Bailout a la Swedish? Not without transparency and tough measures

With a new administration in the White House, different approaches to address the persistent financial crisis are on the table, once more.  Over the last week there's been some talking about the creation of an "aggregator bank" -also called 'bad' bank- that will buy troubled assets with part of the remaining bailout funds (TARP), aiming to take toxicity off financial institutions' balance sheets. 

An aggregator bank that eats all of the junk in the financial sector is expected to finally unfroze credit markets, and gives new life to the idea of a bailout a la Swedish.  However, the Nordic country's experience draws some specific governance lessons that go beyond separating good and bad assets, and that are applicable regardless of the technicalities, features and context that make both cases different.

For starters, according to an International Herald Tribune's article and a study conducted by the Congressional Research Service (CSR), transparency was among the fundamental pillars of the Swedish financial recovery plan.  Transparency along the bailout process made clear the criteria defining who was going to be rescued and under what conditions.

For instance, banks in need of support were requested to first use shareholders' capital to cover for their losses.   The New York Times cites that the Swedish government "extracted pounds of flesh from bank shareholders before writing checks."  The lack of protection to sacred financial cows put the right incentives in place, so that the largest bank of Sweden preferred running a recapitalization process by its own, saving a lot of money to taxpayers.  Also, since the beginning of the process, expected losses and write-downs were presented, clarifying the problems and assistance required -which ultimately held banks responsible and helped in the restoration of confidence. Moreover, non viable banks were not allowed to receive public resources, and were ultimately merged or liquidated.  In the end, Sweden took half a decade to recover, but the overall cost for taxpayers was limited.

Conversely to what the Swedes did, the US government has not been clear neither in its strategy -that has bounced in different directions- nor in which institutions are going to be rescued and which not.  This week a Wall Street Journal article said that political leverage has been used to allocate TARP's funds to non viable banks, such as OneUnited Bank in Boston, which allegedly was involved in poor lending practices and executive-pay abuses.  Even before this and other cases were highlighted, there have been several concerns about transparency and accountability in the use of bailout money.

It is fair to say that the new administration has been very keen on the importance of bringing both governance issues back to the bailout process.  Today, the new Treasury Secretary, Timothy Geithner, announced some measures on this.  New provisions include the public disclosure of the destination of bailout money already spent as well as of future commitments, and the tightening of the rules for the selection of companies receiving assistance, so to avoid any influence by lobbyists and other political groups.

More transparency and accountability points out to the right direction -although let's not forget that both were also praised last year.  Still, embracing them implies that tough decisions will have to be taken, as per the Swedish bailout.  Within the aggregator or bad bank scheme, either banks would have to absorb losses -which in some cases will take them out of business- or the taxpayers would have to continue overpaying for their recovery.  So, the big question remaining is whether or not this time those who are not viable will be let to fail?