Thanks to Ezra Klein’s brand new blog at washingtonpost.com, I just discovered a 10-day-old post by Jim Surowiecki that puts some meat on the bones of an argument that’s been bouncing around my head for a while. We’ve all heard lots and lots about how zombie banks supposedly doomed Japan to a lost decade of semi-depression, which means that our government’s attempts to prop up troubled big banks may lead to the same and yada yada yada.
But my memory was that in Japan the core problem was more zombie companies than zombie banks. Surowiecki agrees, and—as he tends to do—backs up his opinion with research papers:
As this paper by Joe Peek and Eric Rosengreen shows, during the nineteen-nineties, Japanese banks constantly “evergreened”—they kept extending additional credit to companies that already had loans with them. By extending credit, the banks enabled weak corporate borrowers to keep making their interest payments, and to put off bankruptcy. That made the banks’ balance sheets look better, and also kept companies afloat. The economists Ricardo Caballero, Takeo Hoshi, and Anil Kashyap, in fact, found that thirty per cent of publicly-traded firms were “on life support from banks in the early 2000s.”
Evergreening had two effects. First, because the borrowers had little chance of ever actually paying off their debts (because their underlying businesses were so weak), it kept Japan’s economy from making the adjustments necessary to start growing again. Caballero, et al, conclude that the practice led to lower investment, job creation, and productivity for the economy as a whole. Second, it limited Japanese banks’ profitability, because it effectively meant that, instead of making good new loans, they were constantly throwing good money after bad. As a result, they were never able to earn their way back to health. …
Then he makes a crucial point that I think economists without a bunch of first-hand Japan experience tend to miss:
In thinking about the relevance of the Japanese experience to our own, what’s important to note is that Japanese banks did not engage in evergreening solely because it temporarily improved their balance sheets. Rather, they did so because social norms and explicit government pressure encouraged them to do so. (As Peek and Rosengren put it, in Japan, “many lending decisions are strongly influenced by a perceived duty to support troubled firms.”) In fact, Peek and Rosengren point out that government-controlled banks were more likely, not less, to keep extending credit to weak firms.
There’s definitely been some government pressure here (mainly in the form of foreclosure moratoriums) to keep banks from cracking down on troubled borrowers. And we’ve had a couple of zombie companies in GM and Chrysler, where government took over the lending when banks would not. But the foreclosure moratoriums have been expiring, Chrysler is now in bankruptcy and GM is approaching its endgame. The rest of corporate America is in the midst of a vast and brutal restructuring that’s running into very little interference from either social norms or government. Here in the U.S., the biggest risk may not be that we take too long to adjust to a changed financial landscape—which was Japan’s problem—but that we do it too precipitously and risk unnecessary financial and economic carnage in the process.