Bank, Heal Thyself

It's hard to get too far into a discussion about what to do with the nation's large and troubled banks without someone bringing up Japan (or Sweden; they're both popular). In debates over bank policy, Japan has taken on talismanic properties, making it a sufficient answer to just about any difficult question. Why shouldn't we prop up struggling banks? Japan. Why should we nationalize insolvent institutions? Japan. What will happen if we ignore the lessons of Japan? The dreaded Lost Decade.

The basic idea is this -- failure to properly resolve a banking crisis can leave an economy with zombie banks, insolvent but still operating, which do not lend and therefore prevent the economy from recovering fully. Given the situation in which we find ourselves, namely, one in which the government has determined to prop banks up rather than nationalize them or let them fail, this is fairly distressing.

But is it true? In fact, it seems that Japan's banking crisis isn't nearly as analogous to America's as you might expect. As John Hempton has explained, Japanese banks had tons of savings, few loans, and slim margins -- just the opposite of the big banks here. And they didn't impair recovery by failing to lend, but by continuing to provide credit, for political reasons, to large industrial firms that were in terrible shape. This was the zombie relationship. Japanese savers poured money into the banks, the banks rolled over old debt to busted property companies and industrial firms, and so necessary shifts in the economy never took place.

As James Surowiecki notes, political involvement in the banking system in America has not led to a similar outcome -- the banks aren't being told to keep sinking firms afloat. The results have been plain for all to see; old industrial enterprises have been hammered, as have firms tied up in the housing boom. The destruction in "creative destruction" is taking place, leaving plenty of room for creation later.

And that's where the analogy between Japan and America becomes more apt. Paul Krugman, for all his insistence on nationalization, has argued quite forcefully that it was an export boom rather than a banking fix that finally saved Japan. The worrying thing for most economists is that America is unlikely to export its way out of recession -- that's just not how our economy is structured at present -- and it isn't clear where else growth might sprout. Consumption has traditionally been our main engine of growth, but consumers remain saddled with debt and are unlikely to pull the economy out of its doldrums.

In our story, the banks are largely a side issue, dependent on margins to recapitalize themselves which they can only enjoy if the economy begins growing strongly again. But after decades of neglect of the real economy, it's just not clear how strong growth might quickly resume; too many workers simply aren't prepared to find employment outside of manufacturing or construction.

It's important to understand this, because there are ways the government can address structural issues. It will be politically difficult to spend money on the appropriate policies, however, so long as there are economists out there loudly demanding that we keep our powder wet for the bank nationalizations that will eventually be necessary.