Turning Japanese

Japan's post-bubble policies produced a "lost decade." So why is President Obama emulating them?

Anthony Randazzo, Michael Flynn & Adam B. Summers from the July 2009 issue

(Page 3 of 4)

The market needed time to reassess the mortgage market, given the new information it was facing from the Fannie and Freddie debacle. In the meantime, banks watched the numbers on their balance sheets go from millions to zero. Unable to find sufficient capital to meet the requirements demanded by mark-to-market accounting, institutions such as Lehman Brothers, Washington Mutual, and Citigroup fell prey to their debt. Easing the mark-to-market rules at the onset of the crisis, instead of a year later, would have bought firms precious time to recapitalize their balance sheets in a more stable manner. The banks still would have lost money, but they might not have gone bankrupt and caused a negative ripple effect throughout the economy.

Government housing policy. Both Japan and the United States had explicit government policies that encouraged an unhealthy appreciation in land and housing prices. A 2003 report from the Bank of Japan blamed tax and regulatory policies for an unnatural rise in asset values. In America the Federal Housing Administration has for years encouraged the expansion of mortgage lending, including subprime lending, particularly through Fannie Mae and Freddie Mac. This was done to expand homeownership by low-income families. Such policies span administrations of both political parties, from the Community Reinvestment Act passed during the Carter administration in 1977 to George W. Bush’s efforts to create an “ownership society.”

The push to expand homeownership had two big effects. First, it greatly increased the number of buyers, driving up housing prices. Second, it provided mortgages to a large number of people who had a high risk of default.

Recession Responses

By early 1992, realizing that the economy was not going to rebound quickly, the Japanese government hurriedly enacted its first recession-fighting stimulus package. Government spending and loans during the next several years propped up failing Japanese financial firms, but the companies’ lack of vitality and perpetual operating losses earned them the moniker “zombie businesses.”

Given the similar source of the U.S. bubble, American officials should take a careful look at Japan’s ineffectual and massively expensive response to ensure that the United States does not duplicate the following mistakes:

Government lending to poorly managed firms. The Bank of Japan tried to ease economic pain by loaning large amounts to businesses. But the attempts to recapitalize the market ignored underlying management problems in the dying firms. It was a costly mistake. Intense lobbying from special-interest groups representing various sectors of the Japanese economy perpetuated the ill-fated loans and funneled government money to zombie businesses.

The United States has already begun to copy this policy, lending billions of dollars to financial institutions and auto companies and buying up billions more in bank equity in an effort to recapitalize the marketplace. The effect has been to keep poorly managed firms alive with taxpayer money.

Just months after a $25 billion investment in Citigroup, the government had to step in with a second bailout of $20 billion. Despite the infusions, Citigroup is now breaking up its holdings, a process that could have been started months earlier if the authorities had not used tax dollars to feed the zombie firm. Instead of letting the Big Three automakers go bankrupt, the administration has kept them on life support with tens of billions in loans to buy enough time for...likely bankruptcy.

Conflicts of interests. With all those loans, the Japanese government found itself deeply entwined in the market, skewing its policy incentives. Daniel I. Okimoto, former director of the Shorenstein Asia-Pacific Research Center at Stanford University, points out that Japan’s banking industry and economic bureaucracies were too interdependent. Studies from Okimoto’s center and the Bank of Japan concluded that data revealing the scope of the economic malaise were suppressed and that regulations were developed with governmental interests in mind. At the height of financial industry bailouts, there was little transparency or public accountability.

The United States has ventured into the same dangerous waters. In an attempt to recapitalize the banking industry, the Treasury Department forced the major banks to take bailout funds from the Troubled Asset Relief Program, in exchange for which the government took equity stakes. The federal government now owns a majority of the American International Group insurance company, as well as major chunks of General Motors and Chrysler. The dangers of interconnectedness have already become apparent.

With taxpayer money on the line, elected officials feel emboldened to prescribe the marketing, compensation, travel, and other business policies of companies taking government money. Members of Congress and White House staff have criticized specific spending decisions by participating firms. Concern over bonuses to AIG employees led the House to pass an arbitrary tax on a standard business practice that lost public favor. President Obama himself has delved into such business minutiae as whether General Motors should be focusing more on brand consolidation. And a bill now in the Senate would give the Treasury Secretary power to set the salary of all employees, not just executives, at any firm with bailout money burning in its pockets.

Lawmakers’ incentives are to serve their constituencies or their own political careers. This can put them at odds with the businesses they are suddenly attempting to manage. The more the government is involved in directing business activity, the less likely those firms will succeed in maintaining long-term growth, and the more likely they will turn into Japanese-style zombies.

Short-term, static political vision. You can blame the length of Japan’s asset deflation, recession, and liquidity struggles on an unwillingness to choose hard but necessary policies, such as allowing banks to fail and the market to reset itself. Politicians bent on retaining their power and showing the public they were doing something took actions without regard to their long-term effects.

There was little effort to clean up the banking system or get rid of harmful regulations. The government refused to acknowledge the breadth of Japan’s economic troubles, and the Ministry of Finance went so far as to order banks to hide their toxic loans to create the appearance of success. This approach was largely due to fear of the keiretsus, the powerful alliance of Japanese businesses that propped each other up with cross-shareholding and loans. Taking swift action would have upset the traditional way of business and forced the government to admit mistakes.

Comments

Fascitis Necrotizante|6.2.09 @ 7:10AM|#

Obama having turned Japanese.

Chad|6.2.09 @ 7:39AM|#

My first three cents:

1: Yes, we are going to experience something similar to Japan's lost decade. It is a direct consequence of our need to de-leverage and shift towards saving an appropriate fraction of our incomes. Nothing the government can or should do will prevent this.

2: Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality. This idea is almost always false, as changes made by governments are almost always tiny relative to the economy. In the short term and individually, no single policy will have a measurable effect, and in any case, you don't know what would have happened without the policy. For example, did Japanese infrastructure spending prevent the Lost Decade? Obviously not. But did it make it slightly less bad or slightly worse than it otherwise would have been? Only God knows. Odds are, it made it slightly less painful...and at least the Japanese have incredible bridges, dams, roads, and trains that will last generations rather than the junk we tend to blow our money on.

3: Long-term growth rates are going to be much lower than current projections. We should be budgeting for 1% growth, and considering anything else a bonus.

JLM|6.2.09 @ 8:11AM|#

I'm glad I get to read this online before I get my print copy. Wait, what?

|6.2.09 @ 8:23AM|#

Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality.

So if the economy does well, it isn't due to the Obamassiah's economic policies?

Xeones|6.2.09 @ 8:54AM|#

So why is President Barack Obama emulating it?

Because he really does believe that central authority drives all things. The man is a totalitarian, and to a totalitarian, having his hands all over an absolute ratfuck is better than sitting back and letting things stabilize on their own.

Also: hi, Chad! This one's not your best. Maybe you could have tried harder?

Chad|6.2.09 @ 9:00AM|#

So if the economy does well, it isn't due to the Obamassiah's economic policies?

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

People who claim that they can discern the impact of policies by looking what happens to the economy after they are adopted are just plain wrong. Unfortunately, that includes, well, just about everyone, because people can ALWAYS find a policy change they don't like that occured just before the bust, or a policy change that they did like that occured just before the boom. They can then use false causalities to harden their beliefs.

You will not find me making such claims. Instead, you will find me noting that our current economy is a function of a wide variety of factors, including hundreds of policy decisions made both here and abroad over many decades. The impacts of any recent policy changes are almost always minimal and lost in the noise.

As another point. The Democrats and Republicans are arguing over about 2% of the GDP, as the rest of government spending is pretty much agreed upon. Do you honestly think that wild fluctuations in the world economy rest upon what the government does with that tiny fraction of our economy?

Fascitis Necrotizante|6.2.09 @ 9:02AM|#

Chad just won't be happy until we're all doing cosplay while being tentacle raped on a bullet train. Deru kui wa utareru, says Hello Kitty via telescreen.

Spoonman|6.2.09 @ 9:10AM|#

This idea is almost always false, as changes made by governments are almost always tiny relative to the economy.

Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

|6.2.09 @ 9:21AM|#

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Chad|6.2.09 @ 9:35AM|#

Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

Federal spending is usually just a bit over 20% of GDP. State and local push total government spending to just over a third of GDP. My point is that of this 20%, only about 2% is actually disagreed upon the political mainstream. What we do with this 2% has virtually no impact on the world economy.

|6.2.09 @ 9:38AM|#

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

Odds are? Really? The "odds are" that the Obama Administration will create a "Five Year Plan" that will increase economic growth? When it is the market, individuals acting freely, that has produced the most wealth in the history of the world why would the odds favor central planning at this time? Because the administration is going to put the word "smart" in front of everything? Smart bureaucrats instead of the normal, self interested kind can handle it? All they needed was a Messiah to lead them?

Chad|6.2.09 @ 10:02AM|#

When it is the market, individuals acting freely, that has produced the most wealth in the history of the world

If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth", you might have a point. Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

EJM|6.2.09 @ 10:02AM|#

But as Anthony Randazzo, Mike Flynn, and Adam B. Summers write in our July issue, that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits. So why is President Barack Obama emulating it?

Unfortunately, Japan is the Lance White of industrialized East Asian democracies; by extension, South Korea is the Jim Rockford.

That said, Nouriel Roubini is apparently bullish on the Korean economy.

Kris|6.2.09 @ 10:09AM|#

We are Japan.

If we're lucky.

Really, really lucky.

Spoonman|6.2.09 @ 10:11AM|#

Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

The market didn't do that.

Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

|6.2.09 @ 10:27AM|#

What's funny is that Lance became Rockford when he got his own private investigator series.

Chad|6.2.09 @ 10:29AM|#

Spoonman | June 2, 2009, 10:11am | #

The market didn't do that.

There is far more private debt in this country than public debt. What are you talking about?

Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

Let me repeat:

Before ANY boom or bust you can find a:) policies that were adopted that fit your ideology and b:) policies that were adopted that contradict your ideology

Most people then pick-and-choose whichever policy and economic cycle combination fits their beliefs, and assert causality. This is childish logic.

Spoonman|6.2.09 @ 10:37AM|#

There is far more private debt in this country than public debt. What are you talking about?

The Federal Reserve's ability to affect interest rates, and their use of that power to encourage borrowing.

Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

So you've said. Proof?

phalkor|6.2.09 @ 10:43AM|#

doing cosplay while being tentacle raped on a bullet train

What's funny is that this would probably be a sign of economic recovery. Well, or the coming of Robo-Aids; your pick.

squarooticus|6.2.09 @ 10:45AM|#

Chad, what you seem to be arguing is that what will happen will happen, regardless of which of the two major political parties in the US controls the government. For once, I agree.

We were set upon this course decades ago, with the outcome inevitable. I suspect Obama will speed the demise along a tiny bit, but even if Dole were elected in 1996, or Gore in 2000, or McCain in 2008, the ultimate outcome was pre-determined by government policy made long ago: you know, the government policy that comprises the other 28% of GDP that the two political parties functionally agree on.

What I'm saying is that focusing on some silly battle between the two major parties is silly, because they are virtually identical in terms of what policies they support, differing only on a small margin. What is needed is for the other 28% of GDP to be reevaluated. Of course the government will not do this voluntarily, because government is a ratchet on revenue and power: thankfully, our debtors will force us to do this, either nicely (by asking) or not nicely (by destroying the market for our debt). One way or the other, however, this reevaluation is coming.

We'll be lucky if the US goes through only two lost decades. *Lucky*.

In a similar sense, even the warnings of those of us who predicted this are irrelevant: I suspect I've helped some people on a small margin avoid financial ruin when the day of reckoning comes for the dollar, but I have no illusions that my advocacy has had any substantive effect on the overall political composition of the country or will in any substantive way impact the final destruction of the dollar, the (hopefully final) discrediting of central banking, or the lower rates of growth of government during the coming retrenchment and rebalancing of the world economy. These things will happen the way they will happen because the numbers don't allow them to work out any other way: we are armed only with a coffee mug against a rising tide.

|6.2.09 @ 11:34AM|#

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP.

Funny, that's not what the CBO said. Their take, as I recall, was that the stimulus package would be a net negative in the long run.

The world economy does what it does despite our petty political fights.

To me, this sounds like a reason for the Almighty State to back off and do very little. To Chad, it is a reason for the Almighty State to grow, expand, borrow, and spend like crazy.

Colonel_Angus|6.2.09 @ 12:59PM|#

"McMansions, SUVs, cheap Chinese crap" Chav sure does like typing this. I think it's his catchphrase. Suck a fat one, you twat.

|6.2.09 @ 1:01PM|#

Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

Oh, sure, since a few governmentally controlled infrastructure investments are good then 3 or 4 trillion a year must be great?!
My SUV? Bullet trains? You don't even realize that there will be very few children of the children of the Japanese to ride those trains.

Spending more than you have is a Leftard practice, not a Libertarian one. You are claiming that there is either "Five Year Plans" or "short-term consumption" and never the twain shall meet. Fiscal Responsibility doesn't include pissing away more money than you have times ten. Or perhaps the government would limit what I can consume based upon their superior wisdom? Based upon "need"? You know the mantra

From each according to his ability and to each according to his need?

Jordan|6.2.09 @ 2:27PM|#

Two word re: Japan and bullet trains: population density. And credit-default swaps are not market inventions.

|6.2.09 @ 2:52PM|#

I think the case for not spending the money on infrastruture would be stronger if we didn't have bridges collapsing, or a highway system that gets a "D". If I remember correctly we need to spend 2-3 Trillion just to get our current system back in shape.

See once you build stuff you have to maintain it. Moreover, you need to set aside more money to build it again once you can't repair it anymore.

CA is a great example, we built highways, and universities etc, now everything is falling apart becuase we didn't spend the money to maintain it.

Americans have been living beyond their means for a long time, and it's going to suck now trying to pay everything down, and fix everything that's broken.

Jordan|6.2.09 @ 3:18PM|#

With the amount of money government at all levels currently takes in, they could afford to fix every piece of infrastructure several times over. Cut spending and leave us alone.

|6.2.09 @ 3:25PM|#

I suppose that's true. If we didn't spend any money on SS, or Medicare for a couple of years we could fix everything. But that seems unlikely.

Besides the military nothing else even comes close.

bt6|6.2.09 @ 8:33PM|#

"If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth","

McMansion = home that someone owns, rather than living in a government housing project. Owning a home is wealth.

SUV = car that someone owns, rather than standing in a blizzard hoping that the bus gets there before someone steals the food from the bags you're carrying. Owning an SUV is wealth.

Cheap Chinese crap = things that people buy, rather than doing without. Owning things is wealth.

Default credit swaps = a government-created fiasco. This is not wealth.

janejim|6.3.09 @ 1:39AM|#

Banks have huge debts, but they're getting a helping hand from the federal government. If you have overwhelming debt--perhaps from bad investments, or maybe a job loss, a medical crisis or just plain overspending--you're probably on your own. Check the website http://obamadebthelp2009.blogspot.com
to see if they can help. I am glad I did read it before I talk to my CC company and it helped - Jane Jim, California

Marian Kechlibar|6.3.09 @ 7:05AM|#

Kroneborge: you are SO RIGHT about the need to maintain infrastructure once it is built.

In my opinion, this is one thing that separates reasonable transport management from idiotic one.

From this point of view, Germans, Danes, Swiss or Japanese have reasonable, rational transport management.

My own country (Czechia) is a fencesitter, swaying dangerously to the idiotic half.

From what I have heard of California, it is way beyond the fence.

Ogden Homes|6.5.09 @ 4:00PM|#

That's sick. Didn't economists study Japan's problem back in the 90's? History repeats itself. But sometimes we can learn from past mistakes can't we.

I read something that more than 25% of mortgages are upside down. That will take years to recover.