Where Do We As A Country Go From Here?
A discussion in yesterdays comments is the subject of this post. One reader said, “Back in ‘05-’06 the fact that we were in the grips of a RE bubble seemed OBVIOUS to those of us who hung out here, but somehow invisible to many…Now, of course we have the satisfaction of being (mostly) right, but the question is “Where do we, as a country go from here.” Are there any other problems that most people are being willfully blind to, or did we just get lucky on one thing, and should now take off our tin-foil hats?”
I replied, “Ignoring the mania aspect of what is going on leads us in the wrong direction. Example; if you have a “crisis”, somebody (meaning the govt) HAS to do something, right? It’s really just how you frame the issue. If you look at it from affordability, what’s going on is ultimately good for the economy.”
“Back to your question; if we look at recent history and bubbles, the best comparison IMO is Japan’s twin stock and RE bubbles. What lessons are to be gained? Too big to fail and moral hazards were disastrous. We’ve made every mistake they made. The PTB tell us they saved us from a great depression. I’d suggest they’ve merely put off the inevitable (like Japan) and possibly set us up for a Japan like multi-decade recession.”
The first poster replied, “I think one lesson from Japan is that the short term has a way of completely upstaging the long term. Everybody points to the lost decade and the mistakes that the Japanese made that led to it. And yet many of the same people who were doing the pointing are now advocating or making exactly the same mistakes. Sadly, most people are so focused on the short term, or their own interests, that the long term good of the nation is ignored, or given the merest lip service. So we’re pursuing a series of bailouts and stimulus funded by ever increasing levels of government debt of the sort that did NOT do much to put Japan back a long term growth trend.”
(Note: PDF link) From the “Workshop on Japan’s Bubble, Deflation and Long-term Stagnation.” March 21 - 22, 2008, Organized by The Economic and Social Research Institute (ESRI), Cabinet Office, Government of Japan and The Center on Japanese Economy and Business (CJEB), Columbia Business School.
(NOTE PDF)” The Contribution of Bank Lending to the Long-Term Stagnation in Japan.” Joe Peek, “B. Post-Bubble Evidence: Much of the evidence from the 1990s has been interpreted in a way that is not necessarily complimentary of main bank and keiretsu affiliations benefiting firms, at least in the longer run, and certainly not benefiting the macroeconomy more generally. Rather, while possibly aiding individual distressed firms in the short run, the close affiliations of Japanese banks with their borrowers have been viewed by many as contributing to a decade (or more) of subpar economic growth. In particular, if the primary role of bank (and keiretsu) affiliations is to insulate management from market forces by enabling firms to avoid the discipline that can be provided by external creditors and investors, this limiting of outside corporate governance would manifest itself as a misallocation of credit that could delay needed restructuring of individual firms and the reallocation of valuable resources to their best uses.”
“Focusing on the immediate post-bubble period (1990-93), Kang and Stultz (2000) find that the stock return performance of firms that were more dependent on bank loans just prior to the bursting of the stock price and land price bubbles was worse than for firms that were less dependent on bank loans. They also find that keiretsu membership, defined to include both horizontal (bank-centered) and vertical keiretsus, is related to a worse stock return performance. This evidence suggests that, at least during the initial phase of the banking problems and prolonged malaise of the Japanese economy, those firms most closely tied to banks were adversely impacted by that relationship. While those firms that relied relatively more on bank loans had relatively better stock return performance during the good times of the bubble period, once the bubbles burst, those same firms contracted investment more and suffered worse stock return performance relative to those firms that relied less on bank loans…”
“Considering the subsequent period from 1993-99, Guo (2007) finds evidence consistent with that of Kang and Stultz (2000). While during the 1978-92 period, distressed firms with a greater reliance on main bank loans had higher sales growth, and that performance was not affected by the main bank’s health, during the subsequent 1993-99 period, a greater reliance on main bank loans was associated with slower sales growth, and that sales growth rate was lower the weaker was the main bank’s health. Similarly, for the 1993-99 period, a greater reliance on main bank loans and weaker main bank health also was associated with the firm having a lower return on assets. In addition, during this latter period, the duration of distress was longer for firms with a greater reliance on main bank loans…”
“…the fact that the performance of firms with close ties to their main bank suffered is somewhat puzzling, insofar as it appears that many firms increased their reliance on bank loans during the latter half of the 1990s, even as the bond market had been deregulated. This would suggest that many of the firms obtaining increased bank loans must have been among the weakest Japanese firms, so that the main bank assistance was either not sufficient or not used appropriately to enable the firms to recover from their financial distress. In fact, using data for the 1998 fiscal year, Hori and Osano (2002) find that firms with weaker prospects and a greater likelihood of suffering financial distress rely more on main bank loans. Similarly, Arikawa and Miyajima (2006) found that firms with low growth opportunities increased their reliance on bank loans in the 1990s.”
“Why would banks have increased loans to some of the weakest firms? Peek and Rosengren (2005) argue that banks did so in response to the perverse incentives they faced due to the way in which bank regulation and supervision was handled in Japan. Troubled Japanese banks had an incentive to allocate additional loans to their severely impaired borrowers in order to avoid the realization of losses on their own balance sheets. As a bank’s reported capital ratio approached the regulatory minimum, banks were more likely to increase loans to the weakest firms.”
“…Furthermore, this behavior was more pronounced for firms with strong bank and keiretsu ties. Caballero et al. (2006) investigate the implications of bank lending to these “zombie” firms for the Japanese macroeconomy. They argue that this evergreening of loans to zombie firms distorted competition and impaired needed restructuring of distressed firms, lowering productivity and increasing excess capacity in the economy. This evidence is consistent with the finding by Arikawa and Miyajima (2006) that the main bank system impeded needed creative destruction during the prolonged malaise of the 1990s when the Japanese banking sector was in crisis, insofar as greater reliance on main bank loans tended to delay the restructuring of poorly performing firms.”
“…Rather than focusing on the role of main banks and affiliated firms in impeding the financial restructuring of distressed firms in the post-bubble period, Arikawa and Miyajima (2006) investigate the operational restructuring of distressed firms by estimating on the employment adjustment function. While more leverage is associated with a greater shrinkage in employment, the composition of that debt mattered. In particular, a higher ratio of main bank debt to total assets delayed restructuring, again suggesting that the main bank system impeded the needed restructuring in Japan during the prolonged malaise following the bursting of the stock price and land price bubbles when the banking sector was in crisis.”
From Lessons of Japan’s Bubble Economy. “Looking back from today’s perspective, we can see that the Japanese government’s response to the collapse of the bubble created numerous problems. By 1998, eight years after the bubble started to deflate, several major financial institutions had gone bankrupt, including Yamaichi Securities, Hokkaido Takushoku Bank, and the Long-Term Credit Bank of Japan. This was a period when a mountain of bad debts cast a shadow over the economy. The government failed to come to grips with the problem, however, and the financial crisis of the late 1990s was the result. It was not until the 2002–3 period, during the administration of Prime Minister Koizumi Jun’ichirō, that work on clearing away the bad debts began to make substantial progress. More than 10 years had passed with little being done.”
“It was quite some time after the bubble began to deflate that the authorities worked out systems for using the power of the state to recover nonperforming assets (the Resolution and Collection Corporation) and support the reconstruction of companies buried under bad debts (the Industrial Revitalization Corporation of Japan). Furthermore, Japan was short of the human resources required for writing off bad debts, recovering assets, and putting companies back on their feet.”
“As I noted, the Japanese financial system continued to rely excessively on banks for collecting deposits and providing financing. Reforming this financial setup became a crucial task after the bubble burst, but struggling financial institutions were foundering, banks were engaged in realignment through mergers, and arranging a reform paving the way for the introduction of market-based financial methods, as symbolized by property-backed securities, took time. It is fair to say that because such changes and reforms were slow to make progress, the bad debts turned into a veritable quagmire.”
“To deal with the slump that ensued as the bubble lost air, the government relied on conventional fiscal and monetary tools. On the fiscal front, the authorities applied stimulus by cutting taxes and stepping up spending on public works, and on the monetary side, they made cuts in the policy interest rate. While such macroeconomic policies were needed, in themselves they were inadequate for getting to the root of the problems. Fundamental changes in financial markets and systems were also required. It was, in other words, a half-baked stimulus program, and it had a damaging effect. It persuaded financial institutions and debt-ridden firms to postpone radical restructuring. We should further note that the government debt ballooned as a result of the fiscal stimulation, and this placed a severe constraint on policy management over the ensuing years.”
The Daily Ticker. “More than two years after the financial crisis, Lee Farkas, the former Chairman of Taylor, Bean & Whitaker Mortgage Corp, is arguably the only major player in the mortgage industry to face criminal charges. William Black, professor of economics and law at the University of Missouri-Kansas City School of Law, calls the lack of prosecutions a disgrace, and he blames policymakers.”
“It’s a matter of ‘unofficial’ policy, he claims. ‘The de facto policy right now is elite frauds go free if they’re in banking because the whole sector is too fragile. That is significantly insane. It will produce the next crisis.’”
“In the accompanying interview with Aaron Task, he notes that Treasury or White House officials are fully aware of the fraud, citing FBI testimony as far back as 2004 about rampant fraud in the mortgage market. In fact, Black says the problems banks are now facing with foreclosure paperwork are simply a result of the foreclosure frauds that were never addressed. ‘Every time you fail to root out the frauds, the fraud simply migrates. It migrates from the lending process to the foreclosure and servicing process.’”
