July 2009 JMEU conference

The Global Financial Crisis:
The EU and Japan
Session 3, The EU and the Global Economic Governance
Co-organised by
The MEXT Strategic University Collaboration Support Project
between Keio University and Hitotsubashi University,
Keio University GCOE Designing Governance for Civil Society

25th July 2009, Tokyo, JAPAN
Sahoko KAJI, Ph.D.
Keio University

Topics
1. The Japanese crisis of the 1990s--- why,
why how and what
Japanese policies to counter thesolvency and liquidity crises

2. The global crisis of today--- comparing the two crises and policy
responses
3. Some prospects
Sahoko KAJI, Keio UniversitySahoko KAJI, Keio University

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The Japanese crisis (1)Three factors:
1 Expansionary Monetary Policy
1.Expansionary
following the Plaza accord (August 1985,

promise to expand domestic demand and reduce
current account surplus)

2.Mythy that real estate and stock pprices‘never fall’
3.Deregulation in the financial sector
Sahoko KAJI, Keio University

3

The Japanese crisis (2)1. Expansionary Monetary Policy
BOJ'ss Official Discount Rate
BOJ
10998

8.25

87.5

7.25

76

6.5
65498.5

76.25

65.5
55.25

54.25

4.25

3

4.25

7.25
6.25

6

5.5

5.25

5
4.5
4

3.5

3.5
3

2

4.25
3.75
3 25
3.25
2.5

5.5
5
4.5
3.75
3 25
3.25
2.5
1.75

1

1

0

1972.10.02
1973.04.02
1973.05.30
1973.07.02
1973.08.29
1973.12.22
1975.04.16
1975.06.07
1975.08.13
1975.10.24
1977.03.12
1977.04.19
1977.09.05
1978.03.16
1979.04.17
1979.07.24
1979.11.02
1980.02.19
1980.03.19
1980.08.20
1980.11.06
1981.03.18
1981.12.11
1983.10.22
1986.01.30
1986.03.10
1986.04.21
1986.11.01
1987.02.23
1989.05.31
1989.10.11
1989.12.25
1990.03.20
1990.08.30
1991.07.011991.11.14
1991.12.30
1992.04.01
1992.07.27
1993.02.04
1993.09.21
1995.04.14
1995.09.08

0.5

Source: Bank of Japan
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Japanese crisis (3)2. Myth 1: Real estate prices ‘never fall’
Japan s Land Price Index (Mar-90=100)
Japan's(Mar 90 100)
(Average of land for all purposes)

1201008060
40
20Mar-55Mar-56
Mar-57
Mar-58Mar-59Mar-60Mar-61Mar-62Mar-63Mar-64Mar-65
Mar-66Mar-67
Mar-68Mar-69Mar-70Mar-71Mar-72Mar-73Mar-74Mar-75
Mar-76
Mar-77
Mar-78
Mar-79Mar-80Mar-81Mar-82Mar-83Mar-84Mar-85Mar-86
Mar-87
Mar-88Mar-89Mar-90Mar-91Mar-92Mar-93Mar-94Mar-95Mar-96
Mar-97
Mar-98Mar-99Mar-00Mar-010Source: Japan Real EstateSahoko
InstituteKAJI, Keio University

5The Japanese crisis (4)2. Myth 2: Stock prices ‘never fall’

Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Japanese crisis (5)3. Financial market deregulation
Due to increases in the 1970s in:––government bond issuancecross-border financial transactionsin the 1980s,ceilings
g on deposit
pinterest rates wereliberalised/removed
large firms could raise funds in the capital
market by issuing bonds
Sahoko KAJI, Keio University

7The Japanese crisis (6)→ business environment for Japaneseb k changedbankshd
from: protection and regulation underthe ‘convoy system’
to: increased competition in terms ofboth deposit-taking and lending→ expand real estate-related business
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Japanese crisis (7)This expansion into real-estate related lending byJapanese banks coincided with:• JapanJapan’ss CA surplus reaching 3.6%
3 6% of GDP• Japan’s promise at the Plaza to decrease thisby boosting domestic demand• 100% appreciation of the yen after Plaza• Deregulation = ‘hard
hard way outout’,, Monetaryexpansion =‘easy way out’
→ BOJ lowered the ODR 5 times between Jan
1986 and Feb 1987
Sahoko KAJI, Keio University

9The Japanese crisis (8)Economic expansion began in Dec 1986, yet,y• Discount Rate was left at 2.5% for 2 years
and 3 months• Minister of Finance Miyazawa announced
in May 1987 a 6 trillion yen economicpackage• Money supply
l growth
h reachedh d 10%0% perannum by 1987
→ the BUBBLE
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Japanese crisis (9)• BOJ raised ODR in May 1989 to 3.25%
and 5 times after that, to 6% by 1st July 1991
• MOF announced a ‘notification’ in Dec 1989
urging Securities Houses to refrain fromcompensating their corporate clients forstock-market losses• MOF put cap on real estate related lending(from April 1990 to January 1992)→ the bubble BURST
Sahoko KAJI, Keio University11Policies to counter the Solvency Crisis (1)November 1997
Failure ofSanyo Securities
Hokkaido-Takushoku Bank
Yamaichi Securities
severee ccredit
ed t ccrunch,u c , Japa
Japan ppremiume uÆ seveÆloss of confidence in Japanese accounting
and auditing system
Sahoko KAJI, Keio University

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Japan Premium
0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

‐0.1

1997.01
1997.03
1997.05
1997.071997.09
1997.11
1998.01
1998.03
1998.05
1998.07
1998.09
1998.111999.01
1999.03
1999.05
1999.071999.09
1999.112000.01
2000.032000.05
2000.072000.09
2000.112001.01
2001.03
2001.05
2001.072001.09
2001.11
2002.01
2002.03
2002.05
2002.07
2002.09
2002.112003.01
2003.03
2003.05
2003.072003.09
2003.112004.01
2004.03
2004.05
2004.072004.09
2004.110

Source: Bank of Japan

Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (2)By end 1997
Emergency Economic Package
13 thousand billion yen
for capital injection to solvent banks
17 thousand billion yen
for protection of depositors in failedbanks
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (3)BUT the package did not work;
March 1998
ONLY 1.8 thousand billion yen was injected into 21
large banks WITHOUT complete examination orcomprehensive cleanup of bank balance sheets

October 1998
Long Term Credit Bank goes into public receivership

December of 1998
Nippon Credit Bank goes into public receivership
Sahoko KAJI, Keio University

15Policies to counter the Solvency Crisis (4)Just before LTCB went into receivership in 1998,
60 thousand billion yen (12% of GDP) was made available

New: Financial Revitalisation Act
18 thousand billion yen for resolution of failing banks

New: Bank Recapitalisation Act
25 thousand billion yen for capital injection intosolvent banks

Old: Deposit Insurance Corporation
17 thousand billion yen for protection of depositors
Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (5)Financial Revitalisation Act of 1998
• Basically for ‘insolvent’
insolvent institutions• FRA also covers privatization procedure(introducing efficient new management,
injecting capital, disposing bad loans)• Public funds are used to protect depositors
and replenish damaged capital base.

Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (6)Bank Recapitalisation Act of 1998
• For ‘solvent’solvent institutions• Public funds injections to restore credibility
Deposit Insurance Corporation (est. 1971)
Limit of coverage increased twice from 1
million to 10 million yyen byy 1986,,
DIC obtained new power to assist mergers offailed institutions and sound institutions
Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (7)The DIC fund had never been used until 1992
DIC was allowed in 1996 to fully protect
depositors beyond the normal 10 million yen
as temporary measure until March 2001
In May 2000, the Deposit Insurance Law(DIL) was further amended to prepare apermanent resolution scheme for failingbanks
Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (8)Under FRA, LTCB and Nippon Credit
Bank were nationalized in October andDecember of 1998.
Under BRA, 7.5 thousand billion yen of
capital was injected into 15 majorbanks at the end of March 1999.
1999
By late 1998, Japan premium began tosubside
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University2010

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Policies to counter the Solvency Crisis (9)End September 2002:
Economic and Financial Policy Minister Takenaka
designated Minister of Financial Services
Within a month, Takenaka directs FSA to• revise its methods of checking the classification ofbad loans by banks• treat all banks uniformly• hold auditors legally liable for the corporate
results that they authorized→ further large write-offs of non-performing loans
and actual liquidations
cf. Feldman (2008)
Sahoko KAJI, Keio University

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Policies to counter the Solvency Crisis (10)Under DIL, Resona bank (formerlyDaiwa and Asahi banks) was rescued inMay 2003, by injection of public money(1.96 trillion yen of capital through the DIC)

→ ‘now the government will saveshareholders not just depositors’shareholders,depositors→ the Tokyo stock market rallied
cf. Fukao (2007)
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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July 2009 JMEU conference

Policies to counter the Solvency Crisis (11)As of 31st March 2008,
the Japanese government has
recovered 8.8 thousand billion yenout of
the 12.3 thousand billion yen
injected into private sector banks
between 1998 and 2003
Sahoko KAJI, Keio University

23Policies to counter the Solvency Crisis (12)The government started selling off thebanks’ Preferred stock (no voting rights, but givenbankspriority over common stock in payment of dividends and upon liquidation)purchased with the public money in
February of 2000
The government made 1.3 thousandbillion yen worth of profits, due to therise in stock prices (as of March 2008)
Sahoko KAJI, Keio University

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Liquidity Crisis and Monetary Policy (1)The Bank of Japan’s monetary policy
1. Official Discount Rate
2. Overnight Unsecured Call Rate
Zero Interest Rate Policy
3. Quantitative Easing, then back toOvernight Unsecured Call Rate
Sahoko KAJI, Keio University

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Liquidity Crisis and Monetary Policy (2)1. Official Discount Rate
This was the rate at which private banks
borrowed directly from BOJ
In the era of regulation, deposit rates
moved with ODRAfter 1994 when deregulation completed,completeddeposit rates no longer followed ODR→ no longer a direct policy tool
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University2613July 2009 JMEU conference

Liquidity Crisis and Monetary Policy (3)2. Overnight unsecured call rate
This is the rate at which banks borrow
short term from each other
BOJ uses ODR as ceiling for OUCR whichit controls by changing money supply
Zero Interest Rate Policy
Between Feb 1999-Aug 2000 the BOJ
aimed at keeping this close to zero
Sahoko KAJI, Keio University

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Liquidity Crisis and Monetary Policy (4)The economy worsened after the ZIRP
was dropped
dd ini AugustAt 2000
March 2001
ZIRP was introduced againg
Quantitative Easing began andcontinued until March 2006
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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July 2009 JMEU conference

Liquidity Crisis and Monetary Policy (5)3. Quantitative Easing
Under this policy, the BOJ uses the‘current account balances’ which
private banks keep (with no interest)at the BOJ as the main policy target
BOJ has raised the target level severaltimes, to levels far above the level ofrequired reserves
Sahoko KAJI, Keio University

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Current Account Balances at BOJ

Source: Bank of Japan

Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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Liquidity Crisis and Monetary Policy (6)When the BOJ introduced the QE policy,
it p
promised to keep
p it ‘until theannual inflation rate of CPI stabilised
above zero’
Since March 2006, when the BOJ judged
this condition had been met and quit
qQE, the BOJ has been targeting theOvernight Unsecured Call Rate again
Sahoko KAJI, Keio University

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Overnight Unsecured Call Rate

Source: Bank of Japan

Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Global Crisis today (1)Three factors:
1. Microeconomic andMacroeconomic policy
mismanagement
2. Financial imbalances
3. Global imbalances

Sahoko KAJI, Keio University

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The Global Crisis today (2)Microeconomic policy mismanagement• Regulations that encouraged off-balanceoff balance
sheet transactions• Endorsement/encouragement of newinstruments such as CDOs andsecuritisation (misguidedgbelief that theyy
made markets fundamentally more stable via
risk diversification)• Mispricing of risk
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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The Global Crisis today (3)Macroeconomic policy mismanagement
Policy tool: monetary policy
Policy goal:
price stability AND market stability
The ‘Greenspanp pput’:
Emphasis on price stability, will deal withthe bubble after it develops/bursts
Sahoko KAJI, Keio University35

The Global Crisis today (4)Financial imbalances• Increased leverage especially in the USA• Financial sector debt to GDP ratio up from
20% to 200% in the last 30 years• Household debt to GDP doubled to 100%
i 20 yearsin• Private sector debt to GDP ratio has morethan doubled to 300% in 25 years
Sahoko KAJI, Keio UniversitySahoko KAJI, Keio University

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The Global Crisis today (5)Global imbalances• CA deficit/net
d f /foreignfborrowingbon theh partof developed countries such as the USA• CA surplus/net foreign lending on the partof Japan, China and poorer countries• Behind this: explosion in householdspending and borrowing, backed up by thehousing boom in the USA and in the UK
Sahoko KAJI, Keio University

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What do the two crises
have in common? (1)1. Overconfidence in the stability and success ofthe financial model in use2. Crisis originating in the financial sector
spreading to the rest of economy as financial
intermediation froze
3. Downfall of the ‘number 1’ model, disbelief,d i l disgrace
denial,di
4. Haphazard policy reaction as policymakers
scramble for the correct policy
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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19July 2009 JMEU conference

Difficulties of taking action at EU level
1. EU is not equal
qto the single
g currency
y area
2. Member State actions must be consistentwith EU legislation
3. Cannot fund EU/Eurozone levelrescues/packages using taxpayer money
4. Globally active institutions are internationalin good times and national in bad times
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Monetary Policy
After the fall in real GDP growth

Sources: BOJ, Fed, Bank of England, ECB
Start of crisis: dates of fall in real GDP growth, BOJ=1st April 1991, BofE and ECB=1stApril 2008, Fed= 1st October 2007
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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July 2009 JMEU conference

Monetary Policy
After the fall in markets

Sources: BOJ, Fed, Bank of England, ECB
Start of crisis: BOJ=1st Jan 1990 (date of fall in 225 Nikkei index), BofE, ECB and
Fed=25thJune 2007 (date of Fall in Mortgage backed security ABX index)
Sahoko KAJI, Keio University

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Central Bank Balance Sheets
during the current crisis
300 End August 2008=100
250200
150
100
50
BOJ

0
Jan-07

Jul-07

Source: Nomura Securities

Sahoko KAJI, Keio University

ECB

FRB

Jan-08

Jul-08

Sahoko KAJI, Keio University

BOE
Jan-094221

July 2009 JMEU conferenceEuro-area public interventions in thebanking sector

http://ec.europa.eu/economy_finance/publications/publication15487_en.pdf
Sahoko KAJI, Keio University

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What do the two crises
have in common? (2)Fundamental, inevitable nature offi
financiali l markets:k t
i. Fear and greed
ii. Moral hazard
iii. Information asymmetryiv Low cost of transactions,
iv.
transactions high speed ofadjustment
v. Inconsistent triangle
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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July 2009 JMEU conference

What do the two crises
have in common? (3)We cannot remove any of thesefundamental characteristics offinancial markets, the best we can dois to affect some of them by policy
In addition, memories are short→ crisis originating in financial
markets will happen again
Sahoko KAJI, Keio University

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How should we react? (1)In the short-run:
Financial intermediation must recover• Banks’ balance sheets must improve andconfidence must return• Monetary policy to include ‘unconventional
measures’,, introduction of another policy tool
measures• As Japan’s experience shows,none of this is easily done
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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How should we react? (2)Questions in the longer run:
To what extent can saving-investmentbalances be changed by policy?
How should risk be priced?
How can we construct global and local
regulatory structures that discouragedestabilising behaviour?
Sahoko KAJI, Keio University

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How should we react? (3)Questions in the longer run:
What is the role of a bank?
Money’s two important roles:
medium of exchange
store of value
Is it impossible to optimise both at the sametime?
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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July 2009 JMEU conference

How should we react? (4)• This crisis is revealing the importance of markets, notthe uselessness of markets• Nobody, not the government, not the private sector,
can function without the credible price of theirtransactions --- today: price signals are no longer
credible, because markets are not functioning
properly• Just as we need to contain the spread ofprotectionism, we need to make sure intervention
and regulation remain such that they do not distort
market signals.
Sahoko KAJI, Keio University49

How should we react? (5)• At the same time, the problem witht d ’ world
today’s
ld iis ththatt phenomenahth
thattcollectively come under ‘market failure’are increasing in importance.
• We must be careful not to deny theusefulness of markets and market signals,g,but we also need to recognise theshortcomings of market-determinedsolutions.
Sahoko KAJI, Keio University

Sahoko KAJI, Keio University

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