Don't Look To Japan For Rescue Ideas

With talk of Citigroup’s possible nationalization still swirling, it’s worth studying other such experiences. In an earlier blog, I looked at Sweden’s experience at financial rescue and bank nationalization in the late 1980s and early 1990s, with help from a paper written by the Cleveland Federal Reserve.

Now it’s Japan’s turn and it is a story more of serious missteps rather than successes.

Most everyone knows that after decades of trend-setting growth, Japan badly stumbled in the late 1980s. The 1990s became the “Lost Decade” as Japan dealt with deflation, bank failures, recession and its ossified keiretsu economic structure that worked well in the 1960s and 1970s but had become badly outdated.

Its genesis involved a number of issues, including competing regulation by the Ministry of Finance and the Bank of Japan, ineffective financial liberalization, a real estate bubble, and a buying spree of foreign assets. What had been a low interest monetary policy came to a jolting halt when the Bank of Japan slammed on the brakes by raising interest rates in 1990.

That touched of a recession lasting lasted eight years, rendering worthless about half of all loans made by Japanese banks. Since many of those loans involved artificially high real estate and dodgy stock market plays, the economy was further whipsawed. Banks such as Hoikkaido Takushoku and Yamaichi Securities Company failed and two other big banks, Long Term Credit Bank and Nippon Credit were eventually nationalized.

Japanese officials tried some familiar remedies, such as creating its own version of a “bridge” or “bad” bank to soak up toxic assets. But the consensus is that Japan made a series of missteps that are themselves instructive:

• Japanese officials took too long to understand and attempt to rescue their financial system.
• The central bank took too long to address deflation issues.
• A fiscal stimulus attempt was cut off in 1997 when taxes were hiked.
• Japan took an entire decade — from 1988 to 1998 — to start cleaning up and recapitalize its banks.
• Japanese officials waited until 2003, an incredibly long period, to force banks to submit to audits and identify bad debts.

Many Japanese experts worry that the U.S. is heading down the same path. Perhaps, but maybe not. Officials in both the Bush and Obama Administration have identified the need to create some kind of “bad” bank or investment fund to deal with bad debts, although Treasury Secretary Timothy Geithner remains annoyingly vague on details. He is proposing “stress tests” to determine bank health, something it took the Japanese about 15 years to figure out. And, there seems to be no plan out there to raise taxes — just the opposite.

Sweden, by contrast, seemed to get it right. It identified the seriousness of its problems quickly and moved to take remedies. It had its miscues, but it got itself out of a jam. The Swedish example is obviously the better one.