[img]507|left|||no_popup[/img]Everyone likes to throw down a wager now and again.
Most of us gamble everyday; some more than others.
Now that the results of the big bank “stress tests” are out, Treasury Secretary Tim Geithner is wagering that U.S. banks can do something their Japanese counterparts were unable to accomplish in that country’s “lost decade” of the 1990s: earn their way out of trouble.
When the real estate bubble of the 1980s burst, Japanese property values plummeted 87 percent from the peak nationwide. Counting the value of real estate and stocks Japan lost wealth equivalent to three years' worth of gross domestic product.
Although underreported in the U.S., the Japanese economic decline amounted to the largest loss of wealth since the “Great Depression.” The slump became so severe that the Japanese economy slipped into a deflationary spiral. Consumers simply stopped spending, and Japan effectively lost its clout on the world economic stage.
Based on the lessons learned in Japan, several critics of the Obama administration are highly skeptical about the use of massive infrastructure spending as a means to stem the negative economic tide. Conservative commentators like Charles Krauthammer are quick to draw the parallels with the Japanese experience and how their approach failed.
In addition to spending, the Japanese government tried to spur asset prices by lowering interest rates from 8 percent to zero. Despite this drastic action, nothing changed – there was no increase in economic activity and unemployment continued to rise.
Like the U.S., the Japanese were in a “balance sheet recession.” As asset prices collapsed, the people who bought those assets with borrowed money were left with balance sheets underwater. They were reluctant to pay down the debt on assets that no longer had their prior perceived value. Instead of an economy focused on maximizing profits, consumers concentrated on minimizing their debt.
[img]508|left|||no_popup[/img] As a result, lending in Japan came to a virtual standstill.
Similar to the United States, the Japanese attempted to jumpstart lending by infusing their banks with billions of dollars. Looking back through the prism of economic history, critics of Geithner’s approach argue that the Japanese government made the unfortunate mistake of succumbing to political pressure. From their perspective, the Japanese central government was too timid about bailing out the banks. It was not until the government effectively nationalized one major bank and forced the others to write down or sell-off their bad loans that the crisis began to resolve.
Public opposition to providing further bailout monies to U.S. banks is a key factor driving Geithner’s approach to the crisis. He is counting on the yet-to-be launched public-private partnerships to buy up the impaired assets that remain on bank balance sheets. But this program is still sketchy, and the details are little understood.
Several leading economists are concerned that Geithner’s “stress tests” were too easy on the banks. Instead of putting the bank balance sheets through their paces, they contend that the Treasury supervised examination was more of a public relations exercise. In place of rigor, they say the tests were designed to ease the uncertainty that drove bank shares and public confidence in the banks to historic lows.
So far, Geithner’s bet seems to be paying off. Bank stocks have surged and the stock indices have reclaimed the losses posted during the first quarter of the year.
If Geithner’s toxic asset disposal plan falls short or if banks fail to weather the rough seas over the next several months, then all bets could be off. If this happens, then the billions in stimulus spent by the administration may have been for naught.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
