Washington, DC - Congressman Dan Lungren (R-CA) today gave a speech on the floor of the House explaining how best to address America’s current credit and banking crisis by explaining the historical economic recoveries in Japan and Sweden. The following is the text of his speech:

“In light of the announcement by the Treasury Secretary of a new version of the financial rescue package I want to take this opportunity to consider a broader historical context in order to gain a better understanding of how we may best serve our efforts to stabilize our banking system and unlock credit so that we may begin on the path to economic recovery.

“As a recent report by the IMF [International Monetary Fund] points out, there have been a number of financial crises in the Post-War era. However, two examples stand out and have particular relevance to our own difficulties. During the last decade Japan and Sweden suffered financial and economic trauma that involved substantial similarities to the current challenges facing us. However, it is the nature of the very distinct responses of these two nations which warrants our attention.

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“Charles Kindleberger in his classic work Manias, Panics, and Crashes explains the situation confronting Japan in the early 1990s. The bubble in Japan reached its crescendo in 1989. Real estate prices had been skyrocketing and the banks even developed new financial instruments like the 100 year three generation mortgage. In a story that sounds all too familiar, when the bubble burst, Japanese bank loans slowed and as the availability of credit declined, distress sales caused real estate prices to decline. By 1991 stock prices had fallen by 60 percent. It was not until 2003 that stock prices returned to the level they were 20 years earlier.

“To put this into perspective, it will be remembered that seven of the world's largest banks were Japanese at the beginning of the nineties. Before the decade was over these financial giants were insolvent. They remained in business only because of an 'understanding' that the Japanese government would keep them afloat.

“One of the reasons a comparison of the Japanese and Swedish financial bubbles is helpful to our understanding of more recent events is that it reflects the role of an increasingly intertwined global economy. As Kindleberger points out, the bubble in Sweden was largely affected by the offshore branches of banks headquartered in Tokyo and Osaka. The surge in the flow of loans from these banks led to the increase in real estate and stocks in Sweden. Before all was said and done, the price of real estate in Sweden was to rise even faster than it did in Japan.

“In a presentation to the Kansas City Federal Reserve Bank Sweden’s former Central Bank Chairman Urban Backstrom pointed to a number of factors which led to the Swedish bubble: an expansionary monetary policy similar to pre-bubble Japan, a tax policy that favored borrowing, sizeable current account deficits, and an explosion of Swedish debt. Within five years the ratio of debt to GDP rose from 85 percent to 135 percent. This credit boom led to a resulting boom in real estate prices. A speculative bubble had been created and the Swedish economy became vulnerable to an implosion.

“In seeking to rectify policies that had led to high inflation and high nominal interest rates, asset prices began to fall and economic activity headed south. Between the summers of 1990 and 1993 Swedish GDP dropped by 6 percent, unemployment rose to 12 percent and the banking sector had loan losses of 12 percent of GDP.

“We thus have available to us two examples - Japan and Sweden where their economies suffered enormous pain following collapsing real estate markets and the implosion of their financial sectors. What is perhaps most instructive for us is to consider how differently these two nations responded to their respective crises.

“As alluded to earlier, the response of the Japanese government was largely predicated upon the 'understanding' that it would keep them afloat. The absence of any systematic overarching policy framework led to what could best be characterized as an ad hoc approach. As a consequence, the Japanese financial system consisted of a large number of 'zombie banks' which had the effect of undermining the confidence in the banking system. Furthermore, this unwillingness to address the reality of insolvent institutions rendered the banking system as a whole insolvent. There is general agreement among economists that the problems facing Japan were compounded by this unwillingness of Japanese banks to acknowledge the magnitude of their bad loans.

“By contrast, the response of the Swedish government to its financial collapse contains noteworthy contrasts with that of its Japanese counterpart. Swedish Central Bank Chairman Urban Backstrom explained the contours of his nation’s response in a presentation to the Kansas City Federal Reserve Bank. Due to the serious nature of the Swedish financial crisis efforts were made to maintain the banking system's liquidity.

“Significant emphasis was given to the need for transparency and a realistic disclosure of expected loan losses. Banks applying for support had their assets valued by the Bank Support Authority using uniform criteria. In order to minimize the problem of moral hazard the bank guarantee provided protection from losses for all creditors except shareholders. A separate authority was set up to administer the bank guarantee and to manage the banks that faced solvency problems.

“The clear distinction between the Swedish model and that of the government of Japan was an overarching set of rules rather than a series of ad hoc responses. In contrast to their Japanese counterparts, the Swedish government quickly wrote down the value of bad assets and did not prolong the agony of their economy. Sweden, unlike the Japanese government, did not have an understanding that the insolvent banks would be forever protected at the expense of the system as a whole. Swedish policymakers were successful in large part because their decisions reflected an understanding that financial systems require trust if they are to provide the necessary capital to fuel the animal spirits of capitalism.

“In an insightful column in the Washington Post this past Friday Anders Aslund summarized his understanding of the lessons from the Swedish crisis. Although historical events are always subject to interpretation, his comments are worthy of consideration:

“'First, clear and general principles must be chosen. …Second, transparency is the key. …Third, the nonperforming bank debts should be transferred to legally separate "bad debt banks” to relieve the ordinary banks of the burden. …Fourth, recapitalization makes sense only after banks’ books have been cleansed. …Fifth, do not force early sales of assets. …[T]he Swedish bad debt banks sold off their assets over several years, getting decent prices and not depressing asset markets.'

"If nothing else, this is a good starting point for a necessary discussion over how best to revitalize our nation’s financial system. For as George Santayana put it 'those who cannot remember the past are condemned to repeat it.'"