Economist Draws Parallels Between U.S., Japan Banking Crises

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It could well be that much again this time.

What's the nature of nationalising a bank?

Under nationalisation, shareholders are wiped out, so it's not popular with shareholders. Northern Rock (the British bank that went bust), however, already has negative equity anyway. Then, the government takes over, and actually runs the bank. That's vital for the security of the whole financial system, because the bank has millions of arrangements with hundreds of counterparties around the world relating to its business. That's actually the most important part of nationalisation—reassuring counter parties that deals will be honoured. When Long Term Credit Bank (today's Shinsei Bank) was nationalised, the Bank of Japan sent out scores of its staff to reassure counterparties across the world that the derivatives portfolio of LTCB would be honored. That was one of the biggest worries—what might happen if a huge player in the market collapsed. In the savings and loans crisis, the Resolution Trust Corporation was not interested in saving the institutions because they were all so small. Its mission was to sell off the assets of the lenders.

Is the role of real estate in the US similar to the role of real estate in the Japanese bubble?

Yes, the Tokyo area housing bubble in the late 1980s is exactly the same magnitude as the US housing bubble today, but the commercial real estate problem in Japan was far bigger than the one facing the US today. In both countries, prices for real estate went up far too high. As a result, we are in for a pretty bad couple of years. If you look at the US housing inventory ratio, it is at an all time high. For that to return to normal will take at least two years.

Do you feel there is little point in trying to rescue the housing sector?

Yes, forget the housing market. Prices must return to sustainable levels. The priority now is to make sure GDP doesn't fall. The US government must not follow the fiscal example set by the Japanese government, which was dreadfully stop-go. As soon as the economy saw an improvement, the government would cut the fiscal stimulus. I believe the US should have at least a five-year seamless programme of fiscal stimulus. After five years, when the private sector is in better shape, the government can take its turn at fixing its balance sheet.

In retrospect, how did we get into the crisis?

It's because US companies stopped borrowing money after the IT bubble burst. What we are seeing now is the second stage of the bubble. Alan Greenspan (former chairman of the Federal Reserve) had a plan to help the economy out of the IT bubble, namely to stimulate a housing bubble through low interest rates, during which time companies would fix their balance sheet, and eventually resume borrowing, allowing rates to increase and the housing bubble to gradually shrink. But what happened in the US was that companies did NOT borrow money even after their balance sheets were repaired. Managers were too traumatised. On Wall Street, there was consternation. The cost of funding was going up, 'normal' people had bought their houses and companies were not looking for financing. So Wall Street found a new market, the subprime market, $1 trillion went into the subprime market in two years, because the borrowers were willing to pay high interest rates on their homes.

In the recession of the early 1990s, Greenspan saved the banks by giving them a "fat spread". This means keeping funding rates at rock bottom while keeping bank lending rates up. If you give 300 basis points per year to the banks, and do it for three years, you have 9% capital right there. However, that's not possible today, because there is not enough demand to play the fat spread game in the US. Companies and consumers are already too indebted to be willing to take on more debt. That is why capital injection is necessary.