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Japan’s Financial Grief
Saturday, 08 January 2011 08:19

Financial crises happen all the time.  Countries get over them.  So why should Japan take some 15 years to get over its financial crisis?


Japan’s financial crisis was ultimately a product of hubris, over confidence and even madness.  Coming to terms with this is very difficult for a proud nation like Japan.  It means grieving, and passing through all the stages of grief as described by Elisabeth Kubler-Ross, namely, denial, anger, bargaining, depression and finally acceptance.


Japan was on a big high in the 1980s.  It fast-growing economy was catching up with America.  Some even believed that it could overtake America.  Its banks were making investments all over the place.  It seemed that nothing could go wrong.  The 1985 Plaza Accord resulted in a dramatic increase in the value of the yen.  But for many, this just added to optimism and self confidence.


To keep the economy rolling along after the Plaza Accord, the government pursued expansionary fiscal and monetary policies.  Money was being invested everywhere, and especially in stock and property markets.  By end-1989, the Tokyo Stock Exchange Index was about six times higher than a decade before, while urban land prices were some four times higher.  In terms of economic fundamentals, there was no good reason for such price hikes.  But stock and property prices had never even fallen before in our lifetimes. 


So stocks and property must have been a safe bet?  No way, Jose.  The government tightened policy, and stock and property prices went into a tail spin.  Bank loans were concentrated in risky property-related businesses, with the collateral being land.  When land prices crashed, the loans became “non-performing” or turned "bad" in simple English.  Banks also held lots of stocks on the balance sheet, which went up in smoke when stock prices fell.  The subsequent economic slowdown and deflation only added to banks’ bad loans which ultimately peaked in 2002.


Instead of moving into action to solve this banking crisis, Japan then spent the 1991-97 period in the denial, anger and bargaining phases of grief.  The Ministry of Finance protected banks waiting for and hoping for an economic and asset price recovery.  But like Godot, it never really came.  The year 1991 saw Japan’s first post-war bank failure in the form of the Toho Sogo Bank.  In 1994 and 1995, there were failures of other small financial institutions.  Economic growth resumed in 1995-97, only to be nipped in the bud by a tightening of fiscal policy and the Asian financial crisis.  In 1997-98 a weak economy and falling asset prices then pushed Japan into a full-blown banking crisis.  One of the four largest security houses, Yamaichi Securities, collapse, as did a medium-sized one, Sanyo Securities.  Hokkaido Takushoku Bank also failed.


By the end of 1997, Japan was in the deep depression phase of grief, and had accepted that it must finally move into action.  It was only then that the government began to work on the banking system problem seriously and decisively.  In 1998, public funds to the tune of 12 per cent of GDP were made available to the Deposit Insurance Corporation of Japan for financial support for banks.  There were a couple of recapitalization operations.  Two major banks, the Long-Term Credit Bank of Japan and Nippon Credit Bank were temporarily nationalized. 


But even in the phase of decisive policy action from 1998 to 2001, Japan was still bargaining with grief.  After long refusing to recognize the full extent of banks’ bad loans, the government agreed to assess the banks’ balance sheets at the time of the 1998-99 recapitalizations.  But even then, banks massively underreported the extent of their bad loans.


Japan’s Financial Services Agency was created in 2000, and launched a special inspection of bank loans in 2001.  This finally brought some order to the classification of bad loans, and to the health of banks’ balance sheets.  It was only after 2003 that the functioning of the banking system started to improve.  The banking crisis only really ended in 2005 when the non-performing loan ratio of major banks declined to a level (2.9 per cent) below the target set by the government


The costs of this banking crisis to the Japanese economy were massive.  Some 47 trillion yen of public funds were injected into the banking system, only half of which was recovered.  On top of that, there were the opportunity costs to the economy from the decade long stagnation.  Trust in the banking system was damaged.  And Japan has emerged from the banking crisis as a pygmy in the international banking scene.  In Asia, the financial centres are Hong and Singapore, not Tokyo. 


Why did Japan really delay so long in moving into action?  First, it took some time to realize that there had been a bubble which had burst and that things would not return to normal.  Second, there were no domestic or international pressures pushing the government into action.  Even today, life is too comfortable to push the country into major change.  Third, accounting practices allowed banks to delay recognizing losses.  Fourth, the government lacked the legal framework to resolve troubled, large financial institutions.           


What are the lessons?  First, to address a banking crisis properly, prompt action to gauge the exact amount of loan losses is a critical initial step.  Second, a government recapitalization operation that involves taxpayer funds in the effective way to deal with the problem.  Third, removal of impaired assets from banks’ balance sheets is essential to the restoration of bank health.  Fourth, you must get the economy growing again to avoid more bad loans.


The major lesson is that a never-ending and badly-managed banking crisis like that of Japan can break the spirit of a country.  While Japan was in the midst of this crisis, China, Korea and other Asian countries were on the rise.  Korea went into and out of a financial crisis in the space of just a couple of years.  Lots of Japanese industry was relocated elsewhere in East Asia.  Japan’s population aged dramatically, and started declining.  And Japan’s public debt rose to the world record levels of 200 pert cent of GDP. 


Japan should have solved its banking crisis quickly, and readied itself for a dramatically changing world.  But it didn’t.  Japan is today a very different country from the 1980s.  It has lost self confidence, dynamism and direction.  This did not need to happen.





On Death and Dying by Elisabeth Kubler-Ross



Lessons from Japan's Banking Crisis, 1991–2005 by Mariko Fujii and Masahiro Kawai


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