Revisiting Japan’s Crisis

Now, a year and a half later, with the crisis getting worse every month, the lessons are looking rather different — and less comforting. It remains true that Japanese policymakers did not do a good job during the 1990s. But what is now becoming clearer is that there were some quite good reasons why they made their mistakes.

The biggest mistake that the Japanese Ministry of Finance is accused of having made is that it took too long to recognise that the banking system was insolvent. It tried to disguise the impact of bad debts on banks’ profit and loss accounts, and seemed to expect the problem to solve itself once economic growth revived. The stockmarket bubble burst in 1990; the property market bubble burst in 1991-92. Yet, the ministry did not start to nationalise banks or recapitalise them for more than five years.

Time has moved far more quickly for the US and European policymakers. They felt obliged to start nationalising some financial institutions in 2007-08, and to provide public money to boost some banks’ capital during October and November of 2008, and again during February 2009. They have also tried to use big programmes of public spending. The latest and biggest was the $787-billion one proposed by President Barack Obama as soon as he entered office in January.

So, while the Japanese tried fiscal policy (that is, public spending and borrowing) first and only attempted bank nationalisations and recapitalisation much later, the US and Europeans are taking these steps almost simultaneously. Partly because the economic impact of this financial crisis is global and becoming much more severe than the Japanese crisis of the 1990s, the policymakers are moving with more urgency. They think that Japan made a mistake by relying only on fiscal policy at first.

However, in the past few months, my feeling is, US and European policymakers have at last begun to understand why the Japanese authorities acted in the way that they did. They are coming to realise that they are confronted by two huge problems, each of which complicate the solution to the other.

The first problem is that of knowledge amid an evolving financial situation. In theory, what should be done is that banks should add up all their bad debts, and governments should force them to write off those debts or buy them from the banks for a small sum. The trouble is that banks do not know how many of their debts are really bad. Their holdings of complicated derivative securities — the instruments that caused the bubble and this crisis — are almost impossible to value, now that the market for them has collapsed. But also, as the global economy goes into recession, more debts are turning bad, as more companies go bankrupt or default on their obligations.
Japanese interventions in the 1990s seemed inadequate. But that is because the problem kept on getting bigger. And the policymakers faced the second big problem: growing public opposition to the use of public money to rescue banks and other financial institutions, combined with growing concern about the future size of public debts.

Both of these problems now confront the Americans and Europeans too. They have injected public money into banks, but are reluctant to nationalise them. They have produced many plans to deal with bad debts. But these are looking increasingly inadequate, while the use of public money becomes increasingly unpopular.

The US and Europe, as a result, are finding themselves caught in the Japanese trap. They are doing too little, for fear of public opposition and in the hope that economies will improve; but as a result the ultimate cost is likely to increase.

The real lesson from Japan is that governments have to persuade the public that an expensive rescue of the banks is absolutely necessary, or else they have to ignore the public’s opposition and be prepared to lose office in the next election. To ensure that the cost does not keep rising, they need to move quickly to nationalise weak banks, and to write off their bad debts. It will look appallingly costly. But it will be cheaper in the end, and is the only real way to avoid another lost decade.

The author is a former Editor of The Economist.

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(Businessworld Issue Dated 10-16 March 2009)

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