Japan’ Solution To Debt Crisis – Expand Zombie Banking

Japan’s Zombie Banking Taken To New Levels Of Lunacy

Japan’s real estate and stock market bubbles burst in the early 1990’s.   Since then, twenty years of non stop Government stimulus programs have failed and left Japan with the highest debt to GDP ratio in the world and two decades of lost economic growth.   The costly attempt to have failed banks prop up failed companies has lead to a massive misallocation of capital and resulted in Zombie Firms and Zombie Banks.

Banks were not forced to recognize the condition of their balance sheets and were encouraged to continue lending to firms that were themselves unprofitable. Anil Kashyap labels these “zombie firms.”

Zombie banks continued to direct capital to zombie firms. This charade continued for more than a decade, with the result that the once-powerful Japanese economy was completely stagnant for that period. The government’s main response was to dramatically increase spending on infrastructure and frantically try to get Japanese households to save less and consume more. The resulting “lost decade” of economic growth cost Japan more than 20% of GDP.

Japan has now decided to exponentially expand policies that have not worked for two decades by forcing banks to agree to debt moratoriums.

Oct. 6 (Bloomberg) — Japanese banks’ bad loans won’t be driven higher by a proposed moratorium on debt payments by struggling small companies, said Financial Services Minister Shizuka Kamei.

Lenders won’t have to classify loans encompassed by the plan as non-performing, Kamei, 72, said in an interview yesterday at his office in Tokyo. That means they won’t be forced to boost provisions when borrowers postpone repayments of interest or principal, he said. At the same time, Kamei vowed to push banks to extend more credit to small businesses after bankruptcies hit a six-year high in Japan.

“We’re going to get financial institutions to provide these firms with more loans,” said Kamei. “Banks won’t have to treat debt on which they provide a moratorium as bad.”

Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc., posted combined losses of almost $14 billion last fiscal year as bad-debt charges surged.

“There is a potential for any proposal along the lines Kamei has made of debt moratoriums to backfire horribly,” said David Threadgold, a Tokyo-based analyst at Fox-Pitt Kelton. The plan could make banks more reluctant to lend to small firms, Threadgold said.

The moratorium, postponing repayment of principal and interest, will be extended to individuals as well as firms Kamei said. It will aim at giving relief to companies with about 100 million yen ($1.1 million) or less in capital.

“As long as I’m financial services minister, I’m not going to leave small companies in the lurch unable to get loans,” Kamei said. “If a bank takes that approach, I’ll hit them with a business improvement order.”

Japanese “salarymen” struggling to pay mortgages after bonus cuts may be eligible, he said. “We’re going to make it extremely easy for very small companies to get money,” Kamei said.

Let summarize the lunacy of this new plan: debtors pretend they will pay later; the banks pretend that the defaulted loans will be repaid; banks will be forced by the government to lend more money to debtors who cannot repay what they already owe and the banks will not have to set aside loan loss reserves on the defaulted debt.  Japan’s debt moratorium is a final desperate attempt to “save the system” by preventing deeply indebted, income poor borrowers from defaulting on debts that can no longer be serviced.  It will move private bad debt onto the already over leveraged public balance sheet and will encourage debt repudiation on a massive scale.

When Debt Becomes Inconvenient

Debt that cannot be repaid won’t be repaid and the consequences of default are in many cases relatively minor compared to the burden of continued payments.   Japan now joins the U.S. in actively encouraging the repudiation of debt as discussed in How The Government Encourages Ruthless Defaulters and Loan Mods – Just A Warm Up For The Real Thing – A Mortgage Holiday.

Ironically, the biggest impediment to future bank lending is the growing trend of debt repudiation directly sponsored and encouraged by a government concurrently seeking to encourage more lending.

Consumers having trouble paying their debts can now chose from a long list of government programs for debt forgiveness, loan modifications, rate reductions, 125% loan to value mortgages and more programs on the way.  Their is no  longer any shame or embarrassment associated with defaults and bankruptcy.  Defaulting on debt has become a rational choice for many with little repercussions.

If the long shot odds of economic recovery and job growth do not materialize,  expect to see defaults worldwide increase exponentially as even those who can pay will chose not to.  Zombie banking is alive and well.

One Response to “Japan’ Solution To Debt Crisis – Expand Zombie Banking”

  1. My comment to editor:
    Gambling addicts have the same problem as most government “economic experts”—when they lose, they simply keep doubling their bets until they go bankrupt.
    In late 1999 and early 2000, I attended several government-sponsored seminars for college and private school finance instructors. We were told that to create a level playing field and more “affordable” home loans for minorities (underserved groups), low-income borrowers would be eligible for higher loan-to-value loans. Easier loan underwriting standards and lower credit rating standards would be applied. So-called sub-standard loans would now be called sub-prime loans in order not to stigmatize lower-income borrowers. Lenders would be encouraged to make loans by being allowed to apply “risk-based” interest rates—that is, higher rates than normal.
    During the question and answer period, I predicted several outcomes of the program:
    1. Unqualified borrowers would borrow more than they could afford to pay back.
    2. Charging high, risk-based interest rates would hurt the most economically vulnerable borrowers.
    3. Lower down-payments would encourage borrowers in financial trouble to simply walk away from their obligations without trying to work something out.
    4. Non-minority and/or well-off borrowers would see subprime loans as a way to buy larger homes or speculate in flipping homes.
    My comments were treated in much the same way as a gambling addict responds when told that very, very few gamblers win in the long run.

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