By Jason Simpkins
Experts on the Japanese financial crisis, which culminated in 10 years of stagnation known as the "Lost Decade," are fearful that the United States is making similar mistakes with its recent bailout efforts.
The two meltdowns started in much the same way - with busted stock-and-real-estate bubbles. With both the United States and Japan, whose market manias ignited by laughably loose credit policies, smoldered under a lack of oversight from government regulators, market analysts or such private-sector sentinels as credit-rating agencies, and were finally fanned into a frenzied financial conflagration by the promise of easy profits.
The real estate bubble popped and Japan paid the price then, as the United States is paying now. Banks were left holding trillions of yen in loans that were virtually worthless.
By early 2004, houses were selling at 1/10th their peak value, and commercial real estate was selling for less than 1/100th of its peak-market value.
The Nikkei 225 stock index had dropped by almost three-quarters from its heights. All told, an estimated $20 trillion in stock market and real-estate wealth vaporized (although one could easily argue that the peak values weren't real to start with).
Over the course of a decade, a succession of government policymakers waded through the crisis and routinely fell short of solving it. The Japanese lowered interest rates, increased government spending, pumped cash directly into banks and even tapped private capital to help buy some of the bad assets from banks.
All of these measures failed. Japanese taxpayers are estimated to have recouped less than half of what it cost the government to bailout the nation's banking sector.
Yet, the U.S. government has employed many of the exact same tactics.
The benchmark Federal Funds rate stands a range of 0.0% to 0.25%. More than $350 billion has been poured into financial institutions in an effort to shore up their balance sheets and spur lending. And last week, newly appointed Treasury Secretary Timothy Geithner outlined his proposal for a Public-Private Investment Fund, which will buy up many of the toxic assets that have bogged down banks' balance sheets.
"I thought America had studied Japan's failures," Hirofumi Gomi, a top official at the Japanese Financial Services Agency, told the International Herald Tribune. "Why is it making the same mistakes?"
Indeed, many analysts believe the largest U.S. banks to be insolvent, with more liabilities on their balance sheets than assets. These analysts believe the only thing left for U.S. officials to do is the same thing Japan ended up doing: Force major banks to declare their bad debts, and then weed out the weakest and recapitalize the survivors.
Japan's delay in aggressively seizing control of the banking sector cost the economy trillions of dollars and years growth.
"The historical record shows that you have to do it eventually," Adam S. Posen, a senior fellow at the Peterson Institute for International Economics, told the New York Times. "Putting it off only brings more troubles and higher costs in the long run."
Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, estimates that total losses on loans by U.S. financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, with half of that risk falling squarely on the shoulders of banks.
"The United States banking system is effectively insolvent," Roubini said.
However, the government is hoping that over time, the economy will start to recover and some of the bad debt that banks are currently holding will start to regain its value.
"If [financial institutions] had to sell these securities today, the losses would be far beyond their capital at this point," Raghuram Rajan, a professor of finance and economist at the University of Chicago told the Times. "But if the prices of these assets will recover over the next year or so, if they don't have to sell at distress prices, the banks could have a new lease on life by giving them some time."
The strategy has worked before, notably during the Latin America debt crisis of the 1980s. The total risk to the nine money-center banks in New York was estimated at more than three times their capital, the Timesreported. But regulators did not force those banks to value the loans at the hugely depreciated value of the market and averted a catastrophe.
News and Related Story Links:
- Money Morning:
The Lost Decade: How the U.S. Financial Crisis Resembles Japan's Ten Years of Misery - And How to Play it