this sad tale sound familiar?
by low-interest mortgages, real estate prices in Japan had
risen so high that by the end of the 1980s just the land
under the Imperial Palace in Tokyo was nominally worth more
than all the real estate in California. Then, in late 1989,
the bubble burst and real estate prices plummeted, leaving
Japan’s financial institutions saddled with toxic
mortgages and facing bankruptcy.
Despite the common misconception that the Japanese government
neglected the crisis, it intervened from the outset. In
1990, the Japanese Central Bank cut interest rates until
they reached absolute zero. So money was free for banks
to borrow. Nevertheless the Japanese stock market continued
its fall, with the Nikkei index going from a high of 40,000
in 1989 to a low of 12,000 in 2001. So did real estate,
which lost 80 percent of its value during this period.
The government next tried the classic Keynesian tactics,
spending and tax cuts. Between 1991 and 1998, it pumped
100 trillion yen into the economy through public works programs
and, to further stimulate spending. cut taxes by 2 trillion
yen. All these measures succeeded in accomplishing was raising
Japan’s public debt to 100 percent of its GDP.
deal with the ever more ominous threat of bank insolvency,
the Japanese government injected public funds directly into
Japanese banks, investing first in 1996 $100 billion and
then in 1998, under the Obuchi Plan, another $500 billion
to pay for bank loan losses, bank recapitalizations and
depositor protection. The bail-out, which amounted to over
12 percent of GDP, resuscitated the individual banks but
not the financial system . The banks, although on government
life support, resisted lending out their new found capital.
Paralyzed by the fear of losing their new found capital,
many such banks became, in Japanese terminology, “zombies,”
since they were neither dead nor alive (at least in fulfilling
their function of extending credit.) As a result, the money
Japan pumped into its banks did not thaw the frozen system.
Indeed, it was not until 2002 that the Japanese economy,
buoyed by the boom in China and other of its export markets,
showed positive growth. The moral of this financial Kabuki
play is that government intervention does not always work
immediately, or, in this case, for a decade.
America of course is not Japan. The differences, when it
comes to restoring financial confidence, cut both way. On
the bright side, American financial institutions, unlike
their Japanese counterparts, quickly moved to recognize
their losses from their toxic debts and find ways to recapitalize
themselves. The US government also intervened much earlier
in the process than did Japan. In the first year of the
crisis, it committed about $800 billion (about 7% of GDP)
of tax payers’s funds to re-capitalizing the banks
and guaranteed depositors against loss. That is the good
news. On darker side of the equation, unlike in Japan, there
is a multi-trillion dollar casino dealing in credit default
contracts overhanging, like a Sword of Damocles, the financial
system . Through buying or selling these contracts, American
banks, hedge funds, insurers, and other players have wagered
at least $47 trillion on the fate of a wide range debt instruments.
Like any other punter, the buyer or seller of one of these
contract need not own the debt that is being wagered on,
so pay-offs made in the event of a default of a bond can
be vastly higher than its face value. Indeed, a default
can result in such huge losses from these contracts that
it triggers a chain reaction of other defaults. Witness,
for example, the near-bankruptcy of AIG from the credit
default contracts it held. Worse. there is no central registry
that lists obligations undertaken in this casino activity.
This lack of transparency makes it exceedingly difficult
to figure out the exposure of financial institutions to
catastrophic loss. In this environment, banks, even if they
don’t become zombiefied, may not rush to lend their
money out. So the Japanese experience may yet prove instructive.