Toru Yoshikawa was a young investment banker with Canadian Imperial Bank of Commerce in Tokyo in the late 1980s, when the asset bubble economy burst, leading eventually to a historic meltdown in the Japanese stock market.
"It was an incredibly crazy time," says Yoshikawa, now a professor of strategic management at the DeGroote School of Business in Hamilton. "Banks were lending money and there was almost this excessive euphoria and panic that if you didn’t buy a home you would be priced out of the market forever."
Overinflated real estate prices. Easy loans and credit leading to speculation. Financial deregulation of banks that encourages more liquidity. Market chaos as the bubble bursts.
Sound familiar?
To analysts and academics, the financial crisis in North America has a disconcerting parallelism to what happened to the Japanese market two decades ago.
Yuen Pau Woo was the economist responsible for Japan in Singapore’s central bank when the Japanese bubble – helped by a run-up in real estate prices that made Park Ave. co-ops look affordable – caused the world’s second biggest economy to burst.
"It became what was known as the zombie economy," says Woo, now CEO of the Vancouver-based Asia Pacific Foundation think-tank. "Many people look back and see that it was a mistake that they didn’t act quickly enough."
Some influential economists see a striking resemblance between what happened in Japan and what’s happening in the North American economy. The big worry is that in the Japanese example, it took more than a decade for the economy to turn around, with stock prices bottoming out in 2003.
"There are eerie similarities between the United States now and Japan then," says Morgan Stanley Asia economist Stephen Roach, in a policy paper written before the Wall Street implosion of last week.
"The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the 1990s. In both cases, loose money fuelled liquidity booms that led to major losses."
While Americans have passed a controversial $700-billion bailout package, analysts say this isn’t enough. Long-term reform in the financial system is needed, or the U.S. could indeed become another "zombie" economy – tanking global markets in its wake.
In the Japanese example, and at the height of the bubble in 1989, some would famously boast that the land beneath the Imperial Palace in Tokyo was worth more than the entire state of California.
In Tokyo’s Ginza district, properties sold for more than $100,000 per square foot. (The $30 million asking price for the Toronto Four Seasons penthouse is a mere $3,000-plus per square foot.)
The stellar run-up in prices was encouraged by low interest rates and deregulation that allowed Japanese banks to take on riskier assets and loans, says Woo. Eventually, banks got hit after loans made to the real estate sector were "impaired because of speculation in the property market and the fall in the price of real estate."
To prime the economy, Japanese lending rates went down as far as 0.1 per cent – effectively zero – but even that did little to help the moribund market.
In a similar vein, the U.S. government has tried to prime the pump by sending out rebates for families and tax breaks for businesses, while the Federal Reserve has lowered the overnight lending rate to ensure more liquidity.
"Will this medicine work? The same question was asked repeatedly in Japan during its lost decade of the 1990s. Unfortunately, as was the case in Japan, the answer may be no," says Roach (instant pay day loan). "The current recession has been set off by the simultaneous bursting of property and credit bubbles.
"The unwinding of these excesses is likely to exact a lasting toll."
To avoid the problems of the Japanese, lawmakers must ensure that in addition to the quick bailout, they also address long-term regulatory issues, says Woo.
"They have to look at the structural problems, such as making sure financial institutions account for exotic instruments, restructuring accounting regulations, and addressing executive compensation."
Japanese regulators were roundly criticized for not doing enough during their crisis, which caused the economy to stagnate for decades.
"You can argue that the Japanese failed to act at all when it counted," says Peter Dungan, a professor at the Institute for Policy Analysis at the Joseph L. Rotman School of Management. "They did not do the financial restructuring which is now being called for in the North American market."
Dungan says the Japanese let the banks continue to operate as a kind of "gentleman’s agreement where no one confesses failure. No one was allowed to fail, which caused the problems to linger."
In the American example, it seems that at least in the initial stages, movement is happening at a much brisker pace. "In the space of a month you’ve seen virtually the entire investment banking sector disappear," says Dungan.
The next step is to do the hard work of ensuring a tighter regulatory framework to make sure it doesn’t happen again, says Yoshikawa. "Inaction will mean that you’re simply delaying the inevitable."
Still, the academic wonders what many consumers are likely asking: "It’s not as if we haven’t seen it before. Like Japan, the problem starts because of excessive expansion or euphoria, then the banks get a little careless, even reckless when lending money, and then things get out of control. I don’t know why we never seem to learn from history."
Japanese banks certainly seem to be coming around. After buying overpriced U.S. banks and real estate in the ’80s, they seem to have learned about buying on the cheap.
Mitsubishi UFJ Financial Group, Japan’s largest bank, bought 20 per cent of Morgan Stanley for $8.4 billion (U.S.) last month. Japan’s biggest broker, Nomura, snapped up the Asian, Middle Eastern and European divisions of bankrupt Lehman Brothers.
While the Japanese implosion had a major impact in the ’80s, the world economy was not as interconnected back then, so the global impact was more muted. But former Canadian prime minister Paul Martin warned in a speech in Toronto that it’s only a matter of time before economies such as China, India and Brazil see a similar fate.
"What is new is that such is the interconnectedness of the world’s financial markets today … that a mortgage problem in a major country like the U.S. can lead to the bankruptcy of small municipalities in northern Norway, to a debilitating bank credit crunch in Europe, and to panic in the Chinese treasury holding Fannie Mae paper."
Martin called for international dialogue between western and emerging economies. "We have only a short period of time to put in place the kind of forum that will allow power to be shared between the largest economies of the 21st century," he said. "In short, the time to act is when you can see the truck coming, not when it runs you over."
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