US lending doesn't follow the Nordic crisis

I have Nordic background, being half-Swede. Luckily I am also half-Polish so there is more than a large dose of common sense about affairs that also help me out culturally. In the aftermath of the Nordic Banking crisis of the 1990's, the Director Monetary and Exchange Affairs Department, Stefan Ingves at the IMF had a perspective speech that he gave in 2002, and while many are pointing to the similarities in what the US should do, lets see if there is basis for that in the original problem. I will paraphrase heavily, but hope to retain the gist of his overview. In that overview he gives the following as causes for the Nordic Banking crisis:

1. Bad banking - Not only poor lending practices but lack of internal oversight and a culture aimed at gaining market share. There were few incentives to make prudent loans for bank managers or lending officers and there was no accountability when they did hand out loans to those with high risk background.


2. Inadequate market discipline - Lack of transparency in lending practices leading to financial institutions being unable to judge the health of banks. Weak legal institutional and legal frameworks to ensure good banking practices. "Expectations of depositor and creditor bailouts may overpower any policy to the contrary."


3. Weak regulatory and supervisory frameworks - Concentrated lending, portfolio mismatches and inadequate loan valuation. This lead to an overstatement of profits and working capital, as well as leading to poor market valuation. A prime cause here is also a lack of managerial staff to properly process and analyze investments, with such staff being inadequate and/or poorly paid.


4. Inadequate macro policies and adverse macroeconomic developments - This created lending booms, excessive capital inflows, changes in the tax code to incentivize this. This lead to real estate/equity price bubble markets, a slowdown of exports, failing profitability in real estate markets, rising deficits for those institutions, current pricing accountability for institutions and the markets they were in, lower investment, weakening of the public to sustain the growing debt, and sharp exchange rate changes. As noted not all of these *can* be regulated. And then premature liberalization of lending practice rules.


5. Contagion - The weakness and decay in one bank spreading rapidly throughout the banking sector.

The US has seen some of this going on, of course, but it is telling that in the Nordic crisis, as in the US, there was a government involvement in all of these areas that led to those problems. There are some underlying causes in the Nordic countries in the 1990's that are specific to them, however, and without understanding those, the generic 'problems' area cannot be properly assessed. Some of these are marked dissimilarities and others are very close to the current US crisis, so paying attention to them means being able to weight those differences against our current problems.

Mr. Ingves looks at those as follows:

1. Bad bank management - Banks run by small groups of individuals or families, who treat the bank as a 'personal piggy bank' for themselves. That makes both bank managers and the owners problematical in having oversight capability as it is highly biased to the personal interests of the owners. Some owners sought to conceal these problems via off-shore institutions owned by their banks, very much like how the BNL scandal of the early 1980's had separate accounts to give regulators one set of numbers and hide a complete 'bank within a bank'. State owned banks (those licensed or run by governments) had this from the directional side of those governments, with implicit and explicit instructions to run poor lending practices to the benefit of politicians. State run or regulated institutions often do not have the level of accountability or scrutiny applied to them that private institutions have. "The clean up cost is often very large measured as a percentage of GDP."


2. Macroeconomic sustainability constraints - Larger, better capitalized nations fare better than smaller ones in banking problems. While the Asian and Nordic crises would shock their respective regions, the economies, though hard hit, would remain without collapsing. Smaller countries have to put their creditability of their nation behind such bad banking so as to not have a full collapse of their systems. Thus the Nordic Crisis was, for all its pain, mild in comparison to something like what happened in Argentina or Turkey. The Nordic countries were already used to 'micro-managing' and were able to utilize those skills to address the crisis well and quickly, as they had practice in things going wrong with larger institutions.


3. Ability of political systems to make decisions in the public interest - That is in the interest of the public, not public officials. Politicians need to absorb the losses equally across the political spectrum when such a crisis happens, and not politicize it. Banking ownership and structures in many countries prevent this from happening, and government representatives are willing to take a 'do nothing' approach rather than act in the public interest. Supervisors often lack legal protection to allow them to help bring the problems to light and to identify the problem areas involved, thus making the ability to understand what is going on harder. Again, the Nordic countries have a good cultural system which helped here.


4. Access to well-trained staff, with personal integrity - When the Nordic countries couldn't find good, local help, they hired from the outside from reputable organizations or individuals with skills necessary to address the problems. Again the cultural requirement for high degrees of personal honesty and integrity play heavily into this area for being able to manage the crisis.


5. Size and economic importance of banking system - The banking crisis was small in comparison to overall GDP. Many Asian countries had banking systems with a size of over valuated assets equal to 200% of GDP. The very small size of the banking sector in comparison to productivity helped the Nordic countries out immensely and caused very little exposure to deeper losses and long term economic stagnation.

So the US does have some fundamental equivalencies, but also some very stark contrasts with the Nordic banking crisis.

First up is the very nature of the institutions involved. Unlike the Nordic countries, the US does not have banks treated like personal piggy banks by families and small groups. That was the S&L scandal of the 1980's. So that is put by the side as a major causative factor.

Second up is federal influence in lending practices. Here this is more than just a mild equivalence, but a strong one and the primary cause. Fannie Mae and Freddie Mac are explicitly backed federal organs with 'private ownership' which boils down to private investment with the actual lending institutions being led by political cronies appointed by Presidents without oversight. In the atmosphere of increased home ownership lending spurred on by Congress, and then pressured by Congress by seeking to ease monetary policy, these quasi-federal organs then lobbied Congress to remove more constraints on bad lending practices so they could do more of them. Today there are Congressmen who are *still* pushing for allowing borrowers to keep their homes, even though they cannot pay the rates they agreed to... rates pushed on the industry by Congress reducing the amount a borrower had to put down to get FHA mortgage backing.

Third is weakness in oversight. Here, again, it is mostly federally backed institutions with the exception of AIG that made imprudent decisions based on the expected continuation of bad lending practices pushed by Congress. The idea of a bailout in one sector with a bunch of bad loans now gets another sector, those backing auto loans, to seek the exact, same protection and expectation of a bailout for *their* poor lending practices that depended heavily on the flow of easy money for home loans to then allow consumers to live well outside their financial capability and add a new car to the mix.

Fourth is the cultural attitude of responsibility and honesty that saved the Nordic countries. It is wholly absent from the federal side, after having pushed *in* those with political agendas to Fannie and Freddie: these individuals have no want nor need to hold themselves accountable, to point out crony loans or to even worry about the fact that these are public funds they are backed by. Lobbying Congress for politically targeted loans for those who cannot afford them as a way to garner political support then gets Congressional pressure *not* to be honest and uphold accounting standards when reviewing these organizations by other Federal organs, like the Federal Reserve. This becomes a multi-party, multi-President problem going back decades to slowly remove honesty and accountability from the system, not add it in.

Fifth is the size of the economy and the effect of boom/busts in various sectors. Starting in 2000 a large bust cycle in technology stocks was rocking the Nation and that would further be rocked by the 9/11 attacks that would severely hit the real estate market in NYC and the global insurance underwriting market for all the claims that came in due to those private structures coming down. The vast size of the US economy in 2001 weathered that and even showed a small GDP *increase*. With a market bust and a massive terrorist attack that hit the financial center of the US and the world, the United States *still* managed to grow. Those two, combined, would lose more value to the economy in an infrastructure way than the Fannie and Freddie mess will do in a personal way, and yet it is the violins trotted out for those personal losses that seek to get public underwriting for them. After 9/11 some insurance institutions would go 'critical' and either be absorbed or given some help to restructure, but a massive investment into the private underwriting sector of the economy wasn't done and the entire US economy would benefit from having a realistic risk re-assessment take place after 9/11 to properly valuate property and commercial risk to terrorist attacks.

Sixth the ability of public institutions to make good decisions in the public interest. Those institutions are the CAUSE of this problem along with the Congressional system that put them in place and the lack of oversight on Presidential picks to the boards of these institutions. This is a huge problem as these public institutions have been run for long-term political advantage and not on a sound monetary basis, and the two are in direct conflict. While some regulation for upholding such things as accounting and reporting standards are necessary, the 'public good' has been in pressing those economically unable to sustain home ownership and other purchases with public backed loans to assume an unhealthy risk financially for themselves at public expense. It is now the smart thing to take the keys to that overvalued house and drop them on the banks desk and 'walk away' from your responsibilities and there has been no political repercussions because some of those self-same politicians are doing the exact, same thing. That 'public good' has eroded basic honesty and integrity in financial responsibility by individuals, not supported it, which is part of the cultural problem now made worse by direct public support to abuse lending institutions and the public backing of them.

Seventh is the regulatory framework. They are not 'weak' but are operating in a way contrary to sound fiscal policy based on individual accountability. They are 'strong' in their support of political goals. Public institutions that do not have the acumen to understand this nor are willing to hire onto their staffs those that DO are a major and main cause of this problem. Because politicians seek political goals, they hire those with political motivations and ideas which are not in direct concordance with sound fiscal and monetary ideas. If Congress gets the blame in backing such institutions, it is each and every Congresscritter who refuses to take wise counsel from those who are well versed in the non-political requirements of sound fiscal and monetary accountability that are to be held at fault for pushing such unsound regulatory, legal and cultural attitudes out the door. And private institution that follows that lead and disregards its OWN wise counsel deserves the pain it will get as they are aiding and abetting unsound practice in search of political goals.

For all the cursory similarities with the Nordic banking crisis, we cannot and should not follow any path set by them as they have a different underlying basis for culture and the resultant economy of the 1990's than the US does today, in 2008. Those pathways are not an option to the US for those reasons. Until the American people can elect individuals who will eschew monetary and fiscal policy in search of political ends, that will remain the case as long as those elected representatives are in the majority control of both houses of Congress. Individual accountability not only rests with those who asked for such loans, those who gave such loans, but also those who pushed this environment and culture out the door via enacting legislation over the last 70 years to get us to this point in time. We can and should let those institutions *fail* as the economic shock, while large to the public, will be small to the overall economy and will enforce basic practices of accountability for those who have unwisely sought to live beyond their means. No matter the size of the Nation or its economic vibrancy, that will come to a bad and crashing end if it continues, and if our elected representatives cannot understand that, then it is up to the wheels of the economy to do their job for them and to teach them some humility that good politics in push a bad economic ideal comes to bad ends. It is a tiny minority of loans that are exposed in this and the vast majority of US households will only be at risk of having slightly over-valued loans and lower real estate taxes due to that for a period of some years until the bad loans and bad lenders are cleared off the boards.

That requires Fannie and Freddie to bite the dust along with all of the political appointees in them.

Don't I have any sympathy for those who got such loans and their impact to the economy?

No. Get it done and over with so we can learn, as a public, that we are required to recognize the basics of personal responsibility to each other and *not* involve the Nation in ill-conceived ideas about what we are 'due' as citizens. Because we currently don't have the culture to get accountability back into politics. Otherwise the fiscally sane and solvent will be dishing up lots of hard earned cash to bail out those who are neither and who will never have any incentive to GET fiscally sane and solvent.

Otherwise you will slowly lose the population that is fiscally sane and solvent, and that will bring down the Nation in the long run.

And abrogate our responsibility to hand the Blessings of Liberty to our Posterity.

Accountability is part of that.