Swedish "Super" Models

Well the blog post won't be as exciting as the title. There will be no photos of Elin Nordegren (Mrs. Tiger Woods) or her twin sister here. We'll save that for another site.

I thought today may be a good day to publish and old internal piece I did briefly illustrating the "Swedish Model" for handling their housing crisis in the early 1990's. It was done in October of last year and illustrates some interesting points. Take a read. I have comments below....


ROAD MAP FOR THE GLOBAL STOCK MARKETS

Swedish Crisis of the Early 90’s Provides Guidance

Background

Probably the best model to look for parallels
Swedish government implemented a blanked guarantee for all bank liabilities (ex-equity) in 1992
Government injected government capital into most troubled banks (some still failed)
Loan losses were 12% of GDP (this compares to IMF estimates of US loan losses at 10% of GDP)

Swedish government intervened after GDP had been declining for 7 consecutive quarters YoY
US government / FED and central bank are taking a much more proactive approach (this is most likely due to the inter-connectedness of the global financial system)

Key Points

Recession lasted 3 years
Output declined sharply immediately after government intervention (we are seeing this right now)
The economy began to grow again 3 quarters after intervention
Credit growth to the private sector was negative for 2.5 years following intervention
Household savings rate rose dramatically (this is beginning as we speak)

Stock Market Implications

Stock market fell 45% from peak to trough (it took 27 months)
Global markets are all in this range
The bottom in Sweden was made approximately 1 month after government intervention
The following 12 months the market rallied 43% and was followed by another 20% the ensuing year and yet another 24% in year 3
Appears that government intervention provided the floor even though the economy weakened for some time

What can still be done …..?

Governments can guarantee inter-bank lending which will allow the global financial system to begin moving again (look for LIBOR to fall)
Purchase equity stakes directly in distressed financial institutions – so far equity holders have been left holding the bag allowing relentless selling and financial sector short selling (the ban was removed this week) – this would cease
Continued reducing interest rates where possible – a steep yield curve is necessary for the banks to be able to repair their own balance sheets – the ultimate goal would be to pass these reductions on to the end consumer (this has not happened yet)

What is needed ….?

Plain and simple and one word – TIME
Credit bubbles all have two things in common first is the excessive liquidity that gets us into this mess and the second is that TIME is ultimately needed to restore the financial system to equilibrium


Today is the day as the S&P looks to retest its low made in November 2008. Lots has happened in the past 3 months. It is clear that the leverage in the financial system was certainly more than anyone anticipated. For example leverage at Europe's largest financial institutions make Lehman look conservative - remember even though the for sale sign was out no one would buy them in September. This leads to the point that nationalisation in one form or another is inevitable. The sooner the Roubini coined term "zombie banks" are eliminated from the system the sooner the system can begin to get healthy. Don't mistake my words here. Eliminating the insolvent banks isn't the panacea to our problems but is a step in the right direction of a very long unwinding process.

Think of this example: lets say healthy bank A (this in itself seems like an oxymoron right now) has the ability to lend on its balance sheet through a combination of prudent lending and strong capital ratios but insolvent bank B keeps getting bailed out by the government with it unclear if there is more taxpayer money to come (lets refer to this as TARP1, TARP2, TARP3 etc.). Why would healthy bank A begin to lend? Bank A will continue to hoard money and clog up the system. We already know that unless mandated bank B will use the capital infusion to strengthen its balance sheet (they will also argue that they are too big to fail and should such receive more capital in the next TARP rounds). So nobody lends. This is part of our problem today.

The returns in Sweden post government intervention were tremendous. After falling 45% (peak to trough) they rallied 43%, 20% and 24% in the 3 years following intervention. I think we will differ from Sweden on one key point. That being the relative strength of the consumer. Clearly in the years 17 years after the Swedish crisis saving rates in the Western world collapsed (remember when they went negative for a quarter in 2006) while debt expanded. This is what sets this apart. My view is that consensus earnings targets for the S&P are too high (really pick any western world stock market it will be the same if I am correct) and the multiples applied to the earnings are also too high. Markets must go lower to find equilibrium. This is not going to be fun.