Guest Post: Turning Japanese and understanding the consequence of policy half-measures

Submitted by Edward Harrison of the site Credit Writedowns

Edward Harrison here. Yves is away today, so I thought I would spur discussion with a thought regarding the Geithner Plan and Japan.

As I see it, the Geithner Plan is inadequate because it assumes illiquidity where insolvency is the problem. The long and short of it, from my perspective, is that this plan will not get at the heart of the issue, leverage, debt and unsustainable levels of credit growth.  (Dan Roberts of the Guardian has an interesting take on this, suggesting the US is following the UK lead here). 

Nevertheless, I want to suggest that the liquidity thrown at the U.S. economy by this and other stimulus plans is so great that it may induce a cyclical upturn. Heresy? Hardly, as I mentioned in my previous post, this is what essentially transpired in Japan in the 1990s. So, let’s look at Japan for a second.

Last July, I wrote a post, “Japan circa 1996 – forgotten already?” to remind readers of what took place in Japan in the 1990s. The Yamaichi Securities episode of 1996, as told by the International Herald Tribune, was the event I highlighted:

In a reminder of the scale of the bad debts still weighing on Japan’s financial system, Yamaichi Securities Co. on Wednesday became the second of the “Big Four” Japanese brokerage houses this week to unveil a billion-dollar bailout for a subsidiary struggling with irrecoverable real-estate loans.

Ryuji Shirai, vice president of Yamaichi, said the brokerage would spend 150 billion yen ($1.31 billion) to help its nonbank subsidiary, Yamaichi Finance. The bailout forced Yamaichi to revise its earnings forecast for the year to March 1997 to a consolidated net loss of 108 billion yen from a previously predicted net profit of 18 billion yen.

Yamaichi’s move followed an announcement by rival Nikko Securities Co. on Tuesday that it would spend 147.5 billion yen to help three affiliated units write off their bad debts. Nikko also cut its earnings forecast for the year, from a net profit of 24 billion yen to a net loss of 95 billion yen.

Yamaichi and Nikko’s bailouts and forecasts for big losses followed similar moves earlier this year by Japan’s two other major brokerages and came as little surprise.

But they again illustrated the difficulties that even Japan’s biggest financial institutions are having dealing with an estimated $400 billion in mainly unrecoverable real estate loans and underlined that it would take years for Japan’s financial system to recover from its real-estate lending binge in the late 1980s.

Over the past couple of months, Nomura Securities Co. has announced a 371 billion-yen bailout for a troubled financial unit while Daiwa Securities Co. has spent 120 billion yen. Nomura now expects to post an annual loss of 332 billion yen, while Daiwa said its loss would depend on the sale of securities.

The bailout of Yamaichi Finance was designed to maintain Yamaichi’s reputation and to “reinforce its competitiveness through early write-offs of the affiliate’s bad property-related loans,” the company said.

The daily Nihon Keizai Shimbun said Yamaichi Finance, which mainly lends to real estate firms, plans to write off all its bad loans in three years. Yamaichi Finance, which has 140 billion yen of bad loans and assets of 360 billion yen, will receive 100 billion yen from Yamaichi Securities and borrow 50 billion yen at low interest rates, the newspaper said.

Following Yamaichi’s announcement, the ratings agency Moody’s Investors Service Inc. said it was upholding its Baa-3 rating on Yamaichi’s senior debt and its Prime-3 rating on short-term debt, affecting $2.2 billion in debt securities.

“Although the full amount of the cash support will be recognized as an extraordinary loss, the actual impact on Yamaichi Securities will be reduced by the anticipated gain on the sale of securities and other assets and by profits arising from normal operations throughout the year,” Moody’s said.

Moody’s said its ratings had already “incorporated the expectations of substantial losses related to its affiliate” and noted that the size of the bailout was “within the anticipated range.”

“The firm’s capital adequacy, though weakened by its real-estate exposures, remains adequate, given the company’s liquid balance sheet and extensive domestic franchise,” the agency said.

On Tuesday, Nikko said it would give 82.1 billion yen to its affiliate Kyodo Mortgage Acceptance, 47.7 billion yen to Nikko Credit Services and 17.7 billion yen to Nikko Real Estate. Although Nikko plans to provide the money to the three nonbank affiliates during the 1997 financial year, the company said it would report a one-time loss of 147.5 billion yen for its financial year in 1996.

If you recall, Yamaichi was not the only Japanese brokerage to go under. Three of the big four Japanese brokerages, Yamaichi, Nikko, and Daiwa, went belly-up were merged out of independence as the lost decade continued. Only Nomura remains independent from the halcyon days of the 1980s Bubble Economy. Certainly, this might be a bad omen for Morgan Stanley and Goldman Sachs, but more importantly, it should remind us of a couple of things:

  1. Even if economic and monetary policy have poor longer-term consequences, it does not mean that policy won’t gain traction in the short-term.  I see the potential for a cyclical upturn due to the massive stimulus campaign (See Paul Kasriel’s take at the linked pdf). Ask Alan Greenspan regarding his 2001-2003 easy money campaign. This is what happened in Japan before Yamaiichi’s demise in 1996 – and again before Daiwa and Nikko went under as well  were merged out of independence.
  2. Even if economic and monetary policy have stimulative short-term consequences, it does not mean that the structural problems have disappeared.  They are merely lurking underneath, waiting for the next downturn to re-assert themselves.  Again, the Japanese scenario is a cautionary tale on this score.
  3. Asset prices will respond to an upturn, but that does not mean we are about to embark on a new bull market.  Japan is the right precedent here again.  After the upturn inthe mid-1990s, property prices continued to collapse in Japan, sucking many more individuals into the deflationary spiral.
I do hope we can avoid the worst-case scenario here.  However, I am concerned that the Obama Administraton and the Federal Reserve are literally papering over the problem with half-measures.  America is turning Japanese.
Whether they recognize this fact or understand the consequences their actions is unknown.

UPDATE 25 Mar 2009: A factual correction – Daiwa never did go bust and Nikko actually was merged into Salomon Smith Barney to prevent its demise. Therefore, Yamaichi was really the only one of Japan’s Big 4 to die. Cassandra of “Cassandra Does Tokyo” corrected me:

“Neither Daiwa, or Nikko went bankrupt to the best of my recollection – and I traded continuously large diversified books of stocks from 1991 to 2008, and was deeply anal about data integrity, survivorship bias and the likes, and deeply concerned with tail risk so I reckon I would have known had one of these listings drilled a hole in a long portfolio or scored-me a ten-bagger on a short torpedo. I certainly remember Yamaichi’s flame-out since specs (and Tiger Mgmt) started massively shorting each and every Yamaichi security holding on the suspicion and the news – both real and imagined, and this DID hurt and was VERY painful (at least until the end of the fiscal year.

Yamaichi was Fuji’s big-4 brokerage affiliate – both members of the Fuyo keiretsu, (including Fuji Bank, Yasuda Trust, Yasuda F&M, Taisei, Sapporo Brew, Canon, Nissan, Tokyo Tatemono, Marubeni amongst others too numerous to mention). Fuyo was closest to Sumitomo of the competitive keiretsus, and these groups had overlap. Fuji was the JP MOrgan of Japan, but was weakened the most of the major banks thanks to real estate.

Daiwa was the Sumitomo-group big-4 broker, so it was natural that Sumitomo would agglomerate it’s second-tier affiliated brokers and then affix them to its own securities sub and JV with Daiwa in a resignation that they just couldn’t compete. Nikko, as well, didn’t go bankrupt, eventually choosing a foreign partner in 1999 or so that merged Salomon/Citi ops giving the Americans a large stake, and an exit from marginal business, and giving the Japanese access (so they thought) to US distrbution clients and expertise to compete with Nomura. Of course it never happened, but that is just culture plain and simple. Americans took advantage of market punishment to acquire all of it (I think in 2007), though they are probably regretting it.

Even Daiwa Bank (now Resona) was never bankrupt. Rising like a Phoenix from many recaps.”

Nikko was essentially ‘rescued’ by Citi and merged into Salomon Smith Barney. As I recall, everyone outside of Japan (in New York and London) was fired on the deal as several friends lost their jobs. The news story is below:

Salomon Smith Barney, the securities arm of Citigroup Inc., and Japan’s No. 3 brokerage firm, Nikko Securities, said yesterday that their investment banking venture would open on Monday after a month’s delay because of procedural problems. The venture, Nikko Salomon Smith Barney Ltd., will be capitalized at 106 billion yen, or $883 million, and will have a staff of about 1,100. Separately, Standard & Poor’s lowered Nikko Securities’ counterparty rating yesterday to ”BBB-,” one notch above ”junk” status. A counterparty rating reflects a company’s ability to honor its senior obligations for swaps, forwards, options and other financial contracts.

The Daiwa story just seems to be false (Daiwa Bank was the company I was thinking about: they were merged into the weak Resona Holdings with 4 other banks). Daiwa did merge investment banking with Sumitomo but the securities group was never merged out of trouble.  Sorry for the error:

Japanese securities firms have struggled ever since the bubble economy burst nearly a decade ago. Now, deregulation has made things worse, opening the firms to intense competition from foreign concerns with expertise in products and services they know little about.

Outsiders have already made big gains in Tokyo Stock Exchange trading and pension-fund management. Merrill Lynch has taken over Yamaichi Securities, and Salomon Smith Barney is in a joint venture with Nikko Securities.

Only Nomura Securities, the brawny leader of Japan’s securities firms, has a chance to survive as an independent, many analysts suggest.

So in July, when Daiwa, Japan’s No. 2 brokerage firm, announced an alliance with Sumitomo Bank, it was greeted with something verging on disappointment.

Sumitomo, Japan’s No. 2 bank after the Bank of Tokyo-Mitsubishi, is the core of the keiretsu, or business group, that includes Daiwa, and the alliance was largely seen as just another case of circling the wagons.

Moody’s Investors Service, which had already put four Daiwa subsidiaries on notice for a possible downgrade, said the announcement did little to dispel its concerns.

NY Times, 1998


Related article
Geithner plan ‘short-sighted’ – The Age

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Anonymous

    It’s the Second Pig analogy. First pig plays, builds house with straw, loses it to wolf, but can hide at his brothers’ houses. Third Pig loses playtime but has a nice brick house and the love of his brother pigs. Second Pig didn’t get to play AND didn’t get a house because he liked half-measures. Obama is a classic Second Pig.

  2. Timo

    Turning Japanese…HA! Where is similar export machine in the US? Where is the savings rate? Where is super-duper-21th century infrastucture? Where is the educated workforce? Even proper health care?

    USA is turning Northern Argentina and even that is the optimistic best case. Worst case is something resembling Beirut civil war.

  3. Anonymous

    Greenspan’s easy money allowed consumers with declining real incomes to leverage their houses to support consumption. That is gone. So, to your point that increased liquidity may cause an upturn here, what are you suggesting will be the source of increased demand now?

  4. Edward Harrison


    That’s hilarious! You’re right, there is no export machine and no savings. Perhaps I am being too charitable?


  5. Anonymous

    Many things different than Japan with most being noted here (savings rate, exports versus imports). Any 2001-2003 comparison to Greenspan is totally off base as he still had interest rates working in his favor….not so now. Also, from the peak it was five or six years until there mid-ninties upturn.

  6. lineup32

    Japan is a good forward indicator of what lies ahead and while the economies are not exact both had large financial asset bubbles that no longer support a growing collateral lending environment. The FED,Congress and the Treasury are busy blowing financial bubbles which will leak out in various financial speculation runs but whether main street will catch much of a ride is yet to be determined.

  7. Edward Harrison


    you said “Many things different than Japan with most being noted here (savings rate, exports versus imports). Any 2001-2003 comparison to Greenspan is totally off base as he still had interest rates working in his favor….not so now. Also, from the peak it was five or six years until there mid-ninties upturn.”

    No argument there. There are as many differences as similarities. My overall points were the three I highlighted at the end regarding a de-coupling of longer-term and short term consequences and the likely path of asset prices in a longer-term downturn.

    I think America is in a much worse position than Japan, honestly. So, we are probably in agreement that the likely outcomes will be less favourable.

    For more on the Japan analogy, see an article I just posted referencing Rich Bernstein’s thoughts on Japan:



  8. Evelyn Sinclair

    You haven’t mentioned the enormous derivatives bubble. There is still a tremendous unexploded bomb there, with enough suction to implode a lot of institutions when the next round of deleveraging happens.

    I don’t think the leverage situation has ever been like this before by a few orders of magnitude.

  9. Anonymous

    I agree with Evelyn about the unknown unknowns of the derivative bubble and think that the US is deluded if they think that they can keep the dollar as the Reserve Currency with their blatant lack of transperancy about the derivative unknowns. The rest of the world economies have too much to lose by not forcing the issue.

    And America, they are showing a ton more societal morals than you are. Taking America down a peg or two would be a good thing, IMO

  10. Anonymous

    “Skin in the game” is better expressed “Skimming the game.” Hedge funds overbid on bad assets using borrowed money and take kickbacks from the banks that more than covers their small percent of “skin in the game.”

    When you look at who is on the “taxpayers” side of this fiasco it’s clear we’re going to take the losses. Who stands to personally win anything by standing up for what’s right in a democratic society? Hmmm? I look at CitiGroup right now and it’s very tempting to buy some stock because the writing is on the wall that this corporation is going to not only survive but thrive. It will have the largesse of Uncle Sam as a backstop and can go on a buying spree. It can borrow short at 0% and lend long at 5%. What’s not to like? Now it can get hedge funds to buy up its toxic assets at book.

    I’m not a political animal since I can’t find much in either party to like. I was hopeful that Obama would be a little better than the Bush Dynasty at the “vision thing.” What I see is just more bank giantism status quo. Geithner and Summers are advising Obama that to let the US “Too Big to Fail” banks go under would be to allow the US to lose its status as the world financial power. Obama has swallowed it – he’s on their line dangling like a fish flopping out of water. Perhaps he should have stayed in Chicago where he was still in his element.

  11. Anonymous

    Japan, noted structural differences aside, is an apt comparison. Japan, since the end of W.W.II, has been used by the western ruling elite as an R&D project for societal control, global financial manipulation, off shoring of manufacturing, etc. …

    As to your close;

    “I do hope we can avoid the worst-case scenario here. However, I am concerned that the Obama Administraton and the Federal Reserve are literally papering over the problem with half-measures. America is turning Japanese.

    Whether they recognize this fact or understand the consequences their actions is unknown.”

    Having pilot programmed those actions I am sure they are very aware of them. Create a crisis to heroically resolve the crisis is an old ruling elite game. Its the same old shit with a newer and ever more deceptive set of puppets now operating on a vastly smaller and competitive world stage as a result of excessive over consumption.

    Deception is the strongest political force on the planet.

    i on the ball patriot

  12. Anonymous

    “Turning Japanese” would be an acceptable outcome. If we had 20 years of stagnation and reduced expectations followed by slow growth — and that was all — I’d be grateful past words and count myself and my children uncommonly fortunate.

    But I don’t see how we dare compare their outcome with anything we might calmly consider as relevant to our own future.

    Japan had a bubble that burst, but they were powerful exporters and had the entire planet to prop them up as they foundered. Also, they were not really in a position to take out any significant part of the global economy (due both to size, and due to a very different environment at the time.) Their workforce is homogeneous, educated, dedicated and thrifty.

    The US, in contrast, exports nothing of importance, cannot expect to be propped up to any significant degree, and is operating a massive Ponzi scheme of interconnected self-serving counter-parties. Our workforce is outsourced, undocumented and demoralized. We have major problems with quality and evenness of education at home, our transnational corporations have no loyalty, and for 15 years we spent more than we earn as both individuals and as a nation.

    Oh. And the US is in a strong position to detonate the entire global financial system and economy Any Day Now Just Wait For It.


    Under the circumstances, trying to predict market movements, and the future price of gold, and “when we will recover” all sounds like whistling in the graveyard to me. I fail to comprehend why we are not rather totally, irrevocably and inevitably blown to rat sh*t over any near horizon you might point to.

    OK, that’s not helpful. I know. Me and my attitude are part of the problem. But I can see this airframe has no wings and all the talk about landing it normally — like that was somehow in the cards — is really creeping me out.

  13. Anonymous

    I am linking three references to quotes here. I have been able to find two of three quotes I wanted to refer to but the third (just read not 15 minutes ago) eludes me but it said, in effect, “the underlying problem was declining real wages which with the excess supply of credit enabled American workers to access this to fund consumption.”

    This (unprecedented decline in real wages) has been discussed here (Naked Captialism) before and is the underlying problem which needs to be fixed. It also is part of the equation to the export/real production problem (re: Japan vs US comparison).

    The following two quotes, indirectly, are at the heart of this problem – declining real earnings and an unprecedented transfer of wealth from one sector to the finance sector – as Ed Harrison discussed in his first posting today.

    Back to the other two quotes referred to in my opening:
    From ‘Dark Musings’ (Links 24/04): “This is not my country.”

    From ‘Can Geitherner’s public-private parnership get it done?’: “Populist sentiment is running high because people have finally realized that the last quarter-century or more has seen a massive divergence of economic fortune between the wealthy and everyone else. In essence, while credit was flowing and asset prices rose, ordinary Americans appeared to prosper along with the wealthy. However, now that credit revulsion has replaced easy money, it is plain to all that standards of living will decrease. President Obama would be wise to use his inner Bill Clinton and demonstrate he can “feel your pain” or he risks being perceived as aloof.”

    This crisis is not one of the finance sector – this is a cause and needs to be remedied at grass-roots level – but one of economics and public policy concerning governing in the general interest, as discussed yesterday.

    As an aside, I worked for JP Morgan in the early to mid 90’s – pre the Chase merger. It was a fantastic organisation, committed to its charter. What we see today is not the same animal. I’m assuming here that my experience at JPM mirrors that of Yves at Goldman’s – what we see today is not what went before. The morphing occurred mid-90’s on and that practise is what needs to be stamped out. Causes are varied but ignited by lax regulation. The kids ran the kindergarden. Yves – thoughts on your Goldman experience compared to my JPM sentiment??? (I loved working for that firm…)

  14. Edward Harrison

    Anon from JPM,

    Thanks for your comments regarding how JPM was pre-merger. Were those the Dennis Weatherstone days?

    As for falling real wages, some economists like Galbraith think that is the ticket to getting us out of this mess, increasing real wages.

    Take a look at this chart from my site in June:

    This is a huge decline in wages that will be difficult to combat. To me, it suggests the ‘rot’ has gone on for much longer than is presently realized.

    As for grass -roots. That is exactly what blogs like Yves’ are all about, building awareness of some of the underlying problems and spurring action for change.



  15. tyaresun

    The objective is to do enough to get re-elected in 2012, nothing more. What the govt. is doing might be sufficient to meet this objective.

  16. Anonymous

    You are all missing the point.
    The banks can not dump OTC’s for real worth (20 cents on dollar) so Govt needs scapegoat “private sector” to bid up OTC’s. Cronies will do this because Govt backstop on losses.

    This is nothing more than a scam to buy OTC’s at inflated pricing.

  17. Ian Lucas

    Steve Keen’s take on whether the economic stimulus package is likely to induce a cyclical upturn is at Key quote:

    “…at its peak, the annual growth in private debt added $US4.7 trillion to aggregate demand, compared to an annual GDP of $US14 trillion. The immediate impact of the cessation of private debt growth is thus a 25 percent reduction in aggregate spending. If the private sector then succeeded in reducing aggregate debt levels by as little as 5 percent per annum, that would reduce aggregate spending by $US2.7 trillion in the first year. This far exceeds the size of the fiscal stimulus mooted by the Obama administration….A Depression is therefore highly likely.”

  18. Anonymous

    This comparison to Japan-1990 is as inept as the one to US-1929. Or a milder case, Northern Europe around 1992. In all cases, countries with brilliant production-and-export engines.

    Of course, the US of to-day, and a significant part of Europe by the way, is in no situation to get into deflation. Deflation applies to robust natures.

    USA will run out resources and drift into inflation, possibly massive a burst of it. The only question is “how deep into inflation?”. Let us hope the situation does not degenerate too fast.

  19. Gentlemutt

    Presumably the JPM alum was indeed talking about the Dennis Weatherstone days, and not the Sandy Warner days. Warner’s reign was the triumph of style over substance, not only leading to the end of JPM as an independent entity but being emblematic of the rise of the ultra-fast buck crowd.

    Ed, thanks for focusing attention on key long-term issues like that of real wages. What do you think about this as an alternative to the short-term bonus rage?

    Offer significantly lower *corporate* tax rates to companies that keep their compensation distribution within, say, 40:1, from max to min.

    support from those who like lower taxes,
    support from those who like social justice,
    incentive to increase wages at the bottom for managements that want to get paid more and want to see their stock-price rise due to lower tax rate than their competition,
    and industries where leadership is not a scarce commodity (contrary to what so many executives and sycophantic headhunters tell us) would be genuinely separated from industries and companies where a single person makes all the difference.

    Disadvantages? Sorry if this is an intrusion, but since you are monitoring the board it was too tempting to seek your input. Cheers.

  20. Anonymous

    Anon ex-JPM

    Ed – yes. Big sigh, those were the days….. integrity and good deals and focus on credit (Im a credit geek).

    I agree with you and it was probably your link to real wages that I was referring to when I said it’d been discussed here before.

    The ‘rot’ may well be the undoing of us all. Ive been using the analogy of plugging a sinking ship but not fixing the problem for a while now. I also remember never being as scared and anxious that day last year while we waited overnight for Fed’s decision on AIG. Im an anitpodean and it was a long day and I have never felt such fear…what could have happened – not because of confidence and another “big” name but because of the flow on effects to European banks 2nd tier capital via CDS holdings that AIG was supporting.

    Ive been addicted to this blog (and others – yours included) for about a year since I discovered them.

    Financial reporting and thought is woeful here – anything with a bit of bite has been lifted from this blog and others – I know because I read it here and then a couple of days later, voila! its in our press.

    Grass roots is where we have to focus WHILST patching up “everything else”. Where are we (we doesnt mean US – remember Im an anitpodean) going? Putting out bushfires along the path is good but what path are we on?

    Superficial thoughts. I agree but when the ‘chickens come home to roost’ one needs to address the fundamentals.

    As an aside. When I started in finance in the very late 80’s (remember those crises? ie until early 90’s) I heard an analogy – banking is like little boys (not men, note) playing soccer. The ball goes down one end, they all follow. Twenty years on and its the same same. Everyone has to be doing the same thing less they miss out. The little boy analogy differentiates little boys playing from men, where a strategic game develops, based on each teams strengths and weaknesses.

    Maybe its inherent human nature not to want to be left out. That is why we need ‘real’ and ‘strong’ leaders – both in politics and in commerce.

    Have a good day all. Im an hour late for work….

  21. Anonymous

    Hi Ed, good posts.

    Expanding on the sentiments of the ex-JPM comments and other readers, NC has been a real gem the past year or so, and you can see the rumblings at the blog level reaching upwards to shape the main stream news.

    I think NC should continue on the path its toyed with recently of being a little more proactive in setting the dialogue on bailout matters. Turning the discussion towards investigation of fraud, expansion on and analysis of what the ex-JPMer, Yves and other readers have lamented (the 90s transition to style over substance), etc.

    The analysis of media coverage and the likely economics of various plans is good, but all reaction-based. I’d like to see more — perhaps a daily feature, or an end of the day blogosphere-sentiment summary — “If I were in charge” content.

    The idea floated in Pension Pulse’s guest post yesterday was a refreshing change. That kind of blogging does a better power of recognizing and utilizing the power that grass-roots media (blogs) have had during this crisis.

    More discussion of the process, progress and necessity of investigating fraud, as well as discussion of the conditions that spurned it and how to roll-back and restrict them from returning. More proactive floating of alternative ideas. Keep the great content that puts the bullshit detector to media coverage of the politics and business reporting surrounding this.

  22. Don

    For the US economy to rebound even modestly one must assume that increasing income is making it into the pockets of the general population by way of either taking on more debt or an increase in income, or some combination of both.

    Someone will have to explain to me why a large enough percentage of the US population would choose to go further into debt or where the new jobs will come to constitute a substantial increase in income to account for renewed economic growth.

    It seems we have here a Catch 22: renewed economic growth requires an increase in consumption/debt, which itself requires an increase in income. But an increase in income will not come about without obviously new jobs being created to service/produce, which itself won’t come about without an increase in consumption due to an increase in income or debt.

    So which comes first? The thinking behind all efforts to re-start the economy focus on re-staring the production credit/debt. So attention is on finance as the core of the economy of consumption/production. Sure, the stimulus contains some jobs . . . but more of the save rather than create new jobs variety.

    What is missing in this assumption is the failure to adequately understand the US economy within the context of the global economy. Success for the US in re-starting it’s economy implies to some degree success globally, which further implies that the global imbalances of overproduction/over capacity in the East and over consumption and over capacity of retail in the US can continue somewhere near where it left off about 1.5 years ago. Is this at all realistic?

  23. Leo Kolivakis


    If you look at my earlier post, Hedge Fund Socialism?, you’ll find a link to Charlie Rose’s show last night where Paul Krugman basically agrees that these measures only prolong the agony turning the U.S. banks into Japanese “zombie banks”:

    Will all this liquidity lead to a “sustained’ recovery. I am not hopeful because the underlying structural debt problem isn’t going to disappear.

    One thing is for sure, we need a better solution to the crisis than what is being touted now.

    I discussed my idea of having a consortium of pension funds buy these assets off of banks at a fair price that suits both parties and then slowly sell them once the recovery kicks in.

    Pensions have long-term liabilities so it makes sense for them to hold the assets on their books, provided they are worth something and will pick up value.

    I am afraid that Krugman and Galbraith are right and this plan will do little to put the U.S. and global economy back on a sustainable growth path.

    Worse still, if the market starts to perceive that the plan will flop, debt deflation will wreak more havoc on the global financial system.

    What a mess…


    Leo Kolivakis
    Pension Pulse

  24. Yossarian

    Like Japan in the 1990’s, we have a big a big deflationary deleveraging problem to deal with but, this time, there isn’t strong world economy to export to. I am as pessimistic as anyone when it comes to this whole financial mess and the immoral, inept solutions.

    What I have to take issue with is this constant obsession with manufactured exports. We have the ability to manufacture steel, textiles, and widgets, mine iron ore, and run call centers. We don’t because we have evolved into higher margin, more value-added businesses; companies like Cisco, Intel, Google, CAT, Deere, Monsanto, Genentech, and Archer Daniels produce things that few economies can compete with. The world loves IPOD’s- examine how China gets credit for an export when they merely finish the product by snapping together the casing. Who is adding more value and where is the wealth being generated- in the US or in China?

    Another issue I have with the bear case is the massive debt numbers that are thrown around- I think the debt is massive but how much of the number is double-counting? I mean if A lends $100 at 3% to B and then B lends that to C at 4% and C lends to D at 5% then is there really $300 in debt or $100? I’m just not sure how to count debt in a meaningful way…

  25. Independent Accountant

    I can’t see the Japanese analogy. I think a more likely course of events is another inflation induced boom. By the way, I think the “recession” will end in 2009’s fouth quarter or 2010’s first quarter. Then it’s off to the inflationary races.

  26. Anonymous

    “I am as pessimistic as anyone when it comes to this whole financial mess and the immoral, inept solutions.”

    This is just a suggestion- stop talking about morality, it is even more fungible than money.

    There is no place for morality in money, and especially when you are dealing with banks. If you claim to be coming from moral high ground, the banks will kill you every time and take your money as you lie there dead.

    This is not a philosophical argument, this is a economic argument, keep it to the numbers, they are vague enough as it is without trying to ‘moralize’ everything.

  27. Jim in MN

    Morality is always and everywhere one component of legitimacy; but not the only and rarely the most important one.

    One can consider the viability of a system in terms of Maslow’s hierarchy of needs–survival, then one’s family, then one’s affinity group (racial, class, social)…at a certain point the needs run to self-actualization, realization of one’s potential and so on.

    We live in a complex world in which many people have grown accustomed to enough comfort and freedom to ponder their ‘chosen field’, their professional and personal pursuits, etc. Far more, of course, have no such luxury. It is amazing how the need to dream continues to emerge even in the direst straits, the garbage dumps and arid plains…but we generally have had the fat of the land and opulence for generations in the, hmmm (pondering audience of this blog) call it the developed countries.

    A lot of that pyramid of wealth is collapsing like those chaotic grains of sand infected by fingers of instability. It is not about to stop and it is impossible to predict the cross-currents.

    The blogosphere has caught up reasonably fast to events. I think we have concluded that the powers that be cannot tolerate the cascading effects of bond writedowns and that is the barricade being defended.

    This is why the policy is to hope for a Japanese outcome. Both bankruptcy (private failure mode) and nationalization (public failure mode) entail ‘cleaning up the mess’ i.e. the very bond haircuts that cannot be allowed. So, we will “continue to strengthen the financial system” by paying those bonds off in various clear and opaque ways….forever, or thirty years anyway.

    Japan on a shoestring…Japan on the backs of infants is more like it. The backs of my baby girl and her yet-to-be-born brother. Immoral…yeah. It is. Very.

    What I would like the blogistas to consider:

    1. Is the bond haircut scenario really so terrible that we have to be held hostage effectively forever? Please consider how a real writedown would impact various key sectors. In particular, would health insurance companies blow chunks and collapse, taking the health care system down? Aren’t their investments in bonds? More obvious are the pension and life insurance cases, but how bad is it really? And what about the rich and the furriners? Can’t we sort them out and cut their assets/hair preferentially? After all this is economic warfare, and my babies should not, repeat not, be paying fat cats and (arguably) sheiks. Indentured servitude can only go so far–wouldn’t we be better off making an informed decision to wipe out despots’ bond assets and save our insurance and pensions?

    2. What are the lessons for household investment strategy? What would a Japanese housewife do? Should we all cash our chips in and build nicer houses to declare bankruptcy in? If bonds are being defended at all costs, are bond markets good places to hide or terrible ones? Corporate or government? Nothing fancy, please; normal household investment options only.

    I personally believe that all investment categories are about equally screwed, that there will be no such thing as a positive real return for 30+ years, and that the best one can do is remain diversified, increase savings by a huge multiple, and reduce interest and other expenses. Permanently.

    Best of luck to all…

    –Jim in MN

  28. joebhed

    ummm, the historians will have a field day figuring out who to give credit to for prognosticating the best analogy for what the f*$k just happened.
    The post ignores, but some commentors clearly point out, the conundrum of our time.

    We’re what you would call debted-out.
    We REALLY need to think about that as we try to come up with a plan to get the old economic wheels turning again.

    Having done that, the most basic question that should come to mind is this: what is the least-cost solution?
    You saw Bernanke today glibly answering that it would have cost a bigger bundle without AIG’s insurance policies.
    He was claiming ‘least-cost’.

    The problem with the Geithner-Summers-Obama-Krugman-Galbraith solution is a huge slug of debt.
    An incredible, unprecedented series of escalating debt-instruments to pile onto the American taxpayers.
    It’s either that, or the Chicago Plan.
    Debt-free money.
    Spent, NOT BORROWED, into circulation.
    What Milton Friedman espoused.
    Why not take the least-cost solution for the taxpayer?

  29. killben

    “As I see it, the Geithner Plan is inadequate because it assumes illiquidity where insolvency is the problem. The long and short of it, from my perspective, is that this plan will not get at the heart of the issue, leverage, debt and unsustainable levels of credit growth”

    Exactly. The level of debts is very high and the value of assets held is falling, which makes insolvency very real.

    “Even if economic and monetary policy have poor longer-term consequences, it does not mean that policy won’t gain traction in the short-term”

    True. But the situation here is different. The difference today lies in dearth of capital, buyers psyche with all asset classes under siege and job losses, hunkering down by buyers, globalization and world-wide drop in demand . This would indicate that it is going to be extremely difficult to gain traction even in the short term. Also if the short term traction is not there then it further exacerbates long-term consequences.

  30. Juan

    Don: It seems we have here a Catch 22: renewed economic growth requires an increase in consumption/debt, which itself requires an increase in income. But an increase in income will not come about without obviously new jobs being created to service/produce, which itself won’t come about without an increase in consumption due to an increase in income or debt.

    So which comes first?

    Your ‘catch 22’ needs a third term, average rate of nonfinancial profit [not earnings]. Without an expected to be durable rise in this rate, the probability of higher wages and non-immiserizing growth becomes dependent upon counter-cyclic monetary and fiscal policies which, over a number of cycles, lose their punch and can transform into a fiscal crisis of the state.
    Fred, in relatively close agreement w/Edward, say a bit about it here

    Crises are evidence of systemic limits and the attempts to overcome these, which can also be understood as a not-just-national overaccumulation of means of production relative to employed living labor on one hand and ability to realize profit on the other. Crises are not so one-sided as normally portrayed and cannot always be mitigated via demand-side policies — which brings up the necessity to set a social floor, something the financial bailouts definitely do not do.

  31. Juan

    Please note that I’m using the term ‘immiserizing growth’ in other than a strictly terms of trade related sense. Instead, and as e.g. the long-run real wage decline, wage share of profit, etc. indicate, persistent pressure on working class standards of living and greater exploitation even as there has been growth, though the latter has also been in long slowing.

  32. YB


    Japan’s analogy is fine for financial mess. But I think the difference between two countries is not so clear:

    First, my working experience as a Japanese tells me that it’s not obvious that Japanese are better (moralized, educated or whatever) than Americans in the job place. You can find corporate fraud news here many times. Also, working hours per year in Japan are almost similar to those in the US, which means Japanese are no more hard-working than Americans in terms of working hours.

    Second, the savings rate is not so high in Japan. The latest data shows that the savings rate in Japan in 2007 is 2.2%, which is not much higher than the US. US savings rate in January is 5%. So, Americans now would be much conscious for savings than Japanese. Other source indicates that Japanese savings rate is much higher, but I think that we should doubt “Japan’s savings myth”.

    Third, social security system is collapsing fast here. Overall, we can still afford the cheaper medical treatment than the US, but local areas are crying for medical doctors and hospitals because some local governments are not financially healthy to support medical expense. Also, nobody trusts the pension system here. Everybody has much anxiety after retirement.

    One point last. I think that we should look at nominal wages, not real wages, if under deflation. Wages increase in real terms under deflation, which Japan has experienced. Of course, the US has not yet fallen into deflation, but nominal terms would be more useful if prices turn to negative.

    Anyway, I enjoy your post. Thank you for your insight.

  33. Anonymous

    The question of illiquidity and insolvency is a difficult one and perhaps as the answer is different for different banks. There is no doubt in my mind that some UK banks were insolvent whilst most European banks suffer from illiquidity. In the US then most big banks are currently suffering from illiquidity while smaller banks are threatened with insolvency. The problem is though that those big banks will soon become insolvent and the key for me is not exposure to housing or securitisation although commercial real estate may wipe out a good part of banks capital it is the leveraged loans. Meredith Whitney often talked about banks exposure to leveraged loans and I cannot help thinking that in a time when deleveraging is going on the levels of write downs are way too low.

    Some of those buyouts were for zombie companies which have been pretty much asset stripped to make money and could result in a total loss on the loans made. It seems quite obvious from the way the company I work for is beginning to take steps to control credit exposure to large companies as they delay payments and use any method to de-leverage that there are a lot of big companies that will not make it. Big companies mean big write downs at the banks and its these leveraged companies that threaten to spark an avalanche of unemployment.

    Quite simply rescuing the banks is a small part of the steps that need to be taken to turn the economy and all I can see is unemployment accelerating as US exports dwindle and internal demand continues to soften. At some point the economy will pick up such a downward momentum that whether the banks are whole or not becomes irrelevant. Regardless of whether mortgages become cheap, cars are subsidized, banks want to lend an unemployed person wont be joining the party and there comes a point when the employed cannot compensate for the demand drop from the unemployed. It is not how many are unemployed but the speed of deterioration in employment that is my chief concern.

    Still lets go down the Japanese route and postpone things for a while.

  34. PCJ

    This has been a good discussion. In my opinion, the rough consensus coming out of it is correct: the heart of the problem (at least here in the USA) is falling real wages. I see three fundamental reasons for this:
    1) Competition. No way can American workers, making 20 or 30 dollars an hour, compete with Asian workers who have access to comparable technology and are willing to work for much less.
    2) Political hardening of the arteries. Political actors via political manipulation have found ways to earn rents (i.e., non-competitive rates of return). Their success forces everybody else into the political arena to take protective measures. The result is that vast amounts of resources are wasted, and the political arena, the place of collective action, is rendered useless. (See Mansur Olson for this one.)
    3) Rising marginal cost of energy.

    These problems have no general, system wide solution. However, there are local solutions, hence there are reasons to study the general system. We do so in order to anticipate incoming waves of dissolution, and see what can be done to put together elements of a local solution. (Of course, I would say, too, that we study the larger system because of its entertainment value. It is, at least to me, one hell of an interesting spectacle.)

  35. Edward Harrison

    Thanks again to everyone for your comments and insight.

    I especially appreciate the insights on Japan and their experience from a few readers.

    The discussion has definitely been thought-provoking and I intend to use some comments for later posts.



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