Ghost Story: Put Banks Out of Their Misery
Bakemonos are floating through the halls, offices and minds of the economists, business writers and policy wonks of Wall Street and Washington. Bakemono is a Japanese word for ghost.
These bakemonos are repeating reminders of Nippon's 1990s, the economically disastrous decade during which Japan suffered through a painful period of deflation and stagnation. In the 1970s and 1980s, it looked as though Japan had become the world's leader in business and applied technology. Built into that success was a bubble which, as bubbles are wont to do, popped, and then malaise set in.
Try as the nation would, it could not return to prosperity. According to most everybody who has studied it, the reason Japan was unable to cure itself was its policy of propping up the country's major banks, which were largely insolvent.
For ten years these institutions were kept on life support, alive but unable to perform the indispensable function of making loans to businesses and consumers. Finally, Japan euthanized the banks by nationalization and bankruptcy. Only then did prosperity return.
Japan's story is a twice-told tale. American economists and financial businesspeople know the story of Japan's travails, of the reluctance of government to do what had to be done and the costs that followed delay and inaction.
And what of our situation now? The New York Times reports that, "students of the Japanese debacle say they see a similar train wreck heading for the United States." The paper goes on to say:
The Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying--ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr Geithner proposed.
One reason Japan's leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag.
As they did in Tokyo, they are doing in Washington: refusing to accept that the nation's largest financial institutions--with a couple of exceptions--are insolvent, bankrupt, worthless, with debts that far outweigh their capacity to service them.
As was true in Japan, the trouble began with real estate loans, which, in one form or another, turned into those famous toxic assets. Geithner, like his predecessor Henry Paulson, is wrestling with how to get those assets out of the banks, which boils down to the question of how much should the government pay for them.
A free-market solution will not work if the object is to save the banks. Right now the highest price the assets would fetch is about twenty-two cents on the dollar, even though in a few years they are likely to be worth much, much more. Buying them at that price would still leave the banks under water and struggling for air.
If the free market is to be suspended, then the government will have to set a price for the toxic assets, but administered pricing has an unrelievedly dismal history, which may be the reason why Paulson could not figure out a method to set one and why Geithner apparently is doing no better. If Geithner does come up with a price, which is politically palatable but economically ridiculous, the banks will still be dysfunctional zombies.
Why then do the decision makers not suck in their guts, bite the bullet, take the plunge and put the banks into receivership or some other form of bankruptcy? That's what the bakemonos are telling them to do.
Doubtless they are scared out of their wits at what that might do to the stock market. The market will take a big hit, but in due course it will bobble up again. That's what markets do.
They are scared of a financial landscape in which institutions such as Citigroup and Bank of America have been temporarily nationalized. Besides their own friends, the stockholders in these institutions include pension, hedge and mutual funds. These, as well as thousands of individual investors will be wiped out, erased, liquidated. The same may hold true for the bondholders. A lot of people, most of whom are undeserving of such treatment, are going to be badly hurt.
They will be less badly hurt if the deed is done now than they will after ten painful, profitless and demoralizing years have passed, and so will the country as a whole. The damage done by stalling until 2020 will be as great to this society as it was to daily life in Japan.
Mercy killing the insolvent financial institutions is scary. The lives and happiness of millions are at stake. All the more reason to listen to the bakemonos, because this ghost story is true.