STOCKHOLM—Thus far, the Swedish economy has been able to weather the worst effects of the global financial crisis, which is similar to Sweden’s own domestic banking meltdown in the early 1990s. As many policymakers—most notably British Prime Minister Gordon Brown—are realizing, the 1992 Swedish crisis offers lessons that are highly relevant to our current situation.

First, some brief history. After enjoying a long postwar boom, Sweden began experiencing severe economic troubles in the 1970s. The ruling Social Democratic Party responded by introducing the highest income tax rates in the developed world and increasing government regulation of the labor markets. In the 1980s, Sweden moved even closer to Yugoslavian-style “market socialism.” Then, in the early 1990s, the Swedish central bank tried to link an overvalued krona (the Swedish currency) to the European Exchange Rate Mechanism and protect it with 500 percent interest rates. These efforts failed, and a financial panic ensued.

The Swedish economy contracted continuously from 1991 to 1993. The government was running a massive deficit, and its debt reached 80 percent of GDP. Swedish households were also seriously in debt, and the banks had fostered a real estate bubble. Inflation spiked from 2 percent to 11 percent, and unemployment jumped from 3 percent to 12 percent. Some 300,000 jobs were lost in production alone. The failing banks became desperate, recalling even sound loans and driving 80,000 companies into bankruptcy.

Sweden did not just offer a bailout, but rather held the banks responsible for their bad debts.

Under the leadership of Bo Lundgren, who served as minister for fiscal and financial affairs from 1991 to 1994, Sweden’s center-right government adopted a stern policy to save the banking system. It did not just offer a bailout, but rather held the banks responsible for their bad debts. Losses had to be written down, and the government guaranteed all bank deposits and creditors in exchange for shares of the banks. This was important, for it meant that weak balance sheets were confronted directly. (During the Japanese financial crisis of the 1990s, banks were slow to declare all their losses, which delayed a recovery.) Stockholm formed official recapitalization agencies, which were allowed to sell off assets being held as collateral and return the profits to the government.

How large was the Swedish bank rescue plan? All told, the government spent about 4 percent of its GDP at the time. (By comparison, the U.S. financial bailout enacted in October 2008 amounted to roughly 5 percent of America’s GDP.)

Even though Sweden’s coalition government had devised a workable plan to save the banks, it lost the next general election in 1994. Yet when the Social Democrats regained power, they continued implementing Lundgren’s plan. It was a harsh time, but the crisis was overcome. The government ultimately sold its bank shares and liquidated toxic assets. In the end, the rescue plan cost less than expected.

It is important to note that the Swedish government did not become a permanent player in the banking sector. It still owns portions of some banks, but its goal is to sell them and thus further reduce the cost of the bailout. In recent years, the government has run a large budget surplus, and its debt has fallen to less than 41 percent of its GDP. (By comparison, America’s debt is equal to 60.8 percent of its GDP, and Japan’s debt is equal to 170 percent of its GDP.) Sweden has had a stable rate of inflation (between 2 percent and 4 percent) for a decade. Its income tax rates are still way too high, but they are gradually being lowered.

To be sure, global financial markets have become much more complex since the early 1990s. Even still, the Swedish crisis offers valuable lessons that all policymakers should bear in mind during the weeks and months ahead.

Waldemar Ingdahl is president of Eudoxa, an independent think tank in Stockholm.

Image by Darren Wamboldt/The Bergman Group.