Japan's ghosts of bubbles past haunt US in 2008

In early 2001, economist Stephen Roach raised a warning flag that enraged many peers: The US risks repeating Japan's mistakes of the 1990s.

It was during the darkest days of the NASDAQ crash that Roach, then Morgan Stanley's chief economist, began worrying Japan's malaise could be repeated in the No 1 economy. The concern was less about the loss of wealth than policymakers papering over economic cracks with easy money.

Roach called it the "bubble fix", a policy then-Federal Reserve Chairman Alan Greenspan is now at great pains to justify. Ben Bernanke hasn't deviated from that strategy since succeeding Greenspan in February 2006.

At its core is a Bank of Japan-like belief that low short- term rates and liquidity are the cure for sliding stocks, plunging real estate prices and lost investor confidence. As 2008 begins, US policymakers need to look long and hard at whether they're repeating Japan's mistakes.

"The only lesson the US has learned from Japan is how to clean up the post-bubble mess," says Roach, now chairman of Morgan Stanley in Asia. "America has failed to learn the much more important lesson - how to avoid dangerously destabilizing bubbles in the first place. The Greenspan/Bernanke ideology still places disproportionate emphasis on the former while ignoring the latter at great peril.

The argument against the US suffering a Japan-like lost decade lay in the economy's structure.

The US banking system is sounder than Japan's was in the 1990s, while the Fed is thought to be more independent than the Bank of Japan.

US accounting rules are thought to make it harder for banks to hide losses. The lack of cross-holdings of equities that wreaked havoc on Japanese balance sheets also is worth mentioning. And with oil prices near $100 per barrel, US stagflation seems more likely than deflation.

Yet it's becoming clearer that the problems facing the United States are now about banking structure - just as they were with Japan.

The most obvious similarity with Japan is bad loans. The potential scale of US bad loans is spooking investors and raising prickly questions about the transparency of the US financial system. Yale University Economist Robert Shiller recently told the London-based Times that US housing losses may triple in the next five years, with the country possibly heading for a prolonged, Japan-style slump.

For years, regulators and investors sold an appealing tale: The US has become so sophisticated and efficient at managing risk that a financial meltdown is unthinkable.

That was a myth, of course. The aggressive and profitable repackaging of credit risks in recent years made global markets more volatile, not less. In the 1980s, executives and investors put their faith in Japan's system of companies and banks bailing out each other in times of trouble. That banks were maddeningly opaque didn't seem a problem so long as Japan Inc stayed on track.

During the 1990s, then-German Bundesbank President Hans Tietmeyer's skepticism about financial engineering annoyed many investors. Many may wish they'd heeded his call for banks, securities firms and companies trading and using complex investment instruments to provide a clear picture of the scope and nature of such activities and their impact on earnings in financial statements.

Faith is now being lost in the US system. Look no further than Blackstone Group LP's recent experience. On January 1, PHH Corp, the New Jersey-based mortgage and auto-leasing company, scrapped a $1.8 billion sale to General Electric Co and Blackstone after the buyout firm said banks reneged on an agreement to lend the money.

"Banks facing further writedowns are reluctant to lend, so the extra liquidity from the central banks isn't greasing the wheels of commerce as intended," says Simon Grose-Hodge, an investment strategist at LGT Group in Singapore. "When the likes of Blackstone are getting turned down, you've got a problem."

In Japan, the failure of cornerstone institutions such as Yamaichi Securities Co in 1997 brought down the veneer of invincibility.

These days, a similar dynamic may be found in Wall Street titans turning hat-in-hand to foreign governments.

The need for capital recently drove Citigroup Inc to sell a $7.5 billion stake to the Abu Dhabi Investment Authority and Merrill Lynch & Co to accept $5 billion from Singapore's state-owned Temasek Holdings Pte.

So, really, what are the odds of the US sliding into a Japan-like funk?

While not great, there are at least two reasons why the risk can't be dismissed: Denial and easy money.

There's still considerable denial about the magnitude of the US' problems.

The subprime-loan crisis led to a broader contagion in credit markets that's spreading around the globe, much like Asia's meltdown in the 1990s. Denial will only let these problems grow bigger.

Also, all low rates and capital injections from central banks offer markets is breathing room.

They treat symptoms of the problem, not the underlying disease. Japan's interest rates have been at or near zero for a decade and it still has deflation. Japan's economy has yet to return to normal.

If the US is to avoid that trap, it needs to begin taking the lessons of Japan more seriously.

William Pesek is a Bloomberg News columnist. The opinions expressed are his own.

(China Daily 01/08/2008 page16)