The Swiss Way to Beat a Crisis

The global recession knows no sinners, and it knows no saints. Even countries that did not feast on a credit binge and did not inflate their economies with a ballooning real-estate bubble have now been pushed into the sharpest downturn in at least 40 years by the collapse in their export markets and the fear paralyzing the normal flows of money and credit since Lehman Brothers went under in September.

But there are still differences. Take Switzerland. The tiny country nestled away between the Alps and the lakes in the heart of Europe had been among the saints ahead of the crisis and did get its act together faster than anybody else once disaster struck. It may well show its bigger neighbors the way to get out of the mess.

First, Switzerland had done its homework ahead of the crisis, making its economy fit for the good and the bad times. Swiss industry and many of the modern services are completely open to unfettered global competition. Swiss firms have been whipped into shape as a result. And in two giant steps in the past six years, the Swiss opened their labor market to their neighbors from the European Union. Swiss firms can now draw on a vast pool of highly qualified workers from France and Germany, from Poland and the Czech Republic. With a few strokes of a pen, the Swiss thus raised the average rate at which their economy can expand throughout the cycle from less than 1.5 percent to at least 2 percent now. Strong tax revenues and a healthy budget surplus are among the tangible rewards for such virtue.

The Swiss National Bank, arguably the best-managed central bank in the world, was also well prepared for the turmoil. Most central banks focus on an interest rate they can directly set themselves, usually the rate for their own overnight or weekly injections of money into the financial system. However, the Swiss target the rate at which commercial banks lend to each other in the money market for three months. This rate is more important. Because it determines how much banks have to pay to fund themselves in the money market, it influences the interest rate at which banks can then lend on the money to households and businesses.

When the credit crunch struck and trust among banks melted like snow in the sun, the rate at which commercial banks were ready to lend to one another for three months skyrocketed. This hit the economy like a major tightening of monetary policy through the back door. Because the Swiss pay so much attention to this rate, they acted immediately and firmly. Within three weeks, they brought this rate back under firm control. Spotting the first warning signs of an imminent recession, they also slashed their target for this rate aggressively to 1 percent, forcing it close to the target by flooding the money market, even lending overnight for virtually no interest at all. As a result, some Swiss regional banks now seem to be so rich in cash that they may soon see no reason to hoard more money. Instead, they may eventually venture out to lend more freely again, with an appropriate risk premium, to other banks and the economy at large, easing any domestic credit-crunch concerns.

Because the Swiss got their monetary response right from the start, they have less need for a fiscal stimulus than other countries. A fiscal stimulus always runs the risk of wasting resources, especially if governments try to spend too much money in a rush. The Swiss taxpayer, already blessed with a low-tax regime, will probably get through the crisis without a build-up in government debt of such debilitating proportions that the looming specter of future tax rises crimps the recovery, as may well be the case in Britain.

The Swiss have also led the way in designing bank bailouts. The country's two largest banks, UBS and Credit Suisse, through mergers and determined growth, had morphed into institutions better described as global investment banks with a presence in Switzerland than as genuine Swiss banks. The financial turmoil did not leave them unscathed. When the first version of the U.S. financial bailout program hit trouble because it was too difficult to set general prices at which banks could offload their toxic assets to the government, the Swiss came up with a tailor-made bailout for the one big Swiss bank— UBS—that needed it at the time, fitting the prices at which the bank could sell its toxic assets to the circumstances of the bank. The Swiss were quietly pleased when, a few weeks later, the United States de facto copied this approach in their next bailout for a major U.S. bank.

Of course, Switzerland faces risks. The very fact that its two big banks are global players means that a collapse of the oversized financial system could hit the small economy unusually hard. But with its actions so far, and blessed with healthy budget and current account surpluses, the Swiss have deftly defused the risks. Instead, Switzerland's no-holds-barred monetary response and its well-designed financial bailout could set an example for other countries how to best tackle the global crisis.

Schmieding is chief economist for Europe at Bank of America in London.

© 2008