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.
From VoxEU:
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 stimulusThis 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.
Conclusion
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.
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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.
I wonder whether Kobayashi here conflates correlation with causation, though my gut agrees with him. There were a lot of other events going on in the financial world during this entire period.
For example, it also coincides directly with the Asian export boom, which benefitted Japan tremendously both through direct exports to the U.S. and through exports to an industrializing China. I don’t really have any data that would cause me to favor either explanation, and they could both be off.
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.
Whether in the form of quantitative easing or fiscal deficits, I fully agree with this sentiment. It’s harmonic with of Krugman’s excellent early work on liquidity traps.
Krugman makes the point therein that a series of anaesthetic expenditures can still be the best palliative policy, even if it’s not a cure, until the solvency of the sovereign is at risk. I don’t personally agree — not predisposed to palliative measures, in confession — and worry much more about crowding out through imperfect substitution and government solvency issues. But it’s a defensible course of policy, even if it’s politically improbable today.
Thus, Japan has no choice but to keep on priming the fiscal pump to prop up its economy.
I’m a bit surprised that he arrives at this conclusion, given his awareness of the obvious track record of failure fiscal policy has exhibited in Japan and Japan’s monumental sovereign debts. It’s almost Pavlovian, like he can’t help himself.
Fantastic post. Agree with Mr. Kobayashi.
This time the NPAs are chopped off – making them into cluster bombs.
So not only do we have to look at quality of asset under every stone – there is a high probability that there may be a “cluster bomb” NPA sitting under it.
I guess its better to address the root cause – the assets and guarantee them at may be XX cents to a dollar and then let the system bid the prices up. XX cents would represent price to citizens – rest is paid by investors.
The worse off are going to be exporter markets who only hope situation improves. I am getting even more worried about China – after all China 2009 = US 1930 is where depression happened.
These days I am disgusted with my own pessimism!
I have said it many times – US = Japan.
The fact remains that we are in fact poorer. I am maybe 200 to 300K lighter – I accept that but it means my level of expenditure simply cannot be as high as it would have been.
I saw a graph of a micro increase in car sales at Calculated Risk. I think the years of 17 million a year are over for a long, long time. Not to mention how much of GDP was due to MEW (mortgage equity withdrawal). Its gone, and it ain’t coming back.
The old economic rules from decades ago are being re-instated and researchers and politicians are struggling to get their heads round the fact that many of the assumptions of their working and political life have been wrong. These are people who want to leave a legacy of knowledge or achievement and are resistant to starting from scratch with new policies.
Not only are they resistant to re modelling their views but they are too busy papering over the cracks and covering up the fact that they were responsible. Take this report from an ex regulator
that Washington had the power to stop this. Misdirection and half truths seem to be the norm and blind faith in current policies seem little more than wishful thinking.
As for the non conforming assets then if the treasury prints enough money eventually they can pay somebody to take the assets of the banks balance sheets. Nobody is really shouting though that non recourse loans and the concept that every American deserves their own home might have been part of the problem. Nobody says that securitisation hampers the disposal of non performing assets and if they had just charged a little bit more and organised things differently then the problems would have been easier to deal with. No politician turns round to their electorate and says you need to change and these are the consequences, they prefer to secretly tax them more.
Regardless of whether the banks recover and pessimism is overcome there have been fundamental shifts in attitude that no amount of stimulus can change. Banks will have changed their risk models and that will not be undone, consumers will know that assets can fall in price and will not withdraw equity as they used to. I am also not happy with the suggestion that pessimism is somehow irrational, I look round and I see both optimism and pessimism among by friends with unemployment being a big driver. I see little evidence that any of the stimulus packages will do more than soften the blow of unemployment and hence the decline in optimism. The guy on the street is too busy living to be irrational and claims otherwise could well be proved wrong.
I would agree, resolving/writing off bad/non performing assets is the only permanenet way forward.
In normal times then a bit of time allows banks and others to “earn” their way out. he sheer size of the portfolio of bad assets means that the time required could be infinite if left on to their own devices.
Fiscal Policy can work if it prevents a deep slide and thus shorten the time, or preven it from being lengthened. Once again, in this case the scope and scale is too big for fiscal policy to do much in the long run.
Monetary policy helps, but the smae applies. Only someone with a large enough balance sheet can take on these things, set a floor and hold them while life plays out…the bad assts are weighing down the productive assets.
I had thought this was the plan a few months ago, but I have been disappointed that the administration seems to want to take the most indirect route possible.
Time is the one thing governments cannot creat, but that is what is required so that more and more information can be uncovered. The only way to create time is to prevent bad assets from dragging good ones over the event horizon. Banks need to be brought in an retooled in some variant of the Swedish model.
Geithner/Paulsons plan involving leverage is interesting, who else knows the criminal mind better, but I wait to see some progress…this administration takes WAY TOOO LONG getting its act together, whoich is only marginally preferable to running around like a headless chicken.
How does the Japanese crisis or our crisis today, and the official response, differ from this?
Hoover had tried to keep hands off the economic machinery of the country, to permit a supposedly flexible system to make its own adjustments of supply and demand. At two points he had intervened…but otherwise he had mainly stood aside to let prices and profits and wages follow their natural course. But no natural adjustment could be reached unless the burdens of debt could also be naturally reduced through through bankruptcies. And to Americans, as in other parts of the world, the economic systems had now become so complex and interdependent that the possible consequences of widespread bankruptcy to the banks, the insurance companies, the great holding-company systems, and the multitudes of people dependent upon them–had become too appalling to contemplate. The theoretically necessary adjustment became a practically unbearable adjustment. Therefore Hoover was driven to the point of intervening to protect the debt structure–first by easing temporarily the pressure of international debts without cancelling them, and second by buttressing the banks and big corporations with Federal funds.
Thus a theoretically flexible economic structure became rigid at a vital point. The debt burden remained almost undiminished. Bowing under the weight of debt–and other rigid costs–business thereupon slowed still further. As it slowed, it discharged workers or put them on reduced hours therby reducing purchasing power and intensifying the crisis.
–Frederick Lewis Allen, Since Yesterday
What is the cite for the amount of bad assets on the banks’ books? It seems like a rather important point to just casually assert.
Down South:
Great comment. I read half of _Since Yesterday_ and enjoyed what I read–thanks for the reminder.
…clean up nonperforming assets.
You know, I’ve always been disturbed at this assumption. There is no way to “clean up” these underperforming assets (“liabilities”?) except by having the taxpayer purchase them — no invester except the Treasury/Fed will touch them, or for that matter has the resources to purchase them anyway.
But the taxpayer at-large shouldn’t be burdened with these charges because the taxpayer at-large wasn’t the party stupid enough to make these investments in the first place. Seems more than a little unreasonable and unjust to burden ourselves and our great-grandchildren for the investment decisions of some 28 year-old Wall Street douchebag.
I hate to break it to bondholders and other self-interested parties, but the only way out of this for the the firms with these underperforming assets is them to take charges on them — and if this isn’t possible due to the magnitude of the bad assets, to file bankruptcy.
A great article tks and one written in sadness, that all the same mistakes are being made..
How do you get rid of the bad assets??
Go after the bums for fraud, then cxl some especially the CDS’s, as they were all fraudulently written and they are the ones wipeing out the balance sheets.
It costs nothing and there is retribution.
Why not call these institutions what they really are: insolvent? Place them in receivership, wipe out the stock, convert the bonds to equity and see what’s left?
Mr. Gross is not very convincing as to why the bondholders shouldn’t take a hit. I cannot forgive him for his recent advice to ‘invest in whatever the government will bailout next.’
After a little of that he’ll do a better job of pricing his bonds.
Kobayashi is right. Bad Assets need to be dealt with and not moved around hoping one day they will inflate or work out by themselves. If this causes bankruptcies and social upheaval in the short term, so be it. It shall pass and we will come out much stronger for it.
Bailouts and Fiscal stimuli are not only mere short term pain killers, but the resultant deficit will make the situation worse for the future.
I wonder if Japan had their five largest banks directing their policy? There is no way we do what he suggests as long as the banks are running our government. Why resolve these loans when you can get money from the government forever?
There are no alternatives to the US dollar. All currencies are getting killed. The US gov’t is now buying up all bonds and continues to suppress the gold market. Who cares how much money we spend?
For sure we’ll suppress any alternative currencies that look like they might appear on the international market. Why worry when you control all the levers?
Wow, I think that is the best article I have read in the last couple years. We can act like we are different from Japan because we are more optimistic, aren’t savers, acted faster, etc. But the real truth is this issue is 4x larger then Japan’s issues. What really scares me is Japan convince investors to absorb the bad assets and take losses with them, how in the world do we convince the world to take our assets along with many other country’s assets/mortgages, such as Spain and England, wow, truly scary.
低能オバマ氏の夢の夢です！
Hmmm, what kind of recovery can be brought forth merely through the painful disposition of assets — nonperforming or otherwise? The idea of ending the current crisis by “properly” fixing the result of the current underlying economic-political problems, does not address the source.
Moreover, the proposed fixes from governments involve revitalizing the problem source itself — socialization of the costs of speculation. If the neoliberal inconsistencies and moral hazards in current globalized state policies are not corrected, more extreme boom and bust cycles are inevitable. While the analysts may find comparisons to the causes of Japan’s lost decade of growth appropriate during the handling of this financial crisis, they may find that the results of the next crisis in the West will require comparisons to Argentina or Mongolia.
The degree of transparency and rationality of stated objectives in cleaning up this toxic mess is far more important to securing a real, sustainable recovery. Continued clever propaganda from the state and looting of the public treasury by corporations entails more of the worst for most of the human race. It seems that this result is not a lesson that requires relearning by the powerful, but is instead, a desired end game.
Firstly, let me say that I am in favour of having all the bad assets written down. Fullstop.
However, what I would like to see is explained is how?
Anon above made a salient observation: “You know, I’ve always been disturbed at this assumption. There is no way to “clean up” these underperforming assets (“liabilities”?) except by having the taxpayer purchase them — no invester except the Treasury/Fed will touch them, or for that matter has the resources to purchase them anyway.”
Thoughts please
My comment is a little late, so nobody would read it. But I would like to post my idea from a point of Japanese.
For me, Kobayashi looks like exaggerating the influence of nonperforming assets to economic crisis. I don’t belittle the seriousness of nonperforming loan problems, but Japan’s recovery after banking crisis was brought about not merely by the restoration of market confidence in financial sector (again, I don’t deny it), but mainly by the world (especially US) gobbling up Japanese products. Net exports in Japan showed negative sign in 1996, but since then, its share in GDP kept rising and reached 5% in 2007. As a result, net exports contributed the most to overall growth in 2002 to 2007 even though its share is only one eleventh of private consumption, the largest item in GDP. Kobayashi slightly mentions Japan’s recovery, saying “Only after Resona Bank had been temporarily placed under government control, …, did stock prices finally pick up and people come to embrace the recovery.” But that recovery was the result of external demand, which was somewhat reinforced by currency market intervention. In that sense, Japan has not yet fully recovered from the lost decade, irrespective of the existence of nonperforming assets.
Also, I think that his repeated claim that fiscal measures alone cannot solve the problem is too simple. Japan’s experience tells us that the economy would sink if you withdraw fiscal measures too early. Japan’s economic growth turned to minus 2% in 1998 because policymakers, misunderstanding the trend of recovery, contracted public expenditure and raised taxes. It’s reminiscent of the recession of 1937, when FDR cut government spending prematurely. Fiscal policy can have some, be it large or small, effect of mitigating the tide of deflationary spiral.
I hope that US can extrapolate useful lessons from Japan’s performance in the 1990’s, given that we, Japanese people, have meaningful experience to boast.
YB,
Thanks for giving your perspective.
Interesting presentation/podcast at CSIS: Richard Koo discusses Japan’s lost decade and lessons for the US.
It’s from October last year, but still worth listening to if you haven’t already. It’s about an hour.
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