Lessons from Japan’s Bank Crisis

The Wall Street Journal has a good piece from Yuka Hayashi about lessons that can be learned from Japan’s experiences with its bank crisis in the 1990s. While I do take issue with a number of the article’s assertions, on the whole it sheds light on what Japan did in order to shore up its global banking crisis. The article starts off a little on the wrong foot.

As concerns about the mortgage crisis have engulfed U.S. financial institutions, some experts are looking for lessons from Japan’s experience fighting a major banking crisis a decade ago. 

Some big differences already are showing up. Unlike Japanese banks that refused to admit the size of their bad loans for years, U.S. financial institutions began taking action as soon as mortgage-related losses hit their quarterly earnings. While their problems seem far from over, companies such as Merrill Lynch & Co. and Citigroup Inc. already have written off billions of dollars in losses and replenished much of their depleted capital by issuing shares or selling assets.

U.S. financial watchdogs also have stepped in quickly to try to limit the damage, while Japanese regulators waited years, until big institutions began to fail.

Really? What about Level Three Assets? Many commentators have noticed that even Goldman Sachs has a tremendous amount of exposure still hidden in Level Three assets. And regional banks in the United States have not marked to market because mortgage, commercial real estate and construction loans do not have to be unlike CDOs and Asset-backed securities. There are still monstrous losses lurking in the U.S. Financial system. The article does acquit itself somewhat here in the next paragraph.

But analysts caution the jury is still out on the fate of hundreds of U.S. banks still sitting on huge real-estate-related losses. As the nation debates how to deal with them, Japan’s experience — particularly on how to spend taxpayer money more effectively in a bailout — offers clues.

Japan spent nearly $440 billion in taxpayer money, mostly from 1998 to 2003, to protect depositors, nationalize the sickest of banks and beef up the capital of other financial institutions.

About 70% had been returned to government coffers by last year, according to the Deposit Insurance Corp. of Japan, which is funded by both the government and banks and plays a similar role to that of the U.S. Federal Deposit Insurance Corp. More is expected to be recovered later.

I’ll have to take these figures at face value. But, they are not altogether comforting in that they represent a net loss of 30% to taxpayers. In the Bridgewater Associates research piece, it is estimated that an additional $500 billion in losses are expected to add to the $240 billion already written down by U.S. finance companies by July when the report was done. That’s about $740 Billion total. If two thirds of this gets taken out of the system and nationalized by the methods used by Japan, the U.S. taxpayer would still be on the hook for well over $200 billion. in nationalized losses. That is a lot of dosh!

When the failure of two big financial institutions threatened to cause a panic in 1997, regulators implemented what is now considered the most effective of their measures: guarantee virtually unlimited amounts of public funds, so that banks could boost their capital to write off bad loans more aggressively. In 1998 and 1999, the government started to inject capital into banks and eventually put in $120 billion.

To overcome public skepticism, the money came in the form of subordinated debt and preferred shares, which provided generous income and were safer than ordinary shares. Such a mechanism was also more acceptable to bankers, who were reluctant to hand over ordinary shares for fear of giving Tokyo greater influence over their operations.

Public funds also prompted banks to restructure and consolidate, accelerating a wave of mergers. Some are now so healthy they have become providers of capital to big Western banks: Mizuho Financial Group Inc. took a stake in Merrill Lynch and Sumitomo Mitsui Financial Group Inc. bought shares in Barclays PLC. In addition, banks’ share prices rose, generating a profit for the government when it sold its preferred shares.

Still, analysts question the effectiveness of funds used to prop up the weakest of lenders, including two large wholesale banks that were nationalized after becoming insolvent.

Restructuring of Long-Term Credit Bank, now renamed Shinsei Bank Ltd., cost Japanese taxpayers $70 billion before it was sold to a group of private-equity investors in a fire sale. Another bank, now known as Aozora Bank Ltd., sucked in about $40 billion. While the new owners spiffed up operations and adopted new strategies, the two banks are still struggling to find a place in Japan’s crowded banking industry.

While I like these anecdotes and tidbits and they are helpful for context (for more on Shensei, read Gillian Tett’s Book “Saving the Sun“), they leave me wondering whether government money helped or hindered the Japanese situation.

As we push forward, the Swedish seems a better bailout framework for U.S. authorities to consider and I will have more to say about it in due course.

Japan’s Bank Crisis Is Combed for Lessons

Update: I have now posted an entry on the Swedish workout model.
The Swedish banking crisis response – a model for the future?

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