- After a meteoric rise in the 1980s, Japan's housing-driven financial and economic collapse in the 1990s seems similar to what's happening in the US today.
- Although the circumstances are similar, how the two countries have pursued monetary policy couldn't be more different.
- That doesn't mean we won't experience other problems down the line, but it's unlikely we'll reenact Japan's lost decade.
Any 1980s businessman who didn't consider learning Japanese at least once was like an ancient fish scoffing at the first salamander—too stuck in his ways to see the potential. By the end of the 1980s, Japan had grown into the world's second-largest economy and biggest by market cap.
Yet recent comparisons between what happened next (a housing collapse, banking crisis, and nearly a full decade of Japanese economic weakness) and the current crisis are making some folks fear the exact same thing is in store for the US—protracted economic weakness. At least, recent headlines make it seem inevitable.
But while some find current events similar to Japan in the late 1980s, a little due diligence is needed before we declare the next decade irrevocably lost for the US. For starters, in Japan, the amount of "bad debt" (non-performing loans) on banks' balance sheets as a percent of GDP was more than 8 times that of the US currently. That's a significant gap given the policy—or more precisely the speed of policy—that followed.
Japanese banks didn't begin to write off bad loans until the mid-1990s—well after trouble hit. A government bailout of ailing banks didn't arrive until 1999's formation of the Resolution and Collection Corporation. The Bank of Japan didn't start cutting rates until a year after the domestic stock market collapsed in 1990—and took until 1999 to reach zero—a very slow pace. Quantitative easing didn't begin until a decade after the first rate cuts. Simply put: Japan's reaction to the crisis was like molasses dripping at forty below—a poor use of its monetary tools.
Contrast this with the US reaction thus far. Banks took their lumps early, beginning to write down bad assets in 2007 and throughout 2008—almost as soon as the issues came to light. The Fed started cutting interest rates in September 2007, and in just a little over a year, for all intents and purposes, the target rate's reached zero and quantitative easing's been simultaneously instituted. The Fed has committed to "exceptionally low" rates for some time, and even said they'll consider buying longer-duration Treasuries to affect rates further up the yield curve. Additionally, liquidity injections began in early 2008 through a few temporary lending facilities. Those facilities have proliferated to include liquidity support for agency debt, mortgage-backed securities, and corporate paper. And despite an inconsistent and heavy-handed government approach early on, no major financial institution has failed since Lehman Brothers in September.
The speed and intensity of the feds' response couldn't be more different than Japan in the 1990s. That doesn't mean we won't experience other problems down the line—a monetary policy "bazooka" carries different risks. Yet the fallout's uncertain and still years away. And in the meantime, it's unlikely we'll reenact Japan's lost decade. Instead, quick and innovative Fed action has set the stage for recovery—a good thing for stock investors in the coming year.