Sweden has been one of the countries to have best weathered the economic crisis. Despite a hiccup in its domestic economy and the extra deflationary impulse from souring loans to the Baltics in 2009, the Swedish economy has been remarkably resilient. Yet, the economy has begun to falter, in large part because of its connectedness to the euro zone. The Swedish central bank, the Riksbank, has cut interest rates to 1% as the economy slows. But it is housing inflation and the related high levels of household debt which are the true Achilles heel for Sweden.
Over the past few days, I have highlighted a number of posts on the Swedish economy in the links and promised to say a bit more about Sweden in a separate post. Fred Sheehan beat me to it with the last post here at Credit Writedowns on Sweden and Canada. I recommend reading his analysis. I want to frame the issues from my point of view, however.
Before the global financial crisis began in earnest, I had begun to sound the alarm on the four most vulnerable bubble economies, the UK, the US, Spain and Ireland. In August 2008, I looked at two response models from the 1990s for dealing with the crisis I believed would come. First, I looked at Japan’s crisis response and decided it was unclear whether the Japanese response helped or hindered the economy in recovering. On the other hand, I called the Swedish banking crisis response a model for the future because the Swedes wrote down asset valuations quickly, liquidated their banks’ bad debts and separated liquidity and solvency concerns quickly.
In my view, of the bubble economies, Ireland has most closely followed the Swedish response model though the euro tether and the large size of Irish bank balance sheets relative to the size of the domestic economy has hindered Ireland’s success relative to Sweden’s in the 1990s. Moreover, Sweden didn’t really nationalise its banks as is assumed. The UK and the US have more closely followed the Japanese model and I am sceptical about how long-lasting the reprieve this will give these countries. We will be able to understand more clearly during the next economic downturn as we did in Japan in 1997. Spain is now being forced into an Irish-style response, again with less success because of the currency, the socialization of losses, increased state liabilities for a currency user state, and the relative size of the bad mortgage loans.
Yet, during this particular downturn Sweden has not done what it did in the 1990s. About the time I was extolling the Swedish 1990s banking crisis response, the Swedish daily Dagens Nyheter was pointing out that the IMF considered Sweden’s house prices even more overvalued than US housing. Sweden’s response this time was to cut interest rates to zero percent and even charge banks 25 basis points for holding reserves in an effort to get them to lend. Politically, it is much easier to try to recapitalize the banks through higher margin spreads in a steeper yield-curve environment. The Swedish reflation approach re-ignited the concerns about a bubble as early as 2009. But, unless the bubble collapses and problems are as severe as they are in Spain and Ireland, everyone tries to do it this way.
That brings us to the recent articles on Sweden. As I mentioned earlier, Sweden’s housing overvaluation was higher than the United States’ in 2008. And while prices have fallen 6% in real terms since the peak, house prices are still very highly valued after what Macro Business, a widely-read Australian economics blog, calls an increase in house price of 165% in real terms from 1996-2010. This has left behind a mountain of household debt.
While the pace of credit growth has eased, household debt still reached a record 173 percent of disposable incomes last year, the central bank estimates.
That far exceeds the 135 percent peak reached at the height of Sweden’s banking crisis two decades ago. Back then, the state nationalized two of the country’s biggest banks after bad loans wiped out their equity. Nordea Bank AB is the product of a series of state-engineered mergers born of that crisis.
So house prices in Sweden were more overvalued than prices in the US in 2008. House prices in the US fell by a third and they fell by 6% in Sweden. Meanwhile Sweden’s household debt levels are now higher than they were when they suffered a banking crisis twenty years ago. In my view, this combination is what makes Sweden vulnerable.
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