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February 01, 2008

The Fed: Making like Japan

And that’s definitely not a good think, says Jim Jubak.

Why not?

He warns the recent Fed panicky rate cuts could give us a 1990s Japan-style prolonged economic slump. It’s worth an extended quote:
Ben Bernanke's Federal Reserve increasingly looks like it's headed toward a repeat of the errors that took Japan into a decade-long banking crisis and economic slump, beginning in the early 1990s.

Welcome to the United States of Japan, where growth slows to a crawl, the stock market goes nowhere and savings earn nothing. Just in time for the retirement of the baby-boom generation, too.

Japan's crisis, like the recent one in the United States, began with an extraordinary real-estate boom. In 1987, the price of land in Japan's three biggest metropolitan areas climbed 44 percent. Prices went up 12 percent more in 1988 and then 22 percent in 1989.

And like the U.S. real-estate boom, the Japanese boom was fueled by cheap money. The Bank of Japan, that country's Federal Reserve, had lowered the discount rate — the rate it charges other banks — to a post-World War II low of 2.5 percent from 5 percent in 1984-87. In those same years, the money supply grew by better than 10 percent a year.

It all sounds familiar, doesn’t it? And, that’s not all that sounds familiar:
As happened in the U.S. real-estate boom, lending standards in Japan collapsed. At the height of the boom, banks regularly made loans for more than 100 percent of property values. To keep real-estate loans off their books, banks lent through nonbank entities that made the actual loans.

Regulatory oversight took a vacation, too. Japan’s Ministry of Finance allowed companies to include the profits from real-estate speculation in reported earnings. By 1987, Japanese companies made half of their profits from speculative investments in real estate -- and the stock market.

Jubak then describes how big financial agencies, like Mitsubishi Bank, first “floated,” then bought up, insolvent creditors and junior fiscal partners.

That, too, sounds quite familiar, as in Bank of America buying Countrywide just a couple of weeks ago.

Beyond that, Jubak says here’s why Fed head Ben Bernanke isn’t handling the U.S. situation correctly:
By giving banks the hope they can dodge rather than bite the bullet, the Federal Reserve has created the possibility that what would have been a very painful but short lesson for the banks could turn into a long-term drag on the financial markets and the economy.

If banks lend less because they’re spending so much time watching their past mistakes that they shudder at the idea of adding loans to their balance sheets, if nobody trusts the prices for distressed assets, so big parts of the financial markets remain frozen in place, if consumers and corporations with decent credit can’t get new loans to fix bad ones or to expand production or consumption, then the economy will run slower than its potential. And if the Japanese experience is any indication, it will run slower for a very long time.

Shorter Jubak: By making himself too much a hostage to Wall Street, especially the short-term Street, Bernanke is probably doing more damage than good to the longer-term Street.

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