When Bulls Become Bears
To truly gain a perspective of what it’s like out in the marketplace, besides making my own observations, I like to read a lot of what other people write.
Over the years, one of my favorite economic writers has to be Jim Jubak. He’s one of those people who is very realistic, yet still maintains an optimistic spirit. He cautiously explains activities while other writers call for doom and gloom.
So I was a bit troubled with his latest article suggesting the U.S. economy could very well turn out like 90’s Japan’s which took a decade to even begin showing signs of recovery. This has been an argument the housing bears have presented over and over again.
Japan’s problems Jubak explains began -
Japan’s crisis, like the recent one
in the United States, began with an extraordinary real-estate boom. In 1987, the price of land in Japan’s three biggest metropolitan areas climbed 44%. Prices went up 12% more in 1988 and then 22% in 1989.
And like the U.S. real-estate boom, the Japanese boom was fueled by cheap money. The Bank of Japan, that country’s Federal Reserve, had lowered the discount rate — the rate it charges other banks — to a post-World War II low of 2.5% from 5% in 1984-87. In those same years, the money supply grew by better than 10% a year.
As happened in the U.S. real-estate boom, lending standards in Japan collapsed. At the height of the boom, banks regularly made loans for more than 100% of property values. To keep real-estate loans off their books, banks lent through nonbank entities that made the actual loans.Sound familiar?
Worried about inflation, Japan’s Central Bank began a rate increase campaign which caused demand for real estate to fall and subsequently the stock market.
Because banks had invested so heavily in real estate and the stock market, losses in those two sectors quickly undermined the health of the entire banking system.
Further, attempts to keep the “nonbank entities” in business, caused the larger companies to take huge losses.
In 1994, for example, Mitsubishi Bank first wrote off the interest on money owed to it from two affiliated finance companies, Diamond Mortgage and Diamond Factors, to keep the two companies in business. And later in the year, Mitsubishi bailed out the two affiliates by buying loans from them at face value and then selling off the loans at a loss to its own bottom line.
Why do you think American banks are writing down billions in losses? The press says “trouble in the subprime sector,” but that’s code for having to buy back loans our affiliates can’t sell because they are contractually obligated to do so. As Clark B. Hinckley, a Zions senior vice president, told me, ”It enabled us to essentially originate these loans and not have to keep tangible capital behind them.”
Ultimately - The final result was more than a decade of slow or no growth in the Japanese economy and in Japanese asset prices.
Most of us reading this blog are probably too young to remember the Great Depression of the United States. What many of us do remember is the stagnant growth and inflation of the 70’s and early 80’s. Along with that time period came high fuel prices, high unemployment and high interest rates. A lot of people lost their homes due to a popular financing tool called the balloon mortgage, a loan in the same family as the ARM. It’s looking like 1970 all over again.
There are differences. We don’t yet have high unemployment and interest rates appear to be headed lower. As Japan proved, it’s still possible to have stagnation with low interest rates. We appear to be headed towards another stagflation period, but this time the “flation” component represents deflation, not inflation.
Please read all of Jim Jubak’s article. Like I’ve said before, none of us have crystal balls, but if we can’t learn from history, we are condemned to repeat history’s mistakes.