Date: 2009-02-10
Speaker: DANIEL E. LUNGREN (republican)
Chamber: H
State: Cali

fornia. Madam Speaker. in light of the announcement of the Treasury Secretary of a new version of the financial rescue package. I wish to consider a broader context. historical context. perhaps. to gain a better understanding of how we may best serve our efforts to stabilize our banking system and unlock credit for our path to economic recovery. In a recent report by the IMF. there have been a number of financial crises in the postwar era indicated. However. two examples stand out as relevant to our own difficulties. During the past decade. Japan and Sweden suffered financial and economic trauma that involved substantial similarities to the current challenges facing us. However. it is the nature of the very distinct responses of these two nations which warrant our attention. Charles Kindleberger. in his classic work "Manias. Panics. and Crashes." explains the situation confronting Japan in the early 1990s. The bubble in Japan reached its crescendo in 1989. Real estate prices had been skyrocketing. and the banks even developed new financial instruments like the 100year. threegeneration mortgage. In a story that sounds all too familiar. when the bubble burst. Japanese bank loans slowed. and as the availability of credit declined. distressed sales caused real estate prices to decline. By 1991. stock prices had fallen by 60 percent. and it was not until 2003 that the stock prices in Japan returned to the level that they had been 20 years earlier. To put this into perspective. it will be remembered that seven out of 10 of the worlds largest banks were Japanese at the beginning of the 1990s. Before the decade was over. these financial giants were insolvent. They remained in business only because of an understanding that the Japanese government would keep them afloat. One of the reasons the comparison of the Japanese and Swedish financial bubbles is helpful to us is that it reflects the role of an increasingly intertwined global economy. As Kindleberger points out. the bubble in Sweden was largely affected by the offshore branches of banks headquartered in Tokyo and Osaka. The surge in the flow of loans from these banks led to the increase in real estate and stocks in Sweden. -Before all was said and done. the price of real estate in Sweden was to rise even faster than it did in Japan. In a presentation of the Kansas City Federal Reserve Bank. Swedens former Central Bank chairman. Urban Backstrom. pointed to a number of factors which led to the Swedish bubblean expansionary monetary policy similar to prebubble Japan. a tax policy that favored borrowing. sizable current account deficits. and an explosion of Swedish debt. Within 5 years. the rate of debt to the gross domestic product rose from 85 percent to 135 percent. This credit boom led to a resulting boom in real estate prices. The speculative bubble had been created. and the Swedish economy became vulnerable to an implosion. In seeking to rectify policies that had led to high inflation and high nominal interest rates. asset prices began to fall and economic activity headed south. Between the summers 6f 1990 and 1993. Swedish GDP dropped by 6 percent. unemployment rose to 12 percent. and the banking sector had loan losses of 12 percent of the gross domestic product. What is perhaps most instructive is for us to consider how differently these two nations responded. The response of the Japanese government was largely predicated on the "understanding" that it would keep the banks afloat. The absence of any systematic overarching policy frame-. work led to what could be best characterized as an ad hoc approach. And as a consequence. the Japanese financial system consisted of a large number of "zombie banks" which had the effect of undermining the confidence in the banking system. Furthermore. this unwillingness to address the reality of insolvent institutions rendered the banking system as a whole insolvent. The response of the Swedish government to its financial collapse contains noteworthy contrast. This was explained by Swedish Central Bank Chairman Urban Backstrom. Due to the serious nature of the Swedish financial crisis. efforts were made to maintain the bank systems liquidity. Significant emphasis was given to the need for transparency and a realistic disclosure of expected loan losses. Banks applying for support had their assets valued by the Bank Support Authority using uniform criteria. In order to minimize the problem of moral hazard. the bank guarantee provided protection from losses for all creditors except shareholders. A separate authority was set up to administer the bank guarantee and to manage the bank that faced solvency problems. The clear distinction between the Swedish model and the Japanese model was an overarching set of rules rather than a series of ad hoc responses. In contrast to their Japanese counterparts. the Swedish government quickly wrote down the value of bad assets and did not prolong the agony for the economy. Sweden. unlike the Japanese government. did not have an understanding that insolvent banks would be forever protected. We ought to look at the Swedish model.