Avoiding moral hazard, scandanavian style

Apparently Ikea has started to offer a new product using classic Scandi design, BankiRescu. The FED has been taking a few trips over to Elizabeth New Jersey to stock up. From the Telegraph:

A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region's economy to its knees.

It is understood that Fed vice-chairman Don Kohn remains very concerned by the depth of the US crisis and is eyeing the Nordic approach for contingency options.

If this is true, it is encouraging. Even if you don't follow historical precedents, understanding them is important.

[...] there was a major effort [in the Scandi rescue] to avoid the sort of "moral hazard" that has bedevilled efforts by the Fed and the Bank of England in trying to stabilise their banking systems.

To be fair, I would say more the Bank than the FED. For shareholders to get something if the bank is solvent at the time of rescue does not seem unreasonable, after the public purse has been reimbursed for the cost of funding the bank through the rescue. For them to get the share price at the point of rescue, or more, as may well happen in the case of Northern Rock, is pure moral hazard.

Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country's top four banks - Christiania Bank and Fokus - were seized by force majeure.

"We were determined not to get caught in the game we've seen with Bear Stearns where shareholders make money out of the rescue," said one Norwegian adviser.

"The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial," he said.

Stefan Ingves, governor of Sweden's Riksbank, said his country passed an act so it could seize banks where the capital adequacy ratio had fallen below 2pc. Efforts were also made to protect against blackmail by shareholders.

Why 2% I wonder? Why not 8%? After all, if you view regulatory capital as providing a buffer for an orderly liquidation/takeover/whatever, once that buffer is breached, the bank's shareholders and management should lose control. In any case, the idea that bank stock is a fundamentally different thing from the stock of other companies, with a different insolvency regime, makes a lot of sense. That regime is triggered by capital inadequacy or liquidity problems, and at that point the management are out and the shareholder only gets something after the costs of the rescue are met.