Return of the Living Dead

What the U.S. can learn from Japan's failed experiment with "zombie businesses"


Killing zombies isn't typically the responsibility of America's president or treasury secretary. But if the country is going to get through the current financial crisis, President-elect Barack Obama and his economic team better get out their shotguns and aim for the head.

Today, our economy is plagued by struggling markets, liquidity concerns, and frozen credit. Twenty years ago, Japan faced nearly the exact same problems. Then they fell prey to the zombies.

After Japan's asset bubble burst in the late 1980s, their economy took a sharp downturn, prompting government officials to try bailing out banks and investing in infrastructure, much like the activity and proposals floating around America today. The results were terrible.

With the government propping up poor business models rather than allowing further job losses, firms wound up operating over the long-term without making a profit or adding any value to society. Their utter lack of vitality earned these perpetual money-leaching entities the moniker "zombie businesses." And unless American policymakers understand the failures of the Japanese response, we will suffer the same zombie fate.

Remember that the Japanese asset bubble and the American housing bubble have eerily similar origins. Both were driven by aggressive behavior in financial institutions. Wall Street, which sought new ways to get quality returns on investments, turned to securitizing everything it could and issuing unwise subprime mortgages—all highly valued by the rating agencies, and all highly misunderstood. The Japanese aggressively pursued real property assets to the point where the inflated values were unsustainable.

In both cases, the rapid rise in rates of return led to over confidence. In Japan, it is said that the market experienced a sense of euphoria, and poor investments were driven by excessively optimistic expectations of future economic development.

The Nikkei, Japan's stock index, rose from 18,000 in 1986 to an intraday high of 38,975 by the end of 1989. Similarly in the U.S., the Dow Jones went from 7,591 in July 2002 to an intraday high of 14,115 five years later.

These large growth trends led to inadequate risk management, over-leveraged investments, and depleted capital reserves. In both bubbles, loans were given out like candy, often times to people that the banks knew were high risk.

Government practices during both bubbles share many unfortunate similarities as well. In Japan, increased capital requirements caused many firms to struggle when their assets started to depreciate. Similarly, the inflexible mark-to-market regulations in America forced firms to raise capital quickly, sometimes driving them towards bankruptcy.

In America, Federal Housing Administration policies encouraged the expansion of subprime mortgages, particularly through Fannie Mae and Freddie Mac. The idea was to expand homeownership for low-income families, though the increased demand drove housing up until the market was eventually oversaturated. Japanese regulatory policies and tax codes also caused land prices to unnaturally rise until they ultimately burst.

Given these similarities, U.S. officials should take a careful look at how Japan's response to the crisis lead to the more than ten years of recession and stagnation known as "the lost decade." We do not want to duplicate Japan's mistakes.

First mistake. The Bank of Japan tried to ease economic pains during their downturn through the 1990s by loaning large amounts of money to businesses. However, such attempts to recapitalize the market were counteracted by underlying management problems endemic to the dying firms.

According to Shigenori Shiratsuka, Deputy Director and Senior Economist at the Bank of Japan, even though firms became unprofitable, the government still encouraged lending to them to prevent losses from materializing. There were heavy concerns about a failing firm increasing unemployment.

The intense lobbying from special interest groups representing various sectors of the Japanese economy further perpetuated these ill-fated loans, funneling additional funds to zombie businesses. As Shiratsuka notes, "under such circumstances, loans to unprofitable firms become fixed and funds are not channeled to growing firms, holding down economic activity."

Unfortunately, we're seeing a disturbingly similar trend in America today, as the cost of bailing out AIG continues to rise and Congress moves forward with a bailout for the auto industry. The $8.4 trillion (and growing) cost of "saving" firms deemed too big to fail completely ignores the inefficiency and poor quality of the very businesses the government is trying to save.

Second mistake. With all those loans, the Japanese government was simply too integrated into the market to have adequate incentives to create the right policies. Daniel Okimoto, former director of the Asia-Pacific Research Center, points out that the interests of Japan's economic bureaucracies, such as the Ministry of Finance, became interdependent with the banking industry.

Moreover, government officials suppressed data revealing the intense scope of the economic malaise, all while regulations were developed with government interests in mind. Transparency and public accountability were basically nonexistent.

America now finds itself in the same position. The Treasury has taken equity stakes in many major financial institutions and insurance companies, not to mention the pending partial nationalization of Detroit's Big Three. This has created a myriad of conflicting interests as well as vast potential for fraud.

Consider that while the bulk of what the Treasury, FDIC, and Federal Reserve have spent has been tracked, it's far from clear what the banks and other institutions have done with that money. Without this information, it's difficult to measure whether the $8.4 trillion has been effective. Fighting fraud is equally difficult.

Third mistake. The length of Japan's asset deflation, recession, and liquidity struggles has been blamed largely on the lack of foresighted policies and political leadership. Politicians bent on retaining their power took action that sought to solve the present day concerns, such as infrastructure projects, without regard to their long-term effects. As a result, economic growth was not sustained.

America suffers from a similar vision problem. Intent with avoiding any semblance of economic pain, federal officials have thrown moral hazard and laissez-faire principals to the wind. Creative destruction has been rejected, despite long historical proof that it is the best way for an economy to grow.

Fourth mistake. Japan tried to climb out of its economic mess by raising taxes and cutting interest rates. Okimoto cites a series of policy mistakes in a report on Japan's economic stagnation that includes a consumption tax hike, business taxes, and heavy-handed reliance on interest rate cuts that reduced investment incentives.

President-elect Obama has backed down temporarily on his oil industry windfall profits tax and his promise to end the Bush tax cuts. But he still plans on letting the Bush tax cuts expire in 2010 and has set an arbitrary cap of $80 per barrel as the most profit oil companies can make before a windfall tax.

Neither Obama nor Congress has seriously considered cutting business taxes, cutting capital gains taxes, or creating an investment tax holiday. Any of these would encourage capital investment and the growth of businesses, thereby spurring on an economic recovery. Meanwhile, the Fed continues to slash interest rates with the goal of encouraging lending today, thereby limiting investment rates of return over the long-term.

Fifth mistake. With the Japanese government enabling lending to zombie businesses, taking cash away from productive ventures, and passing tax laws and other regulations that did not promote growth, the private sector was actively discouraged from investing.

Japan's economic growth during the 80s was due in large part to consumption growth and heavy capital investment. However, during the 90s, that money dropped-off as savings increased due to uncertainty, leading to a sharp drop in demand that further hurt prospects for recovery. The same problems contributed to the flight of foreign capital from Japan as well.

To counteract the lack of private investment, the Japanese government turned to large-scale infrastructure programs. They built roads, bridges, and airports, all with the goal of creating jobs and saving the economy. But it didn't work. Public debt skyrocketed (it is now higher than GDP), unemployment doubled, and the economy remained stagnant.

While private sector investment isn't totally stalled in America today, there is great uncertainty about what the government will do next, whether taxes will increase, and what future rates of return will be considering the Fed's rate-slashing binge. Foreign investment dollars are slowing as well, partially due to the global economic dip, but also because of errant policy.

To make matters worse, Obama is planning a Japanese-styled infrastructure investment project, with the goal of restarting the economy and creating 2.5 million jobs. But the plans are unlikely to encourage long-term economic growth, the jobs are not sustainable, and the spending will increase national debt.

And while some of Japan's infrastructure projects have served society, that value must be compared to what the private sector could have created with economic policies in place that encouraged free market activity. In other words, what are the unseen losses?

Still there are reasons to be optimistic. Not only does America have the Japanese lesson to study, we are in a much better position to act than Japan ever was. Despite Wall Street's massive losses, for instance, there is over $100 billion in private capital available now for investing in infrastructure. With a little forward thinking, we can unleash the greatest new wave of investment this country has ever seen-one that originates from the private sector, not from government planners focused on propping up the living dead.

Anthony Randazzo is a research associate at the Reason Foundation.

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  1. I heard something interesting along these lines on NPR. Supposedly, Bernake is an expert on the Great Depression and on Japan’s decade+ recession. What he allegedly has learned from these events, particularly from the latter, is that the bailouts and other interventions need to be really big at the outset, not just done bits at a time.

    Naturally, I think that’s nonsense, but that’s what I heard.

  2. Industrial policy is just what we need. That, and a larger chocolate ration.

  3. Great article. I can see there being some argument to keeping banks alive, and also some argument to letting businesses die gracefully, but still die. There is no reason to keep any non-bank company alive for any reason. And there is especially no reason trying to invest gung-ho in infastructure, most of which is not needed. The market will only dip so far before it begins to rebound again, and there are things we can do to help that rebounding by freeing it up.

  4. I can see there being some argument to keeping banks alive

    There are arguments for it, but they’re wrong. When the government keeps zombie banks around, they’re preventing the market from figuring out who’s solvent and who’s not.


  5. Thank you for an excellent article. The best thing to do, in my opinion, is nothing. Let the creative destruction take place. What is happening is a correction to excesses, bad decisions, government involvement and other reasons you’ve listed. May be the financial institutions that caused this should disappear so that their place can be taken up buy better, smarter managers of money. Also, may be housing market was overpriced by a great margin (fueled by imprudent loans indirectly instigated by the government, and sooner or later it needed to deflate, and not everyone needs to be a house owner.

    Just like forest fires sweep away old deadwood which makes it possible for new growth to take place so is the economy. Instead, massive government bailout of banks, auto industry (and who knows what else is in line) is going to preserve everything as is. Correction will be prevented from running its proper course. This will result, I fear, in a long period of no innovation, low job creation, high unemployment, and no new creation of wealth. However, many see it differently.

    Paul Crougman, for example, article after article, is advising Obama not to listen to those who warn him not to do anything drastic. To the contrary, he hopes that Obama’s intervention will be massive and transformational. He does not go into specifics of what exactly should be done. He just says that it should be massive and should transform society. I think that he, just like many of his intellectual comrades, is salivating for the government take over of the means of production. He is anxious to see another great social experiment to take place.

    Personally, I do not see anything appealing in this scenario. It conjures up in my mind bleak landscapes of my birthplace – Soviet Union with its empty shelves, product lines, absence of liberty and absence of economic creativity. Its massive government bureaucratic apparatus controlling all aspects of its citizen’s lives is every liberal’s dream.

  6. “It’s the same old theme since nineteen-thirteen.”

  7. Well, I can see that the zombie companies have already eaten the administration’s brains.

    (No wonder they are still hungry.)

  8. I am glad to see that article. Over the past few weeks, I’ve been reading more and more about Japan’s lost decade and have wondered why it happened. This has at least given me some clues. I agree with much of what is written too. Continuing to prop up dysfunctional businesses only harms the overall economy in the long run.

  9. Is Ving Rahmes available to kick some zombie ass?

    “You coming with us?

    Nah, you’re coming with me. I’ve done this before.”

  10. In a related article on CNN Money, Toyota and other asian carmakers want a bailout for the big 2.5. It seems counter-intuitive at first glance but the primary reasons cited are:

    1)Potential bankruptcies of parts suppliers. Since many auto parts are made by only a few companies with no redundancy in the market mean that any interruption in the supply chain hurts all auto manufacturers equally. I fail to see how propping up 3 big companies instead of 12 smaller ones is any different.

    2)Failure of the big 3 would further weaken the US Economy and reduce demand for all autos. I call bullshit on this one. It may put all UAW workers out on the streets and while it may be a boon to the repo-man for a year or so it won’t really affect forward car sales.

    And lastly, buried at the end of the article, almost as an afterthought:
    3)”The failure of a U.S. automaker could open the door for a Chinese or Indian automaker to buy up the assets of the failed company and create a new low-cost competitor in the U.S.” Yup, the real reason that Toyota, Hyundai and Honda fear the ‘Big 3’ failing is that Tata or Geely could get a huge jump on the US market. Damn those Indians for wanting to sell $2000 cars to cash strapped Americans and beating the Japanese and Koreans at the game they have dominated for the last 20 years. In short, better to waste American taxpayer money on businesses that are “too big to fail” than give it back to taxpayers to spend on affordable cars.

    This “crisis” definitely makes for strange bedfellows.

  11. Potential bankruptcies of parts suppliers.

    I see this potential problem cited all the time, but I don’t get how it could happen. If Honda, Toyota, etc are dependent on these companies, they must be buying parts from them; and if they’re still selling parts to Honda and Toyota after the Big 3 fail, how are they going to go bankrupt?

  12. I have a cunning plan. Rather than propping up these failing companies, the government should use its billions to finish them off. Brilliant!

    Strange that no one else has suggested this.

  13. Pro Lib,

    As usual I have a good idea and you take it and mold it into a great idea. Here I am talking about using Ving Rhames to blow CEO’s heads off(on the assumption they are zombies) and you take it to new heights by suggesting an agency committed to destroying them. Truly you are a genius.

  14. cunnivore,
    There are three ways I can see the part supply bankruptcy playing out.

    First, if the company was running so thin a margin that the lost profit would kill them. I have serious doubts about this.

    Second, if the manufacturing facilities cost so much to run/retool that the options are full production or none at all. Again, I have my doubts unless said suppliers partook of “easy money” to expand business when they should have been holding steady.

    Last, if the companies have no way to “downsize” appropriately. What I mean is, if they are bound by legal/union regulations regarding staffing. I don’t know if this is at all the case but it wouldn’t surprise me given that most US parts manufacturers were spin-offs from the Big 3 (ACDelco comes to mind).

    Otherwise, I’d have to call bullshit on that theory. Even if a couple of the weaker companies went down and the stronger ones took three to six months to tool up for replacement, the Asian manufacturers wouldn’t have to worry about domestic competition for that time.

  15. Naga,

    I see the Department of Killing Off Weak Businesses as an alternative to socialism and increased regulation. Under this scheme, everyone wins. The left gets to enjoy destroying businesses on the brink of failure, while the right and the libertarians get to keep their free market–at least for companies that are self-sustaining.

    I think I’ll deem this Regulatory Darwinism. The government will sit watching. Waiting. Judging. And if a company looks weak enough, the government will send its agents to finish the job. Won’t need Chapter 11 any more, because once these guys are done with a dying business, there won’t be anything left to restructure.

    If this works, then we can use the same system for individuals who declare bankruptcy.

  16. Hemiptera – Our economy has caught The Vapors:

    No fun, no sin, no you, no wonder it’s dark
    Everyone around me is a total stranger
    Everyone avoids me like a cyclone ranger
    That’s why I’m turning Japanese
    I think I’m turning Japanese

  17. A good article. I’ve been in Japan since 1994 and even spent a very enlightening year on a provincial capital’s Chamber of Commerce seeing how things don’t work, how every idea is thwarted by some existing regulation or worry (valid or not). The CoC was looking to revitalize the old shopping arcade, but effectively zero interest loans meant zombies wouldn’t/couldn’t be shut or demolished to make way (though a Daiei that folded did turn into a condo complex). The remaining businesses were in buildings long since paid off, dealing with a clientele of people 50+, all slowly dwindling but at a stable predictable rate. All the young people left for Osaka or Kobe where the jobs and other young people are. Nobody wanted to return to take over the family jewelry or men’s fashion shop. The ongoing question was: Come the death of owner X, childless or whose children don’t want to return, what happens? The trend then was chuushaka, “parking-lotiziation”: turn vacant property into pay parking. I recall parking inside a buliding, one wall of which had simply been removed so 6-8 cars could park inside at an hourly rate.

  18. It’s odd to be where chanage doesn’t happen. Bus and train fares? Museum admissions? Various foodstuffs? Almost all still the same prices they were in 1994, but go outside a metropolis and you can see the decay of inertia in crimbling public buildings, roads, etc.

    NHK recently reported that some private room Internet cafes, where increasing numbers of the poor live for $5/night with hi-speed net access (to seek work, one interviewed guy said), have begun allowing long-term customers to establish official addresses there (it’s a Japanese thing). Without an official address on file at the local ward office, you’re kinda resigned to day laborer work. Now registered at room 123 of Net Cafe X, some 48-year-old guy was finally able to secure a month-long contract at some factory. The private sector filling a niche created by a traditional regulation.

  19. I don’t understand why zombie banks have this problem. Their business model still works; presumably they won’t be investing in what didn’t work before, just like solvent banks. Make them solvent and they’re the same as solvent banks, albeit not great for their current diluted shareholders.

    Unlike buggy-whip companies, or any regular business in the wrong line, which certainly ought to die.

  20. Naga –

    any plan involving Ving Rhames is bacon wrapped awesome.

    Make it so.

  21. “Killing zombies isn’t typically the responsibility of America’s president or treasury secretary.”

    Maybe it should be… personally I feel that dispatching the undead (zombie or otherwise) is a fine indicator of being able to handle national crisis (who ever heard of a local zombie problem?) President Abraham Lincoln for example is reported to have quelled an entire uprising of zombie slave owners with just his bear hands and particularly sharp pencil.

  22. So the Big 2.5 Chapter 11s, and (some of) their parts supplies Chapter 11.

    They’re still around, aren’t they? Making cars and parts, only downsizing/renegotiating?

    Where’s the catastrophe, again?

    I am so tired of people blabbering on like bankruptcy means their plants are levelled, their employees either executed or living out of cardboard boxes, and all that’s left of Michigan is a radioactive wasteland with tumbleweeds blowing down Main Street.

  23. I’ll play devil’s advocate, and repeat the line that “no one will buy a car from a bankrupt car company” since who knows whether they’ll still be in business when you need a new part.

    And given the rep of GM, you WILL be needing a new part, probably a few days after your warranty expires.

  24. President Abraham Lincoln for example is reported to have quelled an entire uprising of zombie slave owners with just his bear hands and particularly sharp pencil.

    Ha ha ha ha ha. No one will catch Time Lincoln!

  25. Bear hands are much more powerful and deadly than human hands. Those long grizzly claws are excellent for beheading zombies.

  26. “President-elect Barack Obama and his economic team better get out their shotguns and aim for the head.”

    They can’t do it… BO & his team are anti-gun. They’ll need the bitter gun owners to help out.

  27. “It’s the same old theme since nineteen-thirteen.”

    Gold Bug – is this a 17th amendment reference? I am not sure that I am hip enough to keep up with the comments section yet…

  28. Gold Bug – is this a 17th amendment reference?

    Nah – its a quote from the most excellent Cranberries song “Zombie.”

    [off to iTunes for a download]

  29. Oooh, yeah – but that was in reference the Easter Rising in 1916. I thought 1913 may have been an inserted reference to the rise of statist government in the US with the passage of the 16th (I said 17th) amendment.

    &*%*… Now I’m going to have that song stuck in my head all day.

  30. In 1913, the Federal Reserve Devil Incarnate assumed control of the nation.

  31. Pretty much agree EXCEPT
    “Similarly, the inflexible mark-to-market regulations in America forced firms to raise capital quickly, sometimes driving them towards bankruptcy.”
    Uh, its called reality. And when you borrow trillions, and your return is 1% less than you expected, all of a sudden you have a shortfall of billions and billions.
    Is that mean of the bondholders not to wait till housing prices go back up? Well, if you were owned 100 million a month, and someone told you to wait till housing prices went back up, would you?

  32. “I am so tired of people blabbering on like bankruptcy means their plants are levelled, their employees either executed or living out of cardboard boxes, and all that’s left of Michigan is a radioactive wasteland with tumbleweeds blowing down Main Street.”

    Plz butt out of my escapist post apocalyptic fantasy. Thx.

  33. So, in reading this article, what came to my mind is the following:

    1) How did folks in Japan get rich during the Zombie company time?

    2) What sectors within the Japanese economy could one invest in and make bank?

    3) Did one HAVE to look outside of Japan to get rich?

    I ask, since, if the basic thesis of the article is right, then perhaps those that got rich in Japan in the 90’s could point the way to get rich in America from 2009 on.

  34. P Brooks scores. RC Dean gets a point for the assist.

  35. Neither Obama nor Congress has seriously considered cutting business taxes, cutting capital gains taxes, or creating an investment tax holiday. Any of these would encourage capital investment and the growth of businesses, thereby spurring on an economic recovery.

    To paraphrase Jon Stewart:
    Oh tax cuts, is there anything you can’t do?

  36. As I understand it the supplier problem is that the suppliers are borrowing on their accounts receivables.

    Most of their accounts receivables are owed to them by the 2.5.

    The value of the receivables as collateral is largely due to the customers ability to pay eventually so that the supplier can pay off the loan.

    Now, if the 2.5 go into Chapter 11 payments to the suppliers will bereduced and/or deferred thus making the banks cut of the credit line.

    So the 2.5 need a bailout so they can pay their suppliers, so their suppliers can stay in business.

    My question is, how the 2.5 will pay their suppliers next time the bills come due?

    Maybe Uncle Sam should bailout the suppliers to give them some time to find some customers that aren’t such a bunch of fucking deadbeats.

  37. On June 4th, 1974 Hubbert testified before Representative Morris K. Udall’s Subcommittee on the Environment.3 In his 21 page written statement he presented his familiar lecture on various growth curves, their equations, curves of world and U.S. production of fossil fuels as well as projections for the future. He next discussed the cultural aspects of the growth problem. He states, “during the last two centuries of unbroken industrial growth we have evolved what amounts to an exponential-growth culture. Our institutions, our legal system, our financial system, and our most cherished folkways and beliefs are all based upon the premise of continuing growth, Since physical and biological constraints make it impossible to continue such rates of growth indefinitely, it is inevitable that with the slowing down in the rates of physical growth cultural adjustments must be made.
    We will never again be able to get sufficient growth of the economy to eliminate or even markedly reduced unemployment. NAFTA, GATT, and Clinton’s hope of growing the economy to solve unemployment is doomed to failure.

    The promise of competing in the global economy is a hoax perpetrated upon the working and unemployed people of this country because over time a nation needs to buy and sell overseas in roughly equivalent amounts.

    All attempts to reduce the deficit, balance the budget or pay off the national debt are futile. The deficit and the national debt represent the subsidy the government has paid in its attempt to keep growth and unemployment at the level of social tolerance.

    The steady state economy into which we are being inexorably forced implies an interest rate of zero.

    An interest rate of zero (as Hubbert explains) means the end of the money system. We are being forced to completely rethink our cultural ideas about how to organize our economy and distribute purchasing power.

    Increasingly desperate means will be used by those who think we can continue to have business as usual.

    The proposals of Negative Population Growth should be implemented immediately.

    Americans are slow to understand world issues
    that all the world in not classical economists

  38. We are going to have a much worse time of it than Japan did, and their crisis lasted a decade. Japanese people save money (investement capital for banks) rather than piss it away on consumer goods.

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