Britannia Radio

There is sound commonsense here.  Especially important is the warning 
that bad banks, badly managed, must be allowed to fail

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TELEGRAPH   4.10.08
We’ve been here before
Bail-out: Can Japan offer the solution to the financial crisis?

Japan’s 1990s banking crisis offers the solution to our woes, says 
Bill Emmott.

We are in an era of globalisation, we are told, of flat, inter-
connected worlds. Yet the response in the US Congress to the 
Treasury’s proposed $700 billion remedy for this very international 
financial crisis has been strikingly parochial.

Not just that: it has been delusional. How else to describe those 
Congressmen who opposed the first vote, accusing Treasury Secretary 
Hank Paulson of practising “financial socialism”, which was somehow 
“un-American”?

This episode bodes ill for the world economy’s stability. For, huge 
as it is, this $700 billion package is unlikely to be the end of the 
story. At some stage next year, the new administration, whether led 
by Barack Obama or John McCain, will most likely need to offer 
another strong dose of “socialism” – a big bag of money, this time 
used to help recapitalise the banks directly. Given the public anger 
displayed in the past week about an undeserved lifeline for the 
greedy bankers of Wall Street, the politics of that next package are 
likely to be just as poisonous.

This may seem like a strange prediction – after all, the package now 
on offer has been sold as a way of solving the problem once and for 
all. But the reason we can make this prediction with confidence is 
because this crisis has happened before.

Just as we have during the past decade, Japan in the 1980s enjoyed a 
decade of astonishing economic growth, as its property and stock 
markets boomed. By 1989, the property value of Tokyo alone was – in 
theory at least – twice that of all the land in America.

What followed when the bubble burst is now eerily familiar: long 
queues of depositors outside banks, withdrawing their money in a 
panic; a huge furore about a public bail-out of housing loan 
companies, which discouraged politicians from attempting a wider 
economic rescue package; the banks’ troubles mounting, with several 
going bust, leading to a soaring suicide rate.

The government was finally obliged to step in, but by then – seven 
years after the collapse had begun – the cost to the Japanese 
taxpayer had become far, far larger than it would have been had 
officials bitten the bullet four or five years sooner.

Is this the fate that awaits the US, along with Britain and Europe? 
Are we witnessing the end of the capitalism red in tooth and claw 
that some of us have known and loved (and others have known and 
hated)? Certainly not – because the Japanese example also offers us a 
path out of our difficulties. Japan’s was the first credit crunch, 
and the first deflationary spiral, to have occurred in a major 
industrial economy since the 1930s.

Businessmen often talk of the desirability of having “first-mover 
advantage”. Yet in this case, coming second is surely better. Even if 
American and Europe make their own mistakes now, we should, with luck 
and foresight, be able to avoid repeating Japan's.

Despite all the name-calling in recent days in Congress and the US 
media about financial socialism, America’s housing market has long 
been the most socialist in the developed world. This is a country 
that provides massive tax subsidies for private home-ownership, and 
set up and nurtured two huge enterprises, Fannie Mae and Freddie Mac, 
which had implicit federal guarantees and a mandate that led them to 
back virtually half of all American mortgages.

So even though America’s problems began in the “sub-prime” sector, it 
was not the housing system that caused the crisis. The blame needs 
instead to be laid on ultra-cheap money, over-confident bankers and 
inadequate regulation. Those were exactly the sort of factors that 
brought about Japan’s financial crisis in the 1990s, the one that led 
to more than a decade of economic stagnation.

The trouble began in the stockmarket. Under the international banking 
rules, the Japanese had been allowed to count equity holdings – 
shares in other companies – as part of their capital. So when the 
Tokyo stockmarket lost a third of its value in the first half of 
1990, the banks’ capital ratios – the measures of how much security 
they had against their various deals and investments – also came 
under pressure.

Despite that, the Bank of Japan was so panicked by a spike in 
inflation that it carried on raising interest rates until August 
1990. It did begin to cut them until July 1991, a full 18 months 
after the market collapse commenced. Ben Bernanke, the chairman of 
the Federal Reserve and fully conversant with Japanese history, 
started to slash interest rates within a few weeks of the credit crunch.

Japan’s biggest mistake, at least with the benefit of hindsight, lay 
in its treatment of its banks. As their capital shrank and as their 
loans turned sour, the Japanese Ministry of Finance decided not to 
intervene, at least not with public money.

It helped banks conceal their losses by massaging their accounts, but 
otherwise hoped that the market would eventually sort it all out – 
albeit with the help of a large programme of public works, building 
new bridges, roads, dams and more in an effort to support growth of 
which John Maynard Keynes would have been proud.

It failed. The reason why it failed is that as banks’ problems 
mounted, they started to reduce new lending, sapping the economy’s 
strength. As the economy weakened, more old loans turned sour, as 
companies went bankrupt or just stopping paying interest. It became a 
slow but vicious spiral. More bad loans, more concealment of losses, 
less trust in the banks, leading to more defaults and to occasional 
runs on smaller banks.

Ironically, Japan had been infamous during its 1980s heyday as a 
clubby, tightly regulated place in which companies, bankers, 
bureaucrats and politicians were in cahoots with one another, while 
incomes were kept fairly equal. Lech Walesa, Poland’s anti-Communist 
hero, was reported to have described it after a visit as the world’s 
only successful example of socialism.

Yet in response to the financial crisis and the crumbling of its 
banks, Japan responded by trying to ignore the problem, hoping it 
would go away.

The lesson is that once a vicious downward spiral begins in the 
financial system, with lending being cut and borrowers going bust, 
the problem will simply get bigger – unless you intervene quickly, 
with public money. If you don’t act, you will find yourself 
intervening anyway, as Japan did in 1997-98, but at a much higher 
cost. The result: a prolonged stagnation and government debts 
totalling more than 180 per cent of GDP, the highest among the 
world’s rich countries.

America begins with a smaller debt: around 70-80 per cent of GDP, 
depending on how you account for the impact of the nationalisation of 
Fannie Mae and Freddie Mac. In Britain and Germany, debt levels are 
lower – and it is not yet clear that we will need similar public bail-
outs to the Paulson plan, for the build-up of bad debts in our banks 
has not yet reached danger point.

With America’s GDP of $14 trillion, even the $700 billion in this new 
package would only push debt up by four per cent more of GDP, The bad 
news, however, is that the cost may well rise further. In the end, 
Japan’s crisis, like Sweden’s earlier in the 1990s, was brought to a 
close only when the government agreed to pump money directly into the 
banks by providing fresh capital in return for shareholdings. That 
really will smack of socialism to many American politicians.

So how do we square the circle? There are two principles of public 
rescue that need to be applied. One is that the government must make 
sure it saves the banks but not the bankers: boards should be sacked, 
fraudsters punished and shareholders made to suffer. Otherwise, 
public support will rightly not be forthcoming, just as it hasn’t 
been for the $700 billion.

The second is that, in return for taking temporary shareholdings or 
even ownership of banks, the government must use the opportunity to 
force reforms in both behaviour and in regulation. Temporary 
socialism can then turn into a process of refreshing and re-
disciplining capitalism itself. By cleaning up the banks and imposing 
new rules on them, governments can ensure that capitalism re-emerges 
in whatever new shape feels right for the market at the time, rather 
than according to some misguided blueprint drawn up in Whitehall or 
Washington.

Plenty of critics of capitalism, and especially of the process of 
liberalisation of trade barriers and regulatory restrictions 
associated with Margaret Thatcher in Britain and Ronald Reagan in 
America in the 1980s, would like to think that this whole episode of 
crisis, rescue and reform will bring about the demise of “neo-
liberalism” and of the leadership role within capitalism of financial 
institutions and markets. Yet unless this crisis brings about massive 
levels of unemployment, prompting a resurgence of interest in public 
ownership and control, that hope is likely to be disappointed.

We know that Wall Street and the City of London, by which is meant 
the big investment banks, are not going to play a dominant role again 
in the American and British economies, for so many investment banks 
are either bust or discredited or both.

But that is not the same as the demise of liberalism. Banks, pension 
funds, insurance companies and other financial institutions are all 
perfectly capable of providing the liquidity, discipline and 
incentives necessary for a successful capitalist economy.

But they can only do this if they have the capital. That is why the 
American rescue was necessary and welcome, and why, in due course, 
European countries may have to do the same.
-------------------------------------------
Bill Emmott was editor of The Economist from 1993-2006 and is the 
author of 'Rivals – How the Power Struggle between China, India and 
Japan will Shape our Next Decade’ (Penguin, £20),

=========================
WALL STREET JOURNAL Online  4.10.08
   
Japan's Bank Fumble Has Lesson for U.S.
    By JAMES SIMMS
   
Washington needs to learn how to profit from others' mistakes. 
Namely, Japan's missteps as it tried to get a handle on its own 
banking crisis in the 1990s.

One lesson lies in what not to do with deposit insurance. For 10 
years, starting in 1996, Tokyo guaranteed bank deposits in full.

That may have prevented runs on banks, but it slowed a needed 
restructuring of the banking sector by protecting weak banks. This, 
along with moves to allow institutions to ignore and sit on problem 
loans, led to the establishment of zombie banks that helped to stifle 
economic growth.

U.S. lawmakers should take care to not repeat those mistakes as they 
move to raise insurance limits on bank deposits to $250,000 from 
$100,000. That in itself isn't necessarily fatal, and part of the 
adjustment could be put down to inflation.

But the increase also raises the possibility that Washington 
eventually will move to fully guarantee deposits. That might seem far-
fetched, but already Ireland has done just that.

What, after all, is so bad about full insurance, if partial insurance 
has been acceptable for 70 years? A 2004 paper from a Japanese-
government-affiliated think tank concluded that limiting the size of 
state guarantees for bank deposits leads savers to be more selective 
about where they put their money and forces banks to operate more 
prudently.

Put another way, if a country wants a strong banking sector, it needs 
to make sure weak banks fail and aren't simply propped up by a flow 
of deposits from customers lured by a government guarantee.

The paper, which covered the 1992-2002 period, said it is important 
for policy makers to take behaviors and attitudes into account when 
crafting a deposit-guarantee policy. The key is to make sure 
depositors patronize banks based on the quality of the lenders' 
management and finances -- and not on a guarantee that applies to 
weak and strong banks alike.

A worthy bit of trans-Pacific advice from a country with experience