Lessons from a “lost decade” - The Economist

Summary:
Some major differences between the US housing bubble and Japan's bubble in the early 90s are overstated. They were comparably severe, and the Japanese policymakers were not slower than American ones to cut interest rates and loosen fiscal policy after the bubble burst. In a way, the US is even more exposed than Japan was, due to a much lower savings rate among the population (more difficult to prop up consumer spending). There are a number of advantages the US today has over Japan back then. The US regulatory system, financial markets and political structure are more transparent, pressing banks into recognising losses and repairing their balance-sheets quicker. The cost of its housing bust is spread across other countries, with foreigners holding a large slice of American mortgage-backed securities and sovereign-wealth funds have provided new capital for American banks. American exports are booming, thanks in part due to a cheap dollar. (Published: 21/08/08)

Notes:

• Japan's decade of stagnation
• followed property bubble
• burst in early 1990s
• was fueled by cheap money and financial liberalisation
• people assumed property prices could not fall nationally
• when property prices fell borrowers defaulted and banks cut their lending
• result was decade with average growth of <1%

• some difference between US and Japanese situations are overstated
• no major difference in relative size of property bubbles
• America's house prices actually rose more and are likely to fall further
• Japanese home prices have since fallen by just over 40%
• American prices already down by 20%, many economist expect another 10%
• Japan's commercial property boom was smaller than America's
• Japan had stockmarket bubble bursting year earlier than in property
• hurt banks, because they counted part of their equity holdings in other firms as capital
• but its impact on households was modest, because only 30% of the population held shares, compared with over half of Americans.
• Japanese policymakers not slower than American ones to cut interest rates and loosen fiscal policy after the bubble burst
• BoJ began to lower interest rates in July 1991, soon after property prices began to decline.
• discount rate was cut from 6% to 1.75% by the end of 1993
  
• two years after American house prices started to slide, the Fed funds rate has fallen from 5.25% to 2%
  
• Japan gave its economy a big fiscal boost
• the cyclically adjusted budget deficit increased by an annual average of 1.8% of GDP in 1992 and 1993
• similar to America’s budget boost this year
• Japan’s monetary and fiscal stimulus did help to lift the economy
• after a recession in 1993-94, GDP was growing at an annual rate of around 2.5% by 1995
• but: deflation also emerged that year
• pushing up real interest rates and increasing the real burden of debt
• from here on that Japan made its biggest policy mistakes
• in 1997 the government raised its consumption tax to try to slim its budget deficit
• with interest rates close to zero, the BoJ insisted that there was nothing more it could do
• only much later did it start to print lots of money
• America’s inflation rate of above 5% is an advantage
• not only are real interest rates negative
• inflation is also helping to bring the housing market back to fair value with a smaller fall in prices than otherwise

• in a way, America is more exposed than Japan was
• when its bubble burst in 1991, Japan’s households saved 15% of their income
• by 2001 saving had fallen to 5%
• helped to prop up consumer spending
• America’s saving rate of close to zero leaves no such cushion

• monetary and fiscal relief were necessary but not sufficient to revive Japan’s economy
• missing ingredient was a clean-up of the banking system
• on which Japanese firms were more dependent than their American counterparts
• Japanese banks hid their bad loans beneath opaque corporate structures, and curtailed new lending to profitable businesses
• vicious circle developed, whereby banks’ bad loans depressed growth which then created more bad loans.

• America's regulatory system, financial markets and political structure will not let it procrastinate for so long
• has a more transparent regulatory structure which presses banks into recognising losses and repairing their balance-sheets
• even if regulators were slow to recognise that the banks were shifting risky securitised assets off their balance-sheets in the first place
• over the past year, American banks have been quicker than those in Japan in the 1990s to disclose and write off losses and raise new capital
• in Japan it took a long while before the political will was there to use taxpayers’ money to plug the banking system
• big test for America’s Treasury will be how quickly it recognises the need to nationalise Fannie Mae and Freddie Mac, the teetering mortgage giants

• Americ's advantage over Japan
• America is spreading the costs of its housing bust across other countries
• foreigners hold a large slice of American mortgage-backed securities
• sovereign-wealth funds have provided new capital for American banks
• America’s booming exports have helped to support its economy
• thanks to the cheap dollar
  
• in contrast, the yen’s sharp appreciation after Japan’s bubble burst hurt exports at the same time as domestic demand was being squeezed