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September 14, 1995

[SSJ: 284] US S&L Crisis and Japan

From: Michael J Smitka
Posted Date: 1995/09/14

>the 20 non-banks related to Hyogo Bank, to be about 1.8 trillion Yen. "Bad
loans" (that won't be repaid) are difficult to estimate. Officially, there are
some 40 trillion of them. In reality, it is probably closer to 100 trillion Yen.
>In March 1995, only five (!) out of 11 city banks had more assets than bad
loans. Forget the trust banks; according to this ratio, by and large they are
history. The only question is: who will pay for this? The answer is, of course:
the taxpayer.

Let me give an American perspective. The U.S. Savings & Loan crisis in the end
involved something on the order of $250 billion to $300 billion in bad loans,
spread across a large number of generally small institutions throughout the
nation. (My uncertainty as to the total is because the Resolution Trust
Corporation proved better at collecting on bad debts than was at first
considered likely, because several regional real estate markets improved faster
than anticipated. The official cost estimate was $500 billion spread over 40
years, hence much less in present value terms.)
Y40 trillion is, in comparison, roughly $400 billion in an economy half the size
of that of the U.S. So even the optimistic scenario is for losses that far
exceed those experienced here. If in fact the total hits $1,000 billion, the
total loss would be 4 times that in the S&L crises, or 8 times as large in
relative terms.

In addition, the losses in the US were concentrated among specialized financial
institutions that focused on real estate, particularly residential real estate.
It did not affect regular banks nearly as much, but there were significant
failures in Texas and New England. Furthermore the growth of secondary markets
in mortgages let regular banks step in and pick up the pieces. (Again, that was
less true in Texas and New England, where growth lagged that in the economy as a
whole.)

How did it affect the economy? The US government had to borrow more, with a
consequent modest impact on interest rates and drain on the budget. But in
general the side effects were small -- with the possible exception in the two
regions noted above. In Japan, however, the institutions in trouble are not on
the periphery of the financial system. Some, indeed, are specialized (the long
term credit banks, for example). Unlike the US, however, bond markets are still
underdeveloped, so there are fewer alternatives for those who desire to borrow
long term funds should those institutions collapse. So the side effects are
likely to be greater. In the current depressed economy the government might be
able to float Y40 trillion of bonds without sinking the market, though since
total government bond issues in 1993 were Y53 trillion (corporate another Y6
trillion) it would have to be spread over several years. But Y100 trillion is a
lot by any standard, about equal to the total size of short-term bond markets in
Japan in 1993, and about 50% of the Y200 trillion total outstanding combined
balance of central and local government bonds in 1994.

Finally, the health of the financial system is built upon trust. Money after all
isn't very tangible -- most of the money in the Japanese economy consists of
deposits, that is, 0s and 1s on a computer hard drive. As long as consumers
maintain their faith that these deposits will keep their value, well and good.
But if that faith erodes, then the financial system can collapse literally
overnight. (We saw that in the US with the overnight collapse of Drexel Lambert,
and in Singapore with Barings, shows how quickly things can unwind. Once
confidence is gone, the end is at most hours away.) And the Japanese government
doesn't have enough yen notes to make more than a minor dent in any overall
panic. Banknotes are only 7% of the money supply, and very little of it rests in
bank or government vaults. (The BOJ only has Y557 billion in currency. In this
Japan is similar to the US. Here at most 10% of cash sits in a vault, roughly 1%
of overall money.) So even a very partial attempt to convert deposits into cash
would totally overwhelm the system.

Such a general panic doesn't strike me as likely, but with the insurance system
broke (in the S&L crisis, the US Congress stepped in long before the FSLIC was
depleted), and with Tokyo and other regional governments slow to bail out
institutions under their purview, it is not totally inconceivable. (Only a
couple of small US institutions, in Ohio and Maryland, were outside the Federal
insurance system.) But the size of the problem in Japan is far larger than in
the US, and it is harder to isolate from the overall system. As one person
pointed out, some banks got their problems under control at an early stage. (I'm
told the same is true of Bank of Tokyo, partly because it was hurting from loans
to LDCs and so wasn't able to lend aggressively during the bubble.) But a note
of caution even there: the press accounts make me suspect that the loans to the
various institutions that just failed would have been classed as "good" loans.

Anyway, this "crisis" shouldn't sink the economy, but it will certainly slow
future growth. But by how much is hard to say, since that will depend on who is
ultimately made to pay the price and in what manner, and of course whether the
loss is close to the current official estimate or much larger. (It's
intrinsically hard to quantify -- I asked around, and even in the US there are
no real estimates of how much the S&L plus bank crisis hurt New England and
Texas/Louisiana, though the concensus is that it did.) If it's the taxpayer
underwriting interest on long-term bonds, so that the cost is spread across the
entire populace and spread across many years, then the impact should be modest.
If it's banks left unable to lend, then the Japanese economy will remain
stagnant the rest of this century.

Mike Smitka
W&L Lexington VA 24450
MSmitka[atx]wlu.edu
Fax (540)463-8639 / Tel -8625 (Home -3702)

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