Worse then Japan

The Economist has an article that suggests that our financial crisis may be worse than Japan's and that we should not dismiss it lightly:

Japan’s outcome—a decade in which growth averaged 1% a year and gross government debt rose by 80 percentage points of GDP—was not one to be proud of. But given the magnitude of today’s mess, it may soon seem not that bad after all.

There are several reasons for thinking that our problems may be worse. Our housing bubble was larger, our shadow banking system has collapsed -- Japan did not have one, de-leveraging is taking place on a massive scale, and it is hard to see where demand is going to come from in the rest of the world to pull us out of this. Japan suffered its crisis with high savings rates, we start with low savings. Hence, as households in America try to restore their balance sheets where will demand come from?

Crisis Deepens

Two signs that the crisis is deepening worldwide. From Russia we see that industrial production fell in January at an annual rate of 16%. Russia is of course suffering from the collapse of the world economy, oil prices declining, and the outflow of capital from its thin financial system. Moreover, since its prosperity had bubble-like features, it is not surprising that its collapse looks so severe.

Meanwhile, Japan's GDP fell by 12.7% in the last quarter, the worst fall since the first oil shock in 1974. See the pictures here. Japan is suffering from the collapse in demand for its exports, and the unwinding of the carry trade which had kept its currency undervalued. Edward Hugh argues that the aging of Japan's population makes them especially vulnerable to declines in export demand since consumption growth is restrained.

And I was already depressed by the "Buy America" features of the stimulus bill. We live in an interdependent world, and such policies are only going to make things worse.

Bank Bailout

Two articles in today's NYTimes on the bank bailout. The first points out that the costs may be much larger than people think.

A sober assessment of the growing mountain of losses from bad bets, measured in today’s marketplace, would overwhelm the value of the banks’ assets, they say. The banks, in their view, are insolvent.

The second article looks at the parallels with Japan's lost decade:

The Japanese have been here before. They endured a “lost decade” of economic stagnation in the 1990s as their banks labored under crippling debt, and successive governments wasted trillions of yen on half-measures.

“I thought America had studied Japan’s failures,” said Hirofumi Gomi, a top official at Japan’s Financial Services Agency during the crisis. “Why is it making the same mistakes?”

Two points come to mind immediately. First, on the size of the losses. These come from marking to market "toxic' assets. But as I noted in previous posts these are due to information and coordination problems. The market values are low because they value an arbitrary collection of mortgages not the whole complex of them. So the amount needed to capitalize the banking system is larger with a plan that is not comprehensive. On the magnitude of the costs and the argument for nationalizing the banks, see this article by Roubini and Richardson in the Washington Post.

Second, delay just magnifies the costs, but here politics is vital. Half measures to avoid the painful costs only multiply them later. But given how difficult the stimulus plan was to pass, is it credible that Treasury will now undertake a comprehensive plan? Of course, my plan is comprehensive, and ultimately not that costly, but where is the groundswell of support?