The turmoil in the U.S. financial system since the last summer reminds me (and many others) of the problems in the Japanese financial system following the end of the land and stock prices boom in the late 1980s. The financial problem in Japan continued for more than a decade and Japanese economy experienced so-called “lost decade.”
There are many differences between the Japanese situation in the early 1990s and the U.S. today. For example, the capital of Japanese banks was quickly eroded after the collapse of stock prices as the regulatory capital included (40% of) the unrealized capital gain of stock holdings of the banks. The capital position of the U.S. banks has been much better. Nonetheless, there are some useful lessons that we can derive from the Japanese experience. Especially, Japan provides us with many examples of “not-to-do’s.”
One of those lessons comes from the experience with jusen. Jusen companies were mortgage lending institutions created by Japanese banks in the early 1970s with strong encouragement from the Ministry of Finance (MOF) that saw growing importance of financing housing for increased urban population. Increased competition in the financial industry following the deregulation in the late 1980s drove jusen companies to shift away from mortgage financing (where they often had to compete with their parent banks) to more risky loans to real estate developers. The banks often “introduced” very high-risk projects that they were reluctant to finance to the jusen for “finder’s fees.” In this sense, the jusen then resembles the bank affiliated SIVs (structured investment vehicles) of the U.S. banks that invest in securitized sub-prime loans.
Large exposure to the real estate sector made the jusen the first casualty of the collapse of land prices. In 1991, the MOF put together a rescue attempt that included loan forgiveness and interest concessions by founder banks to help the jusen, their borrowers, and agricultural coops, which were their important lenders. The financial situation of the jusen, however, did not improve, and the MOF put together the second rescue plan in 1993. Both of these plans were based on the assumption that land prices in Japan would recover soon. The MOF hoped the financial assistance would allow jusen to survive the temporary shock without resorting to fire sales of the properties that backed their loans and without imposing losses to agricultural coops. The land prices did not recover. By 1995, when the jusen were finally closed, the total write-offs were ¥6.4 trillion, much larger than the estimated amount of total non-performing loans in 1991 (¥4.6 trillion).
The jusen case shows how the Japanese government regulators tried to help troubled financial institutions and their borrowers to cope with what they saw as a temporary setback in land prices, and how such a regulatory forbearance failed. The MOF rescue attempts may have stopped the fire sales of properties for a while, but it seems to have just lengthened the falling phase of land prices. Of course, it is hard to tell, but earlier liquidation of the jusen and sales of the properties would have lowered the land prices even more, and that may have attracted new investors who saw the prices have fallen sufficiently.
In the U.S. case of troubled SIVs, there was initially a plan to create a rescue fund for them. The plan eventually failed, and the banks had to bring the losses on their balance sheet. The rescue fund would have helped the banks to continue operating those SIVs without fully recognizing the losses. This might have eventually led to even bigger losses as it happened in the jusen case in Japan. It was fortunate that the rescue fund never materialized.