Sweden experienced a similar downward trajectory, but its macroeconomy was not robust even before deregulation. Sweden’s currency was weak and inflation was relatively high. Labor unions, anticipating continuing devaluations and hence increasing inflation, lobbied for higher wages (Ergungor 2007). Bank deregulation occurred simultaneously, starting in 1983 with the elimination of liquidity ratios for banks, and continuing with the lifting of interest rate and lending ceilings, and placement requirements for insurance companies in 1985. Financial markets were rapidly diversified to include certificates of deposit (CDs) and Treasury bills.

As in Norway, new lending surged in the late 1980s, particularly from banks and mortgage institutions (Englund 1999). Banks also issued guaranteed investment certificates (marknadsbevis) to finance companies that were not allowed to accept deposits, which exposed banks to high-risk transactions. Banks and other financial institutions lent increasingly in foreign currency through the late 1980s. The stock market, as well as real estate prices, increased rapidly after deregulation, creating asset price bubbles. Unemployment declined as the economy verged on overheating.

In the fall of 1989, it appeared that the commercial property market had peaked, and real estate managers were having difficulty finding tenants (Ergungor 2007). The stock market reacted and fell, just as interest rates were rising in step with German reunification, imported as a result of Sweden’s fixed exchange rate. The ERM crisis was affecting Sweden, resulting in interest rate increases and the endangerment of foreign-denominated debt. Reforms in the tax system and high interest rates caused asset prices to fall (Jackson 2008). The value of commercial paper also dropped suddenly.

The first financial firm affected by declining real estate prices was Nyckeln, a financial firm that had specialized in commercial real estate financing (Jackson 2008). Nyckeln’s fall then affected Sweden’s banking system. Credit losses surged between the end of 1990 and 1993, accounting for 17 percent of lending (Englund 1999). The first bank to enter difficulties was Forsta Sparbanken, the largest savings bank (Sandal 2004). The Swedish government stepped in to guarantee bank debt. Then the third-largest bank, Nordbanken, suffered loan losses. At the time, the state owned most of the bank equity, and the state purchased more bank equity and later restructured the bank.

Bad loans were transferred to the new government-owned bank, Securum, which was to recoup losses from non-performing loans. This restored confidence in existing banks by ensuring good loans were separated from bad loans, which were subsequently transferred away.

In 1992, the Riksbank was forced to defend the krona with drastic measures after the UK and Italy left the ERM (Englund 1999). After a series of speculative attacks, the Riksbank allowed the krona to float on November 19. Foreign withdrawal of loans resulted in heavy credit losses in all seven of the largest banks, although Riksbank provided foreign currency liquidity support (Sandal 2004). A crisis resolution bank, Bankstodsnamnden, was instituted in May 1993 to provide capital support to crisis banks upon their application. Most state capital support ended up going to Nordbanken and Gota Bank.

Interest rates fell with the flotation of the krona. The flotation of the krona was important in alleviating the macroeconomic pressures experienced both before and after financial liberalization, since it allowed Sweden to regain control over monetary policy.

Because 40 percent of bank lending was in foreign currency, with mounting signs of distress, loans became increasingly short term. The state guaranteed bank obligations in September 1992, and the guarantee was maintained until 1996 (Sandal 2004). Both the banking and currency crises dampened aggregate demand and exacerbated the economic downturn, but, as in Norway, actions taken by the government were successful in restoring confidence in the economy.

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