The upheaval in the U.S. financial system since Lehman Brothers filed for bankruptcy under Chapter 11 two weeks ago has triggered turmoil worldwide.
The United States government has handed Congress a comprehensive plan to buy up to $700 billion in mortgage-related assets from U.S.-based financial institutions, but it is unclear what will ultimately happen, given the political twists that precede the presidential election in November.
But the fact that such a massive bailout plan was proposed underlines the seriousness of the problem.
“History repeats itself” is the impression this author has been getting from the unfolding crisis, having observed at close range the collapse of the long-term credit banks in Japan and their transformation into regular banks since the turbulent 1990s.
Here are some triggers these two events had in common.
Long-term credit banks were part of Japan’s postwar financial system, which was deliberately compartmentalized as a strategy to efficiently distribute the nation’s scarce savings throughout the economy. There are no doubts this system contributed to Japan’s rapid economic rebuilding.
But as Japan began to steadily post current account surpluses — which resulted in its savings level shifting from shortage to surplus — and as the financial market liberalization progressed, the role played by these special banks — absorbing funds from the market by issuing bonds and supplying the money to industry — quickly lost relevance.
The U.S. investment banks managed to survive wave after wave of globalization because they made full use of IT to create new financial products one after the other. But as global trends shifted to universal banking, these banks too found themselves needing new roles.
This is because their dependence on the markets to raise cash left them vulnerable to the credit crunch triggered by the subprime-mortgage crisis. It seems pretty ironic that the reform in that sector is being driven by the very same bewildering financial products they themselves created.
What is behind these developments in Japan and the U.S.? The mental characteristics of the people, namely, arrogance and lack of self-discipline.
Intoxicated by the catch phrase “Japan as No. 1,” the nation was carried away by the bubble boom and grew overconfident that it had nothing more to learn from other countries. It rested comfortably on its own success story and neglected to conduct reforms in anticipation of changes in the global environment.
Across the ocean, the end of the Cold War left the U.S. the world’s sole superpower, and the IT revolution generated the illusion it would continue to attract money from around the world.
This bears some similarities to the Great Depression of 1929. U.S. economic power had rapidly expanded after World War I. New York replaced London as the center of global finance, and Ford Motor Co.’s Model-T revolutionized mass production. Trans-Atlantic aviator Charles Lindbergh and the Empire State Building became symbols of American might.
But when demand began to fall behind the mass supplies generated by the new economic mechanism, Wall Street fell into the abyss of Black Thursday in 1929.
The lessons of the Great Depression led to the creation in 1933 of the Glass-Steagall Act, which separated banking from the securities business. This was eventually abolished in 1999.
Now it has been found that capital adequacy requirements, which financial institutions were forced to meet to protect the integrity of the financial system, can instead trigger uncertainties during credit crunches. The recent financial turmoil should serve as a reminder that regulations and systems — no matter how effective they were when originally introduced — need to be reviewed in line with changes in the environment.
The depth of today’s global financial troubles — which have been accelerated by waves of securitization and the rapid pace at which money now changes hands — dwarfs the collapse of Japan’s asset-inflated bubble of the early 1990s, which essentially was a domestic problem. Russian and Chinese share prices have not been spared, unlike the then Soviet Union, which was left largely unhurt from the Great Depression.
Even if the White House bailout package is approved by Congress and the U.S. financial system moves toward stabilization, it will likely take more time than is widely thought before the global economy starts to recover in real terms.
Teruhiko Mano is a professor at Seigakuin University Graduate School.