As the global financial system sinks deeper into the abyss, policymakers and economists in Asia are reflecting on their own past financial meltdowns in search of lessons that could help the U.S. and Europe. As ministers for the G-7 group of industrialized nations meet in Washington today to discuss the crisis, Japanese officials in particular are expected to offer up guidance to their Western colleagues. "Japan can be of help by letting them know our experience of struggling" with economic turmoil, Japan's Finance Minister Shoichi Nakagawa told reporters Tuesday.
The message will be blunt: If you want to restore confidence in stock markets and among financial institutions, recapitalize your banks quickly. This message already has some traction in Washington. The U.S. Treasury Department is discussing a plan to use public funds to recapitalize banks. The U.K. government already took that step earlier this week, while Iceland has nationalized its banks.
Japan learned how to handle a financial crisis the hard way. In the 1990s, after stock and real estate bubbles imploded, the country experienced a financial debacle similar to the one facing the U.S. today. The result was the Lost Decade. Between 1992 and 2003, Japan's real GDP growth averaged less than 1% a year.
Japan now realizes the mistake it made back then: failing to act with speed and force. Loose accounting standards had allowed banks to hold soured assets on their books without writing them down to their true market value. This permitted financial institutions that were technically bankrupt to delay taking in fresh capital a move that would have hurt existing shareholders but would have restored banks to health. The government dawdled for more than half a decade, allowing banks to carry on in a diminished capacity despite the fact that with key lending institutions crippled, the broader economy could not thrive.
In 1998 the beginnings of a large-scale bailout program were finally put in place. Over the next several years, the Japanese government spent almost 47 trillion yen or about $470 billion at current exchange rates not only buying banks' bad assets but also recapitalizing them. Two large banks were completely taken over by the government.
The U.S. situation is somewhat different delay is not an option. Accounting standards require financial institutions to routinely write down the value of assets to reflect their actual value. As a result, U.S. banks have booked massive losses, and the government has been forced to aggressively engineer ad hoc bailouts and mergers.
But based on their experience, Japanese analysts believe that actions to date have been insufficient. They say that in addition to the U.S. Treasury Department's plan to spend $700 billion buying bad assets from banks, the government also needs to recapitalize banks using taxpayer money. Only then will confidence in the financial system return, ending the current paralysis in lending that threatens the entire economy. "Taking nonperforming loans out of the balance sheets is not enough," says Jun Saito, director general of the economic-research bureau for Japan's cabinet. "What we've learned [in Japan] from the 1990s is that we need recapitalization."
Other Asian governments faced challenges similar to Japan's during the Asian financial crisis of 1997-98. In South Korea, for example, the government bought bad loans from banks and also injected government money into their balance sheets. Several banks were nationalized. Governments across the region also shut down financial institutions deemed too weak to survive or warrant a government bailout. In August 1997 Thailand closed 42 finance companies. Indonesia closed 16 banks in October 1997, and Korea closed 14 merchant banks that December, according to Merrill Lynch. This separating the wheat from the chaff helped to speed economic recovery because it made clear which institutions were solid and could be trusted.
Lessons from the 1997-98 Asian financial crisis come with caveats, since the conditions were markedly different. The crisis was contained to a relatively small number of countries mainly Korea, Indonesia, Malaysia and Thailand in which banks and businesses were unable to pay off debts owed to the outside world. That allowed the International Monetary Fund (IMF), in cooperation with the World Bank and Washington, to organize bailout packages that allowed Asia to get back on its feet.
IMF and World Bank officials are meeting in Washington on Oct. 13 to search for solutions to the current crisis. But the IMF's role will be limited, because the financial turmoil is global. The organization might be able to lend a hand in specific situations. On Thursday the IMF announced it was restarting an emergency lending program that had been active during the 1990s Asian crisis for developing countries. The IMF has already sent a mission to Iceland, which is suffering from a financial meltdown. "All kinds of cooperation has to be recommended," IMF managing director Dominique Strauss-Kahn told reporters.
The clear message from Asia is that more intervention is needed to restore the financial system. The crisis is "now too big to be solved by the private sector," says Takahide Kiuchi, chief economist of Nomura Securities in Tokyo. It's a lesson Asia learned a decade ago.