AMERICA may be moving closer to creating a "bad bank" to absorb its banking system's impaired assets. Would it work? No one knows, but everyone is looking to Sweden—which used that model in the early 1990s after its banks crumpled under the weight of bad real estate loans—for guidance. I talked to Bo Lundgren, who was the minister in charge of taxation, financial markets, and sports (yes, sports) at the time of the bail-out, to learn more about which issues are likely to prove stickiest for America. What are the toughest challenges—the extent to which banks are nationalised, the relative importance of recapitalisation versus purchases of bad assets, or something else? What follows is based on our conversation.

Sweden’s first major step to alleviate its crisis was a blanket guarantee of all bank liabilities. This immediately restored depositor and creditor confidence, preventing runs which would have made it impossible for banks to restructure. Under emergency legislation passed by the parliament, the financial authorities could then take over and nationalise any bank on the verge of failing. In the end, Sweden only nationalised two banks—Nordbanken (which had been majority government-owned anyway and was in the process of privatisation) and Gota Bank, which was on the verge of failure with some 37% of its loans non-performing. It also provided substantial aid to the leading savings bank.

Though it recapitalised both Nordbanken and Gota, Sweden also set up a bad bank for each to dispose of their bad loans. Mr Lundgren said removing their bad assets in addition to recapitalisation was necessary, else the good banks' management teams would have been consumed with the handling of non-performing loans, rather than making new loans. Moreover, the bad banks were better equipped to dispose of the loans or the underlying collateral (mostly real estate and some corporations). The price of the assets the bad banks purchased from the good banks was determined with the help of consultants and government examiners who tried to apply a value as close to pure market value as possible. Since Nordbanken and Gota Bank were both government controlled at this point, there was no issue of taxpayer subsidy from overpaying or capital depletion from underpaying.

Mr Lundgren anticipated at the outset that even with the blanket liability guarantee, the government would have to inject substantially more capital into almost all the banks. This, he thought, would result in their de facto nationalisation as the government fully intended to buy common shares and to exercise its ownership rights. But this did not prove necessary. The other big Swedish banks, like SEB and Swedbank, gained enough time and creditor patience from the blanket guarantee to restructure themselves. They did this by establishing their own bad banks and then obtaining new capital from private investors, including the Japanese.

The Swedish worried, as Americans do now, that banks would reduce lending in order to rebuild capital and to avoid nationalisation. The blanket guarantee mitigated deleveraging pressure somewhat. Loan growth would have fallen anyway due to the reduced credit-worthiness of so many Swedish borrowers. Large Swedish corporations were insulated somewhat by the availability of capital markets financing outside Scandinavia.

I see at least two important distinctions between Sweden’s situation then and America's now. First, Sweden entered the crisis without existing powers for government authorities to take over banks, as America currently has under FDICIA (although America lacks similar powers for non-banks, a glaring gap in the safety net). It had to get these in the midst of the crisis through emergency legislation. Second, Sweden’s room to manoeuvre was helped by the fact that only Scandinavia at the time was experiencing a systemic banking crisis; this meant that the Swedish economy benefitted from external support, and there existed foreign sources of capital to aid in the bank restructuring process.

One final note: Mr Lundgren says one of the most useful books he read at the time was The banking crisis of 1933 by historian Susan Estabrook Kennedy. (She died in 2003; the book is out of print.) He ended up using the same three categories for banks that Herbert Hoover and Franklin Roosevelt did at the time of the Great Depression—needing little support or guarantees; needing capital but viable in the long run; and needing to be taken over completely.

(Photo credit: Reuters)