Lessons from Sweden’s Central Banker Stefan Ingves for Hong Kong politicians

The government stuck to its guns with housing cooling measures despite worries they would shake investor confidence and hit property sector profits. Chief Executive Leung Chun-ying said measures like the public housing expansion and stamp duties on foreigners, corporations and speculators are here to stay. At least, until they avert or pop a housing bubble.

"People used to think that it was easy to put the pieces [of an economy in recession] back together after an asset bubble bursts. Asset bubbles are hard to define, but it is best to avoid them through micro- and macro-prudential policies [like Leung’s cooling measures]," Ingves explains. 

“These are ways of saying ‘no’ to property buyers, who do not like that. But somebody has to say no or we end up with a problem [of an asset bubble]. We are not used to macro-prudential policies in Sweden. Hong Kong has been rather forceful in using them.”

Hence, property tycoons’ backlash against cooling measures.

Hong Kong and Sweden have to counter housing bubbles that threaten price stability without using interest rates. Sweden’s interest rates support growth while Hong Kong’s maintain the currency peg. “It is best to have strong macro-prudential policies since we only have one policy rate,” says Ingves. Bubbles are a lower priority than other goals.

In 2010, Sweden emerged strong from the economic crisis, but with a housing bubble. This was inadvertently encouraged by low interest rates used to boost growth. Low interest rates stimulate spending and investment by reducing the cost of loans and the return on savings. So Ingves raised interest rates to combat the bubble: ‘leaning against the wind’.

“Growth had a very headline number and the European context was good then. But inflation came in lower than forecasted domestically and globally.” Ingves lowered rates again to avoid the threat of deflation and slow growth.

Hong Kong’s housing bubble increases the cost of living. This hits the poor most, exacerbates inequality and impedes retirement planning for an ageing population. Cooling measures allow the property market to grow sustainably, reduce the risk of a worsening housing bubble, and counter its negative consequences on key policy areas.

Another local debate erupted over a proposed law that allows the government to take over ‘too big to fail’ banks during economic downturns instead of subsidizing them through a ‘bailout’. The controversial law defies Hong Kong’s free market ideology, but was introduced to keep up with global norms on regulation.

Restrictions on bank risk-taking can reduce profits. However, Ingves explains that if banks are well capitalized [because of smart regulation], they have an easier time funding themselves, which can be both safe and profitable. Bank regulation is similar to “consumer protection that prevents consumers from being cheated, misunderstanding products and receiving misleading advice.”

Smart regulation helps not only banks to grow sustainably, but also the economy to cope with banking crises. Ingves’ popularised and extended a method to combat the 1990s Swedish banking crisis. Nobel Prize-winning economist Paul Krugman praised it as the solution to the United States of America’s 2008 crisis.

After Sweden deregulated its banks, they were allowed to merge, grow bigger and introduce riskier programs. Eventually these risky programs failed, pushing the banks into crisis. A handful of banks were 'too big to fail': so large they could destroy the financial sector if they went bankrupt.

Ingves’ method involves government intervention in banks to absorb losses and clean up bad assets until a stable recovery. However, a criticism is that the banks that made the worst mistakes get the most help while taxpayers get toxic loans in return. This is little incentive for banks to change their practices.

Ingves describes two ways to reduce the taxpayer bill. First, the government gains temporary ownership of banks so profits can repay taxpayers. This turns a donation to risk-takers into an investment. Second, regulation should prevent 'too big to fail' banks engaging in such risky practices.

"Almost no [financial innovation] is new. We have to counter the risks of interconnected financial institutions and over-leveraged [i.e. excessively risky] sectors," says Ingves. "Global regulators have laid the major building blocks. But things do not change overnight; it is a gradual, peer pressure process." He likens implementation to an oil tanker, which is slow moving, but will eventually reach its destination.

If Hong Kong wants to remain competitive as a global financial centre, it will need to reduce taxpayer bailouts of risky investments and improve its ability to cope with banking crises, global regulations have to take effect, regardless of local politics.

Government officials might benefit from smart intervention in our free market economy.

“Good economists understand the big picture of economic free market theory. More importantly, they know how to adjust to uncertainty. Often, as with the 2008 recession, the textbook case is reasonable, until things blow up!”

Ingves discussed stable growth at the Asian Financial Forum in Hong Kong.