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3 US can
fast exit from bad times By
Edward J Lincoln
Ministry of Finance in
Japan in 1992 and 1993 and asking them: "So what's
going on? Are you worried? The stock market seems
to be down. The real estate market has turned
down."
They said: "Not to worry. Yeah,
there was a little bubble in the stock market and
real estate market, but, you know, that was being
fueled by a handful of extremely unethical
investors in Japan. Now we've got them. We've
raised interest rates. The market has gone down.
We're going to get rid of those bad guys. No
impact on the real economy. Financial sector, real
sector, you know, not that closely connected. This
was all a game to begin with. So don't worry. A
little slowdown in growth this year and then, man,
we're off again."
That was 1992, when the
growth rate was maybe 1.5%. In 1993 it
was
zero. It bumped between minus-0.5% and plus-1.0%
over the next eight or nine years. So they were
badly wrong.
In the United States, if you
remember what was being said as recently as last
summer when the subprime problems were being
revealed, a lot of people were saying: "Oh well,
that can't be much of a problem. Subprime market?
It couldn't be all that big. The losses can't be
all that bad. We don't think there's going to be
that big a spillover into the rest of the
economy."
And what did we get? At least
temporarily, in the fall, we had other parts of
the financial sector seizing up, because the
financial sector depends upon trust, that you are
engaging in a financial transaction with a
counter-party who is not going to go out of
business tomorrow. As we realized that we don't
know how big this problem is, we don't know how
deeply involved particular financial institutions
are, a lot of the short-term lending between
financial institutions began to dry up, because
that trust in the other party temporarily
evaporated. So we had a temporary credit crunch in
the fall.
When you have a credit crunch,
that is going to have a pretty immediate impact on
the real economy. You know, if General Motors or
Ford or Toyota can't borrow money in American
credit markets easily, then they can't do the
things that they were going to do with that money.
That particular problem we've gotten through.
But now we seem to be having a much
broader fallout on the real estate market. In
fact, you probably could argue that the trigger
for the subprime market actually was an overdue
downturn, overdue correction, in overall real
estate prices. We, too, like the Japanese, had a
bubble in the real estate market. The air starts
going out of that. That begins to pull in the
subprime loans that are going to be the first ones
to turn bad. And we did not realize how big the
downturn in the real estate market would be.
And, particularly in the United States,
probably more so than in Japan, a downturn in the
real estate market has a broad real impact,
because if people aren't buying new houses,
they're not buying furniture, lawn mowers, and
other stuff to put into those houses. So you get
an impact on consumer spending as well.
So
in both countries there was this process that when
the bad news finally comes, initially nobody
really seems to realize how serious it is going to
be.
Okay. So those are similarities. But I
think the differences are more important.
Let me start with disclosure. In Japan,
the full scope of the problems at the Japanese
banks, which had been lending money for both real
estate and stock market speculation - the full
scope of the banks' problems was not disclosed
until the end of the 1990s. So we are talking
about eight-to-nine years of drifting along, in
which both the government and the banks continued
to say, "Oh, don't worry, the problem's not really
big."
By 1996-1997, a lot of people
realized they were lying, but you don't know what
the truth is. So it's not until we get to, maybe,
2000-2001 that the government began to issue
figures on bad debts in the banks that outside
analysts were beginning to believe were reasonably
correct.
How could this happen? Because
the Japanese happened to have a particularly weak
set of rules and regulations and very weak
inspection of banks.
Just to give you an
example, a good friend of mine from grad school,
who was from the Japanese Ministry of Finance, got
in trouble in the late 1990s when the press
revealed that - he was in charge of bank
inspections for a couple of years, and they had an
example of a bank that his department had gone to
inspect. His subordinates were checking through
all the numbers and found that he was being fed
expensive dinners by the owners of the bank.
That's not a wise idea.
He is no longer
with the Ministry of Finance. Actually, he is with
the European Development Bank. He is actually, in
my estimation, a very honorable person, and of all
the people not to be swayed by having dinner with
people in Japan he is probably at the top of my
list. But the fact that he did it got him in
trouble.
Or my other favorite example was
a case around 1990 or so. There was a Japanese
currency trader with Daiwa Bank and he lost US$10
billion. He managed to hide his losses. For quite
a while, he was hiding his losses from his own
bosses who, he said in a magazine article
afterwards, were so dumb and knew so little about
currency markets - these are bankers - that it was
really easy to dupe them. But then he revealed
that and they decided that they were going to try
to hide this from both the US government and the
Japanese government.
The Ministry of
Finance had actually come over to do an
inspection. Now, exactly what their jurisdiction
was I'm not quite sure. But since it was a local
branch of a Japanese institution, they came to New
York and did an inspection of Daiwa's offices.
Again, this guy says that what they did was they
took his little currency-trading operation, put a
bunch of empty boxes in it, and closed the door
and turned the lights off, and told them, "Well,
that's just a storage room." And the more
important part was the inspectors were there for a
grand total of 20 minutes and then spent the next
four days in Las Vegas, at Daiwa expense,
gambling.
So some weaknesses in the
inspection process.
Contrast this to the
United States. Now, granted, we are an imperfect
country, we do not always behave ethically
ourselves, and yet the rules for the financial
sector are relatively tight. This means that
financial institutions in the United States are
required to reveal bad news relatively quickly.
So think about the subprime problem. We're
talking about an issue that really began
developing, say, a year ago. By last summer, you
began to get financial institutions beginning to
report that they had losses. We are still in the
process, but we're only seven to eight months
after that now. My guess is that by the middle of
this year we'll have had a pretty complete, honest
revelation of all the bad news that there is to be
revealed in this process.
Now, I should
say as a caveat in both countries - again, maybe
sort of a similarity - there is an issue of what
is the bad news. What happens when you have an
asset that has declined in value? How do you
re-price it? How do you know what the current real
market value is until you've actually tried to
sell it? So it's still sitting there on your
books. You have not tried to sell it. You don't
really know what the market value of that asset
is.
So there's a little bit of ambiguity
here. But still, I would argue that under US rules
and regulations we'll pretty much know what this
problem is within a few more months. So,
altogether, we're talking about a year, a year and
a half, where in Japan we were talking about eight
or nine years before people really had a grip on
what the bad numbers were.
The second
difference is macroeconomic policy response.
Basically, the Japanese government made a series
of real blunders in macroeconomic policy
throughout this whole period.
First of
all, you can argue it was their fault that this
situation developed in the first place, that
cutting interest rates and providing
administrative guidance to the banks in the
mid-1990s was excessive. They were too slow to
recognize what they had done. When they finally
recognized it, they raised interest rates too far
and they kept interest rates high too long. They
brought them down slowly after about 1993; didn't
get them down to a really low level until
1997-1998. So they did not recognize the need to
take decisive, quick monetary policy action to
deal with this issue as it was developing.
Similarly, on the fiscal policy side they
did some of the right things, although a lot of it
was sort of automatic things. When the economy
slows down, tax revenues go down; expenditures
like unemployment go up. There are automatic
stabilizers. If you had Economics 1.01, a fair
amount of it was that. But they did cut some
taxes. But then they raised taxes in 1997, before
the recovery was really getting going, and by
raising taxes pushed the economy back into
recession. Then, in 2000 the Bank of Japan, in
another blunder, decided to raise interest rates
at a totally inappropriate time.
So there
just is a series of mistakes that, frankly, had
macroeconomists and central bankers in the United
States and Europe shaking their heads and saying:
"What is going on? How could they do this? They're
supposed to be smart people" - and, in fact, they
are smart people. But maybe it's a lesson in how
easy it is to get it wrong.
In the United
States, so far we seem to have had the right
response. Perhaps, because we are dealing in
different periods of time and the Fed is well
aware of what happened to Japan in the 1990s -
particularly [Federal Reserve Board chairman] Ben
Bernanke, who actually wrote an academic article
about similarities and differences between Japan
and the United States, and this was actually the
S&L crisis versus Japan's banking crisis in
the 1990s. He is well aware of what had happened
in Japan.
So we are getting rather quick
and decisive cuts in interest rates in the United
States, which is the right thing to do. That ought
to
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