Wednesday, July 15, 2009

Lessons from Japan's Lost Decade
What are the policy do's and don't's of which we need an awareness. I want to put a particular emphasis on lesson 5 of the Japanese scholars, "Until the focus of disease is removed by surgery, no macroeconomic medicine will be effective."

Do work with other nations to allow an increase in money supply without panicking them. Japan only came out of the "Lost Decade" by an aggressive monetary policy.

Only a comprehensive monetary policy which allows the market to clean up the bad assets and provides enough liquidity to do so will achieve it. The financial institutions need to be able to borrow at near zero rates from the Fed not at the rates in the TARP. Instead of merely tossing money at the banks, we need to reform the valuations of assets. Mark to market needs to be permanently buried and replaced with a more objective income based evaluation for income producing assets. Even though Americans hate to admit it, South Korea showed that aggressively dealing with troubled assets is vital. It had a rough couple of years, but it returned to strong growth while Japan remained mired in difficulty.

Keynes is dead. Lesson 4 of the Japanese scholars was that fiscal stimulus does not work in these circumstances. We have to make economic policy based first upon if it helps business to flourish not based upon some left wing social engineering. The Great Depression became long because "Others say government did not do enough to restore business confidence, or did too much to damage it, piling on taxes, regulation and labor unions," as Howard Jenkins put it. I believe that a good fiscal policy helps to blunt the trauma and is desirable. I believe that tax cuts, aid to states to prevent more unemployment, accelerating existing projects, increasing food stamps, unemployment, medicaid, tax credits for purchases like fuel efficient cars and first time home buyers, and other safety net programs are desirable. They help keep the economy from collapsing while we allow a couple of years for the monetary policy and the markets to work their magic. Otherwise the public panics. When that happens the sanity of the market could be endangered. What I do not believe is that we can spend our way into prosperity. The stimulus money should have been closer to the GOP version and less like the Democrat version. It could have been a little more than half what it was and the rest of the money should have addressed foreclosures which goes back to lesson 4.

We need to address foreclosures. We should have a window where no doc modifications of ARM's (adjustable rate mortgages) convert to fixed rates. Then we could give banks tax credits to compensate for the opportunity loss. Trying to deal with the bank balance sheets first without dealing with the problem which caused the balance sheets to be in trouble is backward. The second step seems to be bankruptcy reform. We have to allow bankruptcy judges to modify mortgages in Chapter 13. It used to be allowed until the Carter Administration as a trade off for the Community Investment Act and other bills. It also protected the banks when they were forced to give out 21% mortgages. The only way to save the banking industry is to allow real value to set the assets and income to start flowing on half of the non performing loans. That is by loan modification inside and outside the bankruptcy court. Those who won't take the second and third chances will just be foreclosed upon. We can allow big government to intervene and try to redo the balance sheets of 80 million people all of whom are different, or we can allow people to do it themselves. Not taking the former approach will lead to a decade's long reliance on the government by millions at a staggering cost.
A final difference between today’s bust and most other big banking crises is the importance of household debt. Historically, serious banking busts have mainly involved overborrowing by firms. In Japan, for instance, corporate borrowing soared in the 1980s against the collateral of rising share and property prices.

Today, however, household profligacy, which underpins much of the other debt, has been the problem. After the dotcom bust, American firms held back. Virtually all the rise in non-financial debt since 2000 was among households, as Americans tapped into the rising equity in their homes. Although troubled business debts, such as commercial property, are rising, households are the worst hit.

That has important implications. Household balance-sheets are more difficult to restructure than corporate ones, which involve far fewer people. Politically, the process raises questions of fairness. How far, for instance, should taxpayers bail out reckless homeowners who bought mortgages they could not afford? On the other hand, the economic dislocation from unwinding a household-debt binge may be less disruptive than restructuring swathes of firms. As Anil Kashyap of the University of Chicago points out, one reason Japan was so loth to acknowledge the depths of its banking problems was the knowledge that a banking clean-up would require a large-scale restructuring of Japanese firms which, in turn, would throw many people out of work. Restructuring household debts may be political dynamite, but it would not require a wholesale remaking of corporate America.
Nonetheless, the rebuilding of American households’ balance-sheets is likely to force a reliance on government demand that is bigger and longer-lasting than many now imagine.


The don't's are simple. Don't raise taxes as the Democrats plan to do when the Bush tax cuts expire. Instead let's have comprehensive tax reform (pt 3). The Japanese tried raising taxes twice and each time triggered real recessions. Don't keep Zombie businesses on the public dole. Don't pile up public debt in the vain hope of spending your way to prosperity. Don't discourage the markets from reshuffling resources to the efficient. Don't engage in anti-growth energy policies like Kyoto.







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