the success and failure of the japanese bank bailout bailouts presentation week 8 mark bass, reid...

THE SUCCESS AND FAILURE OF THE JAPANESE BANK BAILOUT

BAILOUTS PRESENTATION WEEK 8

Mark Bass, Reid Bolton, Robert Dunn & Hadi Nilforoshan

February 26, 2009

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Agenda

The Crisis

The Government Response

Lessons Learned

The Asset Bubble

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Bailouts Seminar Week 8

JAPAN’S ECONOMY BOOMED IN THE 1980’s

HOWEVER THE UNITED STATES PRESSURED JAPAN INTO MODIFYING ITS EXCHANGE RATE

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Plaza Accord signed between US, Japan, Germany, France and UK

THE BANK OF JAPAN STARTED CUTTING INTEREST RATES IN PART TO SPUR DOMESTIC DEMAND AND IN PART TO BALANCE INTERNATIONAL EXCHANGE RATES

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“The Bank of Japan hopes that this action will contribute to achieving domestic demand growth promoted by lower interest rates, and help correct Japan’s external imbalance. The Bank will continue to carefully watch the development of foreign exchange markets in future monetary policy management.”

BOJ Official Statement 1986

JAPAN’S MONEY SUPPLY MORE THAN DOUBLED FROM 1980 TO 1990.

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BANKS SEEKING HIGHER RETURNS BEGAN LENDING MORE MONEY FOR REAL ESTATE PURCHASES AND IMPROVEMENTS

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Increases in real estate loans also mirrored the increasing desperation of banks close to insolvency

REAL ESTATE BUBBLE GROWS SLOWLY FROM 1980 TO 1986 AND THEN EXPLODES BETWEEN 1987 AND 1990

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Land Prices in Japan (1974-2007)Percent (Indexed to 1974)

THE LOOSE MONETARY POLICY AND BOOMING REAL ESTATE VALUES FUELED A MASSIVE INCREASE IN JAPANESE EQUITIES.

NIKKEI 225 1970-2009

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Peak in 1989: Land constituted 50% of corporate tangible assets

GOVERNMENT POLICIES AND AGGRESSIVE BANK BEHAVIOR COMBINED TO PRODUCE THE ASSET BUBBLE


Tax Policies Suppressed the Supply of Land and thus Drove up Prices.

Tax rates were low for those holding land, but relatively high for land transactions. When land prices are expected to rise, those holding land tend to take advantage of the low tax rates and hold onto land. The high tax rate on sales further squeezed the supply by incentivizing land holders to delay their sales. These two factors combined to keep supply low and thus boosted prices higher.

BOJ pursued loose monetary policy for too long and fueled the asset bubble

Loose monetary policy made funding for speculative real estate projects more available. Even as late as 1987, when the asset bubble was starting to emerge, the Bank of Japan lowered interest rates to 2.5 percent. The BOJ was using monetary policy to try and reduce the current account surplus, spur domestic demand, and stabilize the foreign exchange rate. By pursuing so many goals, the BOJ failed to act decisively to the real estate and equity bubble at home.

Deregulation led banks to pursue riskier strategies.

The government deregulated interest on deposits, decreasing bank revenues. Banks began making riskier loans to small companies backed by property, as well as other speculative real-estate based loans. Also, as the government allowed companies greater access to securities markets, banks sought to compete by making risky real estate loans.

THE EFFECTIVE MARGINAL TAX RATE ON CORPORATE LAND FURTHER ENCOURAGED INVESTMENTS IN REAL ESTATE.

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Effective Marginal Tax Rate on Land Holdings

THE GREATEST ASSET BUBBLE IN THE HISTORY OF THE PLANET. . .

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Value of prime property in Tokyo’s Ginza district in 1989 reached $139,000 per sq foot.

A commonly quoted claim in 1989 was that the land under the Imperial Palace in Tokyo was worth more than all of California.

Land Value as Proportion of GDP at Height of Asset Bubble

~1990

~1999

. . . CREATED BULLISH EXPECTATIONS AND SOME HUBRIS

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Everyone Else

Japan

Rockefeller Plaza—$1.9 Billion, Abandoned in 1995

Pebble Beach—Purchased for $841 Million, Sold for $820 Million in 1999

. . . AND THE SPECTRE OF JAPANESE ECONOMIC HEGEMONY!

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On the forty-fifth floor of the Nakamoto Tower in downtown L.A.—the new American headquarters of the immense Japanese conglomerate—a grand opening celebration is in full swing

On the forty-sixth floor, in an empty conference room, the dead body of a beautiful woman is discovered.

The investigation begins…and immediately becomes a headlong chase through a twisting maze of industrial intrigue…a no holds barred conflict in which control of a vital American technology is the fiercely coveted prize—and the Japanese saying “business is war” takes on a terrifying reality

Rising Sun was written in 1992, at the very end of the Japanese boom

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Agenda

The Asset Bubble


Lessons Learned

The Crisis

JAPAN’S CENTRAL BANK MIGHT HAVE TRIGGERED THE CRISIS

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“Popping” of Asset Bubble”

Six years of slow descent instead of

rapid easing

Bank of Japan Overnight Call Rate

JAPAN’S ASSET BUBBLE BURSTS

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Asset Price Deflation 1989-2000Percent

THE CRASH WAS QUICK YET LONG LASTING

CHART OF NIKKEI (JAPANESE STOCK MARKET) 1989- 2001

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80% Drop in Nikkei over ten years

1989 1990 1992 1994 1996 1998 2000

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GDP per capita annual growth ratePercent

AND LED TO A DECADE OF LOWERED GDP GROWTH

NUMEROUS ECONOMIC INDICATORS SIGNALLED A DECLINE IN THE JAPANESE ECONOMY . . .

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Growth in Residential Land Prices

Six Years of deflation in Japan’s real estate

Percent

. . . BUT THE BANKS WERE THE HARDEST HIT

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Poor Oversight by Regulators and Internal Auditors Also Made Japanese Banks Particularly Vulnerable to Downturn

. . . BUT THE BANKS WERE THE HARDEST HIT

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Unique Keiretsu System Decreased Bank Willingness to Foreclose on Loans

• System of “Lead Banks” and cross-shareholding between companies and banks made foreclosure on any loan catastrophic to both the bank and multiple companies connected to the bank

• Foreclosure also signaled that the bank had failed its responsibility of effective oversight which could potentially lead to a run by bank investors

• Therefore banks were willing to “roll-over” the loans continually and unlikely to cut off the companies from credit.

Drop in Real Estate Values Hammered Bank Balance Sheets

Japanese Banks had large proportion of their portfolio of loans in real estateReal estate asset values declined significantly which led to a drastic decline in bank asset values and the downgrading of banks by international credit rating agencies. Banks had large number of Non-Performing Loans (NPLs) within their portfolios

• Lax accounting rules led to under-reporting of NPLs by banks• Approximately 40% of bad loans were made to mafia due to infiltration by mafia in MoF and

bank officials • Foreign banks were not hurt by downturn nearly as much as Japanese banks

THE RISE OF THE “ZOMBIES”

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Banks

Firms

Regulators

• Regulators explicitly and implicitly pressured banks to extend loans to avoid bankruptcy

• Want to avoid job losses and decreases in loans to businesses

• Banks continue to extend credit to

insolvent debtors despite low probability of being repaid

• “with a few exceptions, most Japanese banks still continue to extend new loans to debt-burdened companies, often in exchange for only modest restructuring plans.”

• Firms with negative profitability continue to operate as “zombie firms”

• Promote deflation and hurt innovation across economy

COMMENTATORS RECOGNIZED THE NEED FOR A BANK BAILOUT IMMEDIATELY

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Although the Electorate was More Concerned About Budgetary Discipline

Japanese voters punished politicians at the polls who supported bailouts, particularly when the early bailouts didn’t stop the bleeding.

Japan was slow to move on bank bailouts because of public outrage over the bailouts.

It is critical to promptly restore orderly functioning of the financial system as the lifeblood of the economy.

Finance Minister Hikaru Matsunaga

A consensus developed for saving the banks

Exposing the bad loans and nationalizing some banks “was a turning point in the crisis. After that, markets finally trusted banks again. Mr. Gomi (Japanese Financial Services Agency)

Quick and decisive actions are needed to restore confidence.- Treasury Secretary Rubin

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Agenda

The Asset Bubble

The Crisis

Lessons Learned


GOVERNMENT RESPONSE CAN BE GROUPED INTO THREE PHASES

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Phase 1: Stabilizing the Economy1989-1993

Phase 2: Attempts at Recovery1993-1999• Large Public Works Campaign• Focus on Increase in Consumption• $514 Billion Bailout for Banks• Lack of Fundamental Change Led to the

“Lost Decade”

Phase 3: Jumpstarting the economy2000 and onwards

• Massive bailout of banks• New disclosure requirements for banks• “No bank too big to fail”

• Dramatic Easing of Monetary Policy• Recognition of Problem without Taking

Significant Actions

MAJOR STEPS IN NATIONAL RECOVERY PLANBailouts Seminar Week

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Major Steps

• BOJ decreased discount rates

Resulting Health of Economy

1990-1992

1993

1994

1995

1996

• Nikkei continues to fall-- loses 60% of its value, house prices fall 50%. 14,569 firms with debt equal to +10 Million Yen go bankrupt.

• Discount Rate is kept low,• Banks write off 4.3 Trillion Yen in nonperforming

assets. Government doesn’t take much action.

• Economy continues to struggle, as GDP growth rate is nears zero. Reserves for loan losses of commercial banks grew by 35%.

• Bank of Japan creates a bridge bank with government support which supervises the takeover of two failing credit cooperatives.

• Income Tax Cut

• Tokyo Kyowa and Anzen Credit Cooperative fail, and must be bailed out to prevent runs on other Japanese Depository Institutions

• BOJ provides liquidity and loans to several failing banks through Hougachou system, whereby private institutions support banks.

• A series of bank failures sweep the country, as private institutions start second guess participation in funding pricey bank bailouts.

• Deposit Insurance Law amended to remove the payoff cost limit, which capped amount gov’t could use to support failing banks.

• Gov’t bailouts unable to stop additional bank failures, as appreciating Yen further hurts economy.

MAJOR STEPS IN NATIONAL RECOVERY PLAN

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Major Steps Resulting Health of Economy

1997

1998

1999-2000

2001+

• BOJ props up NCB and other banks but does not bailout Securities Houses. BOJ later forced provide liquidity for interbank market, replacing SH’s

• Consumption tax raised to 5%

• Collapse of Securities Houses furthers crisis. Security house collapse dry up interbank liquidity, as that was the function of SH’s.

• Legislation introduces $30 Trillion Yen in public funds to fix crisis. 13 Tril. for capital injections and 17 Tril. to cover losses of financial institutions

• 40 Trillion Yen Fiscal Stimulus Package passed

• Markets initially stabilize from cap. injection, but drop again as amount is too small. LTCB, Japan’s largest bank fails, and is nationalized

• New legislation (FFESL and FRL) greatly increases government ability to supervise struggling financial institutions, and allows nationalization of banks.

• Capital injection funding doubled, signaling government commitment to resolving crisis.

• 29 Trillion Fiscal Stimulus Package

• Increase in funding for capital injections, and much broader supervisory role slowly helped soothe economy. Nationalization of struggling banks removes need for private support, and allowed gov’t to restructure failing banks and transfer their bad loans.

• Safety net of full-scale protection of depositors and creditors altered.

• Alteration are a system risk exception, • Decrease in the BOJ’s role• Takenaka Plan Adopted

• Nikkei slowly rebounds from 2003 onwards. Japanese banks stabalize.

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DBI-SDA006-20070110- Third EC council

PHASE 1: THE GOVERNMENT TOOK ONLY A FEW IMMEDIATE ACTIONS THAT DID NOT APPEAR TO IMPROVE THE SITUATION

• Increase in Discount Rate

• Reduction in Credit Available for Property Purchases

What they did The Impact

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• Economic Boom Turn into Bust

• Nikkei Begins its Descent

• Housing Prices Fairly Steady

• Inability to Stop Future Economic Troubles

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Automobile Purchases1980-2000

DROP IN INTEREST RATE DID NOT SPUR CONSUMPTION

`

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PHASE 2: THE GOVERNMENT’S LACK OF AMBITIOUS REFORM LED TO A “LOST DECADE” FOR THE JAPANESE ECONOMY

• 100 trillion Yen in Fiscal Stimulus Programso Public Workso Direct Checks

• $514 Billion Bailout Fund Created for Banks

• Interest Rates Lowered to Zero

• Direct Government Lending through FILP Program

• Purchasing Commercial Paper

• 20 Trillion Yen Credit Guarantee for Businesses

What They Did The Impact

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• Early On: Drop in Interest Rate Doesn’t Change Consumption

• Interest Rate + Devaluing Yen Can’t Reverse Damage

• FILP and Credit to Businesses Somewhat Effectiveo Debt = 200% of GDPo Banks Able to Lendo Pork barrel Politics

• “Zombie Banks” Cannot Undo Damageo Stemming the Tide

o Tax cuts helped but then reversed

PHASE 3: TAKENAKA CRACKS SOME SKULLS

"Big banks have their merits…They enjoy economies of scale. . . . But we do not hold the idea that they are too big to fail.

October 8, 2002

Heizo TakenakaMinister of Finance2001-2005

The maximum benefits of recapitalization can only be achieved under strict asset valuation standards. It is necessary to ensure that banks thoroughly and properly disclose their NPLs under the stringent supervision of the relevant regulatory authorities

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PHASE 3: THE LONGER TERM CHANGES APPEAR TO HAVE HAD SOME POSITIVE IMPROVEMENTS

What they Did The Impact

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• Basic Measures of Early 1990’s + New Step of Post 1999 Take Effect

• Better Operation of Banks

• Capital Injections in 15 Bankso Profitability Planso Intervention Option

• Altering the Safety Neto P&A Methodo Systemic Risk

Exceptiono Decreasing BOJ’s

Involvement• Stricter Disclosure

Requirements for Bankso New Accounting

Mechanisms

Takenaka Plan

Implemented

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Agenda

The Asset Bubble

The Crisis

Lessons LearnedLessons Learned


THERE ARE LESSONS THAT WE CAN LEARN FROM THE JAPANESE BAILOUT

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• Concerns about deficits and coming retirement of baby boomers led to diminished fiscal expansion

• Government ended tax cuts after only a year of mild growth, sending GDP back to zero

• Tax cuts are necessary to incent growth but only in the right places

Description

• Discount Rate was close to zero throughout the 1990s and 2000’s• Focus on “hard” infrastructure led to wasteful spending• Many projects built according to political needs, not where most useful

1A. Fiscal and Monetary Stimulus In Isolation Will Not Help

1B. Confront the Banking Problem Quickly

2. Ignore Deficits in the Short/Medium Term

• Half-measures and frequent changes diminish confidence in the restructuring

• Japan’s Finance Ministry did not force banks to write down their debts for several years even after realizing many banks were insolvent

• Government needs “bad cops” to discipline the banking system

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LESSON #1A: FISCAL AND MONETARY STIMULUS WILL NOT FIX THE PROBLEM

Discount Rate

GDP Growth %

GDP Growth vs. Stimulus Measures

10

5

0

Discount Rate

Negative Growth Despite Zero Discount Rate

Massive Stimulus Bills Passed by Congress only had temporary Effect

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LESSON #1A: FISCAL AND MONETARY STIMULUS WILL NOT FIX THE PROBLEM

Vast Majority of Japanese Public Works Spending was on Infrastructure

Marine Bridge, Hamada Japan

Built using stimulus money, it became known as the “bridge to nowhere”

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LESSON #1B: CONFRONT THE BANKING PROBLEM QUICKLY

Japanese Bank Officials Ignored Banking Troubles For Seven Years

Money Supply vs Bank Credit 1994-1997Indexed to 1994 dollars

1994 1995 1996 19979095

100105110115120125130

Monetary baseM2Bank Credit

1990 1992 1994-1995 1997 2000 2001

Asset Bubble Pops

Public recognition of problems in Jusen (S+L) corporations

Credit Cooperatives Shut Down

Several major bank closures

1998

First round of gov’t capital injections

Second round of gov’t capital injections(4x larger)

1999

FSA created to help offload toxic loans

Takenaka becomes FSA head and institutes new accounting rules

2003+

Bank failures and nationalizations begin to improve industry health

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LESSON #1B: CONFRONT THE BANKING PROBLEM QUICKLY (cont.)

Bank Credit Ratings 1980-1999(Top 7 Banks)

A

A/B

B

B/C

C

C/D

D

Government Delayed Major Actions While Watching Major Banks Deteriorate

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Lesson #1B: CONFRONT THE BANKING PROBLEM QUICKLY

We question whether the authorities in the U.S. and Europe have sufficiently examined the management and financial health of recipient banks in deciding how to allocate the public funds

Shimizutani SatoshiFaculty FellowResearch Institute, Economy

Shimbun Newspaper11/28/2008

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Lesson #2: IGNORE DEFICITS IN THE SHORT TERM

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Lesson #2: IGNORE DEFICITS IN THE SHORT TERM

Initial Tax Cuts

Taxes Increased

Percent

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ITS BAAAACK (REDUX?)

THE LIQUIDITY TRAP-that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant

The problem is one of credibility.

The Bank of Japan must create a credible belief that inflation will be 4% over 15 years

• During the 1990s, many economists stated that the Central Bank could fix the situation by creating high inflationary expectations.

• However, Japanese officials did not follow through

• Should the United States attempt these same solutions?

ARE WE GOING DOWN THE SAME PATH?

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Phase 1: Stabilizing the Economy1989-1993

Phase 2: Attempts at Recovery1993-1999• Large Public Works Campaign• Focus on Increase in Consumption• $514 Billion Bailout for Banks• Lack of Fundamental Change Led to the

“Lost Decade”

Phase 3: Jumpstarting the economy2000 and onwards

• Massive bailout of banks• New disclosure requirements for banks• “No bank too big to fail”

• Dramatic Easing of Monetary Policy• Recognition of Problem without Taking

Significant Actions

2007-2008 United States

Policy?

Current US Policy?

US Policy 2010?

CONCLUSION: ARE WE MAKING THE SAME MISTAKES? FOR DISCUSSION

Mistakes

Early Stimulus Package

Disregarding Deficits in the Short Term

Exhausting Monetary Policy Options Early in Crisis

Good Choices

• We have made some of the same mistakes

• And tried some of the same solutions

• Are we acting quickly enough?

• Are we acting decisively enough?

• Are there characteristics of US that make comparisons inappropriate?

??

Wait and See?

?? Public Works Projects Targeted at High Multiplier Spending?

Incremental Injections of Capital Into Banking System instead of “Shock and Awe”

Not Requiring Banks to Disclose their NPLs (yet)

Treasury Secretary Willing to Get Tough with Banks and Force Disclosure?

Federal Reserve Acting as Lender of Last Resort

the success and failure of the japanese bank bailout bailouts presentation week 8 mark bass, reid...

Documents

real estate bubble

asset bubble slide

bank of japan

supply of land

land prices

real estate loans

speculative real estate

insolvency slide