This post first appeared on March 24, 2008
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 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.
If it was difficult to achieve consensus to reconstitute the banking system in Japan, imagine how long it will take here.
From the Financial Times:
The US should inject public funds into its financial system, which is undergoing a worse crisis than that experienced by Japan during its non-performing loan crisis, according to Japan’s financial services minister.
“It is essential [for the US] to understand that given Japan’s lesson, public fund injection [into the financial sector] is unavoidable,” Yoshimi Watanabe told the Financial Times.
Although “it is very difficult for Japan to convey such a message to a foreign government …Japan could, for example, convey – through the G7 [meeting of finance ministers] or central bank governors’ meeting – Japan’s lesson and that we are prepared to take co-ordinated action if necessary”. to help resolve the situation, Mr Watanabe said.
US and European central banks are to consider the possibility of using public funds to purchase mortgage-backed securities as a potential remedy for the crisis.
The remarks are the first public expression of concern by a Japanese cabinet minister that the impact of the current financial market turmoil could be much more serious than Japan’s experience during its “lost decade” of abnormally slow economic growth in the 1990s.
Mr Watanabe warned unless swift and appropriate action was taken by world leaders, the financial market turmoil could lead to a severe dollar crisis.
He said the world’s huge excess liquidity has started flowing out of the US. If that flow were to be extended, it could lead to unprecedented problems.
“One thing is to fix the hole in the bathtub,” he said. “[But] we must recognise that the current crisis is not as straightforward as past dollar crises.”
He had no comment on whether Japan might cut interest rates in a co-ordinated response. Any decision would be made by the Bank of Japan, responsible for monetary policy but headed currently by an acting governor.
The minister said that while the US credit turmoil was structurally similar to Japan’s at the time of its bad debt crisis, there was an important difference in that risk in Japan was contained in the banking sector. In the US, it had been dispersed widely into other areas of the financial industry. So “it is not clear how big the hole [in the US] is because the fire has spread to products other than securitised products”.
Clive Crook of the Financial Times comes to a similar conclusion in “Campaign silence over Wall St woes“:
A lesson from Japan in the 1990s is that efforts to deny and disguise the financial damage only worsen the problem. The US political environment makes repeating that error all too likely. The present administration is serving out its notice; the presidential candidates are busy grubbing for votes. A bill to subsidise mortgage writedowns and widen the scope of government guarantees, thus slowing the rate of foreclosures and cutting interest payments for distressed borrowers, is before Congress. Its focus, naturally, is to address voters’ immediate concerns. A measure like that might be part of the answer – but only if it does not prevent house prices finding their new equilibrium. The temptation is to postpone the day of reckoning; that would do more harm than good.
If house prices have to fall another 20 per cent, it is better that this happens quickly. As the losses strike the financial system, there might be a huge cost to taxpayers – not, one hopes, in protecting banks’ shareholders (perish the thought) but in providing new capital to the system. It is awful to contemplate but the alternative – ask Japan – is worse. And these are not in fact “uncharted waters”. The US has been here before, with the Resolution Trust Corporation established in the 1990s to deal with the collapse of the savings and loan industry.
In an election year, no one wants to face that prospect. For the time being, it is easier to keep talking about Nafta.