U.S. can learn from Japan's deflated economy in the 1990s

"The authorities are reactive, not pre-emptive. They keep on underestimating the problem. The main policy option seems to be hoping for the best," says Christopher Wood, an equity strategist for the brokerage CLSA in Hong Kong and author of an authoritative book on Japan's bubble economy.

Despite the complaints, Bernanke's handling of the contemporary crisis has been more decisive than was his Japanese counterpart's. The Fed lowered its benchmark lending rate in September, then followed with two additional cuts, driving the fed funds rate to 4.25%. In a recent speech, Bernanke signaled that the Fed is likely to cut rates by an additional half a percentage point by month's end.

He also introduced an innovative credit auction in December to pump additional funds into the banking system.

"When Bernanke and his colleagues look to the lessons of Japan, the lesson is not to wait too long until you act strongly. … Bernanke knows that lesson terribly well," says Paul Mortimer-Lee, global head of market economics at BNP Paribas bnpin London.

In Japan, deep uncertainty about the health of Japanese banks impeded recovery. A large proportion of banks' assets were loans that had been used to finance commercial real estate, which in the post-bubble era few wanted to buy because property prices were in free fall. But rather than write off the loans, Japanese banks extended additional credit to borrowers, allowing them to at least make minimal interest payments. That made the banks look healthier than they were, at the cost of impairing the flow of credit to new businesses.

Likewise, difficulties in assessing the full extent of losses stemming from mortgage-backed securities are complicating recovery from the current financial tumult. Those securities also have been sold to financial institutions other than banks and have spread to countries worldwide, adding an additional layer of complexity.

"Market participants still express considerable uncertainty about the appropriate valuation of complex financial assets and about the extent of additional losses that may be disclosed in the future," Bernanke told the House Budget Committee last week.

The good news is that major U.S. banks, unlike their Japanese counterparts in the 1990s, already have swallowed large write-offs for losses on subprime mortgage deals. On Jan. 17, Merrill Lynch wrote off $16.7 billion in losses related to asset-backed securities that went sour, joining Citigroup, Morgan Stanley and UBS in taking massive balance-sheet hits — something Japanese institutions resisted for years.

"Clearly, it is better to take care of problems now (rather) than distort and greatly prolong the needed adjustment process," Rosengren said in the Jan. 8 speech in Hartford, Conn.

Democrats in Congress and President Bush are debating alternative proposals to stimulate the economy and, hopefully, head off a recession. Bernanke has endorsed the idea, so long as any package be enacted quickly enough to affect the economy this year.

Japan, likewise, sought to spur a near-lifeless economy with fiscal adrenaline, ramping up government spending on public works projects, including bridges and river "improvement" programs that literally lined many waterways with cement. So many projects were launched that the share of the workforce employed in construction hit an extraordinary 12% — higher even than the figure reached at the peak of the real estate bubble, according to Posen.

Cleaning up the damage

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