Greg Ip

Articles by The Economist’s U.S. Economics Editor

Is America repeating Japanese history?

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The original post is linked here.

EARLY in his tenure, Tim Geithner, the treasury secretary, promised that American policymakers would not make the same mistakes Japan did in tackling its financial crisis. But as politics threaten to upend his efforts, Mr Geithner should take a second to consider why Japan made its mistakes.

Japanese officials took too long to commit substantial public money to recapitalising their banks. But it was not because they were ignorant of the dangers or Andrew Mellon acolytes hell-bent on liquidating speculators. Like Mr Geithner, they feared being shot down by voters and politicians furious that taxpayers might bail out overpaid bankers.

One Japanese official told me that when he sees Treasury officials testifying before congress with protesters waving anti-banker placards behind them, it reminds him of pictures in Tokyo newspapers in the 1990s. At the time, he and his colleagues knew that saving the financial system would require a lot of public money, but also felt it would be politically impossible to propose it until all other avenues had been tried.

This sentiment is eerily similar to what prevailed inside the Treasury in mid-2008. Shortly after the near collapse of Bear Stearns in March, officials came up with options to pump public money into the financial system. “But these actions all required Congressional action and there was no prospect of getting approval for any of this,” Phillip Swagel, an official with Treasury at the time, writes in a new account. “Such a massive intervention in financial markets could only be proposed if…Congress [was told] the financial system and economy were on the verge of collapse. By then it could well be too late.”

Not until the Lehman bankruptcy and AIG near failure was Congress asked to pony up. Encouragingly, it did, passing the deeply unpopular TARP programme. It looked like we were going to avoid the Japanese fate after all. Now I’m not so sure.

Since then, we’ve begun to move backwards. Soaring unemployment coupled with a stream of revelations of banker excess, capped by the fury over AIG bonuses, has resulted in new restrictions being imposed on TARP recipients and made it impossible for the administration to use the additional $750 billion in TARP money any time soon.

Then there was the curious spectacle of Mr Geithner on ABC’s “This Week” on Sunday asserting that he still has “substantial resources” to support the banking system in part because some TARP “money is likely to come back from banks that are strong enough not to need this capital.”

Let’s be clear. The fact that many banks, such as Goldman Sachs and Bank of America, plan to repay their TARP money as soon as possible is bad news, not good news. I’m sure Mr Geithner knows that, but can’t say it. They are repaying the money not because they have ample capital but because they are repelled by the prospect of political interference if they accept any aid. True, regulators may not allow some banks to repay the money; but they will conserve capital anyway to hasten the date when they can repay it. Either way, banks are going to constrain lending at a time when we badly need them to expand it. Meanwhile, there are doubts about Mr Geithner’s plan to relieve banks of their current bad loans.

Some of the people who know Japan best see Mr Geithner heading, tragically, down the same path. Adam Posen at the Peterson Institute puts it well:

Whatever the political culture, it would seem we have not learned from experience. Or perhaps we cannot act on our learning. The universal barrier would appear to be the political difficulty of recapitalizing banks. That seems obvious, but the constraint it puts on good policy is enormous.

That is why the Geithner plan is so complex and jury-rigged, to avoid the need for public requests for more money for banks. Unfortunately, it is unlikely to succeed absent additional public money and more-intrusive government action.”

I called Anil Kashyap at the University of Chicago who has written extensively on Japan’s crisis. He, too, is turning pessimistic. In the early 1990s, he notes, Japan’s Ministry of Finance (MOF) did not want to commit public money partly because of public resistance and partly to avoid admitting their own regulatory failures. By the time they did commit public money, over the resistance of the opposition party,

The public was pretty pissed. The government promises multiple times not to force you to pay for all this, and they end up doing it. It was a big hit to the MOF’s prestige.

The politicians took the lesson that “the public just doesn’t want us to spend”. So they were loth after that to say, “Here, we’re bringing in more money”.

For a long time I didn’t think the analogy between the US and Japan would hold up because the US response was much faster and more powerful. But after Lehman things began to line up more closely… The fact that people can’t tell exactly why this money was needed and how this money would be used, where Hank Paulson announces he’ll do one thing then does another, now back to what it looked like originally. The public is at its wit’s end. They see this as a gigantic gift to the bankers, rather than a way to help the economy. To be fair how can the public be sure the regulators are not captured by the financial system? The public is right to be sceptical when they see something like this… It’s incumbent on the politicians to explain why it’s so important.

I don’t want to downplay the positive things that have happened. TARP has injected a lot of money into the banking system. Treasury is using the Fed’s balance sheet to purchase the securities for which Congress won’t appropriate money. That has troubling implications for the Fed’s independence, but that’s a concern for a later date. The increased resources that the G20 have promised for the IMF, if implemented, amount to a reliquification of the global economy, analogous to the abandonment of the gold standard that helped end the vicious cycle of monetary contraction in the 1930s.

Yet I am not sure the improvements in the economy that have sparked the recent stock rally will last. There has been too much damage done to the household balance sheets and the financial system to expect a textbook recovery.

The Japanese stock market rallied hard after 1992 as well. The current rally could actually lead to complacency and increased resistance in Congress to doing more. And without doing more to fix the financial system, any economic recovery is at great risk of petering out. Tim Geithner knows this risk; he has repeatedly warned against applying the brakes at the first signs of light. Unfortunately, this may be out of his hands. The laws of politics can be as binding as the laws of supply and demand.

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Written by gregip

April 3, 2009 at 8:49 pm

One Response

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  1. Ip: “The Japanese stock market rallied hard after 1992 as well.”

    Actually, it didn’t. The Nikkei hit 39,000 in Dec 1989, lost almost 50% in nine months (21,000) rallied to 26,000 in Feb 1991, but soon slid to 16,000 in mid 1992. Two and a half years after the market popped, the NIKKEI rose to 21,000 in mid 1992 then back down to 17,000 in Dec 1993. Back up to 20,000 in Jun 2004, back down to 15,000 in Jun 1995; back up to 22,000 in Jun 1996, with a slide back to 14,000 in Sep 1998. There was no hard rally after 1992. (Yahoo finance has a graph)

    tokyo tom

    April 7, 2009 at 6:15 pm


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