The George Santayana saying, “Those who cannot learn from history are doomed to repeat it,” is so oft repeated as to verge on cliche. Yet the US variant of this syndrome is to be aware of history, then rationalize how it does not apply to us.
Japanese policy makers from the early days of the crisis have been saying in an uncharacteristically direct manner that the top priority is resolving nonperforming assets. Recapitalizing banks without taking this step is a mere palliative.
What is telling in this VoxEU account by Keiichiro Kobayashi is how the US and UK are going down the path of denial and expediency blazed by Japan in the 1990s. And Kobayashi contends (in classic Japanese passive voice) that America’s dud assets are two to three times the size of Japan’s at the time of its bust. Since the US economy (then) was roughly two times the size of Japan’s and unlike them, we did not come into our mess with a large buffer of savings, the implication is that our problem is more severe than theirs.
And worse, when Kobayashi says the bad loans need to be worked out, he does not mean simply shifted somewhere else, as the public-private partnership provides. He means renegotiated, a near impossibility with structured deals.
Bad debt is the root of the crisis. Fiscal stimulus may help economies for a couple of years but once the “painkilling” effect wears off, US and European economies will plunge back into crisis. The crisis won’t be over until the nonperforming assets are off the balance sheets of US and European banks.
In proceeding with financial reform in response to the financial crisis, the US has been injecting public funds into banks and struggling companies with little success, sometimes forced to do so repeatedly. It appears that even President Barack Obama, a leader upon whom the expectations of the world await, has been unable to cut the Gordian knot.
The global financial crisis triggered by the collapse of the US housing bubble has been far more serious and fast moving than the crisis following the burst of the Japanese bubble. Yet, just as the two crises differ in their depth and urgency, they also vary in terms of the speed at which they have been dealt with. Indeed, US and European policymakers have responded to the ongoing crisis with much greater alacrity than did Japanese policymakers in the 1990s, or so it initially seemed.
However, as we move beyond the emergency response stage and face the challenge of correcting the fundamental problems that caused the financial crisis, things appear to be quite different. Watching how President Obama has had to continually struggle to work with Congress, I cannot help but realize, all things considered, that politicians in the US, or those in Europe for that matter, are not much different from their Japanese counterparts.
Particularly striking to me has been some of the remarks I have heard from US and British think-tank researchers at recent seminars and conferences. In essence, their remarks can be summarized as follows:
Because we USs are extremely optimistic people, we will regain our confidence and begin to increase consumption in one year’s time.
By stimulating demand through fiscal measures, the prevailing pessimism can be dispelled and confidence in the economy will be restored.
Déjà vu of Japan in the 1990s
It was a bizarre experience. I felt as if I were hearing USs and British recite the same words Japanese politicians, bureaucrats, and bank officials had repeated so many times during the first half of the 1990s. When the finance ministers and central bank governors from the Group of Twenty (G20) major economies met in Horsham, England on March 13-14, they devoted much of their time to discussing fiscal measures. As evidenced by this fact, excessive expectations are being placed on fiscal policies. It is relatively easy to get the people’s approval for using fiscal expenditures to finance public works projects, tax breaks, employment measures, and so forth.
I am afraid that today’s US and European leaders might be adopting the same mentality as that of the Japanese leaders in the 1990s. That is, it seems to me that they are clinging to wishful thinking by hoping that all of the current global economic problems will solve themselves in due time. As this situation prolongs itself, leaders may buy time with pain-relieving fiscal measures, but by doing so they will continue to ignore the true nature of the problems before them.
Bad debt as the root of the problem
The root problem is an enormous mountain of nonperforming assets. Over the past 10 years the US has undergone two bubbles — an IT bubble and the housing bubble — in succession, and has fallen into the habit of borrowing to spend in the process. The aggregate amount of nonperforming assets left in the aftermath of these adjoining bubble periods encompassing the past 10 years is said to be two to three times larger than the amount that Japan had to deal with in the 1990s.
In Japan, two government-backed agencies — the Resolution and Collection Corp. (RCC) and the Industrial Revitalization Corp. of Japan (IRCJ) — were established to dispose of soured loans and restructure troubled corporate borrowers such as Daiei Inc. As we learned from Japan’s experience, the disposition of nonperforming assets is a painful process that takes enormous time and energy. Given that understanding, it is all the more necessary for the US to develop a well-defined, fundamental policy portfolio to solve the problem of nonperforming assets.
However, the package of plans laid out by Treasury Secretary Timothy Geithner was too abstract and failed to provide a concrete road map. The market was disappointed with the package and the Dow Jones Industrial Average has lost more than 720 points in less than two months since President Obama took office.
How Japan finally turned around in the 1990s crisis
The greatest lesson from Japan’s experience is not that bank recapitalization should take place quickly, but that market confidence can be restored only when progress is made on the painstaking process of disposing of nonperforming assets. In retrospect, the recapitalization of banks in 1998 and 1999 delivered only a temporary respite and did not guide the Japanese economy onto a true path of recovery.
Only after Resona Bank had been temporarily placed under government control, the IRCJ had been established, and Japanese banks had embarked on an all-out effort to dispose of bad loans, did stock prices finally pick up and people come to embrace the recovery. Up until then, whatever measures had been taken by the government — whether bank recapitalization or pork-barrel fiscal spending — did nothing but provide temporary pain relief.
How to address today’s problem
Continuing to give “adrenaline shots” of fiscal expenditures would not cure a patient suffering from the “cancerous” effects of nonperforming assets unless the cancer tumour was removed by surgery. However, surgery this time around — the removal of nonperforming assets from US and European banks — is going to be far more difficult than the previous procedure that relieved Japanese banks of their bad loans.
First, the nonperforming assets from the latest crisis have been chopped up and embedded in various forms of different types of securities that have been spread among investors and financial institutions across the world. The disposition of nonperforming assets involves identifying the holders of these securities, determining the amount of losses the creditors have incurred on such securities, and then persuading them to take their share of the losses. Altogether, this process would require an enormous amount of time and effort. Negotiations on burden-sharing are, by definition, a troublesome task that no one wants to deal with. That task is even more challenging this time around because the disposition of nonperforming assets will have to proceed multilaterally with affected parties scattered around the world.
However, due to strong public opposition and/or the intertwining of interests, most countries are far from being ready to coordinate and work together to clean up nonperforming assets. At the present time the US and European countries are most likely in a state of paralysis in terms of addressing the problem of nonperforming assets.
Just 10 years ago in 1999, I had an opportunity to discuss with a leading financial economist what policy measures should be implemented to revive the Japanese economy. After providing clear analysis and pointing to the necessity of disposing of a massive amount of bad loans as a prerequisite to achieving an economic recovery, he self-mockingly added, “but the fact is that all of us are utterly stricken and standing transfixed by the sheer scale of the problem before us, isn’t it?”
Wishful thinking on fiscal stimulus
This might be the state in which the Americans and British find themselves today. A counter-reaction to this state of paralysis might be manifesting itself in the form of excessively wishful thinking about the effects of fiscal policies. Many decision makers want to force themselves to believe that fiscal measures will cure the problem because there is nothing else they can do at the moment. However, as we learned in Japan in the 1990s, people in the US and Britain will soon realize that fiscal measures alone cannot provide an ultimate cure.
What happens next? One probable future scenario would have the US and global economies temporarily regaining strength over the next two to three years with the support of fiscal measures, but the problem of nonperforming assets, the root cause of the ongoing economic turmoil, would remain unsolved because of various political difficulties such as strong public opposition to bailing out banks. Consequently, once the painkilling effect of fiscal measures wears off, the US and global economies would once again plunge into another serious crisis.
Only after going through this ordeal and realizing that fiscal measures alone cannot solve the problem would people recognize the need for ultimately disposing of nonperforming assets. And only then could a global policy scheme for addressing the core problem of financial instability be formulated. But until this happens, the US government will most likely continue to run a fiscal deficit, further snow-balling its already huge federal debt.
For Japan, this crisis is not akin to a fire on the other side of the river. As the US economy continues to stagnate, the Japanese economy will be the hardest hit because its exports will suffer directly from the sluggish demand in the world’s largest market. Thus, Japan has no choice but to keep on priming the fiscal pump to prop up its economy. Finance Minister Kaoru Yosano promised a ¥3 trillion fiscal stimulus package at the Horsham G20 meeting, but Japan will still need to take further fiscal steps and act in tandem with the US in the coming months.
So long as people hold onto the expectation that recovery could be brought about by fiscal measures, no national consensus can be built to proceed with the painful disposition of nonperforming assets. It is necessary to learn by firsthand experience that fiscal measures are only makeshift. In this context, the enormous fiscal deficit that will be built up in the US in the coming months may be the political cost for consensus building, which would be a replay of what Japan went through in the 1990s.
Up until several years ago, the US and European countries had repeatedly criticized Japan’s policy responses for being too slow. But it might be the case that US and European policy responses are just as slow as those of Japan when it comes to tackling the daunting task of solving nonperforming asset problems. By studying Japan’s experience, foreign policymakers have an excellent example from which they can learn what not to do. Yet, the recent developments show just how difficult it is to learn from the mistakes of others. We, as human beings, are by nature probably unable to take to heart anything having negative implications unless we learn its lesson the hard way through firsthand experience.