Your humble blogger has said that rationalizing and recapitalizing the banking system is essential for recovery. Economists like Ben Bernanke attribute Japan’s failure to dig itself out of its hole to not being aggressive enough in terms of fiscal and monetary stimulus,. Yet Japan did a great deal on both fronts. The biggest difference between Japan’s program and that of countries that exited financial crises faster (Sweden, Norway, Chile) was that they tackled their banking mess early on, taking over and resolving insolvent banks.
Indeed, the Japanese recognize their mistake, and gave an uncharacteristically direct warning to the US last year. As we noted in “Japan Says US Financial Crisis Worse Than Its Bust, Urges Government to Recapitalize Banks“:
The comments in the Financial Times by Yoshimi Watanabe, Japan’s financial services minister, are extraordinary. He ventured to give the US advice on its credit crunch based on Japan’s experience during its post-bubble-years banking crisis. And it’s not pretty.
Why are these remarks so unusual? Consider:
Most countries (save the US pushing liberalized capital markets) don’t give other countries advice on how to run their financial services sector. That alone is pretty unheard of (however, the IMF dictated the terms of rescue programs in the Asian crisis of 1997, but those were third world countries suffering capital flight. Of course, their situation, with excessive borrowings, wobbly banks, and unsustainable current account deficits, bears no resemblance to ours)
The Japanese are particularly loath to stick their noses in other countries’ affairs (that gives others license to comment on their practices). Note that even the often-belligerent Chinese sound off in response to US pressure, not in a vacuum
This statement came from the head of Japan’s top financial regulator. If the powers that be had wanted to soft-pedal the message, they would have used a lower-ranking bureaucrat or a retired official
The Japanese comment is effectively a statement that significant actors in the US financial sector are bankrupt and will need to be recapitalized. Again, that is a shocking diagnosis to make in a public forum. Wantanabe says that the US banking system will need to get new equity from the government. The delay in recapitalizing Japanese banks (it was hard to win over the public) is considered within Japan the biggest reason for the length of their economic crisis
The Japanese are as nicely as they possibly can telling the US that we are in a terrible mess and we need to get on top of it ASAP. This is a blunt warning. I am sure the significance of the Japanese attempt at tough love will be lost.
The New York Times article today is playing up the parallels to Japan as “cautionary tales.” This is still short of “Warning! Japan woes ahead!” but is still much more pointed statement of the dangers than its previous positioning (“lessons to be learned from Japan”).
From the New York Times:
The Japanese have been here before. They endured a “lost decade” of economic stagnation in the 1990s as their banks labored under crippling debt, and successive governments wasted trillions of yen on half-measures.
Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail.
By then, Tokyo’s main Nikkei stock index had lost almost three-quarters of its value. The country’s public debt had grown to exceed its gross domestic product, and deflation stalked the land. In the end, real estate prices fell for 15 consecutive years….
“I thought America had studied Japan’s failures,” said Hirofumi Gomi, a top official at Japan’s Financial Services Agency during the crisis. “Why is it making the same mistakes?”
Many American critics of the plan unveiled Tuesday by Treasury Secretary Timothy F. Geithner said the plan lacked details. Experts on Japan found it timid — especially given the size of the banking crisis the administration faces.
“I think they know how big it is, but they don’t want to say how big it is. It’s so big they can’t acknowledge it,” said John H. Makin, an economist at the American Enterprise Institute, referring to administration officials. “The lesson from Japan in the 1990s was that they should have stepped up and nationalized the banks.”
Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
One reason Japan’s leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks.
A further lesson from Japan is that the bank rescue will determine the fate of the wider economy….
Many in Japan thought that low interest rates and economic stimulus measures would help banks recover on their own. In late 1997, however, a string of bank failures set off a crippling credit crisis.
Prodded into action, the government injected 1.8 trillion yen into Japan’s main banks. But the injections — too small, poorly planned and based on little understanding of the extent of the banking sector’s woes — failed to stem the growing crisis.
Fearing more bad news if banks were forced to disclose their real losses, Japan’s leaders allowed banks to keep loans to “zombie” companies on their balance sheets.
Japan, instead, experimented with a series of funds, in part privately financed, to relieve banks of their bad assets.
The funds brought limited results at best, says Takeo Hoshi, economics professor at the University of California, San Diego. For one thing, the funds were too small to make an impact. The depository for bad loans had no orderly way to sell them off. And the purchases that did take place failed to recapitalize banks because the bad assets were priced so low.
So far, the Obama administration’s plan avoids the hardest decisions, like nationalizing banks, wiping out shareholders or allowing banks to collapse under the weight of their own bad debts. In the end, Japan had to do all those things.
It is amazing how the politcization of decisions is driving the US down the same road the Japanese took, despite the considerable differences in the two societies. While Obama strives to strike a new tone, true leadership (as in getting the public to do things that are difficult but in their best interest) went out of fashion in the US a long time ago.
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What makes this truly amusing is that we used to mock the Japanese for making such boneheaded decisions. We knew better and if nothing else our brand of capitalism would force us to confront our problems and take our medicine.
fcomedy, firony, fcomeuppance
What makes this truly amusing is that we used to mock the Japanese for making such boneheaded decisions. We knew better and if nothing else our brand of capitalism would force us to confront our problems and take our medicine.
fcomedy, firony, fcomeuppance
Yves,
EU leaders and officials have in part set the London G20 meeting on April 3 as a deadline for presenting common proposals,micro and macro, to deal with the crisis, including nationalisaiton of banks. The idea is to build on the G20 in DC in November at which the broad roadmap was agreed. We should thus expect a number of sulphurous EU meetings ahead of G20 to hammer out a policy.
If all goes according to plan, I would expect blueprints to begin leaking soon.
Thus, the G20 will be a venue at which bank solvency and systemic risk will be discussed. I assume/hope that the Obama Administration is working against that date (amongst others) to come up with a coherent plan that will not seem as ludicrous in the eyes of the G20 peers as the current draft of a draft.
I assume that the NYT article could be regarded as the Japanese preparing the ground for G20 too, working via the media.
Gordon Brown needs the G20 in London to be a success for a multitude of reasons. He is not getting much help from the Czech EU Presidency.
A voir
Nice video!
What happened to the notion of Japan forgiving all of our debt? Marshall Plan in reverse. I was fond of that idea.
Swedish Lex,
regarding the G20 meeting in April.
I hope the world’s governments have that long. Somehow I doubt it.
If I remember correctly, the 1997 relapse in Japan was triggered by the gov’t tightening the loose fiscal strings as the economic outlook was improving and the budget deficit was looming.
With no real structural reform in sight, I imagine we’ll be following in their footsteps a few years down the road. The administration will see signs of recovery, jump the gun, and realize they didn’t fix anything in the first place when everything comes crashing down again.
Yves – there’s an irony in your comment “…true leadership (as in getting the public to do things that are difficult but in their best interest) went out of fashion in the US a long time ago.”
That’s the attitude the powers that be took last fall with TARP I. The plutocrats/kleptocrats knew better than just about everyone else and used “leadership” as an excuse to rip off taxpayers in favor of wealthy bankster types in order to “save the world.”
Judging by his economic team Obama is not very different in this matter.
There are several things that better than nothing, including things you have suggested, but the Paulson/GS/Geithner approach is not one of them.
Careful what you wish for.
To Anonymous:
I agree that expectations for the G20 should be treated with caution, as you suggest.
However, the mechanics of the EU are such that meetings and summits (that often are horse trading fiestas behind closed doors with a polite group photo at the end) play a significant role to broker deals and, hence, advance on the issues. Peer pressure often play an important role, particularly in times of crisis.
The EU has established the G20 as an important milestone for itself. That is why we are seeing the EU Institutions and the EU Member States rolling out proposals for reform right now. Example: The French Government today proposes new far-reaching hedge fund reglation to be agreed at G 20 – see today’s FT. Expect more to come, possibly also on macro and micro handling of de facto insolvent banks.
Should the EU be able to get its ducks in a row (a very big IF) before G 20, including on a common bank bailout policy, the other members of G 20 would have to respond policy-wise. Geithner’s muddy draft would look deeply insufficient.
EU leaders know that if the G 20 fails, the damage will be far worse than the PR disaster of Davos. The EU can politically not afford not making progress in London. It will be interesting to see how the Obama Administration acts in relation to this.
A bit long, but useful I hope.
Example:
“amazing how the politcization of decisions is driving”.
Unfortunately, economics (as in not the economy, but the high-level economic decisions) is an extension of politics by other means. Yet more unfortunately, it doesn’t seem to get through most of the economic packs that all economic decisions will be judged first and foremost by their politics implications and biases of the group currently in power and its supporting power base(s).
I keep hearing of the similiarities between the Japanese experience and the US but what of the differences?
Japanese banks weren’t holding a bunch of CDO and CDS positions as that stuff had not yet come of age.
If they worried that taking down the bad banks would cost a lot of jobs they didn’t have to worry that pulling on the wrong string would unravel the global financial system.
“Japanese banks weren’t holding a bunch of CDO and CDS positions as that stuff had not yet come of age.
If they worried that taking down the bad banks would cost a lot of jobs they didn’t have to worry that pulling on the wrong string would unravel the global financial system.”
You know the financial lobbyists are losing an argument when they talk about collapse of the financial system. They love the parade of horribles technique, and never provide any factual support for it. Lying liars.
We all know what to do with bad banks. And that’s the problem, a lot of very powerful people and the wealth of status quo are connected.
It is not about banking mechanics, but politics.
Same thing as in Japan.
Our problem: we can’t afford doing what the Japanese did, they have gigantic budget surplus when they started the slip and slide.
Imagine US has 200% sovereign debt in it’s book with the size of trade deficit. We’ll go bankrupt in 5 years, nevermind “lost decade”
Japanese banks were holding a whole bunch of shares in Japanese companies, which came down in value by about 80% since (using NIKKEI as a proxy, with high of 39,000 to today’s 8000).
Selling those shares in open market (well, if ever such a thing really existed in Japan) would drive them down a lot – especially if everyone was selling at the same time.
“It is amazing how the politcization of decisions is driving the US down the same road the Japanese took…”
It’s because we’re both human. Proven time and again in real life and in academic study, taking a loss today is more painful than at some point in the future. Has to do with abstract thinking. No surprises here.
This article appeared in conjunction with another stating that banks need more aid to stay solvent. Someone is floating their trial balloons for nationalization.
Actually we are in worse shape then that. In Japan mortgage loans are non-recourse, people couldn’t just walk away. This caused them to have to pay down the loans which was off set by government spending and taking on a huge budget deficit. They were able to let their currency fall and export their way out. Every time they tried to raise taxes and cut the deficit the economy tanked. The US is in far worse shape then Japan ever was.
Grantham make the comment in his letter that “going the way of Japan” is not really that bad. Maybe we should be hoping things should go as well as that! I think if most people had to choose between Japan’s lost decade and the US’s Great Depression, they would choose the Japanese route. Investors on the other hand would probably prefer a quick and painful Depression. Most of us after all are hoping for stocks to be selling at Q=0.3 in the next year. It would be painful if we have to sit o our cash for 3-5 years waiting for stocks to bottom.
http://www.gmo.com/websitecontent/JGLetter_ALL_4Q08.pdf
I remember reading about Japan’s banking problems years ago and thinking “funny that’s how they try to solve that, we wouldn’t do that in America. I wonder if it’s some cultural thing, the Japanese place such a high value on ‘saving face’ that they can’t go through the collective embarrassment of admitting bankruptcy.”
Turns out the joke’s on me, one more arrogant American who thought the world’s problems weren’t his problems …
When you have a President who isn’t really respected and an opposition party that is simply stupid you’re not going to be able to make the right moves. The US is paying for the stupidity of electing the GOP into office for the last 8 years and then choosing a President whose reputation was smeared during the election as the agent for change. Not a pretty picture.
The US is simply turning it’s insolvent banking system into an insolvent country.
Fear is a protective survival instinct that functions to guide deciding between fight or flight, and conservation/withdrawal.
Using this analogy we can see how fight is not the only Darwinian adaptive choice. Survival depends on optimal instincts and consequent choices. Anyone believing that fight is the inevitable choice will not survive the natural selection process.
As a nation, we are confronted with deciding wether to “fight” by facing red-hot, front-loaded pain stemming from a deep and far-reaching economic calamity or instead chosing the gradual pain of a chronically souring economy that may drag on beyond the end of the next decade.
Unfortunately the decision-making is far murkier than I have outlined above. Being brave and bold is not enough. As many have posted here, the ultimate pain may reside in the ramifications of the choice.
If we bravely but foolishly chose to open up Pandora’s box and face the full extent of the financial debt we are on the hook for, an amount in the tens of trillions, we will have a real depression. We will damage not only banks but all the Downstream institutions, municipalities, retirement funds, endowments and foreign countries that entered into deals over the last decade. The degree of suffering is no longer the issue. Survival of our political system now becoems a question. World peace and order becomes a question. The return of abject poverty, crime and disease become quite possible.
Therein lies the rub. If we chose chronic pain instead of acute pain, thinking we are being reasonable, we may still not be able to fully contain the consequences on the health of our nation. We also have to trust people in the future to stay the course.
This is why I say that Japan has actually become our best-case scenario. Japan has come through their crisis without descending into political chaos, war or dictatorship.
DanyBoy – I am for not all at once but I am for more pain than even you think is possible.
Bottom line – the mortgages that are toxic (debtors quit paying) are cancer. This cancer can spread to other healthier assets if we do not administer strong doses of pain in a timely fashion.
I propose meating out the “zombie” medium banks first to send signals of the intent with the largest.
I understand that Paulson made some deals to attempt to save Wall Street. But in real terms the size of the cancer is to large. This deal to save Merrill by allowing Bank of American to acquire (than secretly assume a Fed bailout of BofA) was a mis judgment, understandable but mistaken.
Pimco made bets last last year that the Fed would bail out the giants. Bad bet (if we do than we should call the firm Pimpco).
The wealth in this country will lesson by about half (I think). The bond holders (a good portion) will be wiped out.
I think by first part of 2010 we should have destroyed a good amount of medium banks with Citi being the first large to be (nationalized – bond holders wiped out, and deposits set back into market under a legally different firm).
In the insuing time frame the Federal Reserve should keep interest rates low, keep flooding the economy with money supply (Friedman remedy), and allow the stronger banks (mostly smaller firms) to absorb the deposits and enlarge their credit portfolios. If this mechanism is not efficient than a banking entity set up by the Federal reserve to dole out credit is warranted.
Bottom line, wipe out bond holders and vanquish the toxic debt in a stronger than expected time table (leadership).
Yves, I would be interested in hearing from you a brief recap of your view as to what precisely is the nature of the problem that we need to solve by nationalizing. Is it a problem of inadequate lending? As you may know, Dick Bove has argued (and shown data) that indicates that banks are in fact lending, and that to the extent the amount of lending is somehow unsatisfactory, it is probably due simply to the fact that the banks are concerned about creditworthiness of borrowers as we plod through the recession. We don’t want the banks just handing out money willy nilly again, right? Do you disagree with Bove, and if so, why?
Also, if in fact there is a shortage of lending capacity, why wouldn’t a very simple solution be to just start new banks instead of injecting capital into old ones? This is what is happening in the muni bond insurance business, where AGO has supplanted MBIA and ABK. Why can’t Treasury play the role that Dinallo has played for the insurers, ie act as a steward to bring fresh capital in. That way the “toxic” assets can continue to sit with the shareholders who own them, and they can bear the losses or reap the gains of holding those assets to maturity.
One more note. With my first strategy in place and working we should work on what really incubated this "cancer" in the first place. And if the simple notion of pure greed on the part of real estate participants is the nexus of this mess you would be mistaken.
Wall street provided the tremendous liquidity of this toxic asset class because that financial power was not being deployed in M&A and IPO opportunities. This was due to the dollar's (and top line cash from the retail economy) decline much earlier than the real estate ramp up.
The cancer was created by oil manipulation. It is still occuring today. Proper (market) oil pricing is $20/barrel or less. The oil industry is expecting a pricing in the $40/barrel range for the forceable future.
If Obama eases into prosecuting the oil firms and their former political thugs the dollar would strengthen and the justice meated out would add robustness to our economic mess. And I say assist in our recovery.
The military mess in Iraq should be a constant reminder of our transgressions by the former Executive branch. This must not pass without punishment.
“With my first strategy” – not my strategy. I am getting the insights from the likes of Yves and other intellects. Please excuse me.
Two things:
1. Re: "Economists like Ben Bernanke attribute Japan's failure to dig itself out of its hole to not being aggressive enough in terms of fiscal and monetary stimulus"
Bernanke needs to be replaced and it's retarded remarks like this that are proof that he is a boob, because Japan did more than toss craploads of cash at corruption and insolvency — which brings me to the remarks made on Japan >>
2: "Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail."
>> Ok, this is #3, but Ben, Obama, Timmy and all the congressional pigmen actors involved in saving their banker buddies or corporate connections will place their bribes and rewards and friendships before America — and they will continue along the same inchoate path and deny the reality of what happened in Japan. These financial crooks, from insurance companies to holding companies and all the obvious unregulated and corrupt wall street banks, need to all be taken away from the control rooms and away from positions where they abuse power.
Do people not understand that these people are like alcoholics, meth users, coke users and abusive people that want more of the same shit and are blind to law and order? The time is here, now, to protest against the bailout of corruption and protest against TARP and what it really stands for, which is bailing out crooks. These crooks are stealing our future and stealing our money and then rewarding themselves while we watch them — why????
FYI: Chris Dodd has decided that the best way to put his sweetheart deals with Countrywide Mortgage behind him is to make them disappear. Dodd announced today that he will have those mortgages refinanced, and managed by a third party to protect against allegations of influence peddling:
Connecticut Sen. Chris Dodd says he’ll refinance two mortgages that he received through a VIP program from Countrywide Financial Corp.
Dodd told reporters Monday that the mortgages for his homes in Washington and East Haddam, Conn., will be refinanced with a different company.
Yves,
I am surprised I don’t see anybody directly taking Obama to task with his comment that we are not Sweden and so that solution is off the table. It makes me suspect, as I think others here have noted, our problems maybe much worse and nobody wants that to come to light with bank closures / nationalization.
http://www.calculatedriskblog.com/2009/02/obama-on-nationalization.html
PRESIDENT OBAMA: Well, you know, it’s interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what’s called “The Lost Decade.” They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn’t see any growth whatsoever.
Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you’d think looking at it, Sweden looks like a good model. Here’s the problem; Sweden had like five banks. [LAUGHS] We’ve got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would — our assessment was that it wouldn’t make sense. And we also have different traditions in this country.
Re: Sweden had like five banks. [LAUGHS] We’ve got thousands of banks.
Also see: Nordea is the largest financial services group in the Nordic and Baltic Sea region, but now with only 250 branch offices in Sweden. Nordea originates from four Nordic banks – from Sweden (Nordbanken including Gota Bank which it acquired in 1993), Finland, Denmark and Norway.
Yes, they had big banks and those banks had branches that were all connected in a financial network ,not unlike the one we have, so yes, Obama’s point is meaningless.
Financial masters of the universe (FMU), i.e., Wall Street bankers, private equity and hedge funds had a once in a century party and invited Washington politicians and the real-estate industry to their festivities. The party’s bill is $3.6 trillion dollars, and rapidly climbing, of which the FMU paid themselves many hundreds of billions of dollars in ill-gotten gains. The FMU convinced their Washington political stooges to see if they could get the people, who weren’t even invited to the party, to pay for the debauchery, the Congressional lackeys readily agreed. If Washington D.C. wasn’t such a stinking cesspool of corruption, these Wall Street crooks would be in jail now along with the Enron crook Jeffrey Skilling.
The US is way over-banked with approximately 8,000 institutions, we would not miss 25 percent of them during this downturn, consequently, let failed banks go bankrupt. The Fed/Bernanke is trying to save all the politically connected bank directors/managers/stock and bond holders and equating that with saving the financial system, which it isn’t. Also, the Fed/Congress is not investigating what went wrong during this financial crisis and how to fix it, e.g., what do we do with credit default swaps (CDS), (answer: naked CDS should be illegal because they are “bucket shop” contracts), lax regulations (they should be beefed up but which ones and how should they be better enforced) and phony accounting rules (how was Lehman Brothers ever a sound business with a $100 billion dollar hole in their balance sheet). Doing more of the same and expecting a different outcome is the height of irresponsibility, but obviously the slimy-on-the-take politicians, i.e., Geithner/Summers/Bernanke/Schumer/Dodd/Frank, subscribe to the Bernie Madoff swindling school of investing and believe the American people can be conned, yet again. President Obama, where are you.
In theory couldn’t you let the failing banks actually fail and somehow void the CDS contracts that aren’t hedges?
Let’s rehash, the debt outstanding that is afraid to be reported is a planet killer.
The holders of the debt are banks which in turn are Countries which boils down to citizens.
The Countries want their money (investments) back and will use the banks to extract it from citizens. It doesn’t matter how ie. taxes, wars, subterfuge, eating their own…..etc.
It’s going to be a long depression since they keep spending and the tax talk hasn’t started yet except in California.
Yves,
A GREAT BIG THANK YOU TO YOU!
You have been on the forefront of calling this crisis and the attempts by the very culprits of this crisis to game the system once again, for what would be a disastrous out come for tax payers and indeed this country.
further substantiation of anon @ 6:58's point above:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a1vxGSD1tWco
if there was true karmic justice in this world, there would be a day when jamie dimon was hung upside down naked by his toes from the george washington's arm at federal hall, for that would be the day that i would set my foot into the pleasure chest to buy a john holmes signature special to bring to the occasion.
wonder if he would flash his trademark smirk through that 'flogging'?
Maybe nationalization isn’t the only answer. There is also the option of a new National Bank, which could open for business without the bad debts of the existing banks.