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.