Thursday, September 18, 2008

U.S. Learns from Japan's Lesson

The Wall Street Journal says that the U.S. is making sure not to repeat the mistakes Japan made when its banking system ran into trouble.
When Japan was mired in economic crisis, the U.S. urged it to take decisive action to deal with its ailing banks. Japan didn't follow the advice and the crisis dragged on for years. Now, it is the U.S. that is mired in crisis and facing the prospect of swallowing the bitter medicine it once proffered. ...

"One of the lessons we took from Japan was the hesitation and refusal to own up to the problem was a disaster," says University of Chicago Graduate School of Business economist Anil Kashyap.

U.S. financial firms, too, have struggled with owning up to the extent of their credit losses, partly because those losses are a moving target. A year ago, Bear Stearns Cos. was reluctant to sell mortgage-related credit at a loss. That decision came back to haunt the firm as declining home prices continued to pummel mortgages, and Bear ended up in a government-backed fire sale to J.P. Morgan Chase & Co. Meanwhile, Merrill Lynch & Co. Chief Executive John Thain said in a January interview that the firm's troubles were "for the most part behind us" — but in July the firm agreed to sell more than $30 billion in mortgage-related assets at a large loss.

Still, U.S. financial firms have been much quicker to acknowledge losses than their Japanese counterparts were. While the slicing and dicing of mortgages into tradable securities played a part in the mortgage mess, accounting rules make it difficult for firms to ignore losses on those securities, says Princeton University economist Hyun Song Shin. In contrast, by continuing to extend credit to bad borrowers, Japanese banks were able to put off recognizing the extent of their debt problems.

"The denial strategy is harder to pull off — it will catch up to you in the accounting," says Mr. Shin. "That's one of the more encouraging and hopeful signs in the U.S." ...

Just as Federal Reserve Chairman Ben Bernanke has been intent on not repeating the Fed's Depression-era mistakes, Treasury Secretary Henry Paulson is intent on not repeating Japan's mistakes in the 1990s, says Brad DeLong, an economic historian at the University of California at Berkeley.


  1. This flies in the face of comments posted here by many people over the course of a long period of time.

    Countless comments have proclaimed "The USA is the same as Japan! The same as Japan!"

    Uh, no. We can start understanding the differences by focusing on culture. How about if we start with the notion of "saving face"? Anyone see a connection? Anyone? Bueller?

  2. Hi!

    Another thing that the U.S. is not likely to do is hold back on its expansionary fiscal policy, as did Japan in the 1990s. Japan ran a tight budget, which is the wrong decision when the banking system freezes up. Monetary policy, although very expansionary, does not flow through to the real economy. So the fiscal sector needs to step in by way of tax cuts or boosting spending to get some income back into the economy.

    I am sure that this Congress will have no problem boosting expenditures (another stimulus program) if needed.


  3. That article presents a complete misinterpretation of history.

    Treas. & the Fed are doing exactly what the BoJ did -- preventing the liquidation of major financial institutions by the infusion of cash. The Japanese just didn't do it as publicly and directly as is being done now. Our govt and the major wall street players have hardly "faced up" to the crisis, but instead have offloaded the burden on to the US taxpayer. (note -- this is a major change from the approach used in the earlier S & L crisis -- FDIC-insured depositors were bailed out, but the insolvent S & Ls were liquidated). "Facing up" would mean the bankruptcy process and possible indictments, not an escort to the Fed' open market operations and the Treasury window.

  4. Japan ran a tight policy in the 1990s? You've got to be kidding. Per capita public spending dwarfed that of the US, and overnight interest rates in Japan were effetively zero throughout the decade. In Japan the effect was economic stagnation; it probably would have been far worse if the Japanese at that time were individually as profligate as Americans.

  5. From the IMF, page 116:

    "In hindsight, the large-scale tightening of Japanese fiscal policy in 1996–97 was clearly excessively ambitious. Looking at the issue ex ante, it must be recognized that some of the things that went wrong in 1997–98, especially the depth and scale of the Asian crisis outside Japan, could not reasonably have been anticipated at the time that key fiscal policy decisions were made in the second half of 1996.”

  6. The problem with Google is that people take whatever appears on the first page of results as gospel. Some times you may have to actually (1) read more than an excerpt and (2) know the particular philosophy or bias of the authors. Those interested should look at public spending as a percentage of GDP for Japan throughout the 90s and the monetary policies of the BoJ during that period. Japan ended the decade with public spending as a percentage exceeding GDP and real interest rates at zero. Japan did not start to see any real growth until after 2002, when public spending was reined in.

    Unfortunately, the current wisdom is to adopt the Japanese approach -- use the central bank and treasury to maintain a false solvency.

  7. Hello anonymous, and I stress the fact that you remain anonymous, touche, expenditures were high, debt was high, but the way that they tried to reign in those problem areas likely hurt and already battered economy.

    Raising a consumption tax in the middle of a banking crisis in an attempt to reduce the budget deficit, as was done in Japan in 1997, is not a smart move.

  8. Whether I'm anonymous or the PM of Japan has no bearing on the argument. And yes, the consumption tax (which was enacted in 1988)and income tax increases on 1997 were certainly depressive, but were unavoidable considering that the stimulative fiscal polices of the time were unsustainable. Contrary to the modern thought, there are limits to how much money a government can spend. The tax increases in 1997 were not helpful but were generally irrelevant to the country's economic policies, which did not change until the election of the LDP in 2001.

  9. Irrelevant in the long term since the debt to GDP ratio was 100% in 1997 and clearly unsustainable (like you say), but why try to rein in debt with a tax hike and shoot an already inured economy in the foot? By 2004, the debt to GDP ratio was still 164%, so clearly hammering out the long-term economic fundamentals took time. So if we must compare the two economies, which as you have implied are not even comparable, I don't think that it is a good time for Congress to be raising taxes, as was done in Japan in 1997.

  10. The Japanese have sustained their system through criss with what we call its "second" budget. This is the money in the government controlled postal savings system and other monies the government has access to, which have been spent on so called public works, etc. (If anyone visits the 'inaka' or the interior of the country, you will see the miles of concrete everywhere, the buildin of which has provided Japanese men jobs.)

    As a result of its government spending, Japan has the highest GDP/debt ratio in the G7. Now, what is different is that that debt shadows its domestic savings, which is also the highest in the G7. Meaning, the debt service to domestic sources is not the same as debt service to foreign sources (the US problem).

    How will the US get out this? By increasing it lean on the foreign bond holders, who have no choice but to continue to finance US debt.

    The two cases are very different. Be careful not to mix them up.