Property bubbles

Been there, done some of that

Lessons from Japan's financial crisis should worry, and embarrass, America

Sadly, he knows the end of the story

ANOTHER month, another bank in trouble, another raised estimate of bad assets in the financial system, and another move by the central bank to try and contain the problem: to observers in Japan, America's spreading credit crunch has an eerily familiar ring.

Though differences between the subprime crisis and the bursting of Japan's own property bubble after 1989 are inevitably great, the similarities are striking. As Kazuto Uchida, chief economist at Bank of Tokyo-Mitsubishi UFJ, points out, both the Japanese and American bubbles were inflated at a time of financial experimentation and easy credit. America saw a huge growth in the securitisation of mortgage assets and “structured investment vehicles” when the Federal Reserve was providing cheap money. Similarly, Japan in the mid-1980s faced pressure from the United States to liberalise its markets. That sparked a wave of “financial engineering”, and the proliferation of new products such as derivatives. The cocktail was given added fizz by American pressure to revalue the yen: in response to a rising currency, the Bank of Japan (BoJ) cut interest rates, flooding the economy with cheap cash. All of which reinforced an impression that the economy had broken free from the usual boom-and-bust cycles.

Crucially, both were property-related bubbles, commercial in Japan and residential in America. Ironically, after the BoJ raised rates and burst the bubble, American bankers and policymakers were quick to lecture the Japanese. With four-fifths of Japanese lending ultimately related to property, Americans were incredulous that banks had been foolish enough to lend against collateral for which the value could go down as up; in the United States, they said, banks lent against cash flow, the best gauge of a borrower's ability to repay a debt. Japan got into the mess by assuming land prices only rose (in cities they have since fallen by about 70%). But American financiers have made the same silly assumptions, gaily advancing money to “ninjas”: people with no income, no job and no assets. Even if some local property markets tanked, they figured, a nationwide bust was almost unthinkable. They were very wrong.

One reason the approach of both crises was widely missed was that most of the warning signs were not at parent banks but in affiliates, subsidiaries and other murky offshoots. In Japan such affiliates were often the parent bank's biggest customers. Yet these did not feel bound to make provisions against souring assets. After all, if things really came to a pass, they believed the parent would bail them out. Also, much of the big banks' lending went to smaller banks, which lent the money on—to subprime borrowers. This chain of property lending kept problems at arm's-length for too long, says Tetsuro Sugiura, chief economist at Mizuho Research Institute. “Had we had integrated balance sheets reflecting the whole picture of banks' lending, we would have been able to recognise the problems much sooner.” That might ring a bell.

The ability of financial crises to spread out from their spawning grounds is also all too familiar. Once Japan's banks were seen as tainted, they were unable to raise funds in the short-term money markets. As a consequence, they scaled back lending to corporate clients (including those overseas), which quickly felt the pain. Unable to raise money from banks or in the capital markets, Japanese companies stopped lending to each other: trade credit, which had accounted for about a third of all lending, dried up.

Meanwhile, depositors took their money out of banks and stuffed it in the post office or under their mattresses. This aggravated the crisis in the banking system. The first estimate of banks' bad loans made by the Ministry of Finance in the early 1990s put them at ¥8 trillion ($8 billion); a decade later, banking analysts reckoned the figure was closer to ¥200 trillion.

Some will argue that the speed with which American banks and their regulators have addressed the subprime crisis renders all other comparisons invalid. For Japan dithered mightily in tackling its problems. At first, it was assumed that property prices would soon resume their happy rise. Until at least 1994, regulators actively colluded with banks to hide the scale of bad loans. It was not the late 1990s that the government stepped in to bail out the banking system, and it only got serious about banks tackling their bad loans after 2002—12 years after the bubble burst.

Undoubtedly America's fast-moving crisis has bred a quicker response. Yet Japanese economists and central bankers see familiar dangers in market-propping intervention that clouds transparency and prevents asset prices from quickly reaching a new equilibrium. The administration's desire to cap some mortgage rates is one example. More worrying, they say, is its backing for the “superfund” proposed by Citigroup, Bank of America and JPMorgan Chase into which all sorts of toxic assets might be poured, out of sight and out of mind. But no Schadenfreude exists in Japan. After all, the subprime crisis also threatens the economic recovery that Japan desperately desires.