Japan endured a painful 10-year economic slump after its stock-and-real-estate bubble burst in 1989. Today, experts are saying that what happened in Japan could never happen in the U.S. Or could it? I put that question to Adam Posen, who wrote the book on the policy mistakes made during Japan's lost decade. Posen is deputy director of the Peterson Institute for International Economics. We spoke yesterday on the eve of the G-20 economic summit in London.
Is this financial crisis unprecedented? You told PBS "the data is getting away from us because no one ever expected things to get this bad."
Adam Posen: Almost all countries suffer bursting bubbles and banking crises at some point in their history. Japan's lost decade has much in common with the U.S. savings and loan crisis of the 1980s, for example, as well as with the Nordic crisis of the early 1990s. Banks with insufficient supervision and insufficient capital misbehave in much the same way. However, more often than not political pressure from the banks and the general public delays a swift policy response by the government. The current U.S. financial crisis is caused by this same basic dynamic.
But aren't there some genuine differences this time -- the global spread, the toxicity of some of the bad assets, the relative speed of the response?
Yes, that's true. But basically this financial crisis is following a standard script.
The Japanese made financial policy mistakes in the 1990s. Could President Obama learn from them?
Japanese policy makers made three big mistakes. Or rather, three mistakes turned what should have been a two-year slump into a 10-year recession. The Japanese were very passive in their response to the crisis. That was their first mistake. It's better to be aggressively activist. The Obama team grasps this point.
The second mistake Japan made was to raise taxes during a recession, while worrying too much about loose monetary policy causing inflation. A better approach would have been to push monetary and fiscal stimulus very hard. The Obama team and the Federal Reserve got this right, although I think household tax cuts enacted by Republicans in Congress will diminish the fiscal impact.
And Japan's third big mistake?
Japanese policy makers weren't tough enough with their banks, especially when injecting capital. Obama has failed to learn this lesson.
Should Obama change leadership at the major banks, like he did at General Motors?
Yes, because these people messed up and there should be a clear message that messing up has costs. I haven't seen any evidence that Treasury Secretary Tim Geithner is going to be tough on bank executives, except when a firm melts down overnight -- as did Bear Stearns and Lehman Brothers. Of course it takes a huge effort not to be tough in cases like that.
What else would you do to stabilize the U.S. financial system and put banks on the right path?
Ultimately what matters is convincing the general public, the financial-system stakeholders, and particularly the regulators and supervisors that the environment has changed. Yes, there is a limited risk of bankers strapping themselves to the bombs of financial positions that have to be unwound -- which seemed to have happened with AIG Financial Products. But the U.S. has laws to deal with this, if the government is willing.
Here is what I would recommend:
I'd mark assets to market -- or price bad assets conservatively close to zero -- and then bolster the banks balance sheets for those losses, as necessary, with the injection of more capital.
I wouldn't wait around for "right" prices to evolve slowly from an arcane set of tests.
I'd resist the temptation to subsidize viable financial firms, even if I wanted those companies to buy things.
When taxpayers put a lot of money into an insolvent institution, I'd put voting and managerial control temporarily in the hands of the government, as the taxpayers' agent.
I'd make sales of government stakes and assets clean, full sales -- no public-private partnerships.
I'd set-up a publicly controlled "bad bank" on the RTC model. In so doing, I'd keep most of the upside on resale of currently distressed assets for the taxpayer.
I'd push Congress to consolidate systemic regulations quickly.
I'd impose stricter oversight of banking supervisors, and allow less room for discretion.
I'd listen to European proposals for additional financial regulation with a more open mind, and let them lead on some of those issues so long as the transatlantic playing field is kept level.
Almost every member of the House Financial Services Committee received large contributions from troubled banks last year. Do we need a new watchdog?
The entire U.S. Congressional system is beset by this kind of problem. I think the relevant committees can retain some desire to do the right thing without bias, especially if the public mood forces them to do so. But yes, it would be better to have public financing of campaigns, and none of this contribution nonsense.
Many pundits say the U.S. will pull out of this recession in 2010. But Obama said we may lose a decade. What is your best guess?
My best guess is that the U.S. economy will stop contracting before the end of this calendar year. The massive stimulus, along with subsidizing banks via the Geithner plan, will provide a temporary boost to the economy. Another lesson learned from Japan is that if you don't mess things up by raising taxes and interest rates during a recession, it is difficult to keep a modern market economy down.
However, the recovery will likely be strong for just three to six months, and then fall off again. The stimulus measures will not create a sustainable recovery unless the private sector is ready to pick up investing, and that will not happen unless the banking problems are really fixed and interest rates stay low.
So you don't believe our banking problems will be fixed any time soon?
I fear that by late 2010 or 2011, the banks will be back in trouble because the Obama team was not tough enough on them. In addition, maybe the Fed will have to ease up on the stimulus because the public debt will have expanded too rapidly. I hope I'm wrong on both counts, and the recovery is sustained beyond mid-2010.
What are the early indicators of a sustained economic recovery?
Look for a narrowing of spreads between interest rates on private-sector and U.S. government debt, while the average interest rate creeps up. Look for an increase in new home building and auto production, but not an increase in housing prices or in auto company shares. And look for a willingness of people to invest in more risky assets, while putting less in savings accounts and treasuries. Unemployment may continue to rise and housing prices may continue to fall during this period, but only for a short while.