With stocks plummeting, economists in Japan warn that U.S. authorities risk making the same mistakes Japan made when banks there collapsed
A month ago market-watchers in Japan were praising U.S. Treasury Secretary Hank Paulson and his attempts to fix the U.S. financial system. Many of those who had watched as Japan took years to mend its own broken financial system in the 1990s gave the former Goldman Sachs (GS) banker solid reviews, citing his decisiveness and banking experience. Paulson, they said, was a sharp contrast to Japan's bureaucrats, who had dithered and been reluctant to take responsibility during the 1990s.
But that was before this week—the worst in history for Japan's the Nikkei 225 benchmark stock index. Following another huge plunge on Oct. 10, the Nikkei has shed 24% in just five trading sessions.
For sure, the recent calamities in the stock market are tough for Japan's hard-pressed investors to take. After all, Japan largely avoided the excesses of recent years. Its banks have on the whole sidestepped subprime losses and have money to spend; its debt-light corporates are far better placed to weather a downturn than they were a decade ago when Japan's financial system teetered on the brink of collapse. Japan's household sector, still scorched by the excesses of the late 1980s Japanese bubble, hasn't experienced a credit-fueled housing boom or the kind of reckless lending that fueled the U.S. housing boom.
Pan Asian Problems
Yet Japanese stocks, like much of Asia's, are being savaged. Today the 9.6% slump in the Nikkei index was the third worst in its 59-year history. The previous third-worst fall was on Oct. 9 when the index lost 9.4%. Today's losses, following a slump in the U.S. stocks overnight, were intensified by midsize insurer Yamato Life Insurance filing for bankruptcy protection just a day after New City Residence Investment, a real estate firm, sought protection from creditors. Elsewhere in the region, Australia closed down 8.3%, while benchmark indices in Hong Kong and China were off 9.4% and 4.4%, respectively. In India, the BSE Sensex closed at 10,527.85 points, down 7%. ICICI Bank stock plunged 20% to close at $7.60.
Part of the problem, say Tokyo-based economists, is the the U.S. Federal Reserve's $700 billion bailout plan (BusinessWeek.com, 10/4/08) doesn't pay close enough attention to the lessons of Japan's massive financial crisis of the 1990s. "We are fairly upset that Paulson and [Federal Reserve chief Ben S.] Bernanke aren't considering the lessons from Japan," says Richard Koo, chief economist at Nomura Research Institute in Tokyo.
Japan watchers say letting Lehman Brothers fail was a big mistake eerily reminiscent of Sanyo Securities, a Japanese broker that collapsed in November 1997. At the time, the Japanese government, wary of being seen as wasting public money, didn't step in. But the longer-term cost was far higher as confidence in Japan's financial system collapsed. The same month, Yamaichi Securities, then Japan's fourth-biggest broker, collapsed and soon after several banks went bust or had to be nationalized.
Pushing for Capital Injection
When Lehman went under it revived painful memories in Tokyo. "It was a mistake to let Lehman go belly up,", says Yoshikiyo Shimamine, chief economist at Dai-ichi Life Research Institute. "We knew what happened here after Yamaichi and the others failed." It was more than five years later, in 2003, when the Nikkei 225 index bottomed out at 80% below its 1989 peak.
Ire at the Federal Reserve's $700 billion U.S. bailout plan is more severe. Nomura's Koo is surprised that Paulson and Fed chief Bernanke have yet to propose injecting capital directly into failing institutions—something which Britain announced as part of its bailout measures (BusinessWeek.com, 10/8/08) on Oct. 8. "In 1998 and 1999, Japan injected capital directly into the banks and the problem got solved," he says. "You would be amazed at how effective the capital injection was." On Oct. 9, White House spokeswoman Dana Perino said Paulson is "actively considering" injecting capital into troubled U.S. banks. According to reports, that could begin as early as the end of October.
JPMorgan's (JPM) chief economist in Tokyo, Maasaki Kanno, agrees that the U.S. will need to inject capital in its flailing institutions, but says political and practical challenges will make it difficult to pull off. In Japan's case, in 1998 the government changed the law so it could inject money in banks, but bank bosses were reluctant to come forward for fear of causing a run on the banks. Only after the government changed the law again to allow it to force banks to accept injections, did the medicine begin to work. "Capital injections are needed but people don't realize how difficult this is to do," he says. "If it's on a voluntary basis there may be no bank which will apply."
Banks Are Biggest Stockholders
Of course, worry in Japan goes beyond concerns for the U.S. economy and the $1.2 trillion of paper losses felt by Japan's households (many of which have invested heavily overseas since the subprime crisis took hold 15 months ago). This week's devastation also risks seriously damaging Japan's economy, which most experts had expected would endure only a brief recession.
Now, the huge stock losses are changing perceptions of whether Japan's banks, until recently relatively unaffected by the credit crunch, will begin to face similar problems as overseas rivals. "Until a week ago I thought Japan would be basically O.K., but not anymore," says Kanno. "There are now some risks that the same credit tightening we've seen in the U.S. and Europe will come to Japan." The problem, Kanno says, is that Japanese banks are still some of the biggest stockholders in Japan. With the Nikkei in freefall, Japan's banks become vulnerable.
Another problem for Japan is that with most of the problems originating overseas, it has few policy options to ease the crisis. At a meeting of the Group of Seven finance ministers and central bankers that starts Oct. 10, the government will call on the International Monetary Fund to set up a lending program that uses foreign currency reserves of Japan and other cash-rich countries to help emerging nations suffering from financial crises. However, the program, not intended to aid G7 nations, does little for Japan or the U.S. At home, new Prime Minister Taro Aso is boosting the economy with fiscal stimulus packages, but beyond that Japan Inc. has little choice but to sit out the crisis and hope that overseas bailout packages succeed sooner rather than later. "Realistically, these problems are other people's problems and Japan is just suffering the consequences of it," says Richard Jerram, senior economist at Macquarie Securities in Tokyo.
Still, even those limited measures can't come soon enough—especially after the bankruptcies at New City Residence Investment and Yamato Life, the first insurer to fail in seven years, highlighted the growing problems faced by some Japanese firms. "Yamato Life failed because of its unique earnings structure, in which it sought to cover the high operating costs of its core business by seeking high returns on securities investments," Economy Minister Kaoru Yosano told reporters. "Other insurance companies are in a different situation." That's unlikely to be a source of much relief in Tokyo.
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