L shaped recessions, Japan in the 1990s

Japan was set to take over the world (if you believed the hype of the books you buy at airport news stands) at the end of the 1980s, but then suffered an unexpected set back and the 1990s are widely seen as a ‘lost decade’, after asset values crashed to earth with a loud bang. 

The Economist this week has a nice article about the differences and similarities of the US now and Japan in that ‘lost decade’  We were following the Japanese situaiton in the 1990s pretty closely and discuss a couple of points.


  1. Both downturns occured after severe asset price bubbles. In Japan, it was houses (actually a somewhat smaller bubble compared to that in the US a couple of years ago), shares (Nikkei reached just shy of 39.000 by Christmas 1989, it’s still less than half today!), and ground
  2. Both bubbles where fuelled by loose money and financial deregulation
  3. Policy reaction. Contrary to myth, Japanese reaction was almost as fast as that in the US today, with rapid declines in interest rates and no end of huge fiscal stimulus packages


  1. The house price bubble was actually smaller in Japan (50% rise in 5 years, compared to 90% in the US)
  2. The stock market crash was much bigger in Japan (at least so far..). On the one hand, that mattered less because only 30% of Japanese households were holding stock (versus 50% of Americans), but more serious was that Japanese banks were big holders of shares, and to make matters worse, part of these counted as their capital base
  3. We might think that the US has a bit of an inflationary problem, but given the present situation that also has a far from insignificant upside. In Japan, the situation was worse because prices were declining, making interest rate on a real basis still positive, which made fighting the recession that much harder. Also, inflation lessens the needed fall in house prices and reduces the real value of debt
  4. Savings rate were much higher in Japan (15% versus close to 0% for the US) before the bubble burst, providing more room to increase consumer spending

The biggest, and by far the most important difference is the role of the banking system, and how it fared:

  • Japanese banks were far more important for financing business compared to the US, were capital markets are equally, if not more important to finance business compared to banks
  • Japanese banks were in denial for a long time, just hiding the bad loan and retrenching, cutting back loans, this made the economy worse, and increased the bad loan problems, a difficult vicious circle
  • The jury is still out on whether US banks are doing enough to rid themselves of their bad loans (bad assets, as the loans have been cut to little pieces and made into securities). One advantage they have is that a good deal of these have ended up abroad

Some further observations:

  • Japan only really started to turn the corner when the Japanese central bank (the BOJ) started to print large amounts of money early this century to combat the deflation that made the interest rate instrument pretty useless (short-term interest rates were zero, but if prices fall, it’s still positive in real terms)
  • The US is already printing large amounts of money, the Fed is buying large quantities of dud assets from the banks, and this money has showed up in the commodities markets, further fuelling a boom that was already well on it’s way, but limiting the possibilities of further drastic action
  • The key will be in house prices, if they turn it will stop much of the rot in the banking system, and whether banks face realities sooner rather than later
  • The danger in the US is now that the rot is spreading, we have already described a couple of vicious circles here.
  • According to Nouriel Roubini, the problem is deeper than the housing crisis. “Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”

That subprime financial system needs a dollup of decent regulation to repair the rampant asymmetric information problems that allow people to sell bad deals to others. The SEC, at least, seems to be waking up.