Transcript PowerPoint - Washington and Lee University

Japan’s Bubble
Economics 102
Winter 2008
Michael Smitka
Professor of Economics
Washington and Lee University
© 2008 Michael Smitka
1
Two Three key causes
• Management geared for high growth
Interacting with
• Macroeconomic policy mistakes
– Including failure to improve regulation in the face of innovation in
the financial sector
• Savings imbalance generated large shifts in flow-of-funds,
swamping capability of financial system
© 2008 Michael Smitka
2
As a result...
• Management had no need for financial controls
– project selection was easy
– failure was hard / recessions were few & far between
• Real interest rates were 0% (or less!)
– Financial innovation allowed firms to borrow cheap!
• Firms overborrowed
• Projects that earned a mere 0% passed muster
• Mindset still seemed to reflect growth expectations
• Banks overlent
• Collateral or track records were enough 1965-1985
• Asset prices proved unrealistic
• Projects didn’t earn 0% ex post
• Banks couldn’t collect on their loans
© 2008 Michael Smitka
3
Confounding factor
• Pricing long-lived assets is hard
– Real estate grew faster than economy 1974-1991
– Stock prices grew faster than economy 1965-1989
– Growth industries grew very fast indeed!!
• Real growth averaged 9.3% during 1956-1973
• Unrealistic price expectations dominated
– Prices on real estate were distorted
• No relation to rents, only expected price appreciation
– Prices on stocks were distorted
• Little relation to dividend levels, rather assets and past growth
© 2008 Michael Smitka
4
Why the “bubble”?
- the lending side • Change undermines rules of thumb for banks
– Change in types of industry / borrowers
– Change in strategic environment / flow of funds
– Change in regulatory environment
• Mistakes are made …
– … and a shock produces crisis
© 2008 Michael Smitka
5
Primary shock
slower growth after 1971
• Industry no longer needs funds
• 1970s: 10% of GDP drop in corporate funding needs!!
• But households keep saving
• Past savings were when incomes were low
• So accumulated wealth was modest
• So people needed to keep saving to fund old age
• Who then will borrow this funds?
• Paradox of Thrift!!
– No discipline by banks…
© 2008 Michael Smitka
6
Japanese GDP Growth
Real Seasonally Adjusted Year-on-Year, SNA68 thru 1995, SNA93 thereafter, 2000 chained from 1995
15.0%
14.0%
13.0%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-3.0%
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-2.0%
© 2008 Michael Smitka
7
Japanese GDP Growth
Real Seasonally Adjusted Year-on-Year, SNA68 thru 1995, SNA93 thereafter, 2000 chained from 1995
15.0%
14.0%
13.0%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-3.0%
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-2.0%
© 2008 Michael Smitka
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© 2008 Michael Smitka
9
Shifts in Japanese Savings
Flows
I (business)
1961-65
17.0
1966-70
16.7
1970
19.6
S (business)
S-I
5.2
-11.7
8.7
-8.0
10.7
-8.9
I (household)
S (household)
S-I
2.8
12.1
9.2
4.3
12.0
7.7
S - I Private
-2.5
I
(Center
S
& Local)
T-G
T - G+S-I
1971-75
15.2
8.8
1976-80
8.3
2.7
1981-85
8.5
1986-92
11.1
2.3
-8.8
-11.2
0.8
-8
-5.7
2.9
-5.5
4.5
12.8
8.3
4.0
16.4
12.4
7
19.9
12.9
6.1
17.1
11.0
2.8
13.6
10.8
1.3
11.6
10.3
-0.3
-0.6
1.2
4.9
5.3
5.3
1.5
5.5
6.9
1.4
5.7
6.6
0.9
5.7
7.6
1.9
6.9
6.7
-0.2
6.5
2.3
-4.2
7.5
2.4
-5.1
6.8
3.6
-3.2
6.4
8.3
1.9
-1.1
0.6
1.3
1.0
0.7
0.3
2.0
3.4
© 2008 Michael Smitka
4.0
1976
10
Reactions to slowdown
• High “S” so “C” did not rise to offset “I”
– “paradox of thrift”
• Reactions:
– In the 1970s, fiscal stimulus
• From 1976-80 helped by trade
– From 1980 monetary policy kicked in
• Trade dominated as fiscal stimulus ended
• Especially during 1980-1987
– From 1987-1991 the “bubble” took over
• I rose, S fell (C rose) … but the bubble popped
– Thereafter massive fiscal stimulus
© 2008 Michael Smitka
11
Interregnum
• Japanese fiscal deficits
• created a new borrower for banks
• MOF policy stopped that by 1982
• Reaganomics: US consumption boom
• Export-led growth in Japan from 1982
• ¥ rise (Plaza Accord) ended that from 1986
• So how adapt?
• Easy money!!!
• But in the interim financial markets evolved…
© 2008 Michael Smitka
12
Secondary Shock
• Bad monetary policy
– with hindsight
– Easy money from 1986, following Plaza Accord
• Kept low after Oct 19, 1987 US stock market crash
– Only hiked interest rates from May 1989
• Low rates for 3-1/2 years
– Then overdid it: repeated boosts thru Aug 1990
• Didn’t cut until July 1991, with both stock and real estate
markets plummeting
© 2008 Michael Smitka
13
Financial evolution & deregulation
• Starting point
• regulated deposit rates
• segmented markets (cf. Glass-Steagal)
• Deficits led to bond markets
• Deposit rates gradually liberalized
– Other rules as well (international flows)
• Large firms became multinational
– Could borrow directly in London
• Disintermediation resulted
– dikes broke
– Banks had to scramble
© 2008 Michael Smitka
14
Contemporary Financing Sources
(% of total assets, large manufacturing firms)
45
40
Bank loans
35
30
25
Retained earnings
20
15
10
Paid-in capital
Bonds
5
0
1960
1965
1970
1975
1980
1985
© 2008Source:
Michael
Smitka
MOF,
Financial Statements Statistics of Corporations
1990
1995
2000
2005
15
Bank Lending: Total & Ratio to GDP
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
© 2008 Michael Smitka
16
Bubble psychology
• “Japan as Number One” psychology
• Growth and profits will remain high
• But slow growth meant historic debt levels suicidal!
• Just as banks sought new borrowers
• Real estate … and more real estate!
– Small business
– Also international loans
• Sectors where banks had little or no experience…
• Collateral & reputation as basis for loans
– cash flow-based credit analysis not done (or done poorly).
© 2008 Michael Smitka
17
Impact
• “Bubble” economy
– Stock prices doubled
– Urban real estate prices rose even more
• Example: Onoue
– Only $2 billion in a $5 trillion economy
• But repeated many, many times over
– pencil buildings, golf, stocks
• Fiscal policy mistakes accentuated
• On-again, off-again policy built up debt
• Created fear of using fiscal policy aggressively
• Regulatory policy errors accentuated
• Banks allowed to make more bad loans
© 2008 Michael Smitka
18
Lending and Asset Prices
1980=100
600
550
Share prices
(Nikkei)
Propertybased loans
500
Index, 1980=100
450
400
350
300
250
200
GDP
150
Land prices
100
1980
1983
© 2008 Michael Smitka
1986
1989
1992
1995
1998
2001
2004
2007
19
In the end…
• Lots of poor-quality investments got funded
• Projects didn’t even earn 0% ex post
• Lots of poor-quality borrowers got money
• Banks’ inexperience led to disastrous lending
• Asset prices proved unrealistic
• Collateral proved inadequate or even worthless
• Banks’ equity (including unrealized capital gains on
investments in companies) shrank rapidly
• Major recession
• 2nd bout of negative growth since 1955
© 2008 Michael Smitka
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Fiscal policy
• Can fiscal policy overcome the bubble???
– But spend on what?
• constituents want politicians to bring home bacon, and they obliged
• But low multiplier
– Done poorly, lost credibility
• 11+ timid packages full of “smoke & mirrors”
• Saved not spent as most explicitly one-time
– Even if in reality “pork” projects took years to complete
• Net effect is a “bond bubble”
– Debt 180+% of GDP
• Current interest rate under 1.5% pa
– Interest due ≈2% of GDP
• But what happens if interest rates “normalize” to (say) 3%?
– Interest eventually ≈5.5% of GDP [current bonds long average maturity]
– Meanwhile, bond holders [banks!] face capital losses if they need to sell
© 2008 Michael Smitka
21
deficits
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
© 2008 Michael Smitka
22
Monetary Policy
if FP didn’t work, how about MP?
• Banks had lots of “zombie” borrowers
• But little capital as value of stock holdings collapsed
– So reluctant to push dud firms into bankruptcy
• Plus few lawyers or workout specialists
• How pump up capital ratio?
– Stop making new loans!
• Shrinks denominator, as long as don’t have to write down
for bad loans
• “Credit crunch”
• Visible in many sectors in 1998-99
© 2008 Michael Smitka
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Bank panic
• Gradual write-downs by large banks
– US$300 billion between 1992 & 1998
– Japan’s GDP is about $5 trillion
– Several failures of specialized banks in 1995
– Mishandled, made regulators slow to support large banks
– Series of dramatic bank failures in 1997
– 4 major banks
– 1 major life insurer
– #2 stock broker
– ¥6 trillion capital injection by govt in March 1999
– Helped offset continued writedown of bad loans
– Mergers from 2000 left 3 large nationwide banking groups
© 2008 Michael Smitka
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Nonperforming Loans
End of Period
March 1999
September 1999
March 2000
September 2000
March 2001
September 2001
March 2002
September 2002
March 2003
September 2003
March 2004
September 2004
March 2005
September 2005
March 2006
September 2006
March 2007
© 2008 Michael Smitka
Large
Regional
Banks
Banks
(% of all loans) (% of all loans)
6.1
5.7
5.4
5.1
5.3
6.2
8.4
8.1
7.2
6.5
5.2
4.7
2.9
2.4
1.8
1.5
1.5
6.2
6.2
6.2
7.1
7.3
7.7
8.0
8.3
7.8
7.5
6.9
6.3
5.5
5.2
4.5
4.4
4.0
Total Value
(trillion ¥)
33.9
31.3
31.8
32.9
33.6
36.8
43.2
40.1
35.3
31.6
26.6
23.8
17.9
15.9
13.4
12.3
12.0
25
Impotent monetary policy
• “credit crunch”
• Particularly small firms?
• Hard to distinguish from reluctance to borrow
• Average real estate prices continued to fall until 2006
– At local level still falling in many places
• Growth slow
– Good firms don’t need loans
– Indeed, overall firms actually repaying debt!!
• So aggressive “ZIRP” (zero interest rate policy)
• Deflation continued so real rates remained high
• Who wants to borrow with falling real estate prices?
© 2008 Michael Smitka
26
BOJ Dis cou nt Rate
Targ et Cal l Rate
6.0 %
Aug 30, 199 0
5.0 %
Ju l 1, 199 1
interest rate s
ke pt h igh for 1 8
mon ths foll owing
the "bub ble's" p eak
4.0 %
3.0 %
Christmas 1989
rate hike
– "b ubbl e" pe aks –
Nov 1, 1986
fol lowing
"Plaza Accord"
2.0 %
Sept 8, 1995
0.5 %
dis cou nt ra te!!
Feb 12, 199 9
"Zero Interest
Rate Policy"
co mmen ces
May 31, 198 9
firs t an ti-"Bub ble"
rate hike
1.0 %
Feb 23, 198 7
200 0/10 /22
200 0/4/22
199 9/10 /22
199 9/4/22
199 8/10 /22
199 8/4/22
199 7/10 /22
199 7/4/22
199 6/10 /22
199 6/4/22
199 5/10 /22
199 5/4/22
199 4/10 /22
199 4/4/22
199 3/10 /22
199 3/4/22
199 2/10 /22
199 2/4/22
199 1/10 /22
199 1/4/22
199 0/10 /22
199 0/4/22
198 9/10 /22
198 9/4/22
198 8/10 /22
198 8/4/22
198 7/10 /22
198 7/4/22
198 6/10 /22
198 6/4/22
198 5/10 /22
198 5/4/22
198 4/10 /22
198 4/4/22
198 3/10 /22
0.0 %
© 2008 Michael Smitka
2008.01
2007.01
2006.01
2005.01
2004.01
2003.01
2002.01
2001.01
2000.01
1999.01
1998.01
Call Rate
1997.01
1996.01
1995.01
1994.01
1993.01
1992.01
1991.01
1990.01
1989.01
1988.01
1987.01
1986.01
1985.01
1984.01
1983.01
Call Rate & Discount
Rate
Discount Rate
8
8.00%
7
7.00%
6
6.00%
5
5.00%
4
4.00%
3
3.00%
2
2.00%
1
1.00%
0
0.00%
28
-2.0%
1982 Jan
1982 Jul
1983 Jan
1983 Jul
1984 Jan
1984 Jul
1985 Jan
1985 Jul
1986 Jan
1986 Jul
1987 Jan
1987 Jul
1988 Jan
1988 Jul
1989 Jan
1989 Jul
1990 Jan
1990 Jul
1991 Jan
1991 Jul
1992 Jan
1992 Jul
1993 Jan
1993 Jul
1994 Jan
1994 Jul
1995 Jan
1995 Jul
1996 Jan
1996 Jul
1997 Jan
1997 Jul
1998 Jan
1998 Jul
1999 Jan
1999 Jul
2000 Jan
2000 Jul
2001 Jan
2001 Jul
2002 Jan
2002 Jul
2003 Jan
2003 Jul
2004 Jan
2004 Jul
2005 Jan
2005 Jul
2006 Jan
2006 Jul
2007 Jan
2007 Jul
2008 Jan
CPI Inflation in Japan
national avg excluding imputed rent
5.0%
4.5%
Bubble peak
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
© 2008 Michael Smitka
29
Today’s Dilemmas
• Monetary policy doesn’t work
• Interest rates can’t be pushed below 0%
• But prices are falling ==> real rates are positive
• Banks (rightly) fear bad assets
• Outstanding loans are shrinking!
• Money growth is of cash…
• “Liquidity Trap”
• If monetary policy doesn’t work, how about fiscal??
• Labor markets still have slack
• “Lost Generation”? - participation rates drop…
© 2008 Michael Smitka
30
© 2008 Michael Smitka
31
© 2008 Michael Smitka
32
Future of the Economy
• Some financial sector problems remain
– Low profitability so vulnerable to shocks
• Working age population is shrinking
– Supply-side potential growth is thus 1-1.5% pa
• Population shrinking, so higher per capita!
• Aging population structure
– Will need to boost taxes / transfers
• But starting point is high deficit and high debt!
© 2008 Michael Smitka
33
Japanese GDP Growth
Real Seasonally Adjusted Year-on-Year, SNA68 thru 1995, SNA93 thereafter, 2000 chained from 1995
15.0%
14.0%
13.0%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-3.0%
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-2.0%
© 2008 Michael Smitka
34
OECD
Comparison
Of
Multiple
Bubble
Experiences
:::
Impact of
Equity vs
Housing
Bubbles
––
GDP & C
© 2008 Michael Smitka
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
35
OECD
Comparison
Of
Multiple
Bubble
Experiences
:::
Impact of
Equity vs
Housing
Bubbles
––
Bank Loans
& Equity
© 2008 Michael Smitka
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
36