What we can learn from the Japanese
The head of the Société Générale Asset Management Japan Core Alpha team on how the past can inform the future
Almost 20 years ago Japan entered a protracted financial crisis, bear market and economic downturn. What lessons does that experience hold as the West struggles with a financial crisis?
The Japanese bubble peaked at the end of 1989 when the Nikkei Stock Average hit 38,915. Last Monday the index closed at 7,162, a fall of more than 80% over 19 years and the lowest close since October 1982.
At the peak of the boom in 1989, there were 19 big banks in Japan. By 2008, this had shrunk to eight. Of those only one still bears the name it did in 1989. The rest have failed, been swallowed up or nationalised.
These were the largest banks in the world, and their restructuring and consolidation was a nerve-wracking, messy business that lasted years and kept returning to haunt bankers, regulators and politicians. It cost at least two generations of them their jobs and reputations. It included government recapitalisation of even the biggest banks and a blanket guarantee of all bank deposits. Strikingly, there were still runs on Japanese banks even after that guarantee was put in place.
It took a while before it became clear (or at least, accepted) that the problem was system-wide. Initially, it was smaller, local banks that got into difficulty.
The first Japanese bank failed in August 1995 (the first since the war). This was dismissed as a local difficulty because it was Hyogo Bank, a regional bank affected by the Kobe City earthquake in that year.
The blanket deposit guarantee was introduced in June 1996, but it did not prevent runs on the banks for two reasons. One was credibility. Saying the money was safe was one thing; proving it was another. Second was practicality. Imagine your bank does go bust. Even if there is no question about whether you will get your cash back, you are faced with complete uncertainty. Far better to get it out straightaway.
The specifics of every banking crisis vary by country and by cycle, but the general forces are the same. When expanding gearing gives way to contracting debt, the stage is set for a liquidity crisis.
For Japan, this occurred in 1997-98. Two large brokers and one big money-centre bank failed, followed a few months later by the nationalisation of two long-term credit banks. A similar liquidity crisis has struck the West.
It is not obvious that the process in the US and the UK has been shorter. If you define the stock-market peak as 1999-2000 and the rally since early 2003 as no more than a relief rally (analogous to Japan’s recovery from 1992 to early 1996), then the timetable is actually similar.
A liquidity crisis has a sharp impact on lending to other parts of the economy. As a result, the economy slows and the debt built up by households and businesses becomes harder to support. This gives rise to the third and final phase: a solvency crisis. Japan’s big banks reached that point about five years after the liquidity crisis.
Three kinds of adjustment are needed before stability can return. First, asset values must discount the credit- constrained world. That is already happening with a vengeance, but take care not to assume too quickly that the process is complete.
A sucker rally (or three) should be expected, to make sure that hope is extinguished before share and house prices can return to any sustainable rising trend.
The Nikkei plunged about 40% in 1990-92, rallied by about one third, then traded between 15,000 and 20,000 from 1992 to early 2000. This range included three rallies of more than 30%.
Second, the banking sector needs to write off bad debts, consolidate (a polite way of saying shrink), and rebuild its capital base. In banking terms, completing the MUFG merger in October 2005 marked the end of the crisis.
Third, the real economy must also adjust to the new credit constraints. In Japan’s case, car sales, land prices, bank lending and the household spending index have, like share prices, returned to the levels of the early 1980s.
Corporate gearing ratios are at levels not seen for 40 years. Its economy has been through a wrenching adjustment over a long time.
Could it take this long in the West? Experience has taught that we should not rule out such a possibility. You could argue that the imbalances in the West are greater and have been allowed to build for longer than in Japan. It is that build-up of imbalances which will determine the scale and duration of this adjustment period rather than the actions of politicians and regulators (who have a tendency first to deny, then to fight the last battle rather than this one).
The author heads the Société Générale Asset Management Japan Core Alpha team
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