Masaaki Shirakawa, Governor of Bank of Japan has given an insightful speech comparing the US situation with Japan’s in 1990s. He points there is a remarkable similarity between the two.
While the economy of this period is often called as ‘Japan’s lost decade,’ in my view, such a categorization might not be perfectly capturing the nature of the problem and challenges of policy measures taken to cope with a financial crisis.
What were the factors that led to a slump in Japan?
First, there was a delay in recognizing the severity of the impact of massive nonperforming assets on the economy. It was a few years after the burst of the bubble when we recognized how seriously the decline in real estate prices affected financial institutions.
Second, there were imperfections in accounting and disclosure standards. At present, vigorous discussions are going on about how to cover the expected losses over the credit cycle in terms of accounting. At the time, there was a lag in showing the incurred losses of financial institutions on the accounting and disclosure front.
Third, partly as a result of the aforementioned two points, the authorities could not resolve troubled financial institutions in a timely manner, because of the delayed progress in establishing a framework of resolution to cope with troubled and failed large financial institutions. Arguably, the legal framework of resolution, operational procedure, and, above all, public funds to cover a capital shortage are vital in ensuring the smooth resolution of troubled and failed financial institutions. And it was in early 1998 after we experienced a series of failures of large financial institutions that the full-fledged safety net framework was put in place.
He then points similar problems are resurfaced now. So, despite the lessons US (and others) are repeating the same. Why? policymaking comes with a lot of ifs and buts. So, terming it Japan’s lost decade ignores the fact that there was just too much uncertainty. Same is the case now.
He says removing uncertainty is the main problem. It was never a liquidity problem but a solvency problem. Until we solve this, there will be little forward movement. He also adds there are lots of dilemmas for policymakers to solve:
A ‘mirage’ phenomenon is taking place in that, despite public capital injection, concern over additional losses on the assets mounts over time and such concern in turn will heighten concern for a capital shortage of financial institutions.
Under those circumstances, it is of vital importance to remove uncertainty. There are two options to remove uncertainty stemming from financial institutions’ nonperforming assets; the government purchases those assets or provides a loss guarantee to those assets. Nevertheless, even in both cases, uncertainty might not be removed for the assets not covered by the purchases or the guarantees, and investors thus would continue to ask the institutions for high risk premiums.
What Japan faced in the past and what the U.S. is facing now is arguably those difficulties. However, even with such difficulties, it is an indispensable process to promptly identify the amount of losses and to carry out recapitalization to secure financial system stability, if necessary.
All this does not look good at all. It is also not just particular to US but many economies are facing the same problem. The problem currently looks deeper than Japan’s as despite some aggressive policy responses(though it could still be a lot quicker), nothing has really happened. Things have only gone worse. True, similar mistakes have been made like that of Japan but policy action did not wait as long as seen in Japan.
What is also interesting (and depressing) is that there are many dilemmas to solve. There is no easy way. You infuse capital, it could signal more losses ahead; you try and buy toxic assets, the pricing is an issue etc etc. It does not look good at all and the way things look, it could take a lot longer for economies to recover. It looks like a long long dark tunnel with light sometime away.