Earlier this week, I read a number of commentators claiming that banking crises and their accompanying bailouts are not that expensive. This claim took a particularly outrageous form when some people suggested that the $700 billion US bail out might, in the long run, actually turn a profit for the US taxpayer.
What do previous banking crises tell us about the likely costs - both directly to the taxpayer and indirectly through the recession that invariably follows a financial meltdown?
Here is a quick tour of recent banking crises in advanced economies. They all have one thing in common; the taxpayer took an almighty hit and the economy went into freefall.
Credit Lyonnais - 1994
In the early 1990s, President Mitterand wanted to create a French financial superpower. He chose Credit Lyonnais to be the vehicle that would make his ambition a reality.
After 1988, the bank began to expand frantically. As the banks created a huge loan portfolio with little regard for quality, it became the subject of numerous ugly financial scandals and a mountain of bad investments, notably in Hollywood.. The premier bank of France ended up with 8.9 percent of its loans classified as non-performing. By1994, Mitterand's dream was torn to shreds.
The French government came to the rescue of Credit Lyonnais by moving its debts and liabilities into a new state-owned company, the Consortium de Réalisation. However, the taxpayer ended up pouring some $27 billion into the stricken bank.
The Swedish banking crisis - 1990-93
After a housing boom in the late 1980s, generated by financial deregulation and a surge in credit, the normally staid Swedish banking system came crashing to the ground. Property prices fell, loans were not repaid, and banks ran out of capital.
Between 1990 and 1993, Swedish banks wrote off 18 percent of total loans. The total direct cost to the taxpayer was 65 billion kronor, the equivalent of $11.7 billion at the time, or $18.3 billion in today’s money. The indirect costs were much higher, with Sweden's slipping into a nasty and prolonged recession, with the cumulative output losses estimated to be around 11 percent of GDP.
The irony of the Swedish banking crisis is that the bail out is generally regarded as being the most successful ever undertaken. If this is success, then heaven help us.
The Norwegian banking crisis -1989-92
Norway's banking crisis had the same pathology as their larger neighbour to the east. Financial deregulation, followed by rapid credit growth, generated an unsustainable real estate bubble. By 1991, the bubble had crashed.
The banks took a major hit, writing off six percent of total loans. Almost 2/3 of the banking system was affected, forcing the government to nationalize the three largest banks. The government had to create a government Bank Insurance Fund that put 5 billion kroner of taxpayers money on the line.
Apart from direct fiscal costs, the Norwegian central bank estimated that output losses was around 10 percent of GDP.
The Finnish banking crisis -1990-92
I know this is getting a little repetitious, but the Finnish banking crisis started with a burst of financial deregulation, followed by huge credit growth, which created a real estate bubble, that culminated in an almighty crash.
By the end of 1992, 13 percent of loans in the Finnish banking system were non-performing. The cumulative output loss over the whole period estimated to be around 22 percent.
The S&L crisis -1987-92
Until the sub prime crisis, this was the daddy of banking crises. Again, it was the same old formula. Deregulation, rapid credit growth, a housing bubble followed by a crash.
The US produced a nasty little twist on the recipe; denial. During the early stages of the crisis, the US government was unwilling to admit there was a problem. This kept far too many insolvent banks operating for far too long, making the crisis much worse.
The ultimate cost of the crisis is estimated to have totaled around $160.1 billion. By the time, the crisis was finally cleaned up 1,142 S&L associations and 1,395 banks were closed. The US economy went through several years of slow growth that ultimately led to President Bush losing the 1992 presidential election.l
The song remains the same
Out of the 10 largest mortgage providers in 2007, two have gone out of business (NRK and the B&B), and two were forced to merge with other banks (HBOS and the Alliance & Leicester).
So far, the UK government has had to take onto its books around ₤150 billion of highly dubious mortgages. The Bank of England has not yet disclosed the amount of liquidity it is pumped into our banks through the special liquidity scheme. Some estimates put the number as high as ₤200 billion.
As a direct consequence of the housing crash and the inevitable follow-on crisis in the banking sector, the UK is now careering towards an almighty recession. It remains to be seen how deep this recession will be, but be in no doubt, it is likely to be long and protracted.
Banking crises are extraordinarily expensive, both in terms of output losses and fiscal costs. Don't let anyone tell you otherwise.