Japan's lost decade and the present financial crisis
As world and consumer prices continue to drop, there is renewed fear of deflation. The nightmare scenario is Japan's 'lost decade'. Michael Lim Mah Hui explains what happened in Japan and considers the prospect of a similar fate.
IN the last 37 years (1970-2007), there have been 124 banking crises, an average of 3.4 every year (Laeven and Valencia, 2008). Some have been minor, others very serious and long-lasting, like the one in Japan from 1991 to 2002. The most recent is the financial crisis that started in the US in July 2007 and is playing out in front of us today. It is also the most serious, systemic, and global since the Great ...view middle of the document...
These S&Ls expanded into making non-housing loans like commercial property, credit cards and the like. Ceiling rates on deposits were also lifted. Hence S&Ls, commercial banks and mutual funds competed for customers by raising interest rates. In periods of economic growth this was regarded as acceptable. The explosive growth in the S&L industry coincided with a real estate and property boom in the economy. Based on rising prices, and loosened regulations and supervision, banks and S&Ls lent recklessly to the property sector that eventually saw a collapse of property prices and the demise of over 1,000 S&Ls.
At the same time, commercial banks were also facing the same competitive pressures from S&Ls, investment banks and mutual funds. Since mutual funds were paying higher interest rates, commercial banks were likewise pressured to do the same and to pay interest on checking accounts. Commercial banks started to lobby the US Congress to allow them to undertake investment-banking activities like underwriting bonds and equities and the trading of securities and derivatives. These were riskier but more lucrative. Bit by bit, the wall between commercial and investment banking activities was eroded until it was completely dismantled in 1999 with the repeal of the Glass-Steagall Act.
Even investment banks were transforming under the deregulatory pressures. Traditionally investment banks enjoyed rich commissions from being broker-dealers. In 1975, the fixed commissions from trading securities enjoyed by investment banks that were mainly broker-dealers were abolished. This put a squeeze on brokering fees and pushed investment banks to undertake more proprietary trading which was riskier.
Economic and financial deregulation was the economic counterpart of the Cold War. This mania and wave of deregulation that began in the US was exported worldwide.
Japan's banking crisis and the lost decade
Japan's financial deregulation began in the late 1970s with reforms in the bond, foreign exchange, and equity markets. All these allowed Japanese corporations to raise capital more cheaply from the capital markets, especially in the foreign bond market, while savers could invest in the equity markets, thereby eroding the dominant position banks enjoyed in the financial system. Fierce competition and decline in margins forced banks to look for alternative sources of business and to increase their risk profile - aggressively lending to the property market, consumers, small-medium size enterprises, and for share purchases. This coincided with a period of high economic growth and low inflation which boosted asset prices (land and equity) to unprecedented levels. Banks lent based on collateral rather than cash flow. Since the value of land rose astronomically, and the belief was widespread that land prices would never decline, banks indiscriminately lent to the real estate and construction sectors. At its peak, the value of land in the Imperial Palace in Tokyo was...