditors is probably weaker in the United States due to the exis-
tence of a legal infrastructure for bank crisis management, including the system of
Structured Early Intervention and Resolution (SEIR). These procedures are dis-
cussed further subsequently.
There are observers, sin embargo, who argue that the implicit insurance of investment
banks and large commercial banks is strong in the United States as well (Brook
2008). This argument is based on the “too big to fail” argument. The failure of a
large non-bank ªnancial ªrm can contribute to systemic risk because of price and li-
quidity effects in securities markets. Any large ªnancial ªrm forced to liquidate as-
sets may put downward pressure on prices and, respectivamente, cause losses for other
ªnancial ªrms. Liquidity in the markets for particular securities may depend on rel-
atively few large ªrms serving as counterparties. Por esta razón, there is pressure
on the government to rescue such ªrms in order to avoid contagion. The Fed actions
with respect to Bear Stearns as well as other major U.S. banks during the current cri-
sis support this reasoning.
In spite of the “too big to fail” argument, it is hard to argue that investment banks
like Bear Stearns were considered truly protected and impervious to creditors’ mar-
ket discipline. As described in Cohan (2009), investment banks in general and Bear
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Stearns in particular built up large exposures to mortgage-backed securities using
the short-term, often overnight, unsecured commercial paper market for funding.
Managers of these ªrms must have been aware that this source of funding could dry
up quickly as it did in the fall of 2007. De este modo, the risk-taking behavior of these ªrms
cannot be fully explained by implicit protection. Failures of corporate governance
are considered subsequently.
Another source of implicit protection of creditors in the markets for mortgages in
the United States is the government backing of Fanny Mae and Freddie Mac. Estos
two ªrms were the largest buyers and insurers of mortgages with the explicit objec-
tive of making home ownership affordable. Although their activities may have con-
tributed to the magnitude of the sub-prime mortgage crisis they cannot be held re-
sponsible for the exposures of investment banks and commercial banks.
These explanations of implicit insurance of creditors and, en algunos casos, sharehold-
ers of ªnancial ªrms that may be considered systemically important, depend largely
on an unwillingness of governments to allow formal insolvency procedures to work
themselves out. These procedures may be considered too time-consuming for large,
complex ªnancial ªrms, En particular, and the procedures may force ªrms to liqui-
date assets rapidly with consequences for asset prices.
4.5.2 Distress resolution and insolvency procedures The difªculty of designing
efªcient insolvency procedures is caused largely by information problems regarding
the cause of distress and asset values. Collateralized loans and priority rules dis-
courage “runs” on the available resources of a distressed ªrm. A run can force a ªrm
into bankruptcy prematurely. In banking this “run problem” is particularly acute.
Although in some ways the roles of insolvency procedures for banks are the same as
for non-ªnancial corporations, the objectives of the procedures differ in important
maneras. These differences are explained by the special characteristics of banks and
other ªnancial ªrms as mentioned previously. Speed of action in distress resolution
is of the essence. Conventional liquidation and restructuring procedures are too
time-consuming to be applied to banks without modiªcation. The case of Lehman
Brothers in the United States indicates that the same argument applies to non-bank
ªnancial ªrms. This ªrm was placed in bankruptcy, which is time-consuming and
has an unpredictable outcome, hasta cierto punto, for many creditors with short-term
claims on the ªrm.
For the reasons mentioned, corporate bankruptcy and restructuring laws are not ap-
plied often in countries where banks fall under the jurisdiction of these laws. Fur-
thermore, few countries have special insolvency laws for banks and other ªnancial
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
ªrms.16 The main exception is the United States, which has implemented bank-spe-
ciªc insolvency procedures through the FDIC’s enactment of the Federal Deposit In-
surance Corporation Improvement Act (FDICIA) en 1991. A bank reaching a capital
ratio of 2 percent is put under the receivership of the FDIC. Speciªc rules for merg-
ing or allocating the assets of the bank exist. A number of small and medium-sized
banks have been closed this way since the beginning of the sub-prime mortgage cri-
hermana. Hasta ahora, the procedures have not been tested on a large bank. Además, the pro-
cedures do not apply to investment banks.
The pre-insolvency phase is of great importance in banking because of the difªculty
of evaluating when the net worth of a bank is zero in market terms. En años recientes,
prompt corrective action (PCA) normas, including structured early intervention at trig-
ger points while there is equity capital left (SEIR) have been advocated. An impor-
tant function of PCA rules is to allow intervention before insolvency occurs to reha-
bilitate or restructure a distressed bank. En los Estados Unidos, legally binding PCA
rules exist since FDICIA’s enactment. PCA rules are only effective if they are credi-
ble by being formalized in law.
Several economists have discussed the potential contribution of bank insolvency
law in enhancing market discipline in Europe, where speciªc bank crisis resolution
procedures have not been implemented.17 Without predictable rules for the alloca-
tion of losses, resolution will be delayed and, in the meantime, management and
shareholders of distressed ªrms are likely to avoid the realization of losses in vari-
ous ways.18
The European Shadow Financial Regulatory Committee (ESFRC) (1998) expressed
the objective of a special insolvency law for banks in the following way:
The implementation of insolvency law for banks . . . should achieve an accept-
capaz, low risk of runs and low risk of contagion while inefªcient owners and
managers exit. The contractual predictability of claims and the predictability of
bankruptcy and PCA-costs should provide efªcient ex ante incentives. By achiev-
16 In addition to the United States, Canada, Italia, and Norway have speciªc insolvency laws
for banks. The existence of a law does not necessarily mean that it is successful in the sense
that it achieves its objectives. If not, as in Norway, the law is typically not put to use. In Swe-
den, a law for public administration of distressed banks was proposed in 2000. The law has
not been implemented yet.
17 See Angkinand and Wihlborg (2006), Eisenbeis and Kaufman (2008), Goldberg, Sweeney,
and Wihlborg (2005), Huertas (2007), Hüpkes (2003), Krimminger (2005), Lastra and
Wihlborg (2007), Llewellyn and Mayes (2003), and Schiffman (1999).
18 The European Shadow Financial Regulatory Committee (1998) and Lastra and Wihlborg
(2007) discuss characteristics of special bank insolvency procedures.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
ing these objectives the government’s and the regulator’s fear of a system crash
should be alleviated. Thereby, non-insurance of groups of creditors and share-
holders would be credible.
4.5.3 Corporate governance in the ªnancial sector During the Swedish banking
crisis in the early 1990s, there were reports that the loan ofªcers who granted the
largest volume of loans won vacation trips to Hawaii. It is obvious that granting in-
centives for credit volume reduces the awareness of credit risk. Adding to the incen-
tives for volume competition in the early 1990s were widespread expectations—
based on the creation of a common European ªnancial market—that the European
restructuring of the banking sector would end up with eight large pan-European
universal banks before the end of the decade. De este modo, banking strategies tended to fo-
cus on volume and universality to create an advantage in the restructuring process.
Similar reports of incentives encouraging volume competition exist in the current
crisis. It is necessary to distinguish between the incentives of the originators of loans
and the incentives of those bearing the risk, sin embargo. The volume incentives of loan
brokers are obvious but one would expect that the loan originators set standards
and loan evaluation procedures for the brokers. Sin embargo, the ability of many sub-
prime mortgage loan originators to securitize the mortgages and, thereby, to transfer
the risk to the buyers of securities could have led to volume competition if prices
of mortgage-backed securities did not reºect risk. In hindsight, risk premiums were
too low. The question is then why the buyers of the mortgage-backed securities did
not properly assess risk and require greater risk-premiums. This question relates to
the role of rating agencies and quantitative risk valuation models, but also to the
compensation schemes for bankers, fund managers, and other investors in the mort-
gage-backed securities. A number of observers including the Federal Reserve gover-
nor Randall Kroszner have argued that remuneration schemes in the ªnancial sector
rewarded short-term proªts without incorporating longer-term considerations
where risk considerations become more important.19
The incentives of top bank and ªnancial ªrm executives must be considered as well.
Top executives are responsible for the remuneration schemes for managers on differ-
ent levels in the organization and for risk-management systems. In an effective cor-
porate governance system, executive compensation schemes should align the inter-
ests of executives with the interests of shareholders. There are many reasons to
suspect that corporate governance systems in the United States, as well as in many
19 At AIG, managers of one unit insuring credit risk were remunerated in proportion to earn-
ings from payments from issues of credit default swaps (CDSs). In the short term, estos
CDSs provided a nearly safe income stream at low cost, while the potential for losses
seemed distant.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
other countries, are not generally efªcient in this respect. Top executives are power-
ful in designing remuneration schemes that favor their own interests in such a way
that large losses do not have much impact on their remuneration.20 In general,
“huge bonuses are deposited and consumed long before the bad deals that gener-
ated them can slam investors.”21 Generous exit packages for corporate executives
that have been responsible for large losses can be motivated by incentives of divers-
iªed shareholders to discourage the risk-aversion of executives. This argument can
be questioned in the ªnancial industry, En particular, where risk management is the
primary business activity. Remuneration of executives based on short-term earnings
and equity prices in combination with generous insurance of executives against fail-
ure contribute to explaining the AIG business strategy as well as the high-risk Bear
Stearns strategy of rolling over short-term commercial paper to fund investments in
mortgage-backed securities.
Another consideration in the ªnancial industry is that incentives for shareholder
wealth maximization create incentives for risk shifting to deposit insurance agencies
and taxpayers to the extent there is explicit or implicit insurance of creditors as dis-
cussed previously. This moral hazard problem in banking is supposed to be counter-
acted by means of risk-sensitive capital adequacy rules and supervision. Aquí, nosotros
are back to the question of whether the explicit and implicit insurance of depositors
and other creditors affect risk-taking incentives.
Corporate governance systems develop in complex interaction between market in-
centives, law, regulación, and politics. The failures of corporate governance leading
up to the current crisis could be a reºection of a corporate law generally in the sense
that it enables management to extract large short-term beneªts at the expense of
shareholders. En cambio, corporate law may be sufªcient to serve shareholders’ in-
terests, but they may conºict with other stakeholders’ interests and societal inter-
ests. The existence of strong explicit and implicit creditor protection implies that
managers of ªnancial institutions do not have incentives to fully consider risk that
can be shifted to taxpayers and deposit insurance funds as noted above. In particu-
lar, they do not have incentives to consider systemic risk arising because of conta-
gion and market frictions as discussed above. In the ªrst case, the remedy must be
sought in general corporate law, whereas in the second case, policy incentives for
implicit insurance for banks’ stakeholders should be considered.
20 Often cited examples in the ªnancial sector are Stan O’Neal and Chuck Prince, who were
forced out of Merrill Lynch and Citigroup, respectivamente, in the face of large losses in the fall
de 2007 with exit packages worth US$ 161 million and US$ 42 millón.
21 Cohán (2008).
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
Executive compensation schemes in the ªnancial sector affect not only ex ante incen-
tives but they may have contributed to the failure of loss allocation and, por lo tanto, a
the systemic effects of the sub-prime mortgage crisis in two ways. Primero, the lack of
incentives to reveal losses could be associated with the incentives for short-term
proªts. Segundo, the separation of loan originators from those bearing the credit risk
may have ampliªed the effects of short-term incentives.
Believers in the efªciency of markets argue that it is in the interest of solvent
ªnancial institutions to reveal asset values at market prices to the extent possible to
distinguish themselves from the insolvent and the dubious ones. Thereby, ellos
would be able to access markets for funding at relatively favorable terms. Similarmente,
the ªnancial institutions that do not make a credible effort to reveal the quality of
their assets would be considered possibly insolvent and unable to gain access to
funding except at a high cost. De este modo, transparency is a consequence of market forces
according to this view.
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Why do we not observe stronger attempts by solvent ªnancial institutions to reveal
their losses quickly and credibly to gain access to markets and reduce funding costs?
One answer could be that they simply do not know. Not knowing does not mean
that they cannot provide a best estimate, sin embargo. It is more likely that they are
holding back because of a “collective action problem”; even the solvent institution is
disinclined to reveal its losses truthfully unless others do the same. Institutions that
reveal larger losses than others do risk being misunderstood and downgraded rela-
tive to others even if they are solvent. Además, top management, which is re-
munerated based on shareholder value and earnings, may be reluctant to reveal
losses and look worse than competitors in the short run. If remuneration were
linked to long-term performance, management would have less to gain from delay-
ing loss recognition and be less concerned with revealing losses even if others do
no. There is little doubt that the reluctance to reveal losses has contributed to the
lack of liquidity in markets for securities and derivatives. The reluctance to reveal
losses as transparently as possible contributes to an adverse selection problem in se-
curities markets since potential buyers may fear that more informed sellers try to
sell the worst assets ªrst.
The problem of liquidity cannot be blamed on incentives created by executive com-
pensation schemes alone. Claramente, accounting rules and transparency standards im-
plied by these rules play an important role as well. Much of the discussion of fail-
ures of corporate governance in the ªnancial sector is, by necessity, speculative.
There is clearly scope for much research to increase our understanding of gover-
nance structures in the ªnancial sector and their effect on incentives.
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
4.5.4 Uncertainty about the political process in times of crisis Expectations of
government intervention to bail out creditors and owners of ªnancial ªrms affect
more than just incentives for risk-taking and high leverage prior to ªnancial crises.
Once a crisis has erupted, expectations of bailouts and uncertainty about the exact
nature of the bailouts can be a source of friction in the process of loss-allocation.
These frictions can be ampliªed by attempts of different interest groups to inºuence
the political process.
During the autumn of 2008, the Fed created a number of facilities that enabled
ªnancial institutions to obtain loans at favorable terms against increasingly weak
collateral. Además, Estados Unidos. Treasury announced the US$ 700 billion Toxic As- sets Relief Program (TARP) in October 2008. The original TARP proposal was quickly shot down because several auction experts considered the suggested reverse auction unworkable for heterogeneous mortgage-backed securities. There was no agreement about other methods for the valuation of toxic assets. The availability of US$ 700 billion for crisis resolution—without political agreement on how to use it—
created incentives for intense lobbying efforts. The funds could be used to recapital-
ize ªnancial institutions or they could be used to help homeowners with negative
equity to slow down the tide of foreclosures. Small and relatively healthy ªnancial
institutions did not want to be left out. Corporations, estados, towns, and municipali-
ties felt deserving of aid as well.
In Europe, governments developed more or less explicit schemes for aid to the
ªnancial sector. The European approach to the crisis is discussed in Section 6. Allá
was political determination to prevent large-scale failures of ªnancial institutions
but the exact procedures were vague. Direct aid to those ªrms that had produced
the largest losses proved to be politically unpopular.
Expectations of aid in one form or another without knowing the exact nature of the
aid creates disincentives for ªnancial ªrms to address problems through their own
initiatives. Recognition of losses becomes delayed until the nature of the aid pack-
ages becomes known. In the current crisis, the lack of centralized clearing of credit
default swaps and other over-the-counter derivatives has contributed to frictions in
the allocation of losses. A relevant question to ask is whether expectations of gov-
ernment intervention are detracting from the organization of cooperative private
initiatives.
It is impossible to know the extent to which private initiatives would be forthcom-
ing to reduce the likelihood of contagion among ªnancial ªrms and to speed up loss
recognition. Credible commitments of no bailouts are not easily obtained in democ-
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
racies. If they were, the regulatory framework could substitute for private initiatives
and focus on institutions that enable insolvent ªnancial ªrms to be closed with a
minimum of contagion, as discussed previously.
4.6 Concluding remarks on institutional failures
The different institutional failures described here are not independent because they
interact in important ways. The lack of operational and credible insolvency proce-
dures for ªnancial ªrms stands at the center. Rule-based procedures for “structured
early intervention” and the closing of banks have been implemented in the United
Estados, but neither work effectively for banks that are “too big to fail” and to non-
bank ªnancial ªrms. Other countries lack effective and predictable procedures com-
pletely.
The lack of speciªc insolvency procedures for ªnancial ªrms implies that govern-
ments are compelled to issue far-reaching guarantees to creditors and even to share-
holders of ªnancial ªrms. These implicit guarantees affect risk-taking incentives of
ªnancial institutions, thereby increasing the likelihood of crises and the incentives of
ªnancial institutions to resolve problems without government bailouts. The risk-
taking incentives can also contribute to the existence of executive compensation
schemes that favor short-term earnings and discourage consideration of risk in the
longer term. Most likely, failures of a corporate governance system go deeper and
depend on corporate law more generally.
Valuation and transparency issues have not been addressed in any depth despite
their importance for crisis resolution. It can be argued, sin embargo, that transparency
and incentives for information revelation are largely endogenous relative to the ex-
plicit and implicit protection of creditors of ªnancial institutions, as well as to com-
pensation schemes. Weak incentives of creditors to monitor risk-taking create weak
incentives for information revelation. In times of crisis, information revelation is dis-
couraged as long as the political process for support is uncertain and subject to lob-
bying efforts.
5. Northern European ªnancial crises and the Swedish model for crisis
resolution
Four Nordic countries (Dinamarca, Finland, Norway, and Sweden) each experienced
severe ªnancial crises during a 10-year period beginning in the mid 1980s.22 These
crises had much in common with the current ªnancial crisis. En cada caso, había
22 The Nordic region consists of these four countries plus Iceland.
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rapid credit growth in a recently deregulated ªnancial environment. Lending by
banks and other ªnancial institutions was used largely for investments in commer-
cial property, fuelling big price increases. In Sweden, Por ejemplo, prices on ofªce
buildings in Stockholm increased 4.2 times in real terms from 1980 a 1990 mientras
prices for residential property doubled. When the property bubble burst, highly le-
veraged ªnancial institutions in the Nordic countries suffered big losses. In Den-
mark, the two largest insurance companies and a number of small and medium-
sized banks collapsed. When there was a run on the second-largest Danish bank, el
central bank had to guarantee its deposits. In Finland, the government guaranteed
all obligations incurred by banks while two of the largest banks were taken over by
el gobierno. The Finnish banking sector received capital injections from the
gobierno. In Norway, almost the whole banking system was nationalized when
the three largest banks were taken over by the government and a number of smaller
banks were merged after serious losses.
En el siguiente, we focus on the Swedish approach to crisis resolution since it has
received much attention during the current debate about resolving the ongoing cri-
hermana. The approach has been presented as a model to emulate by other countries.
Most writers on the subject in the international press have fairly limited knowledge
and sometimes misconceptions about the details of the model, sin embargo. In this sec-
ción, we revisit the Swedish approach to the crisis in 1990–94 and discuss the conse-
quences of speciªc aspects of the approach. We argue, “The devil is in the details.”
En particular, we draw attention to issues of selection and valuation of assets trans-
ferred to a “bad bank” and to potential conºicts of interests caused by the creation
and organization of the “bad bank.” These issues must be considered in any attempt
to resolve a banking crisis without allowing large-scale failures of banks.
5.1 The “Swedish model” in brief
The Swedish crisis had its beginning in September 1990 when a number of ªnance
companies could not reªnance themselves because of falling prices on commercial
real estate, En particular. The commercial banks were the important creditors of the
ªnance companies. Como resultado, the credit losses in the commercial banks increased
rapidly during 1991 y 1992. The credit losses amounted to about 6 por ciento de la
loan stock each of these years.
The crisis peaked during the fall of 1992 when the Swedish government and central
bank were ªghting pressures on the krona. They temporarily increased the marginal
interest rate for overnight borrowing to 500 percent in September before allowing
the krona to ºoat in November 1992 (Oxelheim 1996). By that time, one regional sav-
ings bank, one medium-sized private commercial bank, and one large state-owned
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
bank were insolvent. En el momento, the Swedish market was dominated by ªve large
commercial banks of which one was majority state-owned.
The main ingredients of the Swedish model formulated during the fall of 1992 eran:
a) A blanket guarantee of all liabilities of the commercial banks was issued in De-
diciembre 1992 to ease conditions for the banks’ short-term ªnancing. Al mismo
time a “Bank Support Board” was created to consider possible applications by
the banks for support.
b) The shareholders in the privately owned medium-sized Gota Bank were not pro-
tected when the government took over ownership of the bank for the price of one
krona (25 cents) in the autumn of 1992. The government recapitalized the bank
soon thereafter and the state became the owner. No large bank was nationalized,
sin embargo.
C) The relatively large majority state-owned Nordbanken was divided into a “good
bank” and a “bad bank” during the fall of 1992. The “bad bank,” Securum, ser-
came a separate company on 1 Enero 1993 with the objective of unwinding the
non-performing assets of Nordbanken. Securum as well as Nordbanken received
capital from the state and the sound part of Nordbanken became fully state-
owned. A similar arrangement was made for the smaller Gota Bank, then also
state-owned. The two state-owned banks were later merged, as were the two
“bad banks.”
Nordbanken and the dominating large, privately owned banks recovered quickly in
1993 once the blanket guarantee was issued and economic conditions improved af-
ter the krona was allowed to ºoat in November 1992. The krona depreciated sub-
stantially and interest rates fell. Nordbanken would certainly not have survived
without the recapitalization. It is unclear whether all the privately owned large
banks would have survived without the blanket guarantee of their liabilities. Macey
(1999) argues that owners and creditors of banks were unnecessarily strongly pro-
tected in the sense that a systemic crisis could have been avoided with less drastic
measures.
The general description of the different measures listed above is not sufªcient to
evaluate the costs and beneªts of the approach. En particular, the conditions associ-
ated with the separation of Nordbanken into a “good” and a “bad” bank affected
the outcome, as did the blanket guarantee of banks’ creditors. Próximo, we discuss how
the costs of the mentioned measures depend on coverage of protection, valuation,
and selection of assets transferred to a “bad bank.” We also include a comparison of
the objectives of “bad banks” and regular banks.
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5.2 The blanket guarantee, shareholders’ losses, and risk-taking
There is little doubt that the Swedish banks before the crisis were considered pro-
tected in the sense that most creditors were deemed safe although there was no ex-
plicit deposit insurance system. The banks had been controlled tightly until the mid
1980s and were treated like public utilities. Como resultado, the banks preferred cheap
loan ªnancing and capital was kept low. Bajo estas condiciones, the competition
among banks leaned toward volume competition, since the cost of funding de-
pended little on risk-taking. There are numerous anecdotes from the period before
the crisis about incentives. Credit ofªcers focusing on volume of loans to win trips
to exotic locations is one example. De este modo, the so-called moral hazard effects of ex-
plicit and implicit protection of banks’ creditors are likely to have played a role in
Swedish banks before the crisis.
The blanket guarantee that was issued in 1992 conªrmed the protection of creditors
even beyond expectations. The guarantee is likely to have created lasting expecta-
tions of creditor protection. The formal abolishment of the guarantee after the crisis
was not likely to have affected expectations substantially, since a guarantee can be
re-introduced easily as soon as it is deemed necessary.
The guarantee also protected shareholders indirectly. The banks’ costs of funding
were lowered to the beneªt of shareholders. Como resultado, share prices of the banks in-
creased immediately and continued to rise dramatically during 1993.
In the current crisis, we can observe a conªrmation of these effects. In Sweden and
other countries, banks have been “surprised” holding insufªcient capital, and new
expanded guarantees of creditors have been issued.
In the case of the privately owned, medium-sized Gota Bank, shareholders were not
protected. After failing to sell the bank as a whole, the state took over the bank for
one krona. The government wanted to demonstrate that shareholders would not be
protected. Sin embargo, the policy toward Gota Bank’s owners was contradicted by the
effect of the blanket guarantee on shareholders of the other private banks. One inter-
pretation of the differential treatment of the shareholders in Gota Bank is that this
bank was not big enough for stakeholders to receive protection beyond the formal
guarantee of creditors.
5.3 Asset selection, valuation, and competitive effects of a “bad bank”
There are two important issues to settle when forming a “bad bank” to manage and
unwind the non-performing assets of a bank: the selection of assets that will be
transferred to the “bad bank” and the valuation of these assets. These issues are
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rarely discussed in connection with “Swedish model” but they are critical for the ef-
fects of creating a “bad bank.”
In the Swedish case, the implementation of the “bad bank” model was limited to the
state-owned Nordbanken (including Gota Bank). This created potentially substan-
tial effects on the competitiveness of Nordbanken relative to the privately owned
banks. The magnitude of these effects would depend on the valuation of the assets
Nordbanken “sold” to the “bad bank,” Securum.
A second aspect of the selection issue was that Nordbanken was given free reign to
choose criteria for non-performing loans (NPLs) that were transferred to Securum.
The new management of Nordbanken took the opportunity to think through the
bank’s future strategy and to give the remaining sound bank a good start. The man-
agement kept only loans that would perform with substantial certainty and a large
number of them were transferred to Securum. De este modo, a number of small and me-
dium-sized businesses found themselves in the hands of Securum although they
were current with their interest and principal payments. Nordbanken was able to re-
duce potential costs associated with bankruptcies as well as costs of rescheduling
and forgiving loans to ªrms facing short-run distress. Competing banks did not
have the same opportunities. The consequences for businesses of Nordbanken’s
ability to choose which loans to keep are discussed subsequently.
The valuation of the assets transferred from Nordbanken to Securum also affected
competitive conditions. One model for valuation is that the bank receives a price
representing the market value of an asset, if there is a market, or the value of ex-
pected future cash ºows generated by an asset. En este caso, the bank is primarily re-
lieved of the risk associated with transferred assets while expected losses remain the
responsibility of the bank.23
A second model for valuation is that the transferred assets are valued above eco-
nomic value to recapitalize the bank. En este caso, the bank is compensated for losses
that have already occurred but have not been realized. In the Swedish case, the as-
sets transferred from Nordbanken to Securum were given a value substantially
above their economic value. This overvaluation contributed to the fresh start of the
nuevo, leaner Nordbanken while competitors were struggling to restore their capital
base in the face of substantial credit losses.
23 We neglect here that liquidity can drive a wedge between the market value and the present
value of cash ºows. This issue was not important at the time of the Swedish crisis.
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In the Nordbanken-Securum case, loans with a book value of SKK 67 billion were
transferred to the “bad bank.” The ofªcial price was set at SKK 50 billion, of which
SKK 23 billion were given to Securum as equity capital and SKK 27 billion were bor-
rowed from Nordbanken and backed by a state guarantee.24 The large capital infu-
sion reºected large expected losses for Securum in the process of unwinding the as-
conjuntos. Al mismo tiempo, Nordbanken was given an SKK 10 billion capital infusion.
This amount should also be viewed as a part of the price Nordbanken received.
De este modo, neglecting capital infusions into Nordbanken prior to its division, Nord-
banken received 60 billion for assets booked at 67 billion. At the end of 1993, este
value had been written down to 33.3 billion.25 If we assume that these losses were
expected at the end of 1992, the excess valuation of the assets transferred to the “bad
bank” amounted to 30–35 billion.26 Without this large overvaluation, Nordbanken
clearly would not have survived.
An evaluation of the wisdom of the Swedish model must consider what would
have happened if Nordbanken had been declared bankrupt. The bank was probably
not large enough to be considered a systemic threat and it can be argued that the
other large commercial banks could have recovered faster without competition
from a bank relieved of its NPLs. It should be noted, sin embargo, that there were no
formal procedures for handling the bankruptcy of a bank except the regular, tiempo-
consuming procedures for corporations. There was no attention to such procedures
until after the crisis.27
5.4 Conºicts of interest and unnecessary bankruptcies
The design of the Swedish model raises two types of conºicts of interest to consider.
The ªrst conºict arose because of Nordbanken’s ability to choose which loans to
keep and which loans to transfer to Securum. The conºict amounted to an issue of
equal treatment of borrowers. The second conºict is of a more ethical nature and re-
lates to managers’ ability to use information acquired on the job for personal gain.
We argued previously that Nordbanken’s right to choose criteria for NPLs may have
distorted competition, but it is likely that it also led to a large number of unneces-
sary bankruptcies and, thereby, large losses for individual business owners. El
management of Nordbanken took the opportunity to transfer loans that were up to
24 See Karlsson (2002).
25 See Jennergren and Näslund (1998).
26 Considering that the United States is more than 30 times larger than Sweden, the magniªed
“U.S. equivalent” overvaluation of Nordbanken’s non-performing assets was approximately
US$ 150 billion.
27 A government committee proposed speciªc procedures for bank bankruptcies in 2000 pero
no action was taken. The current crisis has revived the proposal.
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date with payments but had some likelihood of becoming distressed or costly for
the bank if they were to be rescheduled or partly forgiven. If these loans had been
transferred at “fair” prices, the bank would not have gained by transferring them to
the “bad bank.” If they had stayed within Nordbanken, some of the borrowers
would have continued to amortize their loans while others would have run into
difªculties with payments but not to such a degree that the bank would have gained
by declaring them bankrupt. These ªrms would have activities that were sustain-
able in the long term but survival would have required some debt forgiveness. En
esta situación, it would have been advantageous for Nordbanken to help the ªrms
survive by accepting some loan forgiveness. By selling loans of this type to Securum
at excess prices, the bank was able to avoid ªnding itself in a situation where it
would be compelled to reschedule or forgive loans.
The task of contributing to a reconstruction of a ªrm with excess debt can be consid-
ered part of an implicit contract between a bank and a borrower. If Nordbanken had
reneged on this implicit contract, it would not have had any consequences if bor-
rowers had the same opportunities for debt restructuring with Securum. Securum
was not a bank, sin embargo. The ªrm with its existing owner would have had to obtain
ªnancing from another bank to avoid bankruptcy. The problem the ªrm faced was
that it had been classiªed as non-performing by Nordbanken when the loans were
transferred to Securum.
The main task of Securum was to unwind its assets over time and to recover as
much value as possible. The “bad bank” was not likely to play the role of a “house
bank,” however. The industrial expertise may have been lacking and even if it ex-
isted, it would have had to convince other banks that some of its assets were per-
forming or potential buyers that businesses were viable at reduced debt ratios in
spite of having been abandoned by Nordbanken. It is not surprising that the ªrms
with loans that had been transferred to Securum had difªculties ªnding new bank-
ers. Nordbanken was best informed about the ªrms in terms of hard and soft infor-
mation and it had classiªed the loans as non-performing. Bergström, Englund, y
Thorell (2003), who conducted a generally positive study of Securum, noted that a
relatively large share of Securum clients were declared bankrupt in comparison with
ªnancially comparable clients of other banks.
A Swedish study concluded that the frequency of bankruptcies was unnecessarily
high in Sweden at the time as a result of an unwillingness of banks to supply bridge
ªnancing or debt relief to ªrms with viable activities.28 The study may be ºawed be-
28 The study was conducted by the Swedish Employers Federation based on interviews of au-
ditors and bankruptcy lawyers.
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cause it was conducted with some stakeholder interest but its conclusions are sup-
ported by the large number of court cases after the crisis involving Nordbanken and
Securum in particular. In these cases, Nordbanken was sued for reneging on credit
promises. Business owners were not successful in court, sin embargo, because the con-
tracts they referred to were unwritten.
The second type of conºict of interest that has been linked to Securum arose as a re-
sult of the ability of management and employees to use information about assets ac-
quired on the job for personal gain after leaving their jobs.29
5.5 The devil is the details
A “bad bank” of the type Securum represents can contribute to a banking system’s
recovery in a banking crisis if there are widespread expectations that property or
other asset prices will recover after some years whereas rapid assets sales will cause
large losses for the banks. A separate state-owned ªrm can unwind the assets at a
slower pace than a bank without facing liquidity constraints and thereby recover as-
set values more easily than the bank could.
In the current crisis, many banks hold assets they cannot sell at prices that they con-
sider reºections of economic values. The low liquidity, meaning that there are few
potential buyers, depends largely on uncertainty about asset values and potential
buyers’ suspicion that sellers are trying to sell the worst assets ªrst. Aquí, the values
of the banks become uncertain as well. En este caso, the state can enter as a buyer
and remove the uncertain assets from the banks’ balance sheets. The devil lies in the
details, sin embargo. The valuation of the assets determines the extent to which taxpay-
ers take over losses that contractually should be taken by shareholders and unin-
sured creditors of the banks. In case assets are overvalued, the greatest subsidy
tends to go the shareholders and the creditors of the banks that are responsible for
the largest losses. Selectivity in the purchase of assets from different banks contrib-
utes further to competitive distortions.
In the Swedish case, assets transferred to a “bad bank” were valued far above eco-
nomic values at the time and only the state-owned commercial bank received the
implied subsidy. The non-state owned banks dominating the market remained sol-
vent and did not receive similar subsidies, but their cost of funding was lowered
due to the blanket guarantee of liabilities. Such guarantees can be costly, sin embargo,
since incentives of banks’ creditors to consider risk are weakened. Conºicts of
interest relative to clients of banks arise if the banks are given the opportunity to
29 See Björk (2008).
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determine whether assets are “non-performing” themselves. The Swedish case also
indicates that managers and employees of the “bad bank” may obtain inside infor-
mation that can be used for personal gain unless rules of ethics with respect to the
use of such information are introduced.
6. European proposals for crisis resolution and ªnancial sector reform
Differences between Europe and the United States in their approaches to the crisis
can be explained by the greater decentralization of ªscal and regulatory authority in
Europa. Fiscal policy, as well as ªnancial sector regulation and supervision, is a na-
tional responsibility in Europe, whereas monetary policy within the euro area is cen-
tralized to the European Central Bank (BCE). The UK, Dinamarca, Suecia, and Nor-
way, as well as most EU members in Central and Eastern Europe, have independent
currencies and central banks, sin embargo. Even within the euro area there is ambiguity
with respect to the “lender of last resort” role of the ECB relative to the national cen-
tral banks that participate in the ECB.
The less aggressive approach of the ECB relative to the Fed in the United States in
the current crisis can be explained by the lack of legal authority of the ECB to initiate
lending programs to banks without sound collateral. The ECB is not in a position to
risk taxpayers’ money in all member states the way the Fed has by opening facilities
for lending against weak collateral to a variety of ªnancial institutions. Most crisis
management authority lies on the national level where ªscal resources can be com-
mitted. Sin embargo, the European Commission and the ECB can issue recommenda-
tions and act as agents for coordination.
Además, stimulus programs must be decided on the national level since the EU
has no ªscal policy authority. There is no consensus with respect to the required
magnitude of stimulus packages and the extent of government intervention to res-
cue ailing industries. En general, there is currently greater skepticism in Europe than
in the United States with respect to large deªcits as a way out of the crisis. Never-
theless, a European Economic Recovery Plan (EERP) was agreed upon in the EU in
December 2008. This plan committed governments to deªcit ªnanced stimulus
packages amounting to £ 400 million over 2009 y 2010 correspondiente a 3.3 por-
cent of GDP. Aid to speciªc industries is constrained by EU rules with respect to
state aid. Protectionist tendencies in various countries can also be reigned in to an
extent by EU rules with respect to free and fair trade.
Crisis management with respect to the ªnancial sector has also been discussed on
the EU level, although decision-making powers remain on the national level. Coor-
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dinated action was agreed upon on the EU level during the fall 2008. The policy
measures included recapitalization of banks and guarantees to prevent “melt-
downs” of large banks and to restore liquidity in ªnancial markets. The European
Commission presented a communication to member states to guide them in design-
ing measures to deal with toxic assets in such a way that state aid rules within the
EU would not be violated. The alternative measures presented included state pur-
chases, state guarantees, and swapping or hybrid arrangements. Banks holding
toxic assets should disclose them to national supervisors.
Banks’ liabilities were also guaranteed beyond the deposit insurance schemes exist-
ing before the crisis.30 The extent of these guarantees varies from country to country
depending on the ªnancial health of the banking system in each country. It is proba-
bly fair to say that banks’ liabilities have been almost completely guaranteed in
most EU countries even if blanket guarantees have not been implemented.
The European Commission has been active in developing principles for a new
ªnancial regulatory framework. A set of principles was developed before the G20
London Summit on 2 Abril 2009. In a communication, the Commission “invites the
European Council” to take a number of steps with respect to long-term reform of
ªnancial sector regulation and supervision with the objective of creating “responsi-
ble and reliable ªnancial markets for the future.”31 The Commission proposes a new
reform program including:
(i)
(ii)
the creation of a European body to oversee the stability of the ªnancial system
as a whole;
the development of an architecture of a European ªnancial supervision sys-
tema;
(iii) regulatory and supervisory standards for hedge funds, private equity and
(iv)
(v)
other systemically important market players;
the development of tools for early intervention;
initiatives to increase transparency with respect to complex ªnancial prod-
ucts;
increased quantity and quality of capital for trading book activities;
(vi)
(vii) actions to establish a more consistent set of supervisory rules;
(viii) marketing safeguards for retail investment products;
(ix)
the strengthening of measures to protect bank depositors, investors, and in-
surance policy holders;
30 The co-insurance in the pre-crisis UK deposit insurance system has been abolished. The run
on the Northern Rock bank in the UK was blamed on co-insurance.
31 Commission of the European Communities (2009).
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(X) measures on responsible lending;
(xi)
the improvement of risk management through alignment of pay incentives
with sustainable performance;
the strengthening of recommendations on remuneration of directors; y
the implementation of measures to ensure sanctions are more effective.
(xii)
(xiii)
This list is impressive in its scope but it obviously is a list of intentions based on ex-
periences of the current crisis. The list demonstrates the Commission’s intentions to
push far-reaching reform.
When comparing this list to the discussion of institutional failures in Section 4, el
absence of attention to procedures for closing or otherwise dealing with insolvent
ªnancial institutions is glaring. Item (iv), the development of tools for early inter-
vention, is the closest the Commission comes to insolvency procedures. There is also
no mention of problems caused by banks being “too big to fail” and measures that
could enhance the role of market discipline. On the contrary, in item (ix) it seems
that the Commission wants to expand the scope of explicit protection of depositors
and investors.
The most interesting aspect of the Commission’s list is its attention to risk manage-
mento, pay incentives, and remuneration of directors in items (xi) y (xii). Failures
of corporate governance systems to produce effective incentive structures in the
ªnancial sector were discussed in Section 4. Remuneration policies in the ªnancial
sector have received much attention in the EU recently and the Committee of Euro-
pean Banking Supervisors (2009) has developed “high level principles for remuner-
ation policies” in the ªnancial sector. The guidelines developed by the Committee
are intended for both ªnancial ªrms and supervisors. En otras palabras, the intention
is to bring remuneration policies under the scope of supervision.
The principles developed for remuneration refer to objectives, internal and external
transparencia, decision-making with respect to remuneration as well as rules that are
more speciªc for measurement of performance and form of remuneration. The Com-
mittee states explicitly that remuneration should not encourage excessive risk tak-
En g, measurement of performance should include adjustment for risks and cost of
capital, and bonus payments should not be upfront cash payments but contain a
ºexible deferred component that considers a risk-horizon of performance.
These principles provide the foundation for far-reaching intervention in remunera-
tion policies in the ªnancial sector. The danger with such intervention is that incen-
tive effects of remuneration policies are not easily understood. Lacking market disci-
pline on risk taking and indirectly on incentive structures, there are reasons to be
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skeptical about supervisors’ ability to inºuence incentives effectively as well as
efªciently.
7. Implications for economic policy to enhance ªnancial stability in
emerging economies
We turn ªnally to policy implications from an emerging market perspective. Three
types of economic policy in a ªnancial crisis have been discussed. Primero, legal, regu-
latory, and political institutions can contribute to reducing the likelihood that shocks
to the system cause ªnancial crises. Segundo, crisis resolution procedures are required
once a large part of the ªnancial system is distressed. Tercero, macroeconomic policy
including exchange rate arrangements can be conducted to minimize the impact of
shocks and to contribute to an economic recovery. The policy implications for a par-
ticular country would depend on whether it has its own ªnancial crisis or whether
foreign interest rates and demand conditions have affected domestic economic ac-
actividad.
It has been argued that ªnancial systemic effects of an event disrupting the ªnancial
sector can be minimized by the existence of appropriate contractual, legal, regula-
conservador, and political institutions. These institutions would reduce frictions in the allo-
cation of losses caused, Por ejemplo, by the bursting of a real estate bubble by reduc-
ing incentives to delay the allocation of losses in accordance with contractual
arrangements. Such delays contribute to contagion and to the reduced supply of
credit from ªnancial ªrms with uncertain survivability and from investors in
ªnancial markets. The institutions should also contribute to minimizing the incen-
tives in ªnancial ªrms to shift risk to deposit insurance funds and taxpayers.
The institutional failures emphasized here are the implicit protection of creditors
and sometimes even shareholders of ªnancial ªrms; lack of credible, formal insol-
vency procedures for ªnancial institutions and corporate governance systems in the
ªnancial sector; and the failure of the political process to determine principles for al-
location of losses rapidly and credibly. At the center stands the lack of operational
and credible insolvency procedures for ªnancial ªrms. Rule-based procedures for
“structured early intervention” and the closing of banks have been implemented in
the United States but they do not apply effectively to banks that are “too big to fail”
and to non-bank ªnancial ªrms. Other countries lack effective and predictable pro-
cedures completely.
The lack of speciªc insolvency procedures for ªnancial ªrms implies that govern-
ments are compelled to issue far-reaching guarantees to creditors and even to share-
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holders of ªnancial ªrms once ªnancial institutions are weak and insolvency or the
near-insolvency of banks and other ªnancial ªrms threaten the functioning of the
ªnancial system. Policymakers face the problem of minimizing the effects of a possi-
ble credit crunch caused by banks’ need to build up capital. The “bad bank” model
used in Sweden in the early 1990s illustrated the difªculties and potential costs of
conducting such policies. Competitive effects of the valuation of the “bad assets”
must be considered as well as the selection of assets transferred to the “bad bank”
according to rules that minimize potential conºicts of interest.
The extent to which regulation itself contributes to systemic effects in a ªnancial cri-
sis has not been addressed directly. Sin embargo, the “too big to fail” argument for im-
plicit protection of ªnancial ªrms and their stakeholders can be considered a result
of a regulatory failure. The BCAF does not consider the potential systemic contribu-
tion of a particular ªrm’s failure. It actually favors large ªnancial conglomerates.
The ESFRC (2009) recommended that systemically important ªnancial ªrms should
be required to keep a relatively high capital ratio.
In the lack of effective institutions that may prevent or reduce the likelihood of sys-
temic consequences of a large shock in ªnancial markets, policy must focus on creat-
ing a stable macroeconomic environment without strong incentives to build up lev-
erage. Macroeconomic policy can also contribute to making the impact of de-
leveraging as rapid and painless as possible. The design of such policy is highly
controversial and beyond the scope of this paper. Frictions in labor and product
markets would be important for evaluating alternative policy responses.
Turning to the current ªnancial crisis and implications for emerging market econo-
mies without “home-grown” ªnancial crises, there is little doubt that many coun-
tries are or will be seriously affected by a de-leveraging process in the United States
and Europe. The experiences from the Great Depression and from the Japanese crisis
suggest that de-leveraging may stretch over a prolonged period. The experience
from the Nordic crises is more optimistic. The recoveries in Finland, Norway, y
Sweden were supported by large-scale exchange rate depreciations in 1991–92. El
introduction of ºoating exchange rate regimes aided recovery by making it possible
to lower the interest rate and stimulate the demand for exports. This possibility of
using exchange rate depreciations to exit from a ªnancial crisis seems, sin embargo, a
be an option that is limited to small open economies.
A prolonged period of suppressed demand in the advanced industrial economies
implies a radical change in the economic situation of the emerging economies. Eco-
nomic growth in the emerging economies has, during the last decade, been sup-
215
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ported by the strong growth in private consumption and investment, which has
taken place in the United States, the UK, and a number of continental European
countries.
A weakening of demand in the advanced industrial economies will affect economic
growth in the emerging economies through several channels. Primero, a reduction in
private consumption and investments in the advanced industrial economies will
spill over into lower import demand. As a second channel, a lower demand will di-
minish the wage pressures in the advanced industrial countries and will thus make
enterprises from these countries more competitive. The weaker cost pressures in
home markets will make ªrms from the advanced industrial economies less inclined
to shift production to low-cost locations. We may thus expect a reduction in direct
investments to the emerging economies. Finalmente, as a third channel, a reduction in
demand will increase competition in goods markets, implying that producers from
emerging economies will face a harder time when they try to expand their produc-
tion through exports. Enterprises in the advanced industrial countries will try to re-
capture home markets, thus driving out competitors from the emerging economies.
The consequences of increased risk-premiums in markets for debt instruments have
hit the Asian economies through channels familiar from previous crises. In particu-
lar, there has been a capital outºow as investors have withdrawn to countries that
are considered safe heavens, in particular the United States. The credit spread be-
tween securities issued in emerging economies and securities issued by issuers in
the advanced industrial countries has widened. During the stock market crash in
Octubre 2008, stock prices in the Asian countries showed a bigger decline than in
the advanced industrial economies. Due to capital outºows, the currencies of sev-
eral emerging economies have come under pressure.
Another consideration from an emerging market point of view is that the economic
crisis will increase pressures on policymakers in the advanced industrial economies
to pursue protectionist policies. During previous economic downturns, national pol-
icymakers have resisted such protectionist pressures. Sin embargo, the present crisis
may turn out to be more prolonged than previous crises and the effect of the current
crisis on broad segments of the population is likely to increase political pressures for
protectionism.
On a positive note, pressures may develop within the emerging economies for the
introduction of ºoating exchange rate systems. Until now, exchange rate policies,
which have involved varying degrees of exchange rate ªxity vis-à-vis the U.S. dol-
lar, have worked to the advantage of the emerging economies. De este modo, the ªxed ex-
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Orígenes y resolución de las crisis financieras: Lecciones de la crisis actual y del norte de Europa
change rate has made it possible to take full advantage of the strong import demand
from the United States and, at the same time, it has improved ªnancing conditions
through easier access to the international capital markets. The United States has sim-
ilarly seen an advantage in the ªxed exchange rate policies because this has worked
to keep down the real interest rate by facilitating capital imports from the emerging
economías. Sin embargo, in the current situation, a ºoating exchange rate will allow the
emerging economies to pursue more expansive economic policies, thus bolstering
production in the face of lower demand from the advanced industrial countries. A
ºoating exchange rate system will further make it possible for emerging economies
to exploit the savings glut for their own advantage, making it possible to maintain a
low interest rate, which will beneªt industrial development.
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